A single Standard (TFRS 15) replaces IAS 18, IAS 11 and the numerous revenue-related Interpretations. It provides a single, principles-based framework that should improve comparability of revenue recognition across entities and industries, also filling in many of the existing gaps in the current TFRS revenue guidance (like multiple element arrangements and guidance on warranties). Finally, the new Standard will close the current disclosure gap.
TFRS 15 is based on a core principle that requires an entity to recognise revenue in a manner that depicts the transfer of goods or services to customers, at an amount that reflects the consideration the entity expects to be entitled to in exchange for those goods or services.
This core principle involves applying the 5 steps outlined in this article:
- step 1: Identify the contract with a customer
- step 2: Identify the performance obligations in the contract (these are the distinct goods or services an entity promises to deliver to its customer)
- step 3: Determine the transaction price
- step 4: Allocate the transaction price to the performance obligations in the contract
- step 5: Recognise revenue when (or as) the entity satisfies a performance obligation.
Step 1 – the first step in TFRS 15 is to identify the contract, which is defined as “an agreement between two or more parties that creates enforceable rights and obligations.” The TFRS 15 model applies only when all of the conditions outlined in this article have been met. In other words, an entity may only proceed to Step 2 if:
- the contract has commercial substance
- the parties have approved the contract (normally in writing but not necessarily)
- it is able to identify
- each party’s rights, and
- the payment terms for the goods and services to be transferred
- it is probable that the entity will collect the consideration
- when evaluating if collection is 'probable', what matters is the customer's ability and intention to pay the amount of consideration when due. This test is not 'failed’ if an entity has a business practice to accept less than the full contract price (for example if the entity typically grants a price concession).
Finally, the entity will continue to assess the facts and circumstances at each reporting date to determine if at any point in time it may proceed to Step 2 in the model.
Step 2 – identifying the performance obligations is a key part of the new TFRS 15 Standard. A performance obligation is a promise in a contract with a customer to transfer either a good or service, or a bundle of goods or services, that is 'distinct'; or a series of distinct goods or services that are substantially the same and have the same pattern of transfer to the customer. A promised good or service is 'distinct' if these two criteria are met:
- the customer can benefit from the good or service either on its own or with other resources readily available to them, AND
- it is separately identifiable from other promises in the contract
TFRS 15 provides a list of factors that indicate when a promise is separately identifiable, which are as follows:
- significant integration services are not provided (for example, the entity is not using the good or service as an input to produce an output called for in the contract)
- the good or service does not significantly modify or customise other promised goods or services in the contract
- the good or service is not highly dependent on, or interrelated with, other promised goods or services in the contract (i.e. the customer could decide not to purchase that element and it would not impact the other goods or services in the contract).
Step 3 – this step is to determine the transaction price under TFRS 15. The “transaction price” is the amount of consideration an entity expects to be entitled to in exchange for the goods or services promised under a contract. This excludes any amounts collected on behalf of third parties (such as sales taxes). An entity must consider the effects of all the factors in this article when determining the transaction price:
- non-cash consideration
- consideration payable to the customer
- time value of money
- variable consideration and
- the constraint on variable consideration
Firstly, TFRS 15 requires the entity to determine its best estimate of variable consideration using one of two methods:
- the expected value method – which might be the appropriate amount in situations where an entity has a large number of similar contracts, OR
- the most likely amount – which mightbe appropriate in situations where a contract has only two possible outcomes (for example, a bonus for early delivery that is either received in full or not at all)
The entity must then evaluate whether the cumulative amount of revenue recognised should be constrained. The objective of the constraint is for an entity to recognise revenue only to the extent that it is highly probable that there will not be a significant reversal when the uncertainty about the variable consideration resolves. At the end of each reporting period, the entity must update this estimate to reflect any changes during the reporting period.
Step 4 – an entity is to allocate the transaction price to each performance obligation in an amount that depicts the amount of consideration to which the entity expects to be entitled in exchange for transferring the promised goods or services to the customer. This objective is achieved by allocating the transaction price to each performance obligation on a relative stand-alone selling price basis at contract inception. Stand-alone selling price is the price at which an entity would sell a promised good or service separately to a customer. The best evidence is the observable selling price charged by the entity to similar customers and in similar circumstances, if available.
If there is no standalone selling price, it shall be estimated using observable inputs. TFRS 15 suggests 3 possible methods to estimate standalone selling price:
- the adjusted market assessment approach (e.g. by looking at competitor pricing and adjusting that information for the entity's particular costs and margins)
- the expected cost plus margin approach
- the residual approach (which involves taking the total transaction price and subtracting the observable stand-alone selling prices for the other goods/services to arrive at an estimated price)
Step 5 – an entity recognises revenue when oras it transfers promised goods or services to a customer. This can occur at a point in time or over time. A “transfer” occurs when the customer obtains control of the good or service. A customer obtains control when it can direct the use of, and obtain substantially all the remaining benefits from it. Transferring control over time requires a special set of conditions to be met.
The 3 conditions for transferring control over time are as follows:
- condition 1 – the customer receives and consumes the benefits as the entity performs. A classic example would be recurring cleaning services.
- condition 2 – the customer controls the asset as it is created or enhanced by the entity’s performance under the contract (an example would be where an entity builds an asset directly on the client's land).
- condition 3, which has 2 parts:
- firstly, the entity’s performance creates or enhances an asset that has no alternative use to the entity (meaning, it can easily redirect the partially completed asset to another customer if it needs to do so).
- secondly – the entity has the right to receive payment for work performed to date (meaning, the entity is entitled to compensation for the work it has performed to date at an amount that approximates the selling price at any point in time throughout the contract).
In summary, control is considered to be transferred over time if one of the conditions outlined in this article exists. If none of the criteria are met, control is transferred at a point in time.
An entity shall recognize revenue when the customer obtains control of the asset. TFRS 15 provides indicators of control, including:
- the entity has a present right to receive payment for the asset
- the customer
- has legal title
- has physical possession of the asset
- has accepted the asset and
- has assumed the significant risks and rewards of owning the asset.