IFRS Conference Breakout Session: Revenue recognition

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IFRS ConferenceBreakout SessionRevenue
recognition

• John Smith IASB member
• Henry Rees IASB staff
• The views expressed in this presentation are
  those of the presenters, not those of the IASB

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Overview

• Current model
• Proposed model
• focus on assets and liabilities customer
  contracts
• revenue recognition principle
• measurement
• Next steps

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Whats the problem?

• IFRS US GAAP differ and are both deficient
• Earnings notion in US
• defies definition? c.200 sets of requirements
• Principles in IFRS unclear
• difficult to interpret
• IASs 11 18 inconsistent
• Simple contracts are not the problem!

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Solution to the problem

• Develop general revenue recognition model for
  IFRS US GAAP
• Focus on recognition measurement of assets and
  liabilities
• consistent with existing definitions of revenue
• no overrides (eg earnings, risks and rewards)
• changes in assets liabilities in period
  performance
• Not abandoning earnings using
  asset/liability framework to assess revenue
  earned

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Steps in building an asset/liability model

• What assets and liabilities?
• What should the model account for?
• How do assets and liabilities change over
  contract life?
• When is revenue recognised?
• How should assets and liabilities be measured?
• How much revenue is recognised?

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Step 1 Which assets and liabilities

• Contract asset or contract liability
• Not assets to be transferred to customer under
  contract (eg inventory)

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Step 2 How does the contract asset or liability
change
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Revenue recognition principle

• Current definitions of revenue
• US increase in assets, settlement of
  liabilities
• IFRS inflows of economic benefits resulting in
  increase in equity
• In contract model, revenue recognised when
  contract asset increases or contract liability
  decreases
• Revenue recognised in two situations
• when contract obtained if contract asset
  recognised
• when a performance obligation is satisfied

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When are performance obligations satisfied?

• Performance obligation is a promise in contract
  to transfer economic resources to a customer
• PO satisfied when resources transfer to customer
• transfer based on when the customer obtains the
  enforceable right or other means of limiting
  access to the resource
• transfer not based on transfer of risks and
  rewards
• Revenue reflects transfer (ie delivery) to
  customer not activity of entity

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When are performance obligations satisfied?

• Good
• when enforceable rights to good transfer to
  customer
• eg contract for sale of widget typically on
  delivery

• Service
• when service or access to service is provided
• eg contract to provide a warranty as service of
  warranty coverage provided

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Issue When do resources transfer?

• When does customer have the enforceable right to
  the paint on delivery or as painting
  progresses?
• contract contain 2 POs or effectively 1 PO?
• Rebuttable presumption goods used to satisfy
  another PO not transferred until the goods are
  used in satisfying that later PO

• Customer contracts with PainterCo for its house
  to be painted. PainterCo delivers paint to
  customer 31 March. Painting undertaken in April.

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Issue Distinguishing goods services

• Is contract for a good or for the services and
  materials that produce the good?
• Contract for a house or for construction services
  and materials?
• Depends on when economic resources transfer
• does customer have rights to part complete house
  or only completed house

• Homebuilder contracts with customer to construct
  a house in accordance with the features and
  designs chosen by customer.

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Step 3 How should contract asset/liability be
measured?

• Determines how contract initially reported
  subsequently amount of revenue recognised
• Key issue how to measure performance
  obligations
• Two possible measurement approaches considered

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Two approaches for measuring performance
obligations

• Transaction price
• Measure POs at transaction price (ie customer
  consideration)
• assumes transaction price only for goods/services
  yet to be provided

• Exit price
• Measure POs at exit price
• price third party would charge to assume
  remaining obligations
• Price to fulfil remaining POs
• excludes direct/indirect costs of obtaining a
  contract

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Boards preliminary view

• POs initially measured at transaction price
• Price in exchange for promised goods services
• Observable verifiable price
• Concerns about pattern of revenue recognition
  with exit price measurement revenue can be
  recognised at contract inception
• Exit price relies on complete identification and
  appropriate measurement of POs
• unlikely to be observable exit prices, so any
  errors in measurement included in revenue at
  inception

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Applying transaction price approach to
multiple-element contract

• Transaction price is for a bundle of performance
  obligations
• Allocate portion of transaction price to each PO
  on basis of standalone sales price of underlying
  good/service
• estimate standalone price if not observable
• Increase in contract asset or decrease in
  contract liability as each PO satisfied
  recognised as revenue

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Example

• Initial allocation

ComputerCo and customer contract for delivery of
computer hardware for 10,000 on 31 Dec 2007.
Contract includes 1-year service contract.
Hardware service not sold separately. Hardware
delivered 2 Jan when customer pays. ComputerCo
incurs 500 direct incremental contract
origination costs.
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Example (contd)

• Contract position and revenue
• Note also 500 expense recognised 31 Dec.

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Remeasurement of performance obligations

• Update or lock in initial measurement?
• In some cases locked in measure not a faithful
  representation of the POs
• ignores change in outflow of resources required
  to satisfy the POs
• When to remeasure?
• PO is onerous, eg costs to fulfil gt amount
  allocated to PO
• longer term contracts with uncertainty
• How to remeasure?
• exit price if observable
• update expected cash outflows, lock in margin
• No preliminary view

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Next steps

• Discussion paper late Q3
• We want to know
• Is contract-based model the appropriate model?
• are there industries in which recognising revenue
  as POs satisfied would not reflect performance?
• How should performance obligations be measured?
• Under what circumstances ( how) should POs be
  remeasured?