ICPAC IFRS seminar Recent Developments and updates January 2015

ICPAC IFRS seminar Recent Developments and updates January 2015
Costas Seraphim Head of PwC’s Academy

IFRS seminar Agenda IAS 18 – Revenue, IAS11- Construction Contracts and the new IFRS 15 -Revenue from contracts with customers IAS 37 – Provisions, contingent liabilities and contingent assets IAS 32 – Financial Instruments: Presentation IAS 39 – Financial Instruments : Recognition and Measurement IAS 40 – Investment Properties

IAS 18 Revenue IAS 11 Construction Contracts and the new IFRS 15 – Revenue from contracts with customers NOTE: This presentation is a summary of IFRS 15 and does not discuss all matters that might need to be considered to implement this standard. Please see for further details including the standard itself.

IFRS 15 - Project objective
Effective for annual periods beginning on or after 1 January 2017 One Model A single, joint revenue standard to be applied across all industries and capital markets Clear principles Robust framework Comparability across industries Enhanced disclosures Simplified guidance IFRS 15 – Revenue from contracts with customers, is the culmination of a long running joint project between the IASB and the FASB to create a single revenue standard. It applies to all contracts with customers except those that are financial instruments, leases or insurance contracts. It is effective for annual periods beginning on or after 1 January 2017, but entities that use IFRS are allowed to early-adopt the guidance. There is a choice of transition methods – full retrospective application or a practical expedient that permits prospective application, however requires additional disclosures. Under the old guidance revenue recognition was measured and presented inconsistently. The current revenue guidance in IFRS was limited and not sufficient for very complex transactions. There was a significant amount of industry specific literature in US GAAP that could result in different answers for similar transactions and, at times, outcomes that did not represent the economic substance of the transaction. The guidance replaces all existing IFRS (and US GAAP) revenue recognition literature. The objective of the revenue project is to clarify the principles for recognising revenue and to develop a common revenue standard for IFRSs and US GAAP that would: (a) remove inconsistencies and weaknesses in previous revenue requirements; (b) provide a more robust framework for addressing revenue issues; (c) improve comparability of revenue recognition practices across entities, industries, jurisdictions and capital markets; (d) provide more useful information to users of financial statements through improved disclosure requirements; and (e) simplify the preparation of financial statements by reducing the number of requirements to which an entity must refer. (IFRS 15, IN5).

Awareness is essential!
A change in mindset Reassessment of contracts will be time consuming Greatest impact for those that use industry based models Transaction price allocated on a relative selling price basis Change to model for variable consideration Full retrospective application may require running dual systems and gathering of historic data More extensive disclosure requirements Potential impact on compensation arrangements Awareness is essential! IFRS 15 could significantly change how many entities recognise revenue, especially those that currently apply industry-specific guidance. The standard will also result in a significant increase in the volume of disclosures related to revenue. All entities will likely have to consider changes to information technology systems, processes, and internal controls as a result of the increased disclosure requirements, among other aspects of the model. Management will need to perform a comprehensive review of existing contracts, business models, company practices, accounting policies, information technology systems, and internal processes and controls to assess the extent of changes needed as a result of IFRS 15. This may be the case even if the entity’s revenue recognition model has not significantly changed.

Focus on risk and rewards
IFRS 15 – Revenue recognition model IAS 18 /11 IFRS 15 Separate models for: Construction contracts Goods Services Single model for performance obligations: Satisfied over time Satisfied at a point in time Focus on risk and rewards Focus on control Limited guidance on: Multiple element arrangements Variable consideration Licences More guidance: Separating elements, allocating the transaction price, variable consideration, licences, options, repurchase arrangements and so on…. So what’s changed? IFRS 15 will replace IAS 18 and IAS 11 which currently provide separate revenue recognition models for goods and services and for construction contracts. IFRS 15 is based on a single model that distinguishes between promises to a customer that are satisfied at a point in time and those that are satisfied over time. IFRS 15 does not distinguish between sales of goods, services or construction contracts. It defines transactions based on performance obligations satisfied over time versus point in time. Revenue is recognised when control of a good or service transfers to a customer. The notion of control replaces the notion of risks and rewards in the existing guidance. The focus on IAS 18 and 11 is on risk and rewards with control (that is, managerial control) as an aspect of risk and rewards. IFRS 15 focuses on control although risk and rewards is still an indicator of control. One of the more significant changes is that IFRS 15 provides a lot more guidance than the existing standards. For example, it has more detail on multiple element arrangements and variable consideration and provides specific guidance on the accounting for licences, customer options and repurchase arrangements. This is likely to affect existing practice, especially in complex arrangements where existing guidance is limited. IAS 18 provides very limited guidance and the new standard provides significant guidance on key practice issues. This was one of the key objectives of the project from an IFRS perspective.

A reminder of .... IAS 18-Revenue and IAS 11- Construction Contracts

Construction contracts
Date Key principles IAS 18 IAS 11 Sale of goods Rendering of services Use of assets Construction contracts Instructor note: IAS 18 includes an appendix that is illustrative only and does not form part of the standard. Its purpose is to illustrate the application of the standard in specific situations. A number of these examples will be covered by the quiz and examples during this session. This slide summarises the areas we will be covering today. You should be familiar with the definition of revenue from the P2P training. “Revenue is the gross inflow of economic benefits during the period arising in the course of the ordinary activities of an entity when those inflows result in increases in equity, other than increases relating to contributions from equity participants.” (IAS 18, paragraph 7) The key points to note are: Revenue is the gross inflow of benefits. It is restricted to the period covered by the financial statements. It deals with items that arise in the ordinary course of the business. So, for example, the proceeds from the sale of a building surplus to the needs of a clothing manufacturer will not be revenue, since it would not be in the ordinary course of business. Additionally, transactions with owners of the business, acting in their capacity as owners, are also excluded from the definition of revenue. This makes sense, as a cash inflow resulting from a fresh issue of share capital is an equity transaction, not revenue. We will start with some of the practical aspects of applying IAS 18 to the sale of goods. The appendix to IAS 18 details a number of specific examples and provides guidance on the application of IAS 18 principles to both the sale of goods and rendering of services. This is a good source to of guidance when working out how to apply IAS 18 to practical situations. We will look specifically at multi-element arrangements, which, as will become clear, can cover all three topics under IAS 18 as well as construction contracts (IAS 11).

Date Contents Section 1: IAS 18 - Revenue Section 2: IAS 11 - Construction contracts This training looks at some of the more complex issues that arise from IAS 18 (Revenue) and IAS 11 (Construction contracts) and is more detailed than the P2P training. You will need to have covered both of the Revenue and the Construction contracts modules of P2P before doing this training. Our third section covers IFRIC 15, which provides guidance on which revenue standard should be applied primarily in construction contract accounting. This training is based on the standards and interpretations that are relevant for entities with financial periods beginning on or after 1 January 2009.

Section 1 –IAS 18 - Revenue Date
So, let’s take a look at IAS 18, ‘Revenue’.

Section 1 – IAS 18 – Revenue Recognition of revenue from sale of goods
Date Section 1 – IAS 18 – Revenue Recognition of revenue from sale of goods Revenue from the sale of goods shall be recognised when all the following conditions have been satisfied: the entity has transferred to the buyer the significant risks and rewards of ownership of the goods; the entity retains neither continuing managerial involvement to the degree usually associated with ownership nor effective control over the goods sold; the amount of revenue can be measured reliably; it is probable that the economic benefits associated with the transaction will flow to the entity; and the costs incurred or to be incurred in respect of the transaction can be measured reliably. One of the key issues in accounting for revenue is to determine when revenue should be recognised. Having completed the P2P training, you know that revenue on the sale of goods should be recognised when all of the criteria listed on the slide have been met [IAS 18 para 14]. Instructor note Pause to allow participants chance to read this slide. With sale of goods two factors (third and fourth bullets on the slide) will generally follow automatically when the risks and rewards have passed to the customer. These factors are relatively easy in when dealing with sale of goods – they become more complex when we consider rendering of services, but are easier to understand in the context of sale of goods. When goods are being sold there is generally an agreed price. If you go into a shop, the prices are usually displayed and you don’t buy until you’ve agreed that price (or bargained over it). The agreed price is generally the amount of revenue to recognise. Discounts and other variations in price might need to be taken into account, but are generally known at the time the sale is agreed and the risks and rewards move to the customer. Once the sale is agreed, the economic benefits (for example cash, or credit card payment) change hands in a retail transaction. It becomes more complicated if the sale is a building or is a sale subject to a leasing agreement. Generally, again, once the sale of goods is agreed, economic benefits either flow immediately or are almost guaranteed, and so can be recognised as receivables. Costs with sale of goods are generally related to inventory and will have been calculated in accordance with IAS 2 ‘Inventories’. Measurement is usually straightforward in established businesses and existing products. It can be more difficult when a product is new or the business has only just started. Move on to the next slide, where the bottom 3 criteria are dimmed

Sale of goods – risks and rewards
Date Sale of goods – risks and rewards Transfer of significant risks and rewards usually occurs when legal title or possession is transferred to the buyer. It may, however, occur before or even after delivery. Consider: Who has the price risk? Who has the obsolescence risk? Who has the insurance risk? Who has the performance risk? Who has the inventory return risk? Can the sale be cancelled? To illustrate, let’s consider some examples of when a vendor may retain the significant risks and rewards of ownership: The entity retains an obligation for unsatisfactory performance not covered by normal warranty provisions [performance risk]. The receipt of the revenue from a particular sale of goods is contingent on the buyer generating revenue from onward sale of those goods [performance risk, and there may be an inventory return risk as well]. The goods are despatched subject to installation and the installation is a significant part of the contract which has not yet been completed by the entity [insurance risk]. The buyer has the right to cancel the purchase for a reason specified in the sales contract and the entity is uncertain about probability of return [cancellation risk]. Note that the transfer of the risks and rewards of ownership often occurs at same time as the transfer of the legal title or the passing of possession to the buyer ie legal title must normally be transferred before revenue can be recognised. However, the transfer of legal title alone is not an adequate basis on which to recognise revenue and all the terms of any sale need to be analysed to understand when revenue can be recognised. Instructor note In case further explanation is needed of the risks, some guidance appears below. Only use this if participants need further help understanding the concepts. Otherwise, pass on to the next slide. Price risk This is the risk that the price at which the good can be sold changes (both upwards and downwards). Obsolescence risk This is the risk that the good sold becomes obsolete. It is particularly important for the sale of any technology product. Insurance risk This looks at who takes the risk of potential damage to the good. This is often a key indicator of when the risks and rewards of a good are transferred where physical delivery is necessary. For example, we mention above a situation where a significant part of the contract is installation and which has not yet been completed. Performance risk This considers who has the risk of the good not performing as required. For example, when a piece of machinery is sold, has the seller retained any risk of the machinery not performing? It should be noted though (as already mentioned) that normal warranty conditions do not prevent revenue recognition. Inventory return risk this considers who has the risk in the event that the goods are damaged, while still in the seller’s stock. Once the risk of holding the item in stock transfers from the reporting entity, there is a further indicator that revenue can be recognised. Can sale be cancelled? If the sale can be cancelled or not completed, it is necessary to understand when this might happen and whether the risks and rewards of the goods really have been transferred. Cancellation applies when a sale of goods has been agreed, but then the buyer changes his or her mind. Contrast this a right of return included in the sale contract, when the buyer has a contractual right to pull out of the sale.

Scenarios to consider:
Date Sale of goods Scenarios to consider: Seller guarantees product performance outside normal warranty provisions Complex installation, with significant impact on the buyer’s ability to use product as intended Goods are delivered but seller retains title for credit protection purposes Discussion of different scenarios The effect of the "risk and reward" and "continuing managerial involvement" criteria on revenue recognition can be best understood by looking at some common commercial situations. In a moment I am going to show you some examples of transactions. For each one I would like you to determine at which point revenue can be recognised. To make things easier, consider whether the seller has transferred risks and rewards and whether the seller has given up managerial involvement. Instructor note: For each of the slides that follow, read out each of the scenarios and then ask the participants the appropriate point at which revenue can be recognised. Encourage the participants to consider at what point risks and rewards and managerial control transfer. After the participants have given the answers, click the slide to show the correct answer. Briefly talk through the answer and any additional instructor notes. Consider using the risks and rewards factors on slide 8 to assist in the debrief. Be aware of time when going through these examples. Each example should only take two minutes to cover. NOTE - If the participants have a print out of the slides in their learning material ask them to close the binder or put it away as it will tell them the answer. You can also elect to run these questions as a competition (in conjunction with the other "quizzes" in this programme) where table groups get one point for each correct answer and the group with the most points at the end of the programme is the winner. However the questions can also be asked without a competition.

Sale of goods – scenario 1
Date Sale of goods – scenario 1 Point at which revenue should be recognised? Seller guarantees product performance outside normal warranty provisions When seller is no longer exposed to significant risks and has no further performance obligations Point at which revenue should be recognised Points to consider Seller transferred risks and rewards? Seller relinquished managerial involvement? Ask: When do you think revenue can be recognised? Ask the participants for their responses. Click once to show answer. For example a seller may deliver a unique piece of specially designed manufacturing equipment and guarantee its performance (ie guarantee a specific level of output and quality of the output for a specific period). The seller may not be able to recognise revenue up-front. On the other hand, if a seller delivers a routinely designed piece of manufacturing equipment and merely guarantees the parts of the machine for a normal warranty period, revenue may be recognised up-front. Instructor note: It is also worth noting that there may be instances when the warranty can be accounted for separately from the sale of the goods and we will deal with when this might be the case in the multiple element section of this training.

Date Sale of goods – scenario 2 Point at which revenue should be recognised? The installation is complex and has significant impact on the buyer’s ability to use the product as intended Revenue should be recognised only when installation is complete Point at which revenue should be recognised Points to consider Ask: When do you think revenue can be recognised? Ask participants for their responses. Click once to show answer. The determination of whether installation is simple is very judgmental and will depend on the commercial substance of the transaction. That is, how does the customer view the installation? Is it so simple that the customer would do this itself? Or is it clearly an integral and important part of the purchase of the agreement and essential to the equipment operating as intended? You generally would need detailed understanding of your client’s products and business in order to decide. Instructor note: Installation will be covered in a longer exercise, so if the participants have additional questions on this, ask them if you can leave the questions until later. It is also worth noting that there are some situations where the installation can be accounted for separately from the sale of the goods and we will deal with this in the multiple element section of this training. Seller transferred risks and rewards? Seller relinquished managerial involvement?

Date Sale of goods – scenario 3 Point at which revenue should be recognised? Goods are delivered but seller retains title for credit protection purposes On transfer of goods. Credit risk is not a significant risk of ownership Point at which revenue should be recognised Points to consider Seller transferred risks and rewards? Ask: When do you think revenue can be recognised? Ask participants for their responses. Click once to show answer. Transfer of title is generally a requirement to recognise revenue since risk of loss will normally only transfer at that point. However in certain jurisdictions, it is customary to retain title as a way of securing payment (a vendor cannot get a lien for the sold goods or that lien has priority behind other creditors). In these circumstances retaining title would not be seen as retaining significant risk and rewards - credit risk is not a significant risk of ownership. However, this differs from situations where goods are delivered only when the buyer makes the final payment in a series of instalments and, hence, both legal title is retained and physical delivery to the customer has yet to take place. So, typically, in most cases with sale of goods, revenue can be measured reliably and either cash will be exchanged at once or the amount measured can be recognised as a receivable. It gets more complicated with rendering of services. Let’s have a look….. Seller relinquished managerial involvement?

Section 1 – Revenue Recognition – Revenue from rendering of services
Date Section 1 – Revenue Recognition – Revenue from rendering of services We carry on now with recognition of revenue from rendering of services.

Recognition of revenue from rendering of services
Date Recognition of revenue from rendering of services For outcome to be estimated reliably, all these conditions need to be satisfied: amount of revenue can be measured reliably; probable that economic benefits associated with transaction will flow to the entity; stage of completion of transaction at balance sheet date can be measured reliably; and the costs incurred for transaction and costs to complete transaction can be measured reliably. Before we look at criteria, let’s clarify exactly what we mean by a service. You should all be fairly familiar with this concept from the P2P training. Ask: What are the key features that make something a service? Answer: The rendering of services typically involves: the performance of an agreed task over an agreed period of time (either a single period or over more than one periods). Let’s look at the criteria. The conditions (revenue can be reliably measured and economic benefits are probable) are what we’ve just discussed in connection with sale of goods. We will therefore not cover those in any more detail. Instead we will focus on the last two criteria. These last two conditions are unique to revenue recognition from rendering of services (ie they do not apply to revenue recognition from the sale of goods). These items are included because revenue recognition on rendering of services is based on percentage of completion. Stage or percentage of completion Let's start by looking at measuring the stage of completion. This deals with the ability to estimate how far through the "rendering" of the service we are. This is an important point as the way we measure this stage of completion directly affects the amount of revenue recognised for the year. An entity shall use the method that measures reliably the services performed, so we need to understand which method creates that reliable measure. IAS 18 (paragraph 23) makes clear that the reporting entity is expected to have an effective reporting and budgeting system, so that this information is readily available. The key measurement issues are noted on the next slide.

Recognition of revenue from rendering of services
Date Recognition of revenue from rendering of services What are the future economic benefits? Over what period are the services to be rendered? Is there a reliable estimate of the outcome? The main problems that arise in recognition of revenue from rendering services arise typically under the three matters listed on the slide. Measurement: It is not always easy to decide when a service has been delivered. Hence, it may not be clear how much revenue can be recognised, since it may not be known how much of the service has been performed. Long period: Where services are provided over a long period of time, the risk is recognising revenue too early. Outcome: It may not be clear as to whether the outcome has been achieved. It may therefore be necessary to look at the history of rendering of similar services to decide whether the outcome has been achieved and hence whether revenue can be recognised.

Rendering of services - flowchart
Date Rendering of services - flowchart Reliable estimate of outcome ? Yes No Profit ? Expenses recoverable? Yes No Yes No Recognise revenue according to stage of completion Recognise expected loss immediately Recognise revenue to the extent of recoverable expenses (no profit recognised) No revenue is recognised (costs incurred are recognised as expenses) Before we move on to measurement of revenue, here is a summary of how to recognise the revenue arising from the rendering of services. Spend a few moments following this flowchart. Instructor note: Take participants through the flow diagram so they understand the thought process which supports revenue recognition. Suggestion would be: Consider whether the outcome can be reliably estimated. If so, then consider whether rendering the service will or has resulted in a profit. Where it has, revenue can be recognised according to the stage of completion. If, on the other hand, a loss is expected that loss should be recognised immediately (and to the full extent of the loss expected). If the outcome cannot be reliably estimated, the question becomes whether the expenses of rendering the service can be recovered. If they can, revenue can be recognised to the extent that expenses are recoverable (but no profit can be recognised). Where expenses are not recoverable, no revenue can be recognised and costs incurred are recognised as expenses).

Section 1 – IAS 18-Revenue Measurement Date
We leave recognition and move on to how we measure revenue.

Date Revenue and construction contracts Basics of measurement Revenue shall be measured at the fair value of the consideration received or receivable. (IAS 18 para 9) The amount of revenue arising on a transaction is usually determined by agreement between the entity and the buyer or user of the asset. It is measured at the fair value of the consideration received or receivable taking into account the amount of any trade discounts and volume rebates allowed by the entity. (IAS 18 para 10) Here are two extracts from IAS 18 dealing with the basis of measurement. Read through the statements on the slide. [Give participants time to read] These are the general principles to be followed. In the case of sale of goods, the concept of fair value of consideration received is usually clear and is readily determined. In cases where it is not clear, the particular facts will need to be examined closely to ensure that measurement of the fair value is correctly calculated. However, when we come to rendering of services, it becomes more complicated. Sale of services - Percentage of completion method Revenue should be recognised for the sale of services as those services are provided. The same is true for construction contracts (more on this later). The discussion of the percentage of completion method in IAS 18 contains a reference to IAS 11 (IAS 18 para 21), but IAS 18 is the primary guidance for service transactions. IAS 18 para 24, gives guidance on to entities on assessing the stage of completion at the end of each reporting period to determine the revenue to be recorded in that period. The guidance provides a number of methods that may be used in determining the stage of completion including: (a) surveys of work performed; (b) services performed to date as a percentage of the total services to be performed; or (c) the proportion that costs incurred to date bear to the total costs to be incurred. When choosing a method, an entity should use the method that best reflects the services performed. Receipt of cash is not a factor in assessing the stage of completion in and of itself, even if the cash received is non-refundable (as is often the case with milestone payments). Input versus output measures As noted, the method selected is the one that best reflects the services performed. Whether an entity should use an input or an output measure depends on the nature of the service being performed, and each method requires judgment. An output measure approach would be appropriate, for instance when the contract involves processing of transactions over a period of time. An input measure approach would be appropriate when the contract involves completion of an agreed upon project, such as one that involves a mix of labour and other costs. If an input measure is used, only those costs that reflect services performed to date are included in the estimate of total costs incurred to date. Generally, an output measure approach will be most appropriate for service transactions.

Rendering of services – Other measurement methods
Date Rendering of services – Other measurement methods For practical purposes … Indeterminate number of acts: Specific significant act: Two other issues that arise are in connection with stage of completion: indeterminate number of acts and specific single acts. Indeterminate number of acts (IAS 18 para 25) A contract may require that the service provider perform a service that involves an “indeterminate number of acts” over a period of time, for example contracts for the provision of maintenance or outsourcing service contracts. In this situation, the company should recognise revenue on a straight-line basis over the contract period, unless there is evidence that some other method better represents the stage of completion. Significant acts (IAS 18 para 25) An arrangement may include one act that is more significant than the others that results in the deferral of revenue until that act is performed. Note that this method of application of the percentage of completion method is generally rare outside of the financial services sector. We will now look at some examples to illustrate these points.

Rendering of services – Example 1: Fire protection service
Date Rendering of services – Example 1: Fire protection service STRAIGHT LINE Fire protection service (outsourced to a private company) that respond to fires as they occur Don't know how many fires there will be each year - there is an indeterminate number of fire-fighting acts Recognise revenue in a straight line method over the period An example could be a fire protection service (subcontracted to a private company) that respond to fires as and when they occur. Here, and in similar businesses, you don't know how many fires there will be each year: there is an indeterminate number of fire-fighting acts. In such cases, you would recognise the revenue on a straight line basis over the period. Specific significant act The second alternative method is "significant act". Under this method, when one specific act is much more significant than any other acts, the recognition of revenue is postponed until that one significant act is executed. Ask : Can anyone think of an example where there could be a significant act? Poll participants for answers then click on to the next slide.

Rendering of services – Example 2: Literary agent
Date Rendering of services – Example 2: Literary agent SIGNIFICANT ACT The agent is asked by the book author to find a publishing house. Once the contract between the author and the publishing house is signed, the agent is entitled to the majority of his commission. The agent should recognise revenue once this significant act has been achieved. An example here could be a literary agent: The agent is asked by the book author to find a publishing house. Once the contract between the author and the publishing house is signed, the agent is entitled to the majority of his commission. Therefore, the agent should recognise revenue, only once this significant act has been performed even though the majority of the agent's effort will have taken place before the contract is signed, for example, meeting publishers and negotiating terms. The most appropriate method to use will be determined by the commercial substance of the transaction. The method used should be the method that best represents the performance under the contract. An entity should be consistent in their revenue recognition policy and the methods used. When we are auditing a client, we need to consider the approach adopted by the client and understand why management feel the chosen method best reflects the services performed to date. Some judgement is involved in selecting the appropriate method and it is management's responsibility to choose the correct accounting policy. If there is doubt as to the method used, looking to practice in the relevant industry might help to decide the reasonableness of the approach. Instructor note The participants might ask how PwC should recognise revenue for audit services. Audit services are generally fixed price and services are performed over time. There is no single significant act in performing an audit - PwC will almost always complete an audit and hence will almost always be entitled to payment. In addition, PwC can generally make a reliable estimate of the costs to complete an audit. Prior to signing the audit opinion, there is little output that can be measured in the provision of audit services. As a result, it is generally appropriate to measure the stage of completion with reference to input measures. One input measure would be hours worked, but this would not reflect the different values attributed to the work performed by different grades of staff. As a result, revenue on audits is measured by reference to the costs incurred to date as a percentage of total costs on the audit.

Rendering of services Example 3: Maintenance contracts
Date Rendering of services Example 3: Maintenance contracts STRAIGHT LINE Plumb-Quick Limited sells maintenance contracts to building owners whereby Plumb-Quick will visit the buildings as and when maintenance is required. Also, they are available in case an emergency should arise. Straight-line basis since the maintenance contracts result in Plumb-Quick performing an indeterminate number of acts over the maintenance period. Instructor Note Use these next four slides to illustrate some points about the different measurement methods available. Example 3 - Straight-line Even though Plumb Quick visits once a month, the true number of acts cannot be determined since they are on stand-by throughout the period. As such, straight line will be the best method to recognise this revenue. Note that even though there is an indeterminate number of acts, you can still estimate the cost (eg, cost of having engineers ready on stand-by etc).

Rendering of services Example 4: Call centre support
Date Rendering of services Example 4: Call centre support OUTPUT Computers Hotline provides call centre support for entities who purchase specified software. Computers Hotline is paid based on the number of service calls that are logged during the period. Output measure since Computers Hotline is paid based on the number of calls that are processed. Example 4 – Output Since the output in this example is measurable and the fee is linked to the delivery of the output, the best method in this case would be to recognise the fee as the output is delivered.

Rendering of services Example 5: Consulting
Date Rendering of services Example 5: Consulting INPUT Sigma Sieben enters into an arrangement with Acme Co. to perform a study and consult on the efficiency of Acme’s marketing department. Sigma Sieben is paid a fixed fee in instalments at different times. The fee was determined based on estimates of the number of hours incurred for the review Input measure since Sigma Sieben is paid based on the number of hours incurred in their consulting arrangement. Example 5 - Input In this case, it is not possible to measure the output in a reasonable manner. However, the input measure for hours incurred (or cost incurred - in this case those are close to the same) gives a reasonable measurement of how far we are in the "delivery" of the service.

Rendering of services Example 6: Financial reorganisation
Date Rendering of services Example 6: Financial reorganisation SIGNIFICANT ACT Pinstripes financial has agreed to develop a reorganisation plan to save SouthPike bank from insolvency. If Pinstripes’ plan gets accepted by the creditors, Pinstripes will receive a ten million fee for their work. If the plan isn’t accepted it is back to the drawing-board. Example 6 - Significant act In this case, although, technically, Pinstripes deliver an output (the reorganisation plan), the real deliverable is to get all the creditors to buy into this plan and save the bank. Until that has been achieved, Pinstripes has not delivered the service they have agreed to provide. In addition, the fee is tied to achieving this. As such, getting the agreement of the creditors becomes the significant act. Although these examples are written to fall clearly into each of the four categories, in real life it may be harder to put a service into one of these categories. Ask What would you do if you think that there is more than one method that is possible for a given scenario? Poll some answers The important point is that the well reasoned judgement as to which method best reflects the economic reality of the transaction is described in the accounting policy. The key factors to consider are the same as we highlighted in the goods section. That is: Commercial substance of transaction - not legal form How the customer views the transactions Ask Does anyone have any remaining questions on how we determine what method to use for recognising and measuring service revenue? Pinstripes is paid neither on an input basis nor on an output basis. Rather, Pinstripes is paid upon completion of a significant act - the approval by the creditors of the restructuring plan.

Section 1 – Revenue Multiple element arrangements
Date Section 1 – Revenue Multiple element arrangements We will now cover a topic that spans both the sale of goods and the rendering of services, accounting for multiple element arrangements (MEAs).

Revenue recognition – Multiple elements
Date Revenue recognition – Multiple elements Key principles IAS 18 IAS 11 Sale of goods Rendering of services Use of assets Construction contracts Multiple element arrangements Introduction to multiple element arrangements Ask Does anyone have an example of a multiple element arrangement? Instructor note Gather examples of multiple element arrangements. It is not important what the examples are as this is only to create interest. If it is unclear if the elements in the examples are separable or not, accept them and highlight that we will cover accounting for these later. If no-one has examples use the example of a product bought with a one year service agreement. This discussion needs to be short, so guide carefully to ensure participants are not caught in excessive detail. A transaction may contain separately identifiable components that should be accounted for separately. IAS 18 states that it is necessary to apply the revenue recognition criteria to each separately identifiable component of a single transaction in order to reflect the substance of the transaction. We will look at a practical example of this. IAS 18 gives an example of a product sold with an obligation for subsequent servicing. It states that the amount attributable to subsequent servicing should be deferred and recognised during the period the service is performed. Ask Can anyone think of why multiple elements may be sold together? Answers can include: Customers want to negotiate the purchase of two products at the same time to get a better price. Products are sold together with service agreements relating to the products. A future product or service is included in the transaction at a lower price to help motivate the buyer to purchase the product. Hardware products are sold together with large system implementation projects where the seller is best placed to perform implementation and the whole process may take several years to complete. The main reason we need guidance on multiple element arrangements is that often the elements are not all delivered in the same period. As such, we need to know: whether any revenue can be recognised on delivered elements; if other elements are yet to be delivered; and what part of the total consideration relates to which element. Move on to the next slide Other issues

Recognition of multiple element arrangements
Date Revenue and construction contracts Recognition of multiple element arrangements “…in certain circumstances, it is necessary to apply the recognition criteria to the separately identifiable components of a single transaction in order to reflect the substance of the transaction. For example, when the selling price of a product includes an identifiable amount for subsequent servicing, that amount is deferred and recognised as revenue over the period during which the service is performed.” (IAS 18 para 13) The basic principle to apply when looking at MEAs is given in IAS 18 para 13 which states that the revenue recognition criteria are normally applied to separate transactions. There are times when the commercial substance of a transaction cannot be understood unless we break a transaction into its separate components. An example is when an entity sells a washing machine, with an extended warranty to provide insurance against the machine failing after the manufacturer's warranty ends (usually after one year). Assume the warranty gives cover for each of years two to four. We have sold goods (a washing machine) and also agreed to provide insurance after sale for years two to four inclusive. The price of the goods would include an amount for the extended warranty and this element needs to be accounted for over the next four years. This will be done by recognising nothing in year one (which the manufacturer covers) then roughly one-third in each of years two, three and four – the precise amount will be determined by the detail of the facts in the contractual terms. Instructor’s note In most cases like this straight line recognition over years two to four will be the best estimate. However, there may be cases where the amounts are more significant and where there is a known increased likelihood of claims arising later on – that is the nearer to the end of the four years the more likely that a customer might be made. In such cases, weighting the recognition towards the end of the period might be a better estimate. As we can see on the slide, IAS 18 does not have much guidance when it comes to accounting for multiple element arrangements. Instructor note: Give participants chance to read the slide (IAS 18 para 13) If asked, explain that there is other guidance: in the appendix to IAS 18 where example 11 refers to a situation where a product is sold together with services; in IFRIC 13 (Customer loyalty programmes); and in IFRIC 18 (Transfers of assets from customers). Show next slide

Multiple elements – Decision tree
Date Multiple elements – Decision tree Identify the arrangement How many elements? ONE MORE THAN ONE Can elements be separated? NO YES Allocate consideration So let’s walk through this decision tree. First we must determine what the arrangement is. In doing that we have to assess if two or more individual transactions or contracts must be combined into one arrangement. We will talk later about what factors we would look at to determine that. The next step is to assess whether the arrangement consists of just one or more than one element. If there is only one element in the arrangement, then you have nothing more to do. You can move on to recognise revenue for that one element based on the general principles for recognition of goods or services described earlier. As you can guess, the determination of the number of elements you have is closely linked to how you assessed the arrangements in the step before. Instructor note Sometimes, especially for services, the determination of how many elements there are can have some special challenges. Take the example of a plane trip. As part of the trip you have the actual flight, baggage handling, a meal, an in-flight film, the use of a pillow and blanket (if you are lucky) etc. Sometimes these are charged separately and sometimes they are free to everyone on board. In the case where the various services are not separately charged, you should consider the customer's perspective as to whether the customer sees it all as one element (plane trip) or as separate components. It often has little impact on the final answer, though, since, in this instance, the services are all delivered at the same time. ONE ELEMENT COMBINED SEPARATE ELEMENTS Recognise based on the general principles

Multiple elements – One arrangement
Date Multiple elements – One arrangement Factors indicating transactions should be combined in one arrangement include: Are on the same order or in the same contract Entered into within a short time frame Negotiated with the customer as one arrangement Parts are technologically linked Terms in one transaction refer to the other transaction If elements are included in the same contract, they generally are considered to be in the same arrangement. However, putting the elements into separate contracts does not change the conclusion. Factors to consider when trying to decide whether to combine one or more contracts into one arrangement are as follows: Read through the bullets on the slide. Note that this is not a list of strict criteria – it is just some of the most common factors to consider. The two most judgmental are: the time between the transaction; and whether the two (or more) orders have been negotiated as one package. The key is to view it from the customer's perspective. So, what does the customer think has been negotiated? Would the customer see it as one package? Parts that are technologically linked means, for example, that the product mentioned in one order does not work as the customer intends without another product from a separate order. Most customers would not buy a car without the engine, so if you put the chassis and the engine on different orders you would probably need to combine them for revenue recognition purposes. Instructor note: If the buyer is a car mechanic, however, the conclusion could be different. An example of terms in one transaction referring to another transaction is when the payment of product A would be due when product B is accepted. Again, these are only factors to consider. They are not part of the standard. The key matter is to look at the commercial substance. Ask Are there any questions on how to assess what the arrangement is? Move on to the next slide Key factor - Commercial substance

Multiple elements – Can the elements be separated?
Date Multiple elements – Can the elements be separated? Factors indicating that two or more elements cannot be separated include: Elements do not have stand alone value or could not be sold separately in a stand alone transaction Delivery of future element is not within the control of the vendor or is not probable Fair value cannot be established for each element Other elements are insignificant Let’s move on to the question of how to assess whether an arrangement can be split into separate elements. As noted, there is limited guidance on these issues. However, the arrangements could be considered from the customer’s perspective. So, when considering the customer perspective, we would look at the following: Stand alone value to the customer – does the delivered element have value to the customer or do further elements need to be delivered for the arrangement to have value? Is delivery of all components probable and substantially within the company’s control? If it is unlikely that one of the components would be delivered, then it is unlikely that the elements would be accounted for separately. Is there a reliable fair value of both the delivered and undelivered component? A reliable fair value would, for example, be a sale price if one component could be sold separately. Another method would be looking at cost plus margin for that element. If there is no reliable fair value, at least for the undelivered element, it is unlikely that we would be able to separate. Note that fair value should not be specific to the entity. The last factor (insignificant elements) is a little different and deals with situation where the additional element are so insignificant that they would not be treated separately. An example is if you decide to buy a specific brand car and you get a T-shirt in the post later. Here you would not consider the T shirt to be an element because it is so insignificant and you would end up recognising revenue as if the only element is the car. Ask Are there any questions on how to assess whether elements can be separated ? 3.2. QUIZ (15 mins) Instructor Note: Cards are used in this exercise. Make sure that there is one set of cards for each participant on the tables before running the exercise. The answers to the questions are the 3 categories of transactions we have defined above. Multiple element arrangements with non-separable elements Multiple element arrangements with separable elements Separate stand alone arrangements As the scenarios get shown on the slides the participants should hold up the card that they think describes the transaction. You can also elect to run this quiz as a competition (in conjunction with the other quizzes in this programme) where table groups get one point for each participant with the correct answer and the group with the most points at the end of the programme is the winner. However the quiz can also be held without a competition. Introduction and rationale Let’s now try to apply the commercial substance approach and the three categories to some real life examples. Task I will show you five descriptions of product offerings and you should determine which of the three categories each one is. Sharing You will have 1 minute to decide individually for each example and to vote by raising the corresponding card. At the end of each scenario, I'll ask some of you to explain why you have chosen that category. Instructor note: The next five slides relate to this quiz. The slides are animated. For each slide: Click only once to show the situation and ask participants "How would this be treated?" Read the question on the slide and ask participants to hold up the card that they think relates to this scenario. Ask participants to explain why they have selected that category. Then click on the slide again [NEXT] to reveal the answer. Conclude each situation by highlighting the key points from the example. As you can see from the exercise it is not always easy to determine what is a multiple element arrangement. As we saw in this exercise the key is to understand the commercial substance of the transaction. If you know your clients business you are in good shape to sort this out. Key factor - Commercial substance

Multiple elements - Quiz question 1
Date Multiple elements - Quiz question 1 A car dealership sells a car to a customer who also elects to purchase a 5 year maintenance programme offered by the dealership. In this case, there are two elements (the sale of the car and the maintenance programme). Both need to be priced separately, with the car price recognised immediately and the warranty then spread over five years. The amount for the maintenance will normally be spread evenly, with the same amount recognised in each year. This is a clear example of a case where straight line recognition would not be appropriate. Multiple element arrangement with separable elements

Multiple elements - Quiz question 2
Date Multiple elements - Quiz question 2 A car dealership sells a car to a buyer. The buyer declines to purchase the maintenance agreement. A year later the car's transmission breaks down (not covered by warranty) and the buyer comes back to get the car repaired. The full sales price of the car is taken to revenue immediately on completion of the sale. There is no other amount to recognise at that point. The break down of the car and its return to the dealer for repair a year later is a totally unrelated event that requires separate recognition in that next period. This scenario offers a guide as to how to value the car, in question 1. From this question, we know what the dealer would sell the car for, without the maintenance programme. So, the extra charge in the scenario in question 1 that is in excess of the price of the car would be a good guide to the value of the maintenance programme. This amount would then be spread across the five years of the maintenance programme. Separate, stand alone arrangements

Section 2 – Construction contracts
Date Section 2 – Construction contracts We now move on to the other main revenue recognition standard, IAS 11, ‘Construction contracts’. This was the subject of a separate module in the P2P training. A little while ago, we spoke about service revenue and we discussed some of the guidance IAS 11 contains around contract costs. We are now going to look at IAS 11 in a bit more detail specifically focussing on construction contracts. So, what is a construction contract? Instructor note: IAS 11 includes this definition: A construction contract is a contract specifically negotiated for the construction of an asset or a combination of assets that are closely interrelated or interdependent in terms of their design, technology and function or their ultimate purpose or use.

What are construction contracts?
Date What are construction contracts? What is a construction contract? How does it differ from sale of goods? Ask: Can anyone think of an example of a construction contract and what distinguishes a construction contract from, say, sale of goods? Poll participants for their thoughts and some examples. This should bring out 2 key points: Answer: Construction contracts: involve the construction of an asset; and are specifically negotiated, that is the asset is being constructed is to the customer's specification. Instructor Note: Show next slide. This slide is animated. Click once to show each answer. There are four questions and answers. You can also elect to run this quiz as a competition (in conjunction with the other quizzes in this programme) where table groups get one point for each participant with the correct answer and the group with the most points at the end of the programme is the winner. However the quiz can also be held without a competition.

Construction contracts - Quick Quiz
Date Construction contracts - Quick Quiz IAS 18 IAS 11 A sports car with air conditioning, flash gear box, large wheels, quadruple exhaust and 12 speakers A newspaper printing machine designed to meet the requirements of Big Business newspaper which is printed on triangular paper to give a more pointed view Contract with an architect to design an office building Contract for construction of a hospital for the government Lets now do a quick quiz together to demonstrate the difference between arrangements that would be accounted for under IAS 11 and IAS 18. We will do this together as a group, please shout out if you think you know the answer. 1) OK - first question. In the days before the credit crunch, and when investment banks paid large bonuses, let‘s suppose Fred decided to reward himself for his hard work by treating himself to a sports car. However, he does not just want any sports car so specifies his with the following options: Air conditioning, a gear box which changes gear at the push of a button on the steering wheel, extra large wheels, quadruple exhausts, and an in car entertainment system with 12 speakers. Ask: Given the level of specification does this sound like the car manufacturer should account for the order as a construction contract under IAS 11 or as a sale of goods? Answer: This should be accounted for as a sale of goods under IAS 18. Fred is only choosing from a list of options which are minor modifications when compared to the car as a whole. This contrasts with a situation where he might specify the major structural elements of the design of the car and hence move into a construction contract. This is something we return to later when we consider IFRIC 15. 2) Lets look at the next example. Big Business Newspaper is printed on triangular paper. This distinguishes it from competitors and Big Business claims that it represents the fact that the newspaper has a more pointed view than their rivals. Big Business orders a printing machine and specifies that it must be capable of printing on triangular paper. The machine will use many of the parts of standard printing machines but needs to be assembled in a special format to allow it to print on triangular paper. Ask: Does the sale of the machine seem like the sale of goods or a construction contract? Answer: This seems more like a construction contract. While we might want to know a little more about just how different the machine is to standard machines and the level of design involved, it seems likely that the requirement to be able to print on triangular paper, would cause this to be a construction contract as this requires major design and build differences. 3) Lets look at the third example - a contract with an architect to design an office building. Ask: What do you think this falls under? Answer: The contract is for the design of a building - that is, although an office building is to be built, the contract is for the services of the architect only. Therefore it is simply a contract for services under IAS 18. 4) Lastly let's consider a contract for the construction of a hospital for the government. Answer: This one seems fairly obvious - it seems very much like it should be accounted for under IAS 11. It is likely to be heavily specified and is definitely for the construction of an asset. Instructor note: In this example, if the constructor also subsequently operates the hospital we would also have to look as to whether the arrangement falls within the scope of IFRIC 12, 'Service concession arrangements'. IFRIC 12 is not covered in detail this course, but participants may bring it up if they are aware of it. Public to private service concession arrangements like this have become more frequent as governments look to ways to finance public service infrastructure. Typically under such arrangements private companies build the infrastructure and then receive a fee to operate it. The operation fee normally covers both payment for building the infrastructure and for ongoing operation. Although revenue on the construction phase of a service concession arrangement would be in accordance with IAS 11, what IFRIC 12 tells us is how to recognise the receivable in respect of the construction revenue and whether this should be recognised as an intangible asset or a financial asset. You should now have a basic idea of what a construction contract is and determining when an arrangement falls under the scope of IAS 11 or IAS 18. This is the most important point we would like you to take away from this session is an understanding of what arrangements fall under IAS 11 and which fall under IAS 18. One other area we need to conver is multiple element arrangements for construction contracts. See next slide. Show next slide. This slide is animated. The fully built slide is pasted below.

Construction contracts – Combining and segmenting contracts
Date Construction contracts – Combining and segmenting contracts Contract covers a number of assets A group of contracts Optional additional asset in contract Only separate if: Separate proposals and negotiation Costs and revenues can be identified Combine if: Negotiated together Closely interrelated Performed concurrently or in continuous sequence Only separate if: Significantly different Price negotiated without regard to original contract There is another important difference between IAS 11 and IAS 18 that I want to briefly cover - that is looking at "multiple elements" in construction contracts. We have looked at multiple element transactions already in this presentation. Let's see how they relate to construction contracts. Click once on slide to show the boxes on the left. When a construction contract covers a number of assets, the construction of each asset shall be treated as a separate construction contract when the following criteria are met: a) separate proposals have been submitted for each asset; b) each asset has been subject to separate negotiation and the contractor and customer have been able to accept or reject that part of the contract relating to each asset; and c) the costs and revenues of each asset can be identified. As we can see, these are quite different from the guidance we apply under IAS 18 in order to separate different element of a transaction. Instructor note: IAS 18 simply states 'in certain circumstances, it is necessary to apply the recognition criteria to the separately identifiable components of a single transaction in order to reflect the substance of the transaction. For example, when the selling price of a product includes an identifiable amount for subsequent servicing, that amount is deferred and recognised as revenue over the period during which the service is performed. Conversely, the recognition criteria are applied to two or more transactions together when they are linked in such a way that the commercial effect cannot be understood without reference to the series of transactions as a whole.' Hence separation of different elements is based very much on the substance of the transactions under IAS 18. The IAS 11 criteria are stricter and require specific evidence. As a result, there are likely to be less separable elements in a construction contract. In the event that the elements could be separated, though, the revenue to be allocated to each element would be known due to the separate proposals and negotiations. Click once on slide to show the boxes in the middle. IAS 11 also gives us guidance on when separate contracts should be treated as a single construction contract. We saw in IAS 18 that whether more than one transaction should be treated together for the purposes of revenue recognition was based very much on the substance of the arrangements. IAS 11 provides more guidance and gives us specific evidence to consider. A group of contracts, whether with a single customer or with several customers, shall be treated as a single construction when: a) the group of contracts is negotiated as a single package; b) the contracts are so closely interrelated that they are, in effect, part of a single project with an overall profit margin; and c) the contracts are performed concurrently or in a continuous sequence. Click once on slide to show the boxes on the right IAS 11 also deals with the scenario where optional assets are included in the contract, It states that a contract may provide for the construction of an additional asset at the option of the customer or may be amended to include the construction of an additional asset. The construction of the additional asset shall be treated as a separate construction contract when: a) the asset differs significantly in design, technology or function from the asset or assets covered by the original contract: or b) the price of the asset is negotiated without regard to the original contract price. These are similar to the criteria we look at for separating or combining contracts. We are not going to spend too long on when to separate construction contracts into different elements or when to account for them together, but it is important that you understand that there is a difference. Types of contracts We now know the scope of IAS 11 and what a construction contract is. You should also be aware of the two different types of pricing that might apply to construction contracts. Show next slide

Construction contracts Recognising Revenue – Key Criteria
Date Construction contracts Recognising Revenue – Key Criteria Revenue can be measured reliably Probable that the economic benefits will flow to the entity Stage of completion can be measured reliably Costs can be measured reliably Fixed Price Contract Cost Plus Contract You will recall from the P2P training that: a fixed price contract is a contract in which the parties agree to a fixed price for the asset to be constructed or for a fixed price for any unit of output. Under such contracts, the price risk remains with the contractor; and a cost plus contract is a contract in which the constructor receives a payment for its costs plus a separate fee which might be a percentage of the cost or a lump sum. The price risk on such contracts is borne by the customer. We will look at how the revenue recognition of each type of contract differs. The four criteria apply to fixed price contracts under IAS 11 and they should be familiar, since that are almost the same as those we’ve been looking at under IAS 18. Click once on slide to show the "Fixed price contract" box That is: total contract revenue can be measured reliably; it is probable that the economic benefits associated with the contract will flow to the entity; both the contract costs to complete the contract and the stage of contract completion at the end of the reporting period can be measured reliably; and the contract costs attributable to the contract can be clearly identified and measured reliably so that actual contract costs incurred can be compared with prior estimates. When it comes to when an entity is generally able to make reliable estimates, again the same guidance as services applies. That is (in simple terms), an entity can make reliable estimates when a contract, that sets out the rights of each party, the amounts to be paid and when, has been signed. Recognising cost plus contracts The criteria for cost plus contracts are slightly different. Click to move to cost plus As you can see only two of the criteria apply. This simply reflects the fact that, provided the costs on a cost plus contract can be reliably measured, then the revenue can be reliably measured. Like IAS 18, IAS 11 also states that if the outcome of the contract cannot be estimated reliably (eg such as during the early stages of a contract), the contract revenue is recognised only to the extent of costs incurred that are expected to be recoverable. If the contract costs are not probable of being recovered then they are expensed immediately. Instructor note: IAS 11 gives some guidance as to where this might be the case, which might be worth touching on if any questions are asked. The examples given are contracts: (a) that are not fully enforceable, ie their validity is seriously in question; (b) the completion of which is subject to the outcome of pending litigation or legislation; (c) relating to properties that are likely to be condemned or expropriated; (d) where the customer is unable to meet its obligations; or (e) where the contractor is unable to complete the contract or otherwise meet its obligations under the contract. Note that the P2P training covered measurement of construction contracts in some depth – hence it is omitted from this module.

...and now back at the new IFRS 15 – Revenue from contracts with customers
NOTE: This presentation is a summary of IFRS 15 and does not discuss all matters that might need to be considered to implement this standard. Please see for further details including the standard itself.

Scope Revenue is income from ‘ordinary activities’.
Scope exclusions Leases, insurance, financial instruments, certain guarantee contracts and certain nonmonetary exchanges Contracts with elements in multiple standards Evaluate under other standards first Revenue is income from ‘ordinary activities’. A contract has rights and obligations between two or more parties. A customer receives a good or service. The proposed standard applies to all contracts with customers. The customer is defined as ‘a party that has contracted with an entity to obtain goods or services that are an output of the entity’s ordinary activities in exchange for consideration.’ Defining the customer is a new concept. The definition of the customer might not significantly change the nature of transactions previously considered in scope of revenue guidance, but transactions with partners in collaborative arrangements may need to be considered further. Management will need to evaluate arrangements with collaborators and partners carefully to identify whether such arrangements or portions thereof are in the scope of IFRS 15. A transaction that might be outside the scope is one with a collaborator or partner that shares risk in developing a product and that is not for the sale of goods or services that are an output of the entity's ordinary activities, and therefore not a contract with a customer. Example - a biotechnology entity that has an agreement with a pharmaceutical entity to share risks in the development of a specific drug candidate likely will not be in the scope of the standard if the parties share the risk in developing the drug. If, however, the substance of the arrangement is that the biotechnology entity is selling its compound to the pharmaceutical entity and/or providing research and development services, it will likely be in scope. The proposed standard provides a number of scope exceptions. They are very similar in practice to those in today’s guidance. No industries are scoped out of the standard, only transactions. Leases – Lease transactions are out of the scope of the revenue standard. However, intangibles have been scoped out of the leasing standard and are captured in the revenue standard. Financial instruments – Financial institutions will need to look to IAS 39 / IFRS 9 to determine whether transactions are financial instruments or services under the revenue standard. Insurance – Insurance contracts are within the scope of IFRS 4. Guarantee contracts in the scope of other standards are outside the scope of IFRS 15. Product guarantees, however, are in scope. Non-monetary transactions – IFRS 15 excludes non-monetary exchanges between entities in the same line of business to facilitate sales to customers or potential customers. For example, IFRS 15 would not apply to a contract between two oil companies that agree to an exchange of oil to fulfil demand from their customers in different specified locations on a timely basis. For contract with elements in multiple standards, entities should apply separation and measurement guidance in other standards. If not, entities should apply revenue guidance on separation and allocation of the transaction price. EXAMPLE - A contract that includes a lease as well as a service element would be bifurcated based on the guidance in the leasing project. Thereafter, the lease element will be accounted for in accordance with the lease standard and the non-lease (service element) would be accounted for under the revenue standard. 44

Revenue – the five step approach
Core principle Revenue recognised to depict transfer of goods or services Step 1 - Identify the contract with the customer Step 2 - Identify the performance obligations in the contract Step 3 - Determine the transaction price The core principle of IFRS 15 is that an entity recognises revenue to depict (describe) the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. The five steps might appear simple, but significant judgement will be needed to apply the underlying principles, and most entities should expect some level of change from current practice. A change of mindset about revenue recognition might be needed to migrate from an evaluation of risk and rewards under existing guidance to an evaluation of transfer of control under the new standard. To apply the guidance, an entity shall: (a) identify the contract with a customer; (b) identify the performance obligations in the contract; (c) determine the transaction price; (d) allocate the transaction price to the performance obligations; and (e) recognise revenue when the entity satisfies each performance obligation. Each of the above steps will be discussed in more detail. This presentation also discusses a number of other topics including licences, contract costs, disclosures and transitions. For more information on these topics and other matters addressed by the standard, see additional materials on Inform. NOTE: This presentation is a summary of IFRS 15 and does not discuss all matters that might need to be considered to implement this standard. Step 4 - Allocate the transaction price Step 5 - Recognise revenue when (or as) a performance obligation is satisfied

Step 1 – Identify the contract
Agreement between two or more parties that creates enforceable rights and obligations No contract unless customer committed, criteria include: it is probable that the entity will collect the consideration to which it will be entitled Combine two or more contracts with the same customer when: negotiated as a package with a single commercial objective; amount of consideration to be paid in one contract depends on the price or performance of the other contract; or goods or services promised in the contracts are a single performance obligation (see step 2) qThe first step is to identify the contract. The definition of a contract emphasises that a contract exists when an agreement between two or more parties creates enforceable obligations between those parties. The concept of enforceable might vary based on governing laws, regulations or practice. Such an agreement does not need to be in writing to be a contract - agreed terms can be written, oral, or evidenced otherwise. The Boards have specified the attributes of a contract that must be present before an entity would apply the proposed revenue requirements. Those attributes are mainly derived from existing requirements: the parties to the contract have approved the contract (in writing, orally or in accordance with other customary business practices) and are committed to perform their respective obligations; the entity can identify each party’s rights regarding the goods or services to be transferred; the entity can identify the payment terms for the goods or services to be transferred; the contract has commercial substance (ie the risk, timing or amount of the entity’s future cash flows is expected to change as a result of the contract); and it is probable that the entity will collect the consideration to which it will be entitled in exchange for the goods or services that will be transferred to the customer. (IFRS 15, paragraph 9) One of the criteria to determine whether a contract exists is about the customer’s ability to pay. IFRS 5, paragraph 9(e) includes the following criterion: it is probable that the entity will collect the consideration to which it will be entitled in exchange for the goods or services that will be transferred to the customer. In evaluating whether collectability of an amount of consideration is probable, an entity shall consider only the customer’s ability and intention to pay that amount of consideration when it is due. The amount of consideration to which the entity will be entitled may be less than the price stated in the contract if the consideration is variable because the entity may offer the customer a price concession (see paragraph 52). This means that there is no contract if there is significant doubt about whether the customer will pay the amount to which the entity is entitled. This is part of step 1. Once a contract exists and revenue is recognised, any subsequent impairment of receivables as result of the customer default is recognised in accordance with the guidance for financial asset impairment. This ‘threshold’ is not different from the probability threshold included in IAS 18 and IAS 11 above. Under current guidance, the evaluation of whether it is probable that economic benefits will flow creates limited issues in practice. That said, the evaluation is now part of step 1 and thus could lead to a different outcome from current practice. This is an example of where management needs to apply a ‘change in mindset’ and the criterion should be considered carefully. Note for US GAAP preparers: IFRS and US GAAP are not converged on this point. The threshold under US GAAP is also set at probable which is generally considered to be higher than the same threshold under IFRS. That is ‘probable’ under US GAAP is generally the equivalent of ‘highly probable’ under IFRS. Both thresholds however are consistent with existing practice under IFRS and US GAAP respectively. Contract combination guidance is likely to be similar to today but may have an impact on more complex arrangements. Entities may want to consider the need to educate sales staff to understand the implications of pricing negotiations of multiple contracts and contract negotiations. EXAMPLE – An entity signs two separate contracts – one for the operation of a manufacturing facility and the other for the maintenance. The contracts are separate but are entered into a same time and performance bonus on operations contract is linked to the performance of maintenance services. It is likely that these two contracts would be combined.

Contract modifications
Modification accounted for when it creates or changes enforceable rights and obligations Accounting depends on whether distinct goods or services added Distinct goods/services added at price that reflects stand-alone selling price New separate contract: Prospective accounting only Remaining goods or services distinct from existing contract, but not at stand-alone selling price Treated as new contract: Prospective accounting but ‘carry forward’ existing position (e.g. contract liabilities) Goods / services not distinct from existing contract Continuation of contract: Cumulative catch up If combination of above Apply the ‘principles’ above A contract modification is approved when the modification creates or changes the enforceable rights and obligations of the parties to the contract. Management will need to determine if a modification, such as a claim or unpriced change order, is approved either in writing, orally, or implied by customary business practice such that it creates enforceable rights and obligations before recognising the related revenue. This assessment might also be difficult for contract claims, as no specific guidance has been provided for the accounting for contract claims. Management will have to evaluate contract claims similar to other contract modifications and apply judgement to determine when a claim is approved. A contract modification is treated as a separate contract if it results in the addition of a separate performance obligation and the price reflects the stand-alone selling price of that performance obligation. Otherwise, a modification is accounted for as an adjustment to the original contract, either prospectively or through a cumulative catch-up adjustment. An entity will account for a modification prospectively if the goods or services in the modification are distinct from those transferred before the modification. An entity will account for a modification through a cumulative catch-up adjustment if the goods or services in the modification are not distinct and are part of a single performance obligation that is only partially satisfied when the contract is modified. A contract modification that only affects the transaction price will be treated like any other contract modification. The change in price will be either accounted for prospectively or on a cumulative catch-up basis, depending on whether the remaining performance obligations are distinct. Management will need to apply judgement in evaluating whether goods or services in the modification are distinct to determine whether a contract modification should be accounted for prospectively or as a cumulative catch-up adjustment. This may be particularly challenging in situations where there are multiple performance obligations in a contract.

Unit of account IFRS 15 is applied to each individual ‘contract’
specific guidance on contract combination ‘step 2’ covers separation of contract into different promises Portfolio approach allowed as practical expedient only if the entity reasonably expects that the effects of applying the model to portfolio versus individual contracts would not differ materially Judgment required to select size and composition of portfolio The model in IFRS 15 is applied to each individual contract. There is a specific guidance on when contracts can be combined as well as specific guidance on how to identify separate performance obligations. When the IASB and FASB were developing the guidance, some entities with a large number of contracts expressed concern about the practical challenges of applying the model on a contract-by-contract basis. This was a particular concern of the telecommunications industry. In response IFRS 15 paragraph 4 acknowledges that entities might use a ‘portfolio approach’ if the entity reasonably expects that application of the revenue recognition model to the portfolio would not differ materially from the application of the revenue recognition model to the individual contracts or performance obligations in that portfolio. It is important to note that in order to achieve this objective, management will need to apply judgment in selecting the size and composition of the portfolio. In the basis of conclusions (paragraph BC69) the boards note ‘that they did not intend for an entity to quantitatively evaluate each outcome and, instead, the entity should be able to take a reasonable approach to determine the portfolios that would be appropriate for its types of contracts.’ [EXAMPLE – A health club enters into contracts with customer to allow access to their health clubs. A non-refundable upfront fee is paid. Some customers will not renew the contract after one month while others will renew for several years. The upfront fee is amortised to revenue over the average life of all customers as management reasonably expect that this approach would result in a revenue recognition profile similar to if each customer contract were accounted for individually – that is the upfront fee was amortised into revenue over the exact period each customer is retained.’ Also, see IFRS 15, illustrative example 22]

Step 2 – Identify the performance obligations
Performance obligations are promises to transfer goods or services to a customer that are: explicit, implicit, or arise from customary business practices Identifying performance obligations is critical to measurement and timing of recognition 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. A performance obligation is the key building block in applying the standard. The transaction price is allocated to each separate performance obligation (step 4) and the recognition criteria are applied individually to each separate performance obligation (step 5). Examples of promised good or services include: Goods produced for sale or purchased for resale Standing ready to provide goods and services Construction services Granting licences Granting options to purchase additional goods and services Performance obligations do not include activities that an entity undertakes to fulfil a contract unless it results in the transfer of a good or service to a customer. For example, administration costs to set up a contract would not be a performance obligation. An entity accounts for each promised good or service as a separate performance obligation if the good or service is distinct. The boards have provided some detailed criteria to determine whether or not the goods or services are distinct. This is covered on the next slide.

Separate performance obligations
Separate performance obligation if: Distinct good or service: customer benefits from good/service on its own or with other resources; and not dependent on/interrelated with other items in the contract E.g., consumer goods E.g., a building, not the individual ‘bricks’ Series of goods/services that are substantially the same, if consistent pattern of transfer to customer over time E.g., a daily cleaning service A good or service might be distinct and thus a separate performance obligation (POs) if two criteria are met: the customer can benefit from the good or service either on its own or together with other resources that are readily available, and the good or service is separable from other promises – that is, it is not dependent on or interrelated with other items in the contract. This would include, for example, most consumer goods, machines that require simple installation, or a mobile phone that can be used with any network. A performance obligation also might be a group of integrated goods or services. Some goods or services could be seen as distinct, but are interrelated or interdependent with other goods or services in the contract. EXAMPLE – Let’s take a contract is to build a house. The customer could benefit from each individual brick, but in the context of the contract each individual brick is interrelated with all of the other bricks. The house is thus accounted for as a single performance obligation. IFRS 15 includes indicators to help decide whether the goods and services in the contract are interdependent or interrelated. This guidance will not only apply to traditional construction contracts but will also be relevant for goods requiring complex installation or customised software solutions. A series of distinct POs might also be accounted for as a single promise if certain criteria are met. IFRS 15 also states that a series of distinct goods or services is a single performance obligation if the promise is transferred over time and the pattern of transfer is consistent. EXAMPLE – A daily cleaning service might be accounted for as one single performance obligation even though each day or even each hour of the service is distinct. This is because the weekly cleaning service are a series of services that are substantially the same and have the same pattern of transfer to the customer (time-based measure of progress). Accounting for this as a single promise simplifies the rest of the model and does not change the pattern of recognition. What does all this mean for current practice? Current IFRSs say very little about arrangements with multiple elements. IAS 18 requires that a single transaction is separated into components to reflect the substance. IFRS 15 does not change this principle. However, it does provide significantly more guidance than on how to separate a contract into its components and clarifies that the separation is evaluated from the perspective of the customer. The key message is that it’s necessary to look carefully at multiple element arrangements and identify each performance obligation before applying the rest of the model.

Step 3 – Estimating the transaction price
Probability weighted or best estimate More specific guidance covering: time value of money constraint on variable consideration non-cash consideration consideration payable to customers: reduction to transaction price unless for a distinct good or service. The transaction price is the amount of consideration to which an entity expects to be entitled in exchange for transferring goods or services. IFRS 15 includes specific guidance dealing with a number of complexities including the effects of variable consideration, whether there is a significant financing component, non-cash consideration and so on. The transaction price is estimated using a best estimate or weighted average approach, whichever best reflects the amount to which the entity expects to be entitled. Non-cash consideration is measured at fair value. If an entity cannot reasonably estimate the fair value of the non-cash consideration, the entity shall measure the consideration indirectly by reference to the stand-alone selling price of the goods or services in exchange for the consideration. (IFRS 15, paragraph 66-67) Consideration paid (or expected to be paid) to a customer (or to a customer’s customer) will reduce the transaction price unless such consideration is a payment for a distinct good or service from the customer. This includes both cash amounts and credit or other items (for example, a coupon or voucher) that can be applied against amounts owed to the entity. An entity will recognise the reduction of revenue when the later of the following occurs: (a) the entity recognises revenue for the transfer of the related goods or services to the customer; and (b) the entity pays or promises to pay the consideration (even if the payment is conditional on a future event). That promise might be implied by the entity’s customary business practices. (IFRS 15, paragraph 72) More guidance on time value of money and variable consideration to follow.

Time value of money Adjust consideration, if there is a significant financing component: optional if period between payment and performance less than year captures advanced payments Consider: difference between consideration and the cash selling price, and Then combined effect of both: time between transfer of goods/services and customer payment the prevailing interest rates in the relevant market Specific examples of when there is no significant financing component e.g. transfer at customers’ discretion (customer loyalty programmes) Some contracts provide the customer or the entity with a significant financing benefit (explicitly or implicitly). This is because performance by an entity and payment by its customer might occur at significantly different times. An entity should adjust the transaction price for the time value of money if the contract includes a significant financing component. There is a practical expedient which allows entities to ignore time value of money if the time between transfer of goods or services and payment is less than one year. The transaction price should be adjusted for the effects of time value of money when the contract contains a significant financing component. Examples are provided to illustrate when an arrangement includes a significant financing component. Management should consider the following factors: (a) the difference, if any, between the amount of promised consideration and the cash selling price of the promised goods or services; and (b) the combined effect of both of the following: (i) the expected length of time between when the entity transfers the promised goods or services to the customer and when the customer pays for those goods or services; and (ii) the prevailing interest rates in the relevant market. (IFRS 15, paragraph 61) There are also specific examples of when there is no a significant financing component as follows: (a) the customer paid for the goods or services in advance and the timing of the transfer of those goods or services is at the discretion of the customer. (b) a substantial amount of the consideration promised by the customer is variable and the amount or timing of that consideration varies on the basis of the occurrence or non-occurrence of a future event that is not substantially within the control of the customer or the entity (for example, if the consideration is a sales-based royalty). (c) the difference between the promised consideration and the cash selling price of the good or service (as described in paragraph 61) arises for reasons other than the provision of finance to either the customer or the entity, and the difference between those amounts is proportional to the reason for the difference. For example, the payment terms might provide the entity or the customer with protection from the other party failing to adequately complete some or all of its obligations under the contract. (IFRS 15, paragraph 62)

Variable consideration
Included in the transaction price only if it is highly probable that there will not be a significant revenue reversal Uncertainty over long period of time Limited experience with similar contracts Susceptible to factors outside control Broad range of outcomes Key effects Must recognise ‘minimum amount’ that is highly probable of not reversing Reassessed at the end of each reporting period The amount that an entity expects to be entitled to can vary for a number of different reasons –discounts, refunds, price concessions and penalties. It can also vary if the amount is contingent on a future event. For example, consideration is variable when the customer has a right to return the goods, there are performance bonuses, or when the consideration is based on a customer’s future sales – this is normally described as a royalty. Variable consideration does not capture uncertainty about whether the customer will pay. See discussion under slide 7. The transaction price is estimated using a best estimate or weighted average approach, whichever best reflects the amount to which the entity expects to be entitled. However, variable consideration is included in the transaction price only if it is highly probable that there will not be a significant revenue reversal. This principle intended to increase the usefulness of information provided– that is, the IASB does not believe it is useful to recognise revenue that might be reversed in the future. IFRS 15 includes a number of indicators to assess whether it is highly probable that there will not be a significant revenue reversal. These include whether the variability is subject to factors outside the entity’s influence, how long until the variability will be resolved, whether the entity has experience with similar types of contracts and whether there is a broad range of possible outcomes. The ‘minimum’ amount that is not subject to significant reversal is recognised and updated at each period. EXAMPLE - An entity sells machinery for CU 100 today plus a bonus of up to 5% based on the machine meeting future efficiency targets. There is evidence at inception that it is highly probable that the bonus will not be less than 3%. Thus, revenue of 103 is recognised as the ‘minimum’. Part way through the contract, it becomes clear that the whole bonus will be received. The remaining bonus of 2% is recorded once it is highly probable that there will not be a significant revenue reversal. What does this mean in practice? It means that some entities that previously deferred revenue recognition until all contingencies were resolved might need to make an estimate and record revenue earlier. Others might find that the ‘highly probable’ threshold is not met, so revenue might be recognised later than under current practice.

Sales and usage-based royalties exception
For licences of intellectual property with a sales or usage based royalty, revenue recognised only when sales/usage occurs ‘highly probable’ constraint does not apply not meant to be applied by analogy The challenges? What is a licence? What is a sales based or usage based royalty? What is intellectual property? There is an exception to the principle that the transaction price only includes variable consideration for which it is highly probable that there will be no significant reversal. IFRS 15 states that for licences of intellectual property with a sales or usage based royalty, revenue is recognised only when sales or usage occurs. The ‘highly probable’ constraint does not apply to these transactions. This exception is not meant to be applied by analogy –it shall only be applied to sales or usage based royalties arising from the sale of a license. However, it will be necessary to determine what is intellectual property, whether a transaction is a licence or a sale of intellectual property, and what is a sale or usage based royalty. These terms are not defined in the standard. EXAMPLE – If a pharmaceutical entity licences IP to a drug manufacturer. The licence is a right to use and thus, control transfers at a point in time (see future discussion). The consideration to which the pharmaceutical entity is entitled is 5% of the sales of the drug manufacturer over the next five years. This consideration is variable and a sales-based royalty. Revenue is only recognised as the sales by the drug manufacturer occur, even if the pharmaceutical entity is able to estimate the amount and it is highly probable that it will not be subject to significant reversal. The rationale for this exception is that applying the general principle might require an entity to report, throughout the life of the contract, significant adjustments to any revenue recognised even though those changes in circumstances are not related to the entity’s performance. Many thought that this would not provide relevant information to users.

Step 4 – Allocating the transaction price
Allocate transaction price to separate performance obligations based on relative standalone selling price: Actual or estimated Residual ‘approach’ if selling price is highly variable or uncertain (change from current practice) Initial allocation and changes to variable consideration might be allocated to a single performance obligation if: Contingent payment relates only to satisfaction of that performance obligation, and Allocation is consistent with the amount the entity expects to be entitled to for that performance obligation Entities that sell multiple goods or services in a single arrangement must allocate the consideration to each of those goods or services. This allocation is based on the price an entity would charge a customer on a stand-alone basis for each good or service. Management should first consider observable data to estimate the stand-alone selling price. An entity will need to estimate the stand-alone selling price if such data does not exist. Some entities will need to determine the stand-alone selling price of goods or services that have not previously required this assessment. If management estimates the selling price because a stand-alone selling price is not available, they should maximise the use of observable inputs. Possible estimation methods include (but are not limited to): Expected cost plus reasonable margin; Assessment of market prices for similar goods or services; and Residual approach, in certain circumstances. A residual approach may be used to calculate the stand-alone selling price when the selling price is highly variable or uncertain for one or more goods or services, regardless of whether that good or service is delivered at the beginning or at the end of the contract. A selling price is highly variable when an entity sells the same good or service to different customers (at or near the same time) for a broad range of prices. A selling price is uncertain when an entity has not yet established a price for a good or service or the good or service has not been sold previously. The residual approach required by IFRS 15 might be different than the residual applied under IFRS today. Applying today’s residual method generally results in the entire discount in an arrangement being allocated to the delivered item. The residual approach in IFRS 15 is used to estimate the stand-alone selling price of the separate good or service, not to determine the amount of consideration allocated to a specific performance obligation. This approach requires that any discounts related to specific performance obligations first be allocated to those performance obligations prior to using the residual approach to determine the stand-alone selling price of the remaining item(s). This could result in a change for some contracts especially when there are more than two performance obligations. Changes to the transaction price, including changes in the estimate of variable consideration, might only affect one performance obligation. Such changes would be allocated to that performance obligation rather than all performance obligations in the arrangement if the following criteria are met: The contingent payment terms relate to a specific performance obligation or outcome from satisfying that performance obligation; and Allocating the contingent amount of consideration entirely to the separate performance obligation is consistent with the amount of consideration that the entity expects to be entitled for that performance obligation. There is additional guidance proposed on when discounts should be allocated.

Step 5 – Recognition of revenue
Key question: Point in time or over time Guidance applies to each separate performance obligation First, evaluate if performance obligation satisfied ‘over time’ recognise revenue based on the pattern of transfer to the customer If not point in time recognise revenue when control transfers IFRS 15 has replaced the separate models for goods, services and construction contracts with a single model that distinguishes between performance obligations satisfied at a point in time and those that are satisfied over time. The recognition framework is applied to each performance obligation separately - that is, each distinct good or service. The recognition model requires that management consider whether a performance obligation is satisfied over time.

When does control transfer over time?
Customer receive benefits as performed/ another would not need to re-perform e.g. cleaning service, shipping Over time Point in time Yes No Create/enhance an asset customer controls e.g. house on customer land Yes No A performance obligation is satisfied over time if one of three criteria is met. Revenue is recognised over time if the customer simultaneously receives and consumes all of the benefits provided as the entity performs. This criterion generally captures traditional service arrangements, for example, a daily cleaning service or a security service, where the customer receives the benefit of a clean or secure office as the service is being performed. Revenue is also recognised over time if performance creates or enhances an asset that the customer controls. This criterion is likely to capture many construction contract arrangements, for example, building a house on customer’s land where the customer controls the work in progress throughout the arrangement. Finally, revenue is recognised over time when performance does not create an asset with an alternative use and the entity has an enforceable right to payment for performance completed to date. This criterion is more complicated and requires consideration of both whether an asset has an alternative use and the nature of any rights to payment. When does an entity’s work ‘not create an asset with alternative use’? The most common example is a typical service where there is no asset created, for example, legal services. It also applies when an asset is created but has no alternative use to the supplier, for example, the construction of a highly customised asset that could not be sold to another customer. The standard is specific that an asset does not have alternative use if it cannot be redirected to another customer either legally or practically. This might happen for example, in connection with a specialised asset that can only be used by a specific customer or an asset where the contract prevents the entity selling to another customer. It is also necessary that the entity has the right to payment for work completed to date if the customer cancels the contract. This does not need to be in the form of an upfront payment or progress payments. It could be in other forms, for example, a cancellation penalty. Judgment will be required when the right to payment relies on a cancellation provision or milestone payments. The key consideration is whether the payment reflects the work performed to date including a reasonable profit margin. IFRS 15 is explicit that recovery of cost incurred to date is not a right to payment. If a performance obligation is satisfied over time, revenue is recognised by measuring the progress towards satisfaction of the performance obligation. This might be determined based on output or input methods, whatever best reflects transfer to the customer. Specific guidance is given on selecting an appropriate method. Does not create asset w/alternative use AND Right to payment for work to date e.g. an ‘audit’ report Yes No

Indicators of control transfer – point in time
If not over time, then point in time…. Recognise revenue when control transfers Indicators that customer has obtained control of a good or service: Right to payment for asset Customer has accepted the asset Legal title to asset If the performance obligation is not satisfied over time, revenue is recognised when control is transferred to the customer. The standard includes indicators of when control has transferred: The entity has a present right to payment for the asset The customer has legal title to the asset unless legal title is retained solely as protection against the customer’s failure to pay The customer physically possesses the asset. The customer is exposed to the significant risks and rewards of ownership of the asset The customer has accepted the asset No one indicator is definitive and all indicators should be considered when determining the point of transfer. The standard also contains specific implementation guidance on repurchase options, consignment, and bill-and-hold arrangements. The timing of revenue recognition could change for some entities compared to current guidance, which is more focused on the transfer of risks and rewards than the transfer of control. The transfer of risks and rewards is an indicator of whether control has transferred under the new standard, but additional indicators will also need to be considered. Physical possession of asset Customer has significant risk and rewards

Licences intellectual property – two types
Right to use Right to use IP as it exists at a point in time Revenue recognised at a point in time Right to access Right to access to IP as it exists through out the licence period Revenue recognised over time Right to access if following criteria met: Licensor performs activities that significantly affect the IP Rights expose customer to effects of those activities Activities are not a separate good / service A licence is the right to use an entity's intellectual property including, among others: software and technology; media and entertainment rights; franchises; patents; trademarks; and copyrights. Given the diversity in the types of licences granted, there is not a ‘one size fits all’ approach to accounting for licences. Entities that license their IP to customers will need to determine whether the licence transfers to the customer over time or at a point in time. IFRS 15 distinguishes between two types of licences: right to use and a right of access. A licence that is transferred over time allows a customer access to the entity’s IP as it exists during the licence period. Licences that are transferred at a point in time allow the customer the right to use the entity’s IP as it exists when the licence is granted. The customer must be able to direct the use of and obtain substantially all of the remaining benefits from the licensed IP to recognise revenue when the licence is granted. IFRS 15 paragraph B58 provides criteria to determine whether a licence is a right of access: the contract requires, or the customer reasonably expects, that the entity will undertake activities that significantly affect the intellectual property to which the customer has rights (see paragraph B59); the rights granted by the licence directly expose the customer to any positive or negative effects of the entity’s activities identified in paragraph B58(a); and those activities do not result in the transfer of a good or a service to the customer as those activities occur. If these criteria are not met, then the licence is a right to use. It is important to remember that this guidance in only applicable to licences that are distinct performance obligations. Licences, for example, that form a component of a tangible good or those that a customer can benefit from only in conjunction with a related service are not likely separate performance obligations. In such cases, the implementation guidance on licences is not applicable and the entity should apply the normal model for determining whether the performance obligation transfers over time or at a point in time. There are a number of examples in IFRS 15 and significant judgment is required in this area. The fact that licences come in a variety of forms and are common in a number of industries makes it challenging to apply a single, principles-based model. Also, it is important to remember that even licences for which the consideration is a sales- or usage-based royalty will be subject to the exception for variable consideration which permits revenue to be recognised only when the sales or usage occur. See slide 15. Judgment required

Contract costs Incremental costs of obtaining a contract required to be capitalised if expected to be recovered (e.g. sales commissions) May be expensed if expected contract period less than 1 year Contract fulfilment costs Look to other guidance first (inventory, PPE) If out of scope of other standards, required to be capitalised if: Relate directly to a contract and Relate to future performance and Expected to be recovered Amortise capitalised costs as control transfers Impairment reversals required An entity recognises an asset for the incremental costs to obtain a contract that management expects to recover. Incremental costs of obtaining a contract are costs the entity would not have incurred if the contract had not been obtained (for example, sales commission). As a practical expedient, an entity is permitted to recognise the incremental cost of obtaining a contract as an expense when incurred if the amortisation period would be less than one year, as a practical expedient. This is a requirement and not an accounting policy choice. This may be different from current practice where many entities expense contract acquisition costs as incurred, allowing for diversity in practice. An entity recognises an asset for costs to fulfil a contract when specific criteria are met. Management will first need to evaluate whether the costs incurred to fulfil a contract are in the scope of other standards (for example, inventory, fixed assets, intangibles). Costs that are in the scope of other standards should be either expensed or capitalised as required by the relevant guidance. If fulfilment costs are not in the scope of another standard, an entity recognises an asset only if the costs relate directly to a contract, will generate or enhance a resource that the entity will use to satisfy future performance obligations, and are expected to be recovered. An asset recognised for the costs to obtain or costs to fulfil a contract should be amortised on a systematic basis as the goods or services to which the assets relate are transferred to the customer. An entity recognises an impairment loss to the extent that the carrying amounts of an asset recognised exceeds (a) the amount of consideration the entity expects to receive for the goods or services less (b) the remaining costs that relate directly to providing those goods or services. Entities that currently expense all contract fulfilment costs as incurred might be affected by the proposed guidance since costs are required to be capitalised when the criteria are met. Fulfilment costs that are likely to be in the scope of this guidance include, among others, set-up costs for service providers and costs incurred in the design phase of construction projects. 60

Disclosure Both qualitative and quantitative information including;
Disaggregated information Contract balances and a description of significant changes Amount of revenue related to remaining performance obligations and an explanation of when revenue is expected to be recognised Significant judgments and changes in judgments Extensive disclosures are required to provide greater insight into both revenue that has been recognised, and revenue that is expected to be recognised in the future from existing contracts. Quantitative and qualitative information will be provided about the significant judgments and changes in those judgments that management made to determine revenue that is recorded. The following are some of the key disclosures required by IFRS 15: Disaggregation of revenue – Disclose disaggregated revenue information in categories that depict how the nature, amount, timing, and uncertainty of revenue and cash flows are affected by economic factors and describe relationship with disaggregated revenue to revenue for reportable segments. Contract balances - Disclose opening and closing balances of contract assets (such as unbilled receivables) and liabilities (such as deferred revenue) and provide a qualitative description of significant changes in these amounts. Costs to obtain or fulfil contracts - Disclose the closing balances of capitalised costs to obtain and fulfil a contract and the amount of amortisation in the period. Disclose the method used to determine amortisation for each reporting period. Remaining performance obligations – The aggregate amount of the transaction price allocated to the performance obligations that are unsatisfied (or partially unsatisfied) and an explanation of when the entity expects to recognise as revenue for such amounts, except when the performance obligation is part of a contract that has an original expected duration of one year or less or the entity recognises revenue when they receive the right to consideration because such right corresponds directly to the performance completed to date. Other qualitative disclosures – Disclose significant judgements and changes in judgements that affect the amount and timing of revenue from contracts with customers. Disclose how management determines the minimum amount of revenue not subject to the variable consideration constraint. Describe the practical expedients, including those for transition, used in an entity's revenue accounting policies. Interim disclosures – IAS 34 will be amended to specifically require specific disclosures about the disaggregation of revenue. Otherwise, the principles of IAS 34 will apply such that only significant changes will need to be disclosed. Implications - The implications are as follows: Disclosure requirements are more extensive than today Entities will need to assess how systems can be leveraged to capture disclosure information More disclosures

Cumulative effect at 1 Jan 2016
Transition Effective date = 1 Jan 2017 2016 2017 Reliefs NEW IFRS 15 NEW IFRS 15 For completed contracts: No adjustment for interims Hindsight allowed for variable consideration Option 1 – Full retrospective (Apply IAS 8) Cumulative effect at 1 Jan 2016 No reliefs Option 2– Prospective OLD GAAP NEW IFRS 15 IFRS 15 permits an entity to apply the final standard either (1) retrospectively with some reliefs or (2) use the following practical expedient to simplify transition Apply the revenue standard to all existing contracts as of the effective date and to contracts entered into subsequently. Recognise the cumulative effect of applying the new standard to existing contracts in the opening balance of retained earnings on the effective date. In the year the standard is initially adopted, disclose the amount by which each financial statement line item is affected in the current year as a result of the entity applying IFRS 15 and an explanation of the significant changes between the reported results under IFRS 15 and previous guidance. An entity that uses this practical expedient must disclose this fact in its financial statements. The availability of this new simplified transition method should significantly reduce transition issues for preparers that choose this option. The requirement to disclose how all of the financial statement line items in the current year have been affected as a result of applying IFRS 15 will allow for comparability in the year of adoption and provides trend information, a key concern of investors. The longer than normal period of time from finalisation of the standard to the effective date is provided because of the pervasiveness of the standard and the importance of reporting revenue. It is intended to ensure there is sufficient time for entities that want to use full retrospective application as well as for those that use the simplified transition method, given the concerns of preparers about the amount of effort adopting the standard might require. Full retrospective application provides more holistic trend information that some entities might prefer to provide to investors, so it was important to provide sufficient time for these preparers to transition. Disclose OLD GAAP Cumulative effect at 1 Jan 2017 It depends.

What else haven’t we covered?
Customer options Warranties Breakage Non-cash consideration Consideration payable to the customer Returns Repurchase options Principal or agent It is important to remember that one of the more significant changes is that IFRS 15 provides a lot more guidance than the existing standards. This presentation has only provided a high level overview into the requirements of IFRS 15. The standard, implementation guidance, illustrative examples and basis for conclusions is available on Inform. More guidance on the implications on industries is also available. Significantly more implementation guidance than existing IFRS!

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ICPAC IFRS seminar Recent Developments and updates January 2015

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ICPAC IFRS seminar Recent Developments and updates January 2015

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