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customer finds the same product offered by one of the entity’s competitors for a lower
price during a specified period of time following the sale.
Contracts with customers also may contain ‘most favoured nation’ or ‘most favoured
customer’ clauses under which the entity guarantees that the price of any products sold
to the customer after contract inception will be the lowest price the entity offers to any
other customer. How consideration from such contracts would be accounted for under
IFRS 15 depends on the terms of the clause (i.e. whether the price protection is offered
prospectively or retrospectively).
We believe that clauses that require an entity to prospectively provide a customer with
its best prices on any purchases of products after the execution of a contract have no
effect on the revenue recognised for goods or services already transferred to the
customer (i.e. the consideration would not be accounted for as variable consideration).
However, if an entity is required to retrospectively apply lower prices to previous
purchases made by a customer (or has a past business practice of doing so even if the
written contractual terms would only require prospective application), we believe the
contract includes a form of price protection and the consideration subject to this
provision would be accounted for as variable consideration, as discussed above. We
note that these clauses may be present in arrangements with governmental agencies.
For example, an entity may be required to monitor discounts given to comparable
customers during the contract period and to refund the difference between what was
paid by the government and the price granted to comparable commercial customers.
6.2.1.F
Early payment (or prompt payment) discounts
Contracts with customers may include a discount for early payment (or ‘prompt
payment’ discount) under which the customer can pay less than an invoice’s stated
amount if the payment is made within a certain period of time. For example, a customer
might receive a 2% discount if the payment is made within 15 days of receipt (if payment
is otherwise due within 45 days of receipt). Because the amount of consideration to be
received by the entity would vary depending on whether the customer takes advantage
of the discount, the transaction price would be accounted for as variable consideration.
6.2.2
Estimating variable consideration
An entity is required to estimate an amount of variable consideration by using either of
the following methods, depending on which method the entity expects to better predict
the amount of consideration to which it will be entitled:
• The expected value – ‘the expected value is the sum of probability-weighted
amounts in a range of possible consideration amounts. An expected value may be
an appropriate estimate of the amount of variable consideration if an entity has a
large number of contracts with similar characteristics.’
• The most likely amount – ‘the most likely amount is the single most likely amount
in a range of possible consideration amounts (i.e. the single most likely outcome of
the contract). The most likely amount may be an appropriate estimate of the
amount of variable consideration if the contract has only two possible outcomes’
(e.g. an entity either achieves a performance bonus or does not). [IFRS 15.53].
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An entity applies one method consistently throughout the contract when estimating the
effect of an uncertainty on an amount of variable consideration to which the entity will
be entitled. In addition, an entity is required to consider all the information (historical,
current and forecast) that is reasonably available to the entity and identify a reasonable
number of possible consideration amounts. The standard states that the information an
entity uses to estimate the amount of variable consideration would typically be similar
to the information that the entity’s management uses during the bid-and-proposal
process and in establishing prices for promised goods or services. [IFRS 15.54].
An entity is required to choose between the expected value method and the most likely
amount method based on which method better predicts the amount of consideration to
which it will be entitled. That is, the method selected is not meant to be a ‘free choice’.
Rather, an entity selects the method that is best suited, based on the specific facts and
circumstances of the contract. [IFRS 15.53].
An entity applies the selected method consistently to each type of variable
consideration throughout the contract term and updates the estimated variable
consideration at the end of each reporting period. Once it selects a method, an entity is
required to apply that method consistently for similar types of variable consideration in
similar types of contracts. In the Basis for Conclusions, the Board noted that a contract
may contain different types of variable consideration. [IFRS 15.BC202]. As such, it may be
appropriate for an entity to use different methods (i.e. expected value or most likely
amount) for estimating different types of variable consideration within a single contract.
Entities determine the expected value of variable consideration using the sum of
probability-weighted amounts in a range of possible amounts under the contract. To do
this, an entity identifies the possible outcomes of a contract and the probabilities of
those outcomes. The Board indicated in the Basis for Conclusions that the expected
value method may better predict expected consideration when an entity has a large
number of contracts with similar characteristics. [IFRS 15.BC200]. This method may also
better predict consideration when an entity has a single contract with a large number of
possible outcomes. The IASB clarified that an entity preparing an expected value
calculation is not required to consider all possible outcomes, even if the entity has
extensive data and can identify many possible outcomes. Instead, the IASB noted in the
Basis for Conclusions that, in many cases, a limited number of discrete outcomes and
probabilities can provide a reasonable estimate of the expected value. [IFRS 15.BC201].
Entities determine the most likely amount of variable consideration using the single
most likely amount in a range of possible consideration amounts. The Board indicated
in the Basis for Conclusions that the most likely amount method may be the better
predictor when the entity expects to be entitled to one of two possible amounts.
[IFRS 15.BC200]. For example, a contract in which an entity is entitled to receive all or none
of a specified performance bonus, but not a portion of that bonus.
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The standard requires that when applying either of these methods, an entity considers
all information (historical, current and forecast) that is reasonably available to the entity.
Some stakeholders questioned whether an entity would be applying the portfolio
approach practical expedient in paragraph 4 of IFRS 15 (see 4.3.1 above) when
considering evidence from other, similar contracts to develop an estimate of variable
consideration using an expected value method. The TRG members discussed
this
question and generally agreed that an entity would not be applying the portfolio
approach practical expedient if it used a portfolio of data from its historical experience
with similar customers and/or contracts. The TRG members noted that an entity could
choose to apply the portfolio approach practical expedient, but would not be required
to do so.68 Use of this practical expedient requires an entity to assert that it does not
expect the use of the expedient to differ materially from applying the standard to an
individual contract. The TRG agenda paper noted that using a portfolio of data is not
equivalent to using the portfolio approach practical expedient, so entities that use the
expected value method to estimate variable consideration would not be required to
assert that the outcome from the portfolio is not expected to materially differ from an
assessment of individual contracts.
Upon adoption of IFRS 15, many entities will see significant changes in how they
account for variable consideration on adoption of IFRS 15. This will be an even more
significant change for entities that previously did not attempt to estimate variable
consideration under legacy IFRS and simply recognised such amounts when received
or known with a high degree of certainty (e.g. upon receipt of a report from a customer
detailing the amount of revenue due to the entity).
As an example, the standard may change practice for many entities that sell their
products through distributors or resellers. Before revenue could be recognised,
paragraph 14 of IAS 18 required that the amount of revenue be measured reliably and
that it be probable that the economic benefits associated with the transaction will flow
to the entity. [IAS 18.14]. As a result, when the sales price charged to the distributor or
reseller was not finalised until the product was sold to the end-customer, entities may
have waited until the product was sold to the end-customer to recognise revenue.
Under IFRS 15, waiting until the end-sale has occurred is no longer acceptable if the
only uncertainty is the variability in the pricing. This is because IFRS 15 requires an
entity to estimate the variable consideration (i.e. the end-sales price) based on the
information available, taking into consideration the effect of the constraint on variable
consideration. However, in some cases, the outcomes under IFRS 15 and legacy IFRS
may be similar if a significant portion of the estimated revenue is constrained.
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6.2.2.A Situations
in which an entity would not have to estimate variable
consideration at contract inception under IFRS 15
An entity may not have to estimate variable consideration at the inception of a contract
in the following situations:
• Allocation of variable consideration exception – When the terms of a variable
payment relate to an entity’s efforts to satisfy a specific part of a contract (i.e. one
or more (but not all) performance obligations or distinct goods or services
promised in a series) and allocating the consideration to this specific part is
consistent with the overall allocation objectives of the standard, IFRS 15 requires
variable consideration to be allocated entirely to that specific part of a contract. As
a result, variable consideration would not be estimated for the purpose of
recognising revenue. For example, an entity that provides a series of distinct hotel
management services and receives a variable fee based on a fixed percentage of
rental revenue may be able to allocate the percentage of monthly rental revenue
entirely to the period in which the consideration is earned if the criteria to use this
allocation exception are met. See 7.3 below for further discussion of the variable
consideration allocation exception.
• The ‘right to invoice’ practical expedient – When an entity recognises revenue
over time, the right to invoice practical expedient allows it to recognise revenue as
invoiced if the entity’s right to payment is for an amount that corresponds directly
with the value to the customer of the entity’s performance to date. For example,
an entity may not be required to estimate the variable consideration for a three-
year service contract under which it has a right to invoice the customer a fixed
amount for each hour of service rendered, provided that fixed amount reflects the
value to the customer. See below 8.2.1.A for further discussion of the right to
invoice practical expedient.
• Sales-based and usage-based royalties on licences of intellectual property
recognition constraint – The standard provides explicit application guidance for
recognising consideration from sales-based and usage-based royalties provided in
exchange for licences of intellectual property. The standard states that an entity
recognises sales-based and usage-based royalties as revenue at the later of when:
(1) the subsequent sales or usage occurs; or (2) the performance obligation to which
some, or all, of the sales-based or usage-based royalty has been allocated has been
satisfied (or partially satisfied).
In many cases, using this application guidance results in the same pattern of
revenue recognition as fully constraining the estimate of variable consideration
associated with the future royalty stream. However, in cases where an entity is
required to allocate sales-based or usage-based royalties to separate performance
obligations in a contract, it may need to include expected royalties in its estimate
of the stand-alone selling price of one or more of the performance obligations.
See 9.5 for further discussion about sales-based and usage-based royalties related
to licences of intellectual property.
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6.2.3
Constraining estimates of variable consideration
Before it can include any amount of variable consideration in the transaction price, an
entity must consider whether the amount of variable consideration is required to be
constrained. The Board explained in the Basis for Conclusions that it created this
constraint on variable consideration to address concerns raised by many constituents
that the standard could otherwise require recognition of revenue before there was
sufficient certainty that the amounts recognised would faithfully depict the
consideration to which an entity expects to be entitled in exchange for the goods or
services transferred to a customer. [IFRS 15.BC203].
The IASB explained in the Basis for Conclusions that it did not intend to eliminate the
use of estimates from the revenue recognition standard. Instead, it wanted to make sure
the estimates are robust and result in useful information. [IFRS 15.BC204]. Following this
objective, the Board concluded that it was appropriate to include estimates of variable
consideration in revenue only when an entity has a ‘high degree of confidence’ that
revenue will not be reversed in a subsequent reporting period. Therefore, the constraint
is aimed at preventing the over-recognition of revenue (i.e. the standard focuses on
potential significant reversals of revenue). The standard requires an entity to include in
the transaction price some or all of an amount of variable consideration estimated only
/>
to the extent that it is highly probable that a significant reversal in the amount of
cumulative revenue recognised will not occur when the uncertainty associated with the
variable consideration is subsequently resolved. [IFRS 15.56].
In making this assessment, an entity is required to consider both the likelihood and the
magnitude of the revenue reversal. The standard includes factors that could increase
the likelihood or the magnitude of a revenue reversal. These include, but are not limited
to, any of the following: [IFRS 15.57]
‘(a) the amount of consideration is highly susceptible to factors outside the entity’s
influence. Those factors may include volatility in a market, the judgement or
actions of third parties, weather conditions and a high risk of obsolescence of the
promised good or service.
(b) the uncertainty about the amount of consideration is not expected to be resolved
for a long period of time.
(c) the entity’s experience (or other evidence) with similar types of contracts is limited,
or that experience (or other evidence) has limited predictive value.
(d) the entity has a practice of either offering a broad range of price concessions or
changing the payment terms and conditions of similar contracts in similar
circumstances.
(e) the contract has a large number and broad range of possible consideration amounts.’
The standard does have an exception ‘for consideration in the form of a sales or usage-
based royalty that is promised in exchange for a licence of intellectual property.’
[IFRS 15.58].
To include variable consideration in the estimated transaction price, the entity has to
conclude that it is ‘highly probable’ that a significant revenue reversal will not occur in future
periods once the uncertainty related to the variable consideration is resolved. For the
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purpose of this analysis, the meaning of the term ‘highly probable’ is consistent with the
existing definition in IFRS 5 – Non-current Assets Held for Sale and Discontinued
Operations, i.e. ‘significantly more likely than probable’. [IFRS 5 Appendix A]. For US GAAP
preparers, ASC 606 uses the term ‘probable’ as the confidence threshold for applying the
constraint, rather than ‘highly probable’, which is defined as ‘the future event or events are
International GAAP® 2019: Generally Accepted Accounting Practice under International Financial Reporting Standards Page 417
