As we’ve discussed in many previous articles, the IASB has issued IFRS 15, Revenue from Contracts with Customers, effective for annual reporting periods beginning on or after January 1, 2018.
The new standard is built around a five-step framework, the second step being to identify the performance obligations in the contract. A performance obligation is:
- A promise in a contract with a customer to transfer to the customer either:
- (a) a good or service (or a bundle of goods or services) that is distinct; or
- (b) a series of distinct goods or services that are substantially the same and that have the same pattern of transfer to the customer.
In many situations, of course, it’s easy to identify the promises made to a customer (even if, as we’ve discussed here several times, it may not be as straightforward to conclude when those promises have been entirely fulfilled, or how this should affect the pattern of recognizing revenue). For example, in an everyday retail transaction, the promise is to transfer a particular item to the customer in return for receiving payment, and this promise can be rapidly fulfilled once the customer initiates the transaction. In other cases, a contract may encompass a number of different goods and services: some of them delivered at or near to the time of intercepting the contract, others in the future, or over a period of time.
IFRS 15.B40 says this:
- “If, in a contract, an entity grants a customer the option to acquire additional goods or services, that option gives rise to a performance obligation in the contract only if the option provides a material right to the customer that it would not receive without entering into that contract (for example, a discount that is incremental to the range of discounts typically given for those goods or services to that class of customer in that geographical area or market). If the option provides a material right to the customer, the customer in effect pays the entity in advance for future goods or services and the entity recognizes revenue when those future goods or services are transferred or when the option expires.”
The IASB and FASB’s joint transition resource group for revenue recognition discussed various complexities arising from this concept, arising from such mechanisms as sales incentives, customer award (loyalty) credits (or points), contract renewal options, or other discounts on future goods or services. The group’s discussion on the area came down to two broad questions:
First, should the evaluation of whether an option provides a material right be performed in the context of only the current transaction with a customer, or should it also consider past and expected future transactions with that customer? For example, consider an entity with a loyalty program in which its customers accumulate one point for every dollar spent, and points may be exchanged for free products when the customer accumulates enough points; assume that based on its historical data, the entity determines it’s likely that its customers will accumulate enough loyalty points to receive a free product. The standalone selling price of the points attaching to any individual transaction is likely to be trivial, so if the entity considers the accounting on that basis alone, it might quickly conclude that this aspect of the arrangement isn’t material. But the group agreed that the entity should instead consider whether the loyalty points earned from the current transaction are expected to contribute to a material right that the customer accumulates over time.
The second question: is the evaluation of whether an option provides a material right solely a quantitative evaluation or should it also consider qualitative factors? Consider an entity that provides to its customers who purchase goods on a particular day a voucher for 25% off their next purchase of any size, expiring after 60 days; based on its historical data for similar offerings, the entity determines that customers typically use the voucher to make an additional purchase that’s more expensive than what they would typically purchase otherwise. On the day the entity offers these vouchers, one customer purchases a product for $200 and another purchases a product for $10.
If the evaluation here is solely quantitative, then the entity assesses whether each customer received a material right based on the standalone selling price of the voucher in relation to the transaction with the customer. This might lead to concluding, depending where the entity draws the line, that the first customer received a material right and the second customer didn’t. On the other hand, if the evaluation is also qualitative, it takes into account that both customers have received the opportunity to receive a 25% discount on a future purchase of any size, and that the value of this right might be much greater than the selling price of the current transaction. The group agreed that the second approach is the appropriate one.
In simple terms, the overriding question in both these cases is to what extent the revenue from a transaction should be recognized later rather than sooner. Under the approach in IFRS 15, it’s necessary to assess comprehensively all the ways in which the terms of a contract might end up conveying value to the customer. The examples above illustrate that terms included as “sweeteners” or concessions or suchlike might in some cases have a significant impact on the pattern of revenue recognition. Of course, this provides a good reason for fully understanding their implications at the time they’re put in place…
The opinions expressed are solely those of the author