IFRS 15 in action, part 6 – more on non-refundable upfront fees

Let’s take a look at some other recent examples of changes resulting from the implementation of IFRS 15.

This is from Freshii Inc:


Of course, as in all these cases, I’m just using Freshii’s disclosure as a springboard, and not trying to comment on the company’s specific application. With that background, this seems like a good opportunity to return to the topic of non-refundable upfront fees charged to customers at or near the time of incepting a contract. IFRS 15.B49 comments:

  • To identify performance obligations in such contracts, an entity shall assess whether the fee relates to the transfer of a promised good or service. In many cases, even though a non-refundable upfront fee relates to an activity that the entity is required to undertake at or near contract inception to fulfil the contract, that activity does not result in the transfer of a promised good or service to the customer. Instead, the upfront fee is an advance payment for future goods or services and, therefore, would be recognized as revenue when those future goods or services are provided. The revenue recognition period would extend beyond the initial contractual period if the entity grants the customer the option to renew the contract and that option provides the customer with a material right…

This must be a common issue, as my original article on the topic turned out to be just about the most frequently visited thing I ever posted here. As I said there:

  • …the non-refundable fee may notionally relate to initial administrative work or suchlike, but the customer doesn’t get anything out of that. In some cases where such a fee is paid (other examples in the standard include activation fees in telecommunication contracts, setup fees in some services contracts and initial fees in some supply contracts), the non-refundable fee may at least in part relate to a good or service, in that the customer does receive something at the outset of the contract. In this case, the entity evaluates whether the good or service constitutes a separate performance obligation: if so, then it recognizes a portion of the total contract revenue – although not necessarily the entire amount of the up-front fee, if that doesn’t represent a reasonable estimate of the stand-alone selling price for the good or service –  at that point.

Now, as an aside, this all depends on identifying a contract between the two parties. IFRS 15.11 notes: “Some contracts with customers may have no fixed duration and can be terminated or modified by either party at any time. Other contracts may automatically renew on a periodic basis that is specified in the contract. An entity shall apply this Standard to the duration of the contract (ie the contractual period) in which the parties to the contract have present enforceable rights and obligations.” Put another way, and as clarified by the FASB/IASB Joint Transition Resource Group for Revenue Recognition (TRG), if a contract can be terminated by each party at any time without compensating the other party for the termination (that is, other than paying amounts due as a result of goods or services transferred up to the termination date), then the duration of the contract does not extend beyond the goods or services already transferred. This is another example of how the analysis under IFRS 15 may be affected by what may initially seem like contract terms of relative secondary importance.

The TRG also considered another variation, relating to that last sentence of paragraph B49:

  • A contract that requires an entity’s customers to pay a non-refundable upfront fee (that does not relate to a promised good or service), but also includes an option that allows customers to renew the contract without paying an additional fee. The renewal rate may be fixed at contract inception or agreed upon at a later date.

It saw this situation as follows:

  • If (the entity) concludes that the activation fee provides a material right, the fee would be recognized over the service periods during which (the customer) is expected to benefit from not having to pay an activation fee upon renewal of service. Determining the expected period of benefit often will require judgment. Conversely, if (the entity) concludes that the activation fee does not provide the customer with a material right, the activation fee is, in effect, an advance payment solely on the contracted services (for example, a one-month contract term).

Identifying such a material right might depend on such factors as the monthly fee charged to renewing customers versus new customers, the availability and pricing of alternative service providers, and past experience of customer renewals. Of course, as with any determination that requires judgment, it follows that the assessed expected period of benefit for such fees may change over time, for example based on observed changes in customer activity, prospectively changing the recognition period for any unamortized portion of the initial fee.

I expect this general topic will continue to be one of the more contentious aspects of the standard – entities have every incentive to bring cash in through the door as quickly as they can, and if there’s no chance of ever having to give it back, then the logic of recognizing it in income immediately may seem fairly unassailable (after all, it was good enough in the past for old Canadian GAAP). But that’s only if you’ve yet to absorb the IFRS 15 worldview…

The opinions expressed are solely those of the author

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