International GAAP® 2019: Generally Accepted Accounting Practice under International Financial Reporting Standards
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met to capitalise costs to fulfil a contract, including the criterion that the costs must
generate or enhance resources of the entity that will be used in satisfying performance
obligations in the future. An entity recognises such costs when control of a good or service
transfers to the customer. As such, the cost of those sales would not generate or enhance
resources of the entity used to satisfy future performance obligations.
Consider the following example: An entity sells goods with a cost of £500,000 for
consideration of £600,000. The goods have a high risk of obsolescence, which may
require the entity to provide price concessions in the future, resulting in variable
consideration (see 6.2.1.A above). The entity constrains the transaction price and
concludes that it is highly probable that £470,000 will not result in a significant revenue
reversal, even though the vendor reasonably expects the contract to ultimately be
profitable. When control transfers, the entity recognises revenue of £470,000 and costs
of £500,000. It would not capitalise the loss of £30,000 because the loss does not
generate or enhance resources of the entity that will be used in satisfying performance
obligations in the future.
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10.3.2.B
Accounting for fulfilment costs incurred prior to the contract
establishment date that are outside the scope of another standard
How should an entity account for fulfilment costs incurred prior to the contract
establishment date that are outside the scope of another standard (e.g. IAS 2)? Entities
sometimes begin activities on a specifically anticipated contract (e.g. before agreeing to
the contract with the customer, before the contract satisfies the criteria to be accounted
for under IFRS 15).
At the March 2015 TRG meeting, the TRG members generally agreed that costs in
respect of pre-contract establishment date activities that relate to a good or service that
will transfer to the customer at or after the contract establishment date may be
capitalised as costs to fulfil a specifically anticipated contract. However, the TRG
members noted that such costs would still need to meet the other criteria in the standard
to be capitalised (e.g. they are expected to be recovered under the anticipated contract).
Subsequent to capitalisation, costs that relate to goods or services that are transferred
to the customer at the contract establishment date would be expensed immediately. Any
remaining capitalised contract costs would be amortised over the period that the related
goods or services are transferred to the customer.142
For requirements on recognising revenue for a performance obligation satisfied over time
when activities are completed before the contract establishment date, see 8.2.4.F above.
10.3.2.C
Learning curve costs
As discussed in the Basis for Conclusions on IFRS 15, ‘a “learning curve” is the effect of
efficiencies realised over time when an entity’s costs of performing a task (or producing
a unit) decline in relation to how many times the entity performs that task (or produces
that unit)’. [IFRS 15.BC312]. Learning curve costs usually consist of materials, labour,
overhead, rework or other costs that must be incurred to complete the contract (but do
not include research and development costs). These types of efficiencies generally can
be predicted at inception of an arrangement and are often considered in the pricing of
a contract between an entity and a customer.
The IASB noted that in situations where learning curve costs are incurred in relation to
a contract with a customer accounted for as a single performance obligation that is
satisfied over time to deliver a specified number of units, IFRS 15 requires an entity to
select a method of progress that depicts the transfer over time of the good or service to
the customer (see 8.2 above). [IFRS 15.BC313]. The IASB further noted that an entity would
probably select a method (such as a costs incurred measure of progress) for these types
of contracts, which would result in the entity recognising more revenue and expense at
the beginning of the contract relative to the end. The IASB clarified that this would be
appropriate as an entity would charge a higher price to a customer only purchasing one
unit (rather than multiple units) in order to recover its learning curve costs.
Conversely, when learning curve costs are incurred for a performance obligation
satisfied at a point in time (rather than over time), an entity needs to assess whether
those costs are within the scope of another standard. The IASB noted that in situations
in which an entity incurs cost to fulfil a contract without also satisfying a performance
obligation over time, the entity is probably creating an asset that is within the scope of
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another standard (e.g. IAS 2). [IFRS 15.BC315]. For example, if within the scope of IAS 2,
the costs of producing the components would accumulate as inventory in accordance
with the requirements in IAS 2. The entity would then recognise revenue when control
of the inventory transfers to the customer. In that situation, no learning curve costs
would be capitalised under IFRS 15 as the costs would be in the scope of another
standard.
If the learning curve costs are not within the scope of another standard, we believe they
generally will not be eligible for capitalisation under IFRS 15 because the costs relate to
past (and not future) performance.
10.3.2.D
Accounting for pre-contract or setup costs
Pre-contract costs are often incurred in anticipation of a contract and will result in no
future benefit unless the contract is obtained. Examples include: (1) engineering, design
or other activities performed on the basis of commitments, or other indications of
interest, by a customer; (2) costs for production equipment and materials relating to
specific anticipated contracts (e.g. costs for the purchase of production equipment,
materials or supplies); and (3) costs incurred to acquire or produce goods in excess of
contractual requirements in anticipation of subsequent orders for the same item.
Pre-contract costs that are incurred in anticipation of a specific contract should first be
evaluated for capitalisation under other standards (e.g. IAS 2, IAS 16, IAS 38). For
example, pre-contract costs incurred to acquire or produce goods in excess of contractual
requirements for an existing contract in anticipation of subsequent orders for the same
item would likely be evaluated under IAS 2. As another example, costs incurred to move
newly acquired equipment to its intended location could be required to be capitalised
under IAS 16 (see 10.3.2.E below). Pre-contract costs incurred in anticipation of a specific
contract that are not addressed under other standards are capitalised under IFRS 15 only
if they meet all of the criteria of a cost incurred to fulfil a contract. Pre-contract costs that
do not meet the criteria under IFRS 15 are expensed as incurred.
10.3.2.E
Capitalisation of mobilisation costs as costs to fulfil a contract with a
customer under IFRS 15
Entities incur mobilisation costs when moving personnel, equipment and supplies to a
pro
ject site either before, at or after inception of a contract with a customer. They are
incurred in order to ensure that the entity is in a position to fulfil its promise(s) in a
contract (or specifically anticipated contract) with a customer, rather than transferring
a good or service to a customer (i.e. they are not a promised good or service).
The assessment of whether mobilisation costs can be capitalised depends on the specific
facts and circumstances and may require significant judgement. Entities need to ensure
that the costs are: (1) within the scope of IFRS 15; and (2) meet all of the criteria in
paragraph 95 of IFRS 15 to be capitalised.
Are the costs within the scope of IFRS 15?
If the asset being moved (e.g. equipment in the scope of IAS 16, inventory in the scope
of IAS 2) is in the scope of another standard, an entity should determine whether the
mobilisation costs are specifically addressed by the other standard. If so, the cost is
outside the scope of IFRS 15.
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If the mobilisation costs are not specifically addressed in another standard, or it is not
clear whether these are within the scope of another standard, an entity further analyses
whether the mobilisation costs are:
• specific to the asset being moved or applicable to more than one customer under
unrelated contracts; in the latter case it is likely that they would not be within the
scope of IFRS 15. For example, moving an asset between different premises of the
entity to better utilise the asset in preparation for future contracts with many
customers; or
• specific to the contract with the customer, in which case, it would be within the
scope of IFRS 15. For example, moving an asset to a remote location at the
customer’s request, which does not provide a benefit to the entity beyond ensuring
it is in a position to fulfil its obligation(s) to the customer under the contract.
Do the costs meet the criteria in paragraph 95 of IFRS 15 to be capitalised?
As discussed above, IFRS 15 includes three criteria that must be met for costs to fulfil a
contract within its scope can be capitalised:
(a) Entities may need to use judgement to determine if costs relate directly to a
contract (or a specific anticipated contract) as required in paragraph 95(a) of
IFRS 15. Indicators that a cost, by function rather than by nature, may be directly
related include, but are not limited to, the following:
• the costs are explicitly or implicitly chargeable to the customer under the contract;
• the costs are incurred only because the entity entered into the contract;
• the contract explicitly or implicitly refers to mobilisation activities (e.g. that
the entity must move equipment to a specific location); or
• the location in which the entity must perform is explicitly or implicitly
specified in the contract and the mobilisation costs are incurred in order for
the entity to fulfil its promise(s) to the customer.
(b) Significant judgement may also be required to determine whether costs generate
or enhance resources of the entity that will be used in satisfying performance
obligations in the future as required by paragraph 95(b) of IFRS 15. This
determination would include (but not be limited to) considering whether:
• the costs are incurred in order for the entity to be able to fulfil the contract;
and
• location is implicitly or explicitly an attribute of the contract.
If a performance obligation (or a portion of a performance obligation that is
satisfied over time) has been satisfied, fulfilment costs related to that performance
obligation (or portion thereof) can no longer be capitalised (see 10.3.2 above for
further discussion).
(c) For costs to meet the ‘expected to be recovered’ criterion as required by
paragraph 95(c) of IFRS 15, they need to be either explicitly reimbursable under
the contract or reflected through the pricing on the contract and recoverable
through margin.
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10.3.2.F Accounting
for
loss leader contracts
Certain contracts may be executed as part of a loss leader strategy in which a good
is sold at a loss with an expectation that future sales contracts will result in higher
sales and/or profits. In determining whether these anticipated contracts should be
part of the accounting for the existing loss leader contract, entities need to refer to
the definition of a contract in IFRS 15, which is based on enforceable rights and
obligations in the existing contract (see 4.1 above). While it may be probable that the
customer will enter into a future contract or the customer may even be economically
compelled, or compelled by regulation to do so, it would not be appropriate to
account for an anticipated contract when there is an absence of enforceable rights
and obligations.
In addition, if the fulfilment costs incurred during satisfying the initial contract are
within the scope of other accounting standards (e.g. IAS 2), the entity must account for
those costs under that relevant standard. Even if the costs are not within the scope of
another standard, the costs would relate to a satisfied or partially satisfied performance
obligation (i.e. the original contract priced at a loss) and, therefore, must be expensed as
incurred. IFRS 15 does not permit an entity to defer fulfilment costs or losses incurred
based on the expectation of profits in a future contract.
10.3.3
Amortisation of capitalised contract costs
Any capitalised contract costs are amortised, with the expense recognised on a
systematic basis that is consistent with the entity’s transfer of the related goods or
services to the customer. [IFRS 15.99].
It is important to note that certain capitalised contract costs relate to multiple goods or
services (e.g. design costs to manufacture multiple distinct goods when design services
are not a separate performance obligation) in a single contract, so the amortisation
period could be the entire contract term). The amortisation period could also extend
beyond a single contract if the capitalised contract costs relate to goods or services being
transferred under multiple contracts or to a specifically anticipated contract (e.g. certain
contract renewals). [IFRS 15.99]. In these situations, the capitalised contract costs would
be amortised over a period that is consistent with the transfer to the customer of the
goods or services to which the asset relates. This can also be thought of as the expected
period of benefit of the asset capitalised. The expected period of benefit may be the
expected customer relationship period, but that is not always the case. To determine
the appropriate amortisation period, an entity will need to evaluate the type of
capitalised contract costs, what the costs relate to and the specific facts and
circumstances of the arrangement. Furthermore, before including estimated renewals
in the period of benefit, an entity should evaluate its history with renewals to conclude
that such an estimate is supportable.
An entity updates the amortisation period when there is a significant change in the
expected timing of transfer to the customer of the goods or ser
vices to which the asset
relates (and accounts for such a change as a change in accounting estimate in accordance
with IAS 8), as illustrated in the following example:
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Example 28.92: Amortisation period
Entity A enters into a three-year contract with a new customer for transaction processing services. To fulfil
the contract, Entity A incurred set-up costs of $60,000, which it capitalised in accordance with
paragraphs 95-98 of IFRS 15 and will amortise over the term of the contract.
At the beginning of the third year, the customer renews the contract for an additional two years. Entity A will
benefit from the initial set-up costs during the additional two-year period. Therefore, it changes the remaining
amortisation period from one year to three years and adjusts the amortisation expense in the period of the
change and future periods in accordance with the requirements in IAS 8 for changes in accounting estimates.
The disclosure requirements of IAS 8 related to changes in estimates are also applicable.
However, under IFRS 15, if Entity A had been in the position to anticipate the contract renewal at contract
inception, Entity A would have amortised the set-up costs over the anticipated term of the contract including
the expected renewal (i.e. five years).
Determining the amortisation period for incremental costs of obtaining a contract with
a customer can be complicated, especially when contract renewals are expected and
the commission rates are not constant throughout the entire life of the contract. When
evaluating whether the amortisation period for a sales commission extends beyond the
original contract period, an entity would also evaluate whether an additional
commission is paid for subsequent renewals. If so, it evaluates whether the renewal
commission is considered ‘commensurate’ with the original commission. See 10.3.3.A
below for further discussion on whether a commission is commensurate. In the Basis
for Conclusions, the IASB explained that amortising the asset over a longer period than
the initial contract would not be appropriate if an entity pays a commission on a contract
renewal that is commensurate with the commission paid on the initial contract. In that
case, the costs of obtaining the initial contract do not relate to the subsequent contract.
[IFRS 15.BC309]. An entity would also need to evaluate the appropriate amortisation period