Our Accounting News of May 2017 discussed the issues relating to the sequence of revenue steps and the application of the portfolio approach. In September 2017, the Accounting News elaborated on the requirements of IFRS 15 relating to the identification of contracts with customers. By way of a reminder, please note that detailed articles focusing on IFRS 15 were also published in the Accounting News of July 2014, October 2014 and December 2016. By way of a reminder, please note that detailed articles focusing on IFRS 15 were also published in the Accounting News of July 2014, October 2014 and December 2016. In this issue we will look into the rather problematic Step 2 of the five-step model because proper identification of the performance obligations in a contract is critical to achieving the core principle in IFRS 15.

Step 2: Identification of performance obligations
Once an entity has established that it has a contract to which the five-step model can be applied, the next step is to assess whether there are goods or services promised in the contract that represent separate performance obligations. This process is sometimes referred to as ‘unbundling’. According to IFRS 15.22, a separate performance obligation can be either:

a) a good or service (or a bundle of goods or services) that is ‘distinct’; or
b) a series of distinct goods or services that are substantially the same and that have the same pattern of transfer to the customer.

Note: Term ‘distinct goods and service’ is in detail discussed in sections 26 – 30 of IFRS 15:
“A good or service that is promised to a customer is distinct if both of the following criteria are met:
a) the customer can benefit from the good or service either on its own or together with other resources that are readily available to the customer (ie the good or service is capable of being distinct); and
b) the entity’s promise to transfer the good or service to the customer is separately identifiable from other promises in the contract (ie the promise to transfer the good or service is distinct within the context of the contract).”

IFRS 15.23 specifies the criteria that must be met for an entity to conclude that a series of distinct goods or services have the same pattern of transfer to the customer – both of the following criteria should be met:

a) “each distinct good or service in the series that the entity promises to transfer to the customer meets the criteria in IFRS 15.35 to be a performance obligation satisfied over time; and
b) in accordance with IFRS 15.39 and 40, the same method would be used to measure the entity’s progress towards complete satisfaction of the performance obligation to transfer each distinct good or service in the series to the customer.”

The following diagram sets out the key questions to be assessed by entities to identify whether there are separate performance obligations.

Question 1: Is unbundling optional?

Answer: No. Proper identification of the performance obligations in a contract is a critical aspect of the Standard’s core principle, which is to “recognise revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services”. Failure to identify and account for the separate performance obligations in a contract could result in the incorrect timing of revenue recognition.

As a practical matter, it may not be necessary to apply the Standard’s detailed requirements on unbundling if the amounts recognised and disclosed in the financial statements will be the same irrespective of whether unbundling is applied. For example, when control of two or more goods or two or more services is transferred at exactly the same time, or on the same basis over the same period of time, and if those items do not need to be segregated for disclosure purposes, then it will not be necessary to unbundle each of those concurrently delivered items because the amount and timing of revenue recognised and disclosed under the model would not differ if the items were unbundled. For example, imagine the situation when a company sells during one order and delivery skirt and trousers through its e-shop. Although there are two distinct goods, it is not necessary to unbundle these items because revenue for both items will be recognised at exactly the same time.

Question 2: If an entity concludes that a series of distinct goods or services meet the requirements of IFRS 15.22(b), is it required to treat that series as a single performance obligation or may it choose to regard the distinct goods or services in the series as individual performance obligations?

Answer: An entity that reaches this conclusion is required to account for the series of goods or services as a single performance obligation. IFRS 15.BC113 clarifies the boards’ intent to mandate the use of this simplification, which enables the entity providing the same good or service consecutively over a period of time (e.g. a repetitive cleaning service) to account for a single performance obligation instead of each hour of cleaning. IASB states that they “decided to specify that a promise to transfer a series of distinct goods or services that are substantially the same and that have the same pattern of transfer to the customer would be a single performance obligation if two criteria are met”.

Question 3: For an entity to determine that the series requirement in IFRS 15.22(b) is met and, specifically, that goods or services have the “same pattern of transfer to the customer”, must the goods or services be transferred consecutively?

Answer: No. The series requirement is intended to simplify the application of the revenue model in IFRS 15 and to promote consistency in the identification of performance obligations. Neither of the criteria in IFRS 15.23 refers to the consecutive transfer of goods or services to the customer and, therefore, the applicability of IFRS 15.22(b) does not depend on whether the goods (services) will be delivered (performed) consecutively.

For example, an entity might enter into a contract to provide the same package of cleaning services each consecutive week for 52 weeks. Alternatively, the cleaning contract might envisage that some services are not provided in certain weeks but are provided in other weeks on an overlapping basis whereby cleaning begins before the previous week’s work has been completed. Both of the criteria in IFRS 15.23 could be met in each of the cleaning contract examples.

Question 4: For distinct goods or services to be considered substantially the same, and therefore accounted for as a series under IFRS 15.22(b), do the tasks in each increment of service need to be substantially the same?

Answer: No, it is not necessary for the tasks in each increment of service to be substantially the same. The evaluation of whether distinct goods or services are substantially the same requires significant judgement based on the relevant facts and circumstances of the contract. An entity should first determine the nature of the promised goods or services to be provided under the contract by evaluating whether the nature of the arrangement is to provide the customer with a specified quantity of distinct goods or services or to stand ready to provide an undefined quantity of goods or services over the duration of the contract period.

If the nature of the promise is the delivery of a specified quantity of a service, then the evaluation should consider whether each service is distinct and substantially the same. If the nature of the entity’s promise is the act of standing ready or providing a single service for a period of time (because there is an unspecified quantity to be delivered), the evaluation would focus on whether each time increment is distinct and substantially the same, rather than the underlying activities.

Examples illustrate different circumstances in which an entity determines that a series of distinct goods or services are substantially the same.

Example 1: Series of distinct goods or services that are substantially the same – specified quantity of distinct goods or services
Company ALFA provides Customer Z with monthly payroll processing services for one year and concludes that each monthly service (1) is distinct, (2) meets the criteria for recognising revenue over time, and (3) has the same method for measuring progress. In addition, it is concluded that the arrangement is to provide the customer with a specified quantity of distinct goods or services (i.e. 12 distinct instances of monthly payroll processing).

Having determined that it is to provide 12 distinct services, ALFA determines that even though the exact volume of employee payroll data processed may vary each month, the benefit consumed by the customer (i.e. the processing of payroll for that month) is substantially the same for each monthly transaction.
Therefore, ALFA concludes that the monthly payroll services are substantially the same and satisfy the requirements of IFRS 15.22(b) to be accounted for as a single performance obligation.

Example 2: Series of distinct goods or services that are substantially the same – undefined services over the contract period (hotel management services)

Company BETA provides hotel management services to Customer Y that include hiring and managing employees, procuring goods and services, and advertising and marketing the hotel. On a given day, BETA could clean guest rooms, perform marketing efforts to increase occupancy, and operate the concierge desk.BETA concludes that the nature of the contract is to provide integrated hotel management services over the term of the contract and not a specific quantity of specified services (i.e. it is not specified that 100 guest rooms must be cleaned per day). The underlying activities in providing the hotel management services can vary significantly from day to day; however, the daily services are activities that are required to satisfy BETA’s obligation to provide an integrated hotel management service. Therefore, the integrated service of hotel management transferred to the customer is substantially the same during each period because Customer Y receives substantially the same benefit each period (i.e. there is the same pattern of transfer to the customer).

BETA concludes that each increment of service (i.e. day or week) is distinct, meets the criteria for recognising revenue over time, and has the same method for measuring progress and, therefore, that the hotel management services satisfy the criteria in IFRS 15.22(b) to be accounted for as a single performance obligation.

Example 3: Series of distinct goods or services that are substantially the same – undefined services over the contract period (IT outsourcing services)
Company DELTA provides information technology (IT) outsourcing services to Customer X for a five-year period. The IT outsourcing services include providing Customer X with server capacity, maintenance of the customer’s software portfolio, and access to an IT help desk. DELTA considers the nature of the promise to Customer X and concludes that it is to provide continuous access to an integrated outsourced IT solution and not to provide a specified quantity of services (e.g. processing 100 transactions per day). The underlying activities in providing IT outsourcing services can vary significantly day to day; however, the daily services are activities performed to fulfil DELTA’s integrated IT outsourcing service and are, therefore, substantially the same.

DELTA concludes that, for each period, (1) it is providing an integrated IT outsourcing service; (2) the customer is continuously receiving substantially the same benefit, which is distinct (i.e. there is the same pattern of transfer to the customer); and (3) each increment of time is substantially the same (i.e. the same integrated IT outsourcing solution is provided in each time period). DELTA concludes that each distinct increment of time meets the criteria for recognising revenue over time and has the same method of measuring progress. Therefore, DELTA concludes that the IT outsourcing services satisfy the criteria in IFRS 15.22(b) to be accounted for as a single performance obligation.

Source: Deloitte’s guide to IFRS 15
www.iasplus.com

The article is part od dReport – October 2018, Accounting news.