IFRS 15 provides a comprehensive framework for revenue recognition, but there are certain special cases that require careful attention. These cases arise in situations where the standard’s general principles may not apply straightforwardly or require additional judgment. Understanding these exceptions is crucial for ensuring accurate revenue recognition in complex scenarios, aligning financial reporting with the true substance of transactions.
Let’s explore each of these cases in more detail to understand the necessary steps for proper revenue recognition in such scenarios.
SALE WITH A RIGHT OF RETURN
Under IFRS 15, for sales with a right of return, revenue is recognized net of expected returns. The seller estimates the expected returns based on historical data or other reasonable expectations, and recognizes revenue for the amount expected to be retained.
An entity should recognize:
- Revenue for products that are not expected to be returned.
- A refund liability for products that are expected to be returned.
- An asset for inventory, valued at cost, for products that are expected to be returned.
WARRANTIES
Under IFRS 15, warranties are classified into assurance-type and service-type warranties, with different accounting treatments.
- Assurance-type Warranty: This type guarantees that the product meets specified criteria for a set period. It is not a separate performance obligation but an assurance that the product complies with agreed-upon standards. Revenue for the product is recognized at the point of sale and provision for future warranty costs is also recorded based on expected servicing costs in accordance with IAS 37.
- Service-type Warranty: This warranty provides additional services, such as extended coverage, beyond the standard warranty. It is treated as a separate performance obligation. The revenue for the warranty is allocated based on its standalone price and recognized over the warranty period, usually on a straight-line basis, as the service is provided.
DISCOUNT VOUCHER
A discount voucher is treated as a separate performance obligation if it grants the customer a distinct good or service. This occurs when the voucher:
- Gives the customer the right to future goods or services at a discounted price.
- Is not tied to the original sale, but instead provides a right to a future transaction (such as a future purchase).
When a discount voucher is treated as a separate performance obligation under IFRS 15, the total transaction price is allocated between the goods or services sold and the voucher based on their relative standalone selling prices. The portion allocated to the voucher is recorded as deferred revenue at the time of sale. Revenue for the voucher is then recognized when the customer redeems it for a future purchase. This ensures that the revenue from both the initial sale and the voucher is recognized appropriately as the customer receives the goods or services.
PRINCIPAL VS AGENT
Under IFRS 15, the distinction between principal and agent determines how revenue is recognized. A principal controls the goods or services before transferring them to the customer, bears the risks and rewards, and recognizes gross revenue (the full amount billed to the customer). An agent, on the other hand, arranges for the provision of goods or services by another party without controlling them, and recognizes net revenue (the commission or fee earned).
Key factors in determining this include
- control over the goods,
- inventory risk,
- pricing discretion, and
- responsibility for fulfilling the contract.
For example, a company selling products directly to customers is a principal, while a travel agency earning a commission for selling airline tickets is an agent.
CONSIGNMENT ARRANGEMENT
Under IFRS 15, in a consignment arrangement, the consignor retains control over the goods until they are sold to the end customer, so revenue is recognized only when control is transferred to the customer. The consignor does not recognize revenue upon delivery of goods to the consignee, but instead when the goods are sold by the consignee. The consignee typically earns a commission or fee for facilitating the sale and recognizes revenue based on that. The consignor continues to recognize the goods as inventory until sold.
BILL-AND-HOLD ARRANGEMENT
A bill-and-hold arrangement occurs when a seller bills a customer for goods but retains physical possession of the goods until the customer requests delivery at a later date. Under IFRS 15, revenue recognition for such arrangements depends on whether the seller has transferred control of the goods to the customer, even though the goods are not yet delivered. The seller must ensure the goods are specifically identified, ready for transfer, and the customer has a valid reason for the delay (e.g., storage limitations). Additionally, the customer must assume the risks and rewards of ownership, and the seller must not be able to redirect the goods to another customer. If these conditions are met, revenue can be recognized when the goods are billed, even though delivery is postponed.
REPURCHASE AGREEMENTS
Under a repurchase agreement, an entity sells an asset and either promises or has the option to repurchase it. Repurchase agreements typically take three forms:
- The entity is obligated to repurchase the asset (a forward contract)
- The entity has the right to repurchase the asset (a call option)
- The entity is required to repurchase the asset if the customer requests it (a put option).
In the case of a forward or call option, the customer does not gain control of the asset, even if they have physical possession. The entity will account for the contract as follows:
- As a lease under IFRS 16 if the repurchase price is lower than the original selling price.
- As a financial arrangement if the repurchase price is equal to or greater than the original selling price.
In the case of a put option, an entity must consider whether or not the customer is likely to exercise that option.
- If it is probable that the customer will exercise the put option (i.e., the repurchase price is equal to or greater than the expected market value of the goods at the repurchase date), then the accounting treatment will be the same as for a forward agreement or call option.
- If otherwise, the contract should be accounted for as an outright sale, with a right of return.
CONTRACT COSTS
Contract costs refer to costs incurred by an entity in fulfilling or obtaining a contract with a customer. These costs are categorized into two main types: costs to obtain a contract and costs to fulfill a contract. The treatment of these costs depends on whether they are directly related to the contract and meet specific criteria for capitalization.
- Costs to obtain a contract: These are costs that an entity incurs to secure a contract with a customer, such as sales commissions or legal fees related to contract negotiation. Under IFRS 15, these costs should be capitalized if they are incremental (i.e., the entity would not have incurred them if the contract had not been obtained) and expected to be recovered. Capitalized costs are amortized over the period the related revenue is recognized, which generally reflects the contract’s duration or the transfer of goods or services to the customer.
- Costs to fulfill a contract: These are costs incurred directly to fulfill a contract, such as direct labor, materials, and overhead. They are capitalized if they meet the following criteria:
- They are directly attributable to the contract (e.g., direct labor and materials)
- They are expected to be recovered
- They create or enhance resources that will be used to fulfill future performance obligations under the contract.
Similar to costs incurred to obtain a contract, costs to fulfill a contract are amortized over the period in which related revenue is recognized.
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