Question

Background Getswift Ltd (“Getswift”) is a newly listed company involved that provides a software distribution solution. The board has heard that a new revenue standard (IFRS 15) has been issued and as none of the board has a financial background, they are unsure what it means for them. They have heard though that the impact of the new standard on most businesses will be significant. As a result, they have engaged your consultancy firm to provide them with a letter of advice to explain the impact that the new standard will have on the income recognition of Getswift. REQUIRED You are required to provide a letter of advice to the board of Getswift explaining the requirements of the new revenue standard with a focus on how it will impact their particular revenue recognition. In addition, you are required to write a short transmittal email enclosing the letter of advice. Important Additional Information You are expected to research this company and gain an understanding of what they do so that you understand the nature of their revenue. The 2016/2017 annual report should be used as a starting point but you are expected to go further than this. This assessment requires much more than copying the requirements from the new standard and those students that just do this will be marked poorly. The majority of the marks will be for the application of the standard to Getswift’s revenue sources. Therefore, you need an understanding of what they do. The language of your letter of advice should be tailored to the audience and their level of financial literacy. Required Format and additional requirements You are required to produce: 1. A transmittal email to the Board 2. A Letter of Advice, addressed to the Board, which includes references

Answer 1

A) Transmittal e-mail to the Board of Background Getswift Ltd

Background Getswift Ltd (“Getswift”)

Dear Board Member

As …Our Name……we are pleased to submit for your consideration the enclosed" letter of advice" in response to your …letter or contract No.… On requirement of IFRS 15 to your orgnisation. We prepare a report on requirement of IFRS 15 in your organisation, we consider the all factor as well as all statutory requirement of IFRS 15 in a report which is enclosed with this letter.

We look forward to hearing from you and answering any questions that you might have. Please feel free to contact us …contact No………… or by email at …Email id

Sincerely.

[Firm or consultancy Name]

B) A Letter of Advice,

An Overview of IFRS 15

International Financial Standard 15 Revenue from contract with customer, promulgated by the international accounting standard board, provide guidance on accounting for revenue from contracts with customer, Public companies must adopt the new revenue standard in 2018. Almost every company will be affected to some extent by the new guidance, though the effect will vary depending on industry and current accounting practices.

Background Getswift Ltd (“Getswift”) is a software distribution solution company and Revenue recognition within the software industry has historically been highly complex with much industry-specific guidance. The new revenue standards replace industry-specific guidance with a single revenue recognition model.

The Effective Date of reporting

The Effective Date of reporting varies for companies reporting under each framework.

• Under US GAAP, public business entities must apply ASC 606 for annual reporting periods (including interim periods therein) beginning after December 15, 2017.
• Entities that are not public business entities reporting under US GAAP are required to apply ASC 606 for annual periods beginning after December 15, 2018.
• The standard permits early adoption for all companies for annual reporting periods beginning after December 15, 2016
• Companies that report under IFRS are required to apply IFRS 15 for annual reporting periods beginning on or after January 1, 2018
• Early adoption is also permitted.

IFRS 15 provide guideline for recognise revenue from contracts with customer.

This is a five step model for recognise the revenue.

Step 1:

1. Identify the contract

• A contract may be written, oral, or implied by the vendor’s customary business practices.
• Generally, any agreement with a customer that creates legally enforceable rights and obligations meets the definition of a contract under the new guidance.
• Software companies should consider any side agreements, whether verbal or written, as these may create enforceable rights and obligations and have implications for revenue recognition.
• In the software industry, a contract may take the form of formal signed contracts, purchase orders, electronic communications, or, in the case of consumer products, sales receipts. Master agreements often define all of the basic terms and conditions for transactions between the parties.
• A second communication in the form of a purchase order or electronic request that specifies the software products, quantities, and requested delivery dates often supplements the master agreement. In these cases, the master agreement and the additional communication constitute the contract with the customer because the quantities specified create enforceable rights and obligations between the two parties.
• (2) Collectability:
• As part of identifying the contract, companies are required to assess whether collection of the consideration is probable,
• which is generally interpreted as a 75-80% likelihood in US GAAP and a greater than 50% likelihood in IFRS.
• This assessment is made after considering any price concessions expected to be provided to the customer.
• In other words, price concessions are variable consideration (which affect the transaction price), rather than a factor to consider in assessing collectability.
• Further, the FASB clarified in an amendment of ASC 606 that companies should consider, as part of the collectability assessment, their ability to mitigate their exposure to credit risk, for example by ceasing to provide goods or services in the event of non-payment.
• The IASB did not amend IFRS 15 on this point, but did include additional discussion regarding credit risk in the Basis for Conclusions of their amendments to IFRS 15.

Expected impact

• Today, software companies that customarily obtain a written contract from their customers are precluded from recognizing revenue under US GAAP until there is a written, final contract signed by both the company and customer.
• The assessment of whether a contract with a customer exists under the new revenue guidance is less driven by the form of the arrangement, but rather by whether an agreement between the parties (either written, oral, or implied) creates legally enforceable rights and obligations between them.
• The purpose of the collectability assessment under the new guidance is to determine whether there is a substantive contract between the company and the customer.
• This differs from current guidance in which collectability is a constraint on revenue recognition.
• We expect the application of the collectability assessment to be similar under ASC 606 and IFRS 15, with the exception of the limited situations impacted by the difference in the definition of “probable”.
• The new guidance also eliminates the cash-basis method of revenue recognition that is often applied today if collectability is not reasonably assured (US GAAP) or probable (IFRS).
• Companies that conclude collection is not probable under the new guidance cannot recognize revenue for cash received if (1) they have not collected substantially all of the consideration and (2) continue to transfer goods or services to the customer.

In Case of Contract modifications:

• It is common in the software industry to change the scope or price of the contract.
• any change to an existing contract is a modification per the guidance when the parties to the contract approve the modification either in writing, orally, or based on the parties’ customary business practices.
• A new contract entered into with an existing customer could also be viewed as the modification of an existing contract, depending on the circumstances.
• In determining whether a contract has been modified, among other factors, company might consider whether:
• the terms and conditions of the new contract were negotiated separately from the original contract, and
• the additional goods or services were subject to a competitive bid process, and
• any discount to the standalone selling price of the additional goods or services is attributable to the original contract. Modifications are accounted for as either a separate contract or as part of the existing contract (either prospectively or through a cumulative catch-up adjustment).
• This assessment is driven by whether

(1) the modification adds distinct goods and services and

(2) the distinct goods and services are priced at their standalone selling prices.

Modification accounted for as a separate contract

A modification is accounted for as a separate contract if the additional goods or services are distinct and the contract price increases by an amount that reflects the standalone selling price of the additional goods or services.

Modification accounted for prospectively

The modification is accounted for as if it were a termination of the original contract and the creation of a new contract if the additional goods or services are distinct, but the price of the added goods or services does not reflect standalone selling price. Any unrecognized revenue from the original contract and the additional consideration from the modification is combined and allocated to all of the remaining performance obligations under the original contract and modification.

Modification accounted for through a cumulative catch-up adjustment

If the added goods or services are not distinct and are part of a single performance obligation that is only partially satisfied when the contract is modified, the modification is accounted for through a cumulative catch-up adjustment.

In case of 2 or more contract are Combine

• Multiple contracts need to be combined and accounted for as a single arrangement when the economics of the individual contracts cannot be understood without reference to the arrangement as a whole.
• The determination of whether to combine two or more contracts is made at contract inception.
• Contracts must be entered into with the same customer (or related parties of the customer) at or near the same time to account for them as a single contract.
• A software vendor should combine individual contracts entered into at or near the same time if they are negotiated as a package with a single commercial objective.
• Contracts might have a single commercial objective if a contract would be loss-making without the consideration received under another contract.
• Contracts should also be combined if the price or performance under one contract affects the consideration to be paid under another contract. This would be the case when failure to perform under one contract affects the amount paid under another contract.
• Lastly, contracts should be combined if the goods or services in the contracts are a single performance obligation.

Step 2. Identify performance obligations

Software arrangements are typically comprised of:

• Multiple goods and services, such as software licenses
• Unspecified or specified future updates or upgrades / enhancements
• Specified or unspecified additional software products
• Exchange and platform transfer rights
• PCS
• Installation
• Other professional services

The new revenue guidance requires companies to consider whether the customer has a valid expectation that the vendor will provide a good or service when it is not explicitly stated.

If the customer has a valid expectation, the customer would view those promises as part of the goods or services in the contract.

A promised good or service must be distinct to be accounted for as a separate performance obligation when there are multiple promises in a contract.

A good or service is distinct if

(1) the customer can benefit from the good or service either on its own or together with other readily available sources (that is, it is capable of being distinct) and

(2) if the good or service is separately identifiable from the other promises in the contract (that is, distinct in the context of the contract).

Determining whether a good or service is distinct may require significant judgment.

Under the new guidance, how to identify separate performance obligations is a significant change for companies in the software industry.

The new guidance eliminates current software industry-specific guidance under US GAAP (which was often applied by analogy under IFRS) and thus, vendor specific objective evidence (VSOE) of fair value is no longer required to separately account for elements in a software licensing arrangement. As a result, companies that couldn’t separately account for elements due to a lack of VSOE may recognize revenue earlier. Licenses of intellectual property The new standards provide specific guidance on accounting for licenses of intellectual property. A license arrangement establishes a customer’s rights related to a company’s intellectual property (IP) and the obligations of the company to provide those rights.

Licenses in the software industry come in many forms and can be term-based or perpetual, exclusive or nonexclusive. Consideration received for licenses often includes upfront payments, over time payments, or some combination of the two.

These arrangements also frequently include other licensor obligations such as PCS, including specified or unspecified upgrades or enhancements, telephone support, and professional services. Management will first need to determine whether an arrangement includes a license of IP, particularly in arrangements that include cloud services or software as a service (SaaS).

License renewals and cancellations

material rights Software vendors often provide customers the option to renew or extend the term of or to cancel a license.

A cancellation right that allows a customer to cancel a multi-year contract after each year without penalty should be accounted for the same as a one-year contract with a renewal option, since the customer makes a decision annually whether to continue under the contract.

The new US GAAP standard also specifies that revenue from the renewal or extension of a license cannot be recognized until the customer can use or benefit from the license renewal (that is, at the beginning of the renewal period). This is true even if the vendor provides a copy of the IP in advance of the renewal period or the customer has a copy of the IP from another transaction. This differs from current guidance in which revenue is generally recognized from a license renewal on the date the renewal is executed.

• Therefore, companies may recognize revenue for renewals later under the new guidance as compared to today.
• IFRS does not include specific guidance on license renewals.
• Companies applying IFRS should evaluate whether a renewal or extension should be accounted for as a new license or a modification of an existing license.
• This could result in recognition of revenue from renewals earlier under IFRS compared to US GAAP in some cases.

Post-contract customer support

Post-contract customer support (PCS) is an element included in virtually every software arrangement; it represents the right to receive services or unspecified product upgrades/enhancements, or both.

PCS is often explicitly promised in the contract, but could also be implied as a result of the vendor’s past business practices.

Consideration for PCS may be included in the license fee or separately priced.

Software companies should assess individual services included in PCS to determine whether they are distinct.

Generally, a software license and PCS will each be distinct, even when PCS is not optional, because the software remains functional without the PCS.

In limited circumstances, however, a software license may not be distinct from the unspecified updates/upgrades if

(1) those updates/upgrades are critical to the continued utility of the software, and

(2) without the unspecified updates or upgrades, the customer’s ability to benefit from the software would decline significantly. In such cases, the software license and the right to the unspecified product upgrades/enhancements are accounted for as a single performance obligation.

A software vendor should evaluate whether a promise to exchange a product or to transfer the software from one platform or operating system to another is distinct, and therefore represents a performance obligation. The following factors may indicate that a promise to exchange a product or to transfer platforms or operating systems is not a separate performance obligation:

• The license agreement does not contractually permit the customer to continue using the original platform software in addition to the new platform software.
• The platform transfer or exchange is for the same software product that currently exists. That is, there are no more than minimal differences in price, features, and functionalities between the software products being exchanged.
• The platform transfer or exchange is for specified existing or currently-unavailable new software, which is or would be marketed as the same product even though there may be differences due to environmental variables (operating systems, databases, user interfaces, and platform scales). Indicators of “marketed as the same product” include (1) the same product name (although version numbers may differ) and (2) a focus on the same features and functions. · The platform transfer or exchange does not provide the customer an increased number of copies or concurrent users of the software product available under the license agreement. These factors are not all-inclusive; other factors may be relevant based on the circumstances.

Step 3. Determine transaction price:

3. Determine transaction price

> The transaction price in a contract reflects the amount of consideration to which the software vendor expects to be entitled in exchange for goods or services transferred.

> The transaction price includes only those amounts to which the company has enforceable rights under the present contract.

> Management must take into account consideration that is variable, noncash consideration, and amounts payable to a customer to determine the transaction price.

> Management also needs to assess whether a significant financing component exist

> Consideration that is variable includes, but is not limited to, discounts, rebates, price concessions, refunds, credits, incentives, performance bonuses, and royalties.

>Management must estimate the consideration to which it expects to be entitled to determine the transaction price and to allocate consideration to performance obligations.
> Under the new guidance, variable consideration is only included in the estimate of transaction price up to an amount that is probable (US GAAP) or highly probable (IFRS) of not resulting in a significant reversal of cumulative revenue in the future.

>While different terminology is used under IFRS, it is intended in this situation to have the same meaning as in US GAAP.

Extended payment terms

• Software companies may offer payment terms that extend over a substantial portion of the period during which the customer is expected to use or market the software.
• Extended payment terms should be considered when assessing the customer’s ability and intent to pay the consideration when due, and may impact the vendor’s assessment of whether the collectability criteria is met in Step 1 (discussed previously), and therefore, whether a contract exists.
• Software vendors should also determine if there is a possibility of a future price concession, which may lead to the conclusion that the transaction price is variable.
• The new guidance differs from current US GAAP guidance in which payment terms beyond one year typically preclude revenue from being recognized because there is a presumption that the fee is not fixed or determinable.
• Although there is no similar guidance under current IFRS, companies are required to evaluate whether the inflow of benefits was probable.
• As a result, companies that provide extended payment terms might recognize revenue earlier under the new guidance.
• Extended payment terms could also indicate that the arrangement includes a significant financing component that would need to be accounted for separately.
• A significant financing component does not exist, however, when the difference between the promised consideration and the cash selling price arises for reasons other than financing. This may occur,

> SLAs that could result in payments to a customer (e.g., refunds or penalties) should generally be accounted for as variable consideration.

Step 4. Allocate transaction price

> Many contracts involve the sale of more than one good or service. For example, they might involve the sale of multiple goods, goods followed by related services, or multiple services.

> The transaction price in an arrangement must be allocated to each separate performance obligation based on the relative standalone selling prices (SSP) of the goods or services being provided to the customer.

> Standalone selling price for software licenses and PCS SSP for certain software products or services may not be directly observable and may need to be estimated because it is common practice in the software industry for vendors to bundle their software licenses together with other products and services.

> A vendor should not presume that a contract price or list price for a product or service represents SSP although these prices may be a factor to consider in determining SSP.

>When the contractual price of a good or service falls outside of the range, companies should apply a consistent method to determine the standalone selling price within that range for that good or service (e.g., the midpoint of the range or the outer limit closest to the stated contractual price)

Residual approach

The residual approach involves deducting from the total transaction price the sum of the observable SSPs of other goods and services in the contract to estimate SSP for the remaining goods and services.

> This approach is an estimation methodology, not an allocation methodology like the residual method applied under current US GAAP and IFRS guidance.

>Under the new guidance, the residual approach is only permitted if the selling price of a good or service is highly variable or uncertain.

>Before utilizing this approach, management should first consider the overall principle that a company should maximize the use of observable data and should assess whether another method provides a reasonable method for estimating SSP.

> Even when the residual approach is used, management still needs to consider whether the results achieve the objective of allocating the transaction price based on standalone selling prices.

> Allocating discounts and variable consideration The transaction price should be allocated to each performance obligation based on the relative standalone selling prices of the goods or services provided to the customer.

> Discounts and variable consideration are typically allocated to all of the performance obligations in an arrangement based on their relative standalone selling prices. However, if certain criteria are met, a discount or variable consideration is allocated to only one or more performance obligations in the contract rather than to all performance obligations.

Step 5. Recognize revenue

> A performance obligation is satisfied and revenue recognized when control of the promised good or service is transferred to the customer.

>A customer obtains control of a good or service if it has the ability to

(1) direct the use of and

(2) obtain substantially all of the remaining benefits from that good or service.

Directing the use of an asset refers to a customer’s right to deploy that asset, allows another company to deploy it, or restrict another company from using it. Management should evaluate transfer of control primarily from the customer’s perspective, which reduces the risk that revenue is recognized for activities that do not transfer control of a good or service to the customer

• Software license combined with other goods or services When a software license is not distinct and is combined with other goods or services (such as implementation services or PCS) in a contract, the company needs to assess whether control of the combined performance obligation transfers to the customer at a point in time or over time.
• If the combined performance obligation qualifies for over time recognition, the company will measure its progress toward completion by selecting a single input or output method that best reflects the transfer of control of the goods or services.

Sell-through approach

• Under current guidance, many software companies that sell to distributors use the sell-through approach, in which revenue is not recognized until the product is sold to the end customer.
• This approach might be used because the distributor is thinly capitalized, does not have a high-grade credit rating, or has the ability to return the unsold product, rotate older stock, or receive price concessions, or because the company cannot reasonably estimate returns or concessions.
• The effect of the new standard on the sell-through approach will depend on the terms of the arrangement and why sell-through accounting was applied historically.
• The standards require management to determine when control transfers to the customer. If the distributor has control of the product, control transfers when the product is delivered to the distributor. Any amounts related to expected sales returns or price concessions affect the amount of revenue recognized (that is, the estimate of transaction price), but not when revenue is recognized.
• A company that is not able to estimate returns, but is able to estimate a minimum amount of revenue that is not probable of being reversed should recognize this minimum amount at the time of sell-in, provided that control has transferred.
• When revenue is deferred until sell-through to the end customer, management should re-evaluate the appropriateness of the deferral each reporting period rather than defaulting to recognition upon sellthrough of the product to the end customer.

Sales or usage-based royalties

The standards provide an exception relating to the recognition of variable consideration for sales- or usage-based royalties received in exchange for licenses of IP. Under this exception, royalties should be recognized as the underlying sales or usages occur, as long as this approach does not result in the acceleration of revenue ahead of the company’s performance. This means that, in many cases, the accounting treatment of contingent royalty transactions will remain consistent with current practice under both US GAAP and IFRS.

The application of this exception is not optional; therefore, companies should review their contracts for any in-substance royalties promised in exchange for a license of IP.

Companies that sell, rather than license, IP cannot apply the royalty exception.

Additionally, when applying this exception to an arrangement, it is not appropriate to recognize revenue in the period that the sales or usages are reported by the customer (i.e., recognize on a “lag” basis). Instead, revenue is recognized when the sales or usage occurs.

As a result, it may be necessary to estimate sales or usages prior to receiving reporting from the customer. Additional complexities may arise when a sales- or usage-based royalty relates to both a license of IP and other goods or services.

The royalty exception should only be applied when the license of IP is the predominant item to which the royalty relates.

Because the standards do not provide a specific definition of “predominant,” judgment will be required to determine whether the predominant item to which a royalty relates is the license component. If a customer would ascribe significantly more value to the license component, it would likely be predominant.

Minimum royalty guarantees are common in arrangements with sales- or usage-based royalties. In some cases, the minimum guarantee is negotiated due to uncertainty about the customer’s performance and its ability to successfully exploit the IP.

In other cases, the minimum guarantee is established as a cash flow management tool to provide the licensor with predictable timing of some of the cash flows under the contract.

A minimum royalty guarantee is fixed consideration and is not subject to the sales- and usage based royalty exception. Therefore, minimum royalty guarantees should be recognized when the licensor transfers control of the IP to the licensee.

The variable consideration (the amount above the fixed minimum) should be recognized in accordance with the sales- or usage-based royalty exception.

Customer acceptance

A customer acceptance clause provides protection to a customer by allowing it to either cancel a contract or force the vendor to take corrective actions if the software or services do not meet the requirements in the contract.

>revenue from SaaS arrangements will generally be accounted for as a single performance obligation, except when accounting for contract modifications and allocating variable consideration. In these two areas, the model is applied to the distinct good or service within the series.

Disclosure

Disclose sufficient information which enable the user of financial statement to understand the nature , amount timing and uncertainty of revenue and cash flow arising from contract with customers, an entity should disclose.

• It’s contract with customer
• It’s siginificant judgement and change in judgement, made I applying the guidance to those contract and
• Any assets recognised from the cost to obtain or fulfill a contract with customer.