International GAAP® 2019: Generally Accepted Accounting Practice under International Financial Reporting Standards

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  progress – that is, a time-based measure of progress).

  At contract inception, the entity considers the requirements in paragraphs 50–54 of IFRS 15 on estimating

  variable consideration and the requirements in paragraphs 56–58 of IFRS 15 on constraining estimates of

  variable consideration, including the factors in paragraph 57 of IFRS 15. The entity observes that the promised

  consideration is dependent on the market and thus is highly susceptible to factors outside the entity’s influence.

  In addition, the incentive fee has a large number and a broad range of possible consideration amounts. The entity

  also observes that although it has experience with similar contracts, that experience is of little predictive value

  in determining the future performance of the market. Therefore, at contract inception, the entity cannot conclude

  that it is highly probable that a significant reversal in the cumulative amount of revenue recognised would not

  occur if the entity included its estimate of the management fee or the incentive fee in the transaction price.

  At each reporting date, the entity updates its estimate of the transaction price. Consequently, at the end of

  each quarter, the entity concludes that it can include in the transaction price the actual amount of the quarterly

  management fee because the uncertainty is resolved. However, the entity concludes that it cannot include its

  estimate of the incentive fee in the transaction price at those dates. This is because there has not been a change

  in its assessment from contract inception – the variability of the fee based on the market index indicates that

  the entity cannot conclude that it is highly probable that a significant reversal in the cumulative amount of

  revenue recognised would not occur if the entity included its estimate of the incentive fee in the transaction

  price. At 31 March 20X8, the client’s assets under management are ¥100 million. Therefore, the resulting

  quarterly management fee and the transaction price is ¥2 million.

  At the end of each quarter, the entity allocates the quarterly management fee to the distinct services provided during

  the quarter in accordance with paragraphs 84(b) and 85 of IFRS 15. This is because the fee relates specifically to

  the entity’s efforts to transfer the services for that quarter, which are distinct from the services provided in other

  quarters, and the resulting allocation will be consistent with the allocation objective in paragraph 73 of IFRS 15.

  Consequently, the entity recognises ¥2 million as revenue for the quarter ended 31 March 20X8.

  See 7 below for a discussion of allocating the transaction price.

  Applying the constraint is a new way of evaluating variable consideration and it applies

  to all types of variable consideration that must be estimated in all transactions.

  For a number of entities, the treatment of variable consideration under the standard

  could represent a significant change from previous practice.

  Under legacy IFRS, preparers often deferred measurement of variable consideration

  until revenue was reliably measurable, which could be when the uncertainty is removed

  or when payment is received.

  Furthermore, legacy IFRS permitted recognition of contingent consideration, but only

  if it was probable that the economic benefits associated with the transaction would flow

  to the entity and the amount of revenue could be reliably measured. [IAS 18.14, 18, IAS 11.11].

  Some entities, therefore, deferred recognition until the contingency was resolved.

  Revenue

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  Some entities had looked to US GAAP to develop their accounting policies in this area.

  Legacy US GAAP had various requirements and thresholds for recognising variable

  consideration. As a result, the accounting treatment varied depending on which US GAAP

  standard was applied to a transaction. For example, the revenue recognition requirements

  in ASC 605-25 limited the recognition of contingent consideration when the amounts

  depended on the future performance of the entity and SAB Topic 13 required that the

  transaction price be fixed or determinable in order to recognise revenue.71

  In contrast, the constraint on variable consideration in the standard is an entirely new

  way of evaluating variable consideration and is applicable to all types of variable

  consideration in all transactions. As a result, depending on the requirements entities

  were previously applying, some entities may recognise revenue sooner under the

  standard, while others may recognise revenue later.

  6.2.3.A Applying

  the

  constraint on variable consideration: contract level versus

  performance obligation level

  At the January 2015 TRG meeting, the TRG members were asked whether an entity was

  required to apply the constraint on variable consideration at the contract level or at the

  performance obligation level.

  The TRG members generally agreed that the constraint would be applied at the contract

  level and not at the performance obligation level. That is, the significance assessment of

  the potential revenue reversal would consider the total transaction price of the contract

  (and not the portion of transaction price allocated to a performance obligation).72

  Stakeholders raised this question because the standard refers to ‘cumulative revenue

  recognised’ without specifying the level at which this assessment would be performed

  (i.e. at the contract level or performance obligation level). Furthermore, the Basis for

  Conclusions could be read to indicate that the assessment should occur in relation to

  the cumulative revenue recognised for a performance obligation. [IFRS 15.BC217].

  6.2.3.B

  Would an entity be required to follow a two-step approach to estimate

  variable consideration?

  The Board noted in the Basis for Conclusions that an entity is not required to strictly

  follow a two-step process (i.e. first estimate the variable consideration and then apply

  the constraint to that estimate) if its internal processes incorporate the principles of both

  steps in a single step. [IFRS 15.BC215]. For example, if an entity already has a single process

  to estimate expected returns when calculating revenue from the sale of goods in a

  manner consistent with the objectives of applying the constraint, the entity would not

  need to estimate the transaction price and then separately apply the constraint.

  A TRG agenda paper also noted that applying the expected value method, which requires

  an entity to consider probability-weighted amounts, may sometimes achieve the objective

  of the constraint on variable consideration.73 That is, in developing its estimate of the

  transaction price in accordance with the expected value method, an entity reduces the

  probability of a revenue reversal and may not need to further constrain its estimate of

  variable consideration. However, to meet the objective of the constraint, the entity’s

  estimated transaction price would need to incorporate its expectations of the possible

  consideration amounts (e.g. products not expected to be returned) at a level at which it is

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  highly probable that including the estimate of variable consideration in the transaction price

  would not result in a significant revenue reversal (e.g. such that it is highly probable that

  additional returns above the estimated amount would not result in a significant revers
al).

  6.2.4

  Reassessment of variable consideration

  The standard specifies that at the end of each reporting period, an entity must ‘update

  the estimated transaction price (including updating its assessment of whether an

  estimate of variable consideration is constrained) to represent faithfully the

  circumstances present at the end of the reporting period and the changes in

  circumstances during the reporting period.’ The entity accounts for changes in the

  transaction price in accordance with paragraphs 87–90 of IFRS 15. [IFRS 15.59].

  When a contract includes variable consideration, an entity needs to update its estimate

  of the transaction price throughout the term of the contract to depict conditions that

  exist at the end of each reporting period. This involves updating the estimate of the

  variable consideration (including any amounts that are constrained) to reflect an entity’s

  revised expectations about the amount of consideration to which it expects to be

  entitled, considering uncertainties that are resolved or new information that is gained

  about remaining uncertainties. As discussed in 6.2.3 above, conclusions about amounts

  that may result in a significant revenue reversal may change as an entity satisfies a

  performance obligation. See 7.5 below for a discussion of allocating changes in the

  transaction price after contract inception.

  6.3 Refund

  liabilities

  An entity may receive consideration that it will need to refund to the customer in the

  future because the consideration is not an amount to which the entity ultimately will be

  entitled under the contract. If an entity expects to refund some or all of that consideration,

  the amounts received (or receivable) need to be recorded as refund liabilities.

  A refund liability is measured ‘at the amount of consideration received (or receivable)

  for which the entity does not expect to be entitled (i.e. amounts not included in the

  transaction price).’ An entity is required to update its estimates of refund liabilities (and

  the corresponding change in the transaction price) at the end of each reporting period.

  The standard also notes that, if a refund liability relates to a sale with a right of return,

  an entity applies the specific application guidance for sales with a right of return.

  [IFRS 15.55].

  While the most common form of refund liabilities may be related to sales with a right

  of return, the refund liability requirements also apply when an entity expects that it

  will need to refund consideration received due to poor customer satisfaction with a

  service provided (i.e. there was no good delivered or returned) and/or if an entity

  expects to have to provide retrospective price reductions to a customer (e.g. if a

  customer reaches a certain threshold of purchases, the unit price is retrospectively

  adjusted). For a discussion of the accounting for sales with a right of return, see 6.4

  below. We address the question of whether a refund liability is a contract liability

  (and, therefore, subject to the presentation and disclosure requirements of a contract

  liability) at 11.1.1.D below.

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  6.4

  Rights of return

  The standard notes that, in some contracts, an entity may transfer control of a product

  to a customer, but grant the customer the right to return. In return, the customer may

  receive a full or partial refund of any consideration paid; a credit that can be applied

  against amounts owed, or that will be owed, to the entity; another product in exchange;

  or any combination thereof. [IFRS 15.B20]. As discussed at 5.7 above, the standard states

  that a right of return does not represent a separate performance obligation. [IFRS 15.B22].

  Instead, a right of return affects the transaction price and the amount of revenue an

  entity can recognise for satisfied performance obligations. In other words, rights of

  return create variability in the transaction price.

  Under IFRS 15, rights of return do not include exchanges by customers of one product

  for another of the same type, quality, condition and price (e.g. one colour or size for

  another). [IFRS 15.B26]. Nor do rights of return include situations where a customer may

  return a defective product in exchange for a functioning product; these are, instead,

  evaluated in accordance with the warranties application guidance on warranties

  (see 10.1 below). [IFRS 15.B27].

  ‘To account for the transfer of products with a right of return (and for some services

  that are provided subject to a refund), an entity shall recognise all of the following:

  (a) revenue for the transferred products in the amount of consideration to which the

  entity expects to be entitled (therefore, revenue would not be recognised for the

  products expected to be returned);

  (b) a refund liability; and

  (c) an asset (and corresponding adjustment to cost of sales) for its right to recover

  products from customers on settling the refund liability.’ [IFRS 15.B21].

  Under the standard, an entity estimates the transaction price and applies the constraint to

  the estimated transaction price to determine the amount of consideration to which the

  entity expects to be entitled. In doing so, it considers the products expected to be returned

  in order to determine the amount to which the entity expects to be entitled (excluding

  consideration for the products expected to be returned). The entity recognises revenue

  based on the amount to which it expects to be entitled through to the end of the return

  period (considering expected product returns). An entity does not recognise the portion

  of the revenue subject to the constraint until the amount is no longer constrained, which

  could be at the end of the return period. The entity recognises the amount received or

  receivable that is expected to be returned as a refund liability, representing its obligation

  to return the customer’s consideration (see 6.3 above). Subsequently, at the end of each

  reporting period, the entity updates its assessment of amounts for which it expects to be

  entitled and make a corresponding change to the transaction price (and, therefore, to the

  amount of revenue recognised). [IFRS 15.B23].

  As part of updating its estimate, an entity must update its assessment of expected returns

  and the related refund liabilities. [IFRS 15.B24]. This remeasurement is performed at the end

  of each reporting period and reflects any changes in assumptions about expected returns.

  Any adjustments made to the estimate result in a corresponding adjustment to amounts

  recognised as revenue for the satisfied performance obligations (e.g. if the entity expects

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  the number of returns to be lower than originally estimated, it would have to increase the

  amount of revenue recognised and decrease the refund liability). [IFRS 15.B23, B24].

  Finally, when customers exercise their rights of return, the entity may receive the

  returned product in a saleable or repairable condition. Under the standard, at the time of

  the initial sale (i.e. when recognition of revenue is deferred due to the anticipated return),

  the entity recognises a return asset (and adjusts the cost of goods sold) for its right to

  recover the goods returned by the customer. [IFRS 15.B21]. The enti
ty initially measures this

  asset at the former carrying amount of the inventory, less any expected costs to recover

  the goods, including any potential decreases in the value of the returned goods. Along with

  remeasuring the refund liability at the end of each reporting period, the entity updates the

  measurement of the asset recorded for any revisions to its expected level of returns, as

  well as any additional decreases in the value of the returned products. [IFRS 15.B25].

  IFRS 15 requires the carrying value of the return asset to be presented separately from

  inventory and to be subject to impairment testing on its own, separately from inventory

  on hand. The standard also requires the refund liability to be presented separately from

  the corresponding asset (on a gross basis, rather than a net basis). [IFRS 15.B25].

  The standard provides the following example of rights of return. [IFRS 15.IE110-IE115].

  Example 28.42: Right of return

  An entity enters into 100 contracts with customers. Each contract includes the sale of one product for CU100

  (100 total products × CU100 = CU10,000 total consideration). Cash is received when control of a product

  transfers. The entity’s customary business practice is to allow a customer to return any unused product

  within 30 days and receive a full refund. The entity’s cost of each product is CU60.

  The entity applies the requirements in IFRS 15 to the portfolio of 100 contracts because it reasonably expects that,

  in accordance with paragraph 4, the effects on the financial statements from applying these requirements to the

  portfolio would not differ materially from applying the requirements to the individual contracts within the portfolio.

  Because the contract allows a customer to return the products, the consideration received from the customer

  is variable. To estimate the variable consideration to which the entity will be entitled, the entity decides to

  use the expected value method (see paragraph 53(a) of IFRS 15) because it is the method that the entity

  expects to better predict the amount of consideration to which it will be entitled. Using the expected value

  method, the entity estimates that 97 products will not be returned.

  The entity also considers the requirements in paragraphs 56-58 of IFRS 15 on constraining estimates of