limited to the views in the TRG agenda paper. However, the staff emphasised that it would
not be acceptable for entities to apply any measure of progress in any circumstance. For
example, the FASB staff noted it would not be acceptable to apply multiple measures of
progress to a single performance obligation, such as one measure for fixed consideration
and a different one for variable consideration. The staff also thought it would not be
appropriate for an entity to apply the breakage model in paragraph B46 of IFRS 15 (see 8.10
above) because it is likely that a customer would not have an unexercised right in a licence
arrangement if the entity is providing the customer with access to its intellectual property
over the entire term of the arrangement. [IFRS 15.B46]. Another approach that would not be
appropriate, according to the FASB staff, is one that ignores the royalties recognition
constraint application guidance in paragraph B63 of IFRS 15, which requires revenue to be
recognised at the later of when: (1) the subsequent sale or usage occurs; or (2) the
performance obligation to which some or all of the sales-based or usage-based royalty has
been allocated is satisfied (in whole or in part) (discussed at 9.5 above). [IFRS 15.B63].
9.5.2.F
Application of the royalty recognition constraint for sales-based or
usage-based royalties when an entity does not own the intellectual
property or control the intellectual property as a principal in the
arrangement
We generally believe entities can apply the royalty recognition constraint if their revenue
is based on a sales-based or usage-based royalty from a licence of intellectual property,
but they do not own or control the intellectual property as a principal in the arrangement.
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Consider the following example. University U has intellectual property for its logo.
Company Z, acting as an agent for University U, identifies an apparel company
looking to license University U’s logo to put it on merchandise. University U is paid
a royalty based on sales and usage of its intellectual property (the logo) by the
licensee (the apparel company). Company Z receives a portion of the royalty
earned by University U. Company Z does not control the intellectual property at
any point during the arrangement and its ability to receive consideration from
University U depends on the licensing of University U’s intellectual property. We
believe that application of the royalty recognition constraint may be appropriate in
this example because the royalties earned by University U and, in effect, the
amount Company Z expects to be entitled to receive, are directly tied to the usage
of the intellectual property.
It is important to note that this view applies only to licences of intellectual property
for which some or all of the consideration received by both the licensor and the
agent is in the form of a sales-based or usage-based royalty. Entities cannot
analogise to this view for other situations. Entities should disclose their use of the
royalty recognition constraint because it is likely to effect the amount and timing
of revenue recognised.
9.5.2.G
Can entities recognise sales-based or usage-based royalties before the
sale or usage of the intellectual property occurs if they have historical
information that is highly predictive of future royalty amounts?
Entities cannot recognise sales-based or usage-based royalties before the sale or usage
of the intellectual property occurs even if they have historical information that is highly
predictive of future royalty amounts. In accordance with paragraphs B63-B63B of
IFRS 15, revenue from a sales-based or usage-based royalty promised in exchange for a
licence of intellectual property is recognised at the later of when: (1) the subsequent sale
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 (in whole or in part).
Revenue recognition cannot be accelerated even if an entity has historical information
that is highly predictive of future royalty amounts. That is, the use of the royalty
recognition constraint is not optional.
10
IFRS 15 – OTHER MEASUREMENT AND RECOGNITION
TOPICS
10.1 Warranties
Warranties are commonly included in arrangements to sell goods or services. They
may be explicitly included in the contractual arrangement with a customer or may be
required by law or regulation. In addition, an entity may have established an implicit
policy of providing warranty services to maintain a desired level of satisfaction
among its customers. Whether explicit or implicit, warranty obligations extend an
entity’s obligations beyond the transfer of control of the good or service to the
customer, requiring it to stand ready to perform under the warranty over the life of
the warranty obligation.
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The price of a warranty may be included in the overall purchase price or listed
separately as an optional product. While the standard notes that the nature of a warranty
can vary significantly across industries and contracts, it identifies two types of
warranties: [IFRS 15.B28]
• warranties that promise the customer that the delivered product is as specified in
the contract (called ‘assurance-type warranties’); and
• warranties that provide a service to the customer in addition to assurance that the
delivered product is as specified in the contract (called ‘service-type warranties’).
10.1.1
Determining whether a warranty is an assurance-type or service-type
warranty
If the customer has the option to purchase the warranty separately or if the warranty
provides a service to the customer, beyond fixing defects that existed at the time of sale
paragraph B29 of IFRS 15 states that the entity is providing a service-type warranty.
[IFRS 15.B29]. Otherwise, it is an assurance-type warranty, which provides the customer
with assurance that the product complies with agreed-upon specifications. [IFRS 15.B30].
In some cases, it may be difficult to determine whether a warranty provides a customer
with a service in addition to the assurance that the delivered product is as specified in
the contract. In assessing whether a warranty provides a customer with a service (in
addition to the assurance that the product complies with agreed-upon specifications),
an entity is required to consider factors such as: [IFRS 15.B31]
• whether the warranty is required by law – if the entity is required by law to provide
a warranty, the existence of that law indicates that the promised warranty is not a
performance obligation because such requirements typically exist to protect
customers from the risk of purchasing defective products;
• the length of the warranty coverage period – the longer the coverage period, the
more likely it is that the promised warranty is a performance obligation because it
is more likely to provide a service in addition to the assurance that the product
complies with agreed-upon specifications; and
• the nature of the tasks that the entity promises to perform – if it is necessary for
an
entity to perform specified tasks to provide the assurance that a product complies
with agreed-upon specifications (e.g. a return shipping service for a defective
product), then those tasks likely do not give rise to a performance obligation.
The standard specifies that the following do not give rise to performance obligations:
• ‘a law that requires an entity to pay compensation if its products cause harm or
damage’ – the standard gives the example of a manufacturer that sells products in
a jurisdiction that, by law, holds the manufacturer liable for any damages arising if
a consumer has used a product for its intended purpose; and
• ‘an entity’s promise to indemnify a customer for liabilities and damages arising from
claims of patent, copyright, trademark or other infringement by the entity’s
products’. [IFRS 15.B33].
The following figure illustrates these requirements:
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Figure 28.18:
Determining whether a warranty is an assurance-type or service-
type warranty
Does the customer have the option to
purchase the warranty separately?
Yes
Service-type warranty — The warranty
No
(or part of the warranty)* provides an
additional, distinct service to the customer
and is accounted for as a separate
Does the warranty provide a service to the
performance obligation. See 10.1.2 below.
customer beyond fixing defects that existed
Yes
at the time of sale?
No
Assurance-type warranty
The warranty (or part of the warranty)*
does not provide an additional, distinct
service to the customer (i.e. it is not a
separate performance obligation). The
customer is effectively receiving a
guarantee of quality and the warranty
is accounted for in accordance
with IAS 37. See 10.1.3 below.
Some contracts may include both as assurance-type warranty and a service-type warranty.
* See 10.1.4 below for further discussion
Entities may need to exercise significant judgement when determining whether a
warranty is an assurance-type or service-type warranty. An entity’s evaluation may be
affected by several factors including common warranty practices within its industry and
the entity’s business practices related to warranties. For example, consider an
automotive manufacturer that provides a five-year warranty on a luxury vehicle and a
three-year warranty on a standard vehicle. The manufacturer may conclude that the
longer warranty period is not an additional service because it believes the materials used
to construct the luxury vehicle are of a higher quality and that latent defects would take
longer to appear. In contrast, the manufacturer may also consider the length of the
warranty period and the nature of the services provided under the warranty and
conclude that the five-year warranty period, or some portion of it, is an additional
service that needs to be accounted for as a service-type warranty. The standard
excludes assurance-type warranties, which are accounted for in accordance with
IAS 37. [IFRS 15.B33].
See 6.2.1.B above for a discussion on whether liquidated damages, penalties or
compensation from other similar clauses should be accounted for as variable
consideration or warranty provisions under the standard.
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10.1.1.A
Evaluating whether a product warranty is a service-type warranty (i.e. a
performance obligation) when it is not separately priced
At the March 2015 TRG meeting, the TRG members generally agreed that the evaluation
of whether a warranty provides a service (in addition to the assurance that the product
complies with agreed specifications) requires judgement and depends on the facts and
circumstances. There is no bright line in the standard on what constitutes a service-type
warranty, beyond it being separately priced.
However, paragraph B31 of IFRS 15 includes three factors that would need to be
considered in each evaluation: (1) whether the warranty is required by law; (2) the length
of the warranty coverage; and (3) the nature of the tasks that the entity promises to perform.
Consider the following example from the TRG agenda paper: A luggage company
provides a life-time warranty to repair broken or damaged baggage free of charge.
The luggage company evaluates the three factors and determines that the warranty
is a performance obligation (in addition to the assurance that the product complies
with agreed-upon specifications) because: (1) there is no law that requires the
luggage company to make a promise for the lifetime of the product; (2) the length of
the warranty is for the life of the baggage; and (3) the tasks include both repairs to
baggage that does not meet the promised specifications and repairs for broken or
damaged baggage.
Furthermore, the TRG agenda paper emphasised that entities cannot assume that their
current accounting remains unchanged under IFRS 15. Entities need to evaluate each
type of warranty offered to determine the appropriate accounting treatment.127
10.1.1.B
Should repairs provided outside the warranty period be accounted for as
a service-type warranty?
We believe entities need to carefully consider the factors in paragraph B31 of IFRS 15
(e.g. the nature of the services provided, the length of the implied warranty period) to
determine whether services provided outside the warranty period represent a service-
type warranty. Sometimes, entities provide these services as part of their customary
business practices, in addition to providing assurance-type warranties for specified
periods of time. For example, an equipment manufacturer may give its customers a
standard product warranty that provides assurance that the product complies with
agreed-upon specifications for one year from the date of purchase. However, the entity
may also provide an implied warranty by frequently repairing products for free after the
one-year standard warranty period has ended. See 5.1 above for a discussion of implied
performance obligations.
If the entity determines that the repairs made during the implied warranty period
generally involve defects that existed when the product was sold and the repairs occur
shortly after the assurance warranty period, the entity may conclude that the repairs are
covered by an assurance-type warranty. That is, the term of the assurance-type
warranty may be longer than that stated in the contract. However, all facts need to be
considered to reach a conclusion.
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10.1.1.C
Customer’s return of a defective item in exchange for compensation:
right of return versus assurance-type warranty
Should an entity account for a customer’s return of a defective item in exchange for
compensation (i.e. not for a replacement item) as a right of return or an assurance-type
warranty? We believe that an entity should account for the right to return a defective item
in return for cash (instead of a replacement item) under the right of return application
&nb
sp; guidance in paragraphs B20-B27 of IFRS 15, rather than as an assurance-type warranty.
The Basis for Conclusions states that ‘... the boards decided that an entity should recognise
an assurance-type warranty as a separate liability to replace or repair a defective product’.
[IFRS 15.BC376]. This description of an assurance-type warranty does not include defective
products that are returned for a refund. It only contemplates defective products that are
replaced or repaired. See 6.4 above for a discussion of rights of return.
However, there may be limited circumstances in which the cash paid to a customer for a
defective item would need to be accounted for in accordance with the warranty application
guidance, instead of as a right of return. For example, an entity may pay cash to a customer
as reimbursement for third-party costs incurred to repair a defective item. In this case, the
cash payment to the customer was incurred to fulfil the entity’s warranty obligation. This
assessment requires judgement and depend on the facts and circumstances.
10.1.2 Service-type
warranties
The Board determined that a service-type warranty represents a distinct service and is
a separate performance obligation. [IFRS 15.BC371]. Therefore, using the relative stand-
alone selling price of the warranty, an entity allocates a portion of the transaction price
to the service-type warranty (see 7 above). The entity then recognises the allocated
revenue over the period in which the service-type warranty service is provided.
[IFRS 15.B29, B32]. This is because it is likely that the customer receives and consumes the
benefits of the warranty as the entity performs (i.e. it is likely that the warranty
performance obligation is satisfied over time in accordance with paragraph 35(a) of
IFRS 15, see 8.1.2 above).
Judgement may be required to determine the appropriate pattern of revenue
recognition associated with service-type warranties. For example, an entity may
determine that it provides the warranty service continuously over the warranty period
(i.e. the performance obligation is an obligation to ‘stand ready to perform’ during the
stated warranty period). An entity that makes this determination is likely to recognise
revenue rateably over the warranty period. An entity may also conclude that a different
pattern of recognition is appropriate based on data it has collected about when it
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