Question

How has IFRS 15 affect financial statements of 2020 especially since the pandemic is going on.

Answer 1

As a result of COVID-19 entities are generally expecting to experience significant declines in revenue and decreases in progress of delivery of performance obligations for long-term contracts. These declines in revenue may arise from decreases in volume and changes in variable consideration. This article highlights key aspects of IFRS 15 ’Revenue from Contracts with Customers’, that are expected to be particularly relevant during the COVID-19 pandemic.

It is likely that, as a result of changes in the economic environment, customers will seek to modify contracts; it is also possible that the ability of customers to pay for goods may be called into question prior to delivery occurring.

The entity may choose to transact in this situation notwithstanding the uncertainty. Both trade receivables and contract assets may also be subject to additional credit risk. Finally, onerous contracts may arise as contracts become loss-making through either a decrease in variable consideration or an increase in contract costs.

1. Applying the ‘5 step model’

IFRS 15 is based on a core principle that requires an entity to recognise revenue in a manner that depicts the transfer of goods or services to customers and at an amount that reflects the consideration the entity expects to be entitled to in exchange for those goods or services. Applying this principle involves following the ‘5-step model’.

In the current economic climate, entities may more often enter into contracts with customers with a high risk of non-payment. If collecting the consideration is not probable at contract inception, the normal IFRS 15 guidance does not apply. Instead, the supplier recognises revenue only if/when it collects the consideration and has no remaining obligations to perform. In effect, the entity should cash account for transactions of this nature.

Generally, once a contract meets the conditions to apply the normal IFRS 15 model, any deterioration in the customer’s ability to pay is accounted for under the expected credit loss model set out in IFRS 9 ‘Financial Instruments’. However, if the customer’s ability to pay deteriorates significantly while the contract is still in progress the entity should reassess whether collection is probable.

2. Variable consideration

Variable consideration is any consideration which is not fixed in the contract. Variable consideration changes can potentially impact the assumptions used in measuring revenue from goods or services which have already been delivered, especially where contracts contain:

• Penalties including liquidated damages
• Rights of return
• Performance bonuses (esp. time-based bonuses)
• Volume-based variable pricing
• Price concessions (see note below)
• Unpriced change orders.

For contracts with variable consideration, IFRS 15 requires these factors to be reassessed and if necessary, adjusted at each reporting date for both the best estimate and the (so-called) constraint. The impact of the above will therefore be required to be included in revenue at each reporting date. A significant reversal of revenue is possible as each of the above is remeasured which may, for a contract, result in negative revenue in the current reporting period. Management’s assumptions concerning variable consideration (based on facts and circumstances at the reporting date) will need to be reviewed in the context of COVID-19.

A price concession granted to a customer could be within the scope either of the variable consideration guidance or the contract modification guidance depending on the facts and circumstances.

Example EnginCo, an entity with a 31 December year-end, commenced a contract with CustomerCo in May 2018 involving the production of eight tractors. CustomerCo agreed to pay EnginCo CU1,000 upon delivery of each tractor, with a bonus of CU2,000 if all tractors are delivered by 30 June 2020. At 31 December 2019, six tractors had been delivered, with the seventh nearing completion and the eighth on schedule for delivery 31 May 2020. On 31 March 2020, EnginCo ceased construction due to social distancing rules with seven tractors delivered. Assume no contractual ability to terminate under force majeure. Assume also that point-in-time revenue recognition is appropriate. As of 31 December 2019, EnginCo recognised the following revenue: Delivery of 6 tractors (CU1,000 x 6): CU6,000 Share of bonus (CU2,000 x 6/8): CU1,500 Total revenue recognised: CU7,500 It was appropriate to recognise the share of performance bonus at 31 December 2019 – at that date, it was 'highly probable that a significant reversal in the amount of cumulative revenue will not occur when the uncertainty associated is subsequently resolved' (IFRS 15.56). Note that the hurdle is 'highly probable' not 'certain' – it may have been reasonable, at 31 December 2019, to not anticipate a pandemic. For the half-year ended 30 June 2020, it is apparent that the performance bonus will not be received. As of 31 March 2020, the aggregate amount of revenue to be recognised is: Delivery of 7 tractors (CU1,000 x 7): CU7,000 Share of performance bonus CUnil Total revenue recognised: CU7,000 This results in a required reduction in revenue recognised of CU500 – negative revenue results.