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A new global standard on revenueWhat this means for the manufacturing industryThe International Accounting Standards Board (IASB) and US FASB have finally issuedtheir new Standard on revenue – IFRS 15 ‘Revenue from Contracts with Customers’(ASU 2014-09 or Topic 606 in the US). This bulletin summarises the new requirementsand what they will mean for the manufacturing industry.Recently issued IFRS 15 ‘Revenue from Contracts with Customers’ replacesIAS 18 ‘Revenue’ and IAS 11 ‘Construction Contracts’ and provides significantnew guidance addressing key questions such as: Can contract acquisition costs be capitalised, or must they be expensed? Under what conditions can customisation or installation services be considered separately from therelated product sale? Can non-refundable upfront fees be recognised in revenue when received? How should incentive payments be accounted for? Can revenue be recognised before delivery has occurred (bill and hold)? How are standard and extended warranties treated? Is it possible to recognise revenue before the customer signs off on acceptance?With IFRS 15’s potential to significantly impact the timing and amount of revenue recognised,manufacturing entities will want to invest time up front to ensure all critical impacts are identified andunderstood well in advance of implementation.
A new global standard on revenueThe new Standard at a glanceThe new Standard replaces IAS 18, IAS 11, and some revenue-related Interpretations.All transactions within its scope will apply a single, control-based model centredaround the following 5-steps:Step 1: Identify the contract with acustomerStep 2: Identify the performanceobligationsStep 3: Determine the transaction priceStep 4: Allocate the transaction price tothe performance obligationsStep 5: Recognise revenue when/asperformance obligations are satisfiedIFRS 15 changes the criteria for determiningwhether revenue is recognised at a point in time orover time. IFRS 15 also has more guidance in manyareas where current IFRSs are lacking such as: multiple-element arrangements non-cash and variable consideration rights of return and other customer options seller repurchase options and agreements warranties principal versus agent (gross versus net) licensing intellectual property breakage non-refundable upfront fees consignment and bill-and-hold arrangements.IFRS 15 will require considerably more disclosureabout revenue including information about contractbalances, remaining performance obligations(backlog), and key judgements made.Transition and effective dateIFRS 15 is effective for annual periods beginning onor after 1 January 2017. Transition is retrospective,subject to some simplifications, including an optionto not restate comparative periods. Early applicationis permitted.Manufacturers deal with a broad range of accounting issues, from accumulating contract costs, measuring progresstowards completion, assessing whether revenue should be recognised over time or at a point in time, and determiningwhether or not promised goods or services represent separate performance obligations, to questions of customeracceptance, performance bonuses, and the impact established practices can have on contractual incoterms and thetransfer of control. IFRS 15 provides additional guidance in many of these areas and as a result, entities will need tocarefully assess their current practices for possible changes to the timing of revenue recognition.2
Manufacturing industryWhat this means for themanufacturing industryIFRS 15 provides additional guidance in a number of areas not currentlyaddressed by existing IFRS guidance. The extent of differences between theold and new guidance will depend (to some extent) on the accounting policiesadopted by manufacturers under existing IFRS where gaps currently exist. Althoughin many cases entities will find the new guidance provides a similar result to the old,an evaluation of the new control-based model and new criteria is necessary as somemanufacturers may find the timing of revenue recognition differs under IFRS 15.Step 1: Identify the contractwith a customerStep 1 of the new model is toidentify the contract. An entity isonly able to proceed to the nextsteps in the model if: the contract has commercialsubstance the parties have approved thecontract each party’s rights and thepayment terms can be clearlyidentified it is probable the entity willcollect the consideration.Criteria not metWhen the above criteria are notmet, revenue cannot be recogniseduntil they either are met, or one ofthe following occurs: performance is complete andall consideration received isnon-refundable the arrangement has beencancelled and anyconsideration received isnon-refundable.Depending on thecircumstances, a contractmodification is accounted foreither as a separate contract,as the termination of an existingcontract and creation of a newcontract, or as part of anexisting contract.Contract modifications/changeordersDepending on the circumstances, acontract modification is accountedfor either as a separate contract, asthe termination of an existingcontract and creation of a newcontract, or as part of an existingcontract. For example, where afixed price manufacturing contractis impacted by a subsequentchange order that is notconsidered to be ‘distinct’ fromthe original performanceobligation, the seller adjusts boththe transaction price and themeasure of progress towardscompletion and adjusts revenue ona ‘cumulative catch-up’ basis.3
A new global standard on revenueStep 2: Identify the performanceobligationsA cornerstone of the IFRS 15model is the fact that revenue isrecognised based on satisfaction of‘distinct’ performance obligationsrather than the contract as a whole.A promised good or service is‘distinct’ if both: the customer benefits from theitem on its own or along withother readily available resources it is ‘separately identifiable’(eg the supplier does not providea significant service integrating,modifying, or customising thevarious performanceobligations).Existing IFRS lacks detailedguidance on ‘multiple elementarrangements’.Entities will be required toevaluate the separability of multipleelements based on the ‘distinct’criteria outlined above which mayA cornerstone of theIFRS 15 model is the factthat revenue is recognisedbased on satisfaction of‘distinct’ performanceobligations rather than thecontract as a whole.4result in more or different elements(referred to as ‘performanceobligations’) being separated (suchas services attached to standardwarranties, material discounts onfuture purchases, and contractrenewal options, among others).The subsequent allocation ofarrangement consideration tothe individual performanceobligations identified is discussedin Step 4 below.WarrantiesExisting IFRS lacks detailedguidance on whether warrantyobligations are separate deliverables.We understand that many entitiestoday account for extended-typewarranties as separate deliverables,with allocated revenue recognisedover the coverage period, whilestandard-type warranties are nottypically regarded as separatedeliverables and are insteadaccounted for by accruing estimatedcosts under IAS 37 ‘Provisions,Contingent Liabilities andContingent Assets’.Existing IFRS lacksdetailed guidance onwhether warrantyobligations are separatedeliverables.We expect that the newguidance will not change currentpractice as under IFRS 15, theentity will account for the warrantyas a separate performanceobligation (and therefore allocate aportion of the contract transactionprice based on relative stand-aloneselling price as discussed in Steps 3and 4) if either: the customer has the option toseparately purchase thewarranty all or part of the warrantyprovides the customer with anadditional service (beyond theassurance that the product willcomply with agreed-uponspecifications).If the conditions above are not met,the entity accounts for the warrantyusing the cost accrual guidance inIAS 37.
Manufacturing industryStep 3: Determine the transactionpriceVariable consideration:performance incentivesVariable pricing arrangements (egawards or incentive payments) ofone type or another are commonin the manufacturing industry.Under IFRS 15, an entityestimates and includes variablepayment amounts in the contractprice using either a probabilityweighted or most likely amountapproach. This amount is furthersubject to a revenue constraintsuch that estimated amounts areincluded in the contract price onlyto the extent that it is highlyprobable that a subsequent changein the estimate will not result in asignificant reversal of cumulativecontract revenue recognised.We do not expect theserequirements to have a significantimpact on the timing of revenuerecognition for incentive paymentsas existing guidance requires suchpayments to be included incontract revenue when both: it is probable that the specifiedperformance standards will bemet or exceeded the amount of the incentivepayment can be measuredreliably.Variable consideration: returnand refund rightsUnder the new guidance, variableconsideration also includes acustomer’s right to return goods. Amanufacturer should record arefund liability for the amount ofrevenue not expected to berecognised and a newly defined asset(a ‘contract asset’) for its right to thereturned goods. The asset ismeasured by reference to the formerUnder IFRS 15, anentity estimates andincludes variable paymentamounts in the contract priceusing either a probabilityweighted or most likelyamount approach, subjectto a constraint.inventory amount, adjusted throughcost of sales for recovery costs andany expected decline in value.This is similar to existingpractice where a liability andrelated asset are also recognisedalthough the asset is typicallypresented on the balance sheetunder inventory, representing anentity’s claim on the goodsexpected to be returned. UnderIFRS 15, the contract asset must bepresented separately frominventory and will need to beassessed for impairment underIFRS 9 ‘Financial Instruments’(or IAS 39 ‘Financial Instruments:Recognition and Measurement’).5
A new global standard on revenueStep 4: Allocate the transaction priceto the performance obligationsCurrently, there is no prescriptiveguidance in IAS 18 on when orhow to allocate revenue tomultiple deliverables within acontract.Under IFRS 15, when amanufacturer determines that acontract contains more than oneperformance obligation, it isrequired to allocate the transactionprice to each performanceobligation based on relativestand-alone selling prices.Stand-alone selling priceIFRS 15 defines stand-aloneselling price as “the price at whichan entity would sell a promisedgood or service separately to acustomer”. The observable sellingprice charged by the entity,if available, provides the bestevidence of stand-alone sellingprice. If not available, the entityestimates the stand-alone sellingprice using all availableinformation, maximising the useof observable inputs. IFRS 15suggests (but does not require)three possible methods: adjustedmarket assessment, expectedcost plus margin or the residualapproach.Step 5: Recognise revenue when/asperformance obligations are satisfiedRecognising revenue over timeor at a point in timeAn entity determines at contractinception whether eachperformance obligation will besatisfied (that is, control will betransferred) over time or at aspecific point in time.An entity determines atcontract inception whethereach performance obligationwill be satisfied (that is,control will be transferred)over time or at a specificpoint in time.6While many manufacturingtype contracts will transfer controlat a point in time, an entity cannotpresume that there is no change andmust carefully assess when controltransfers under the new model todetermine when to recogniserevenue.Broadly, control is transferredover time if any one of thefollowing conditions applies: the customer controls the assetas it is created or enhanced bythe manufacturer’s performanceunder the contract the customer receives andconsumes the benefits of themanufacturer’s performance asit occurs the manufacturer’s performancecreates or enhances an asset thathas no alternative use to theentity, and the manufacturer hasa right to receive payment forwork performed to date.If none of the above conditions arepresent, then control transfers at apoint in time. In these situations amanufacturer recognises revenue byevaluating when the customerobtains control of the asset. IFRS15 provides indicators of controlincluding (but not limited to) thefollowing: the entity has a present right toreceive payment for the asset the customer has legal title tothe asset the customer has physicalpossession of the asset
Manufacturing industry the customer has assumed thesignificant risks and rewards ofowning the asset the customer has accepted theasset.Bill-and-holdIFRS 15 provides additionalguidance to consider whenassessing whether control over thefinished product has beentransferred to the customer andtherefore revenue may berecognised in a ‘bill-and-hold’scenario. Although these criteriadiffer in some respects from theguidance provided in IAS 18, weexpect that in most cases, theaccounting conclusion will bethe same.Manufacturers should alsoremember to consider whethertheir custodial duties from productcompletion to delivery represent adistinct performance obligation towhich a portion of the arrangementconsideration must be allocated(see Step 2).Customer acceptanceIFRS 15 includes applicationguidance related to customeracceptance; therefore, wherecontracts include clauses requiringcustomers to formally accept thedelivered goods or services, anentity must carefully consider howthe guidance in IFRS 15 willimpact their assessment of whethercontrol of the related asset haspassed to the customer. If themanufacturer can objectivelydemonstrate that all agreed-uponspecifications have been met,customer acceptance is a formalitythat does not affect when thecustomer obtains control of thegood or service.Additional considerations withrespect to customer acceptanceunder IFRS 15 include: goods delivered for trial,demonstration, or evaluationpurposes – no revenue isrecognised until the trial periodlapses or the customer formallyacceptsIFRS 15 providesadditional guidance toconsider when assessingwhether control over thefinished product has beentransferred to the customerand therefore revenue maybe recognised in a‘bill-and-hold’ scenario. goods delivered subject to ageneral right of return – themanufacturer applies therequirements for variableconsideration to determine theamount of consideration towhich it expects to be entitled(see Step 3 above).In practice, we expect that in mostcases where customer acceptance isbased on seller-specified orcustomer-specified requirements,the accounting conclusion will bethe same as under IAS 18.Other guidanceContract acquisition costsIFRS 15 requires an entity tocapitalise the incremental costsof obtaining a contract (eg salescommission) when certain criteriaare met. However, as a practicalexpedient, a manufacturer isallowed to expense the costs asincurred if the amortisation periodis one year or less.Under IFRS 15, where amanufacturer expects to recoversuch costs through future revenueunder a contract, the costs areamortised to profit or loss asrevenue is earned and the relatedasset is assessed for impairment inaccordance with IAS 36.Disclosuresamong many other new disclosuresthat manufacturing entities maynot have previously reported. As aresult, systems and processes willneed to capture and summarise theincremental information neededfor manufacturers to comply withthe new requirements.IFRS 15 requires quantitativeand qualitative disclosures thatdisaggregate revenue streams andidentify contract assets/liabilities,7
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acceptance, performance bonuses, and the impact established practices can have on contractual incoterms and the transfer of control. IFRS 15 provides additional guidance in many of these areas and as a result, entities will need to carefully assess their current practices for possible chang
