Example: applying the IFRS five-step model

On 1 January 20X4, Angelo enters into a twelve-month ‘pay monthly’ contract for a mobile phone. The contract is with TeleSouth, and terms of the plan are:

(a) Angelo receives a free handset on 1 January 20X4

(b) Angelo pays a monthly fee of $200, which includes unlimited free minutes. Angelo is billed on the last day of the month

Customers may purchase the same handset from TeleSouth for $500 without the payment plan. They may also enter into the payment plan without the handset, in which case the plan costs them $175 per month.

The company’s year-end is 31 July 20X4.

Required

Show how TeleSouth should recognise revenue from this plan in accordance with IFRS 15 Revenue from contracts with customers. Your answer should give journal entries:

(a) On 1 January 20X4 (b) On 31 January 20X4

Solution

IFRS 15 requires application of its five-step process:

(i) Identify the contract with a customer. A contract can be written, oral or implied by customary business practices.

(ii) Identify the separate performance obligations in the contract. If a promised good or service is not distinct, it can be combined with others.

(iii) Determine the transaction price. This is the amount to which the entity expects to be 'entitled'.

For variable consideration, the probability – weighted expected amount is used. The effect of any credit losses shown as a separate line item (just below revenue).

(iv) Allocate the transaction price to the separate performance obligations in the contract. For multiple deliverables, the transaction price is allocated to each separate performance obligation in proportion to the stand-alone selling price at contract inception of each performance obligation.

(v) Recognise revenue when (or as) the entity satisfies a performance obligation, that is when the entity transfers a promised good or service to a customer. The good or service is only considered as transferred when the customer obtains control of it.

Application of the five-step process to TeleSouth

(i) Identify the contract with a customer. This is clear. TeleSouth has a twelve-month contract with Angelo.

(ii) Identify the separate performance obligations in the contract. In this case there are two distinct performance obligations:

(1) The obligation to deliver a handset

(2) The obligation to provide network services for twelve months

(The obligation to deliver a handset would not be a distinct performance obligation if the handset could not be sold separately, but it is in this case because the handsets are sold separately.) (iii) Determine the transaction price. This is straightforward: it is $2,400, that is 12 months × the

monthly fee of $200.

(iv) Allocate the transaction price to the separate performance obligations in the contract. The transaction price is allocated to each separate performance obligation in proportion to the stand-alone selling price at contract inception of each performance obligation, that is the stand-stand-alone price of the handset ($500 and the stand-alone price of the network services ($175 × 12 =

$2,100.00):

Performance obligation Stand-alone

selling price % of total Revenue (=relative selling price = $2,400 × %)

$ $

Handset 500.00 19.2% 460.80

Network services 2,100.00 80.8% 1,939.20

Total 2,600.00 100% 2,400.00

(v) Recognise revenue when (or as) the entity satisfies a performance obligation, that is when the entity transfers a promised good or service to a customer. This applies to each of the performance obligations:

(1) When TeleSouth gives a handset to Angelo, it needs to recognize the revenue of $460.80.

(2) When TeleSouth provides network services to Angelo, it needs to recognize the total revenue of $1,939.20. It’s practical to do it once per month as the billing happens.

Journal entries On 1 January 20X4

The entries in the books of TeleSouth will be:

DEBIT Receivable (unbilled revenue ) $460.80

CREDIT Revenue $460.80 Being recognition of revenue from the sale of the handset

On 31 January 20X4

The monthly payment from Angelo is split between amounts owing for network services and amounts owing for the handset.

DEBIT Receivable (Angelo) $200

CREDIT Revenue (1,939.20/12) $161.60

CREDIT Receivable (unbilled revenue )(460.80/12) $38.40 Being recognition of revenue from monthly provision of network services and ‘repayment’ of handset

4.20 Presentation

Contracts with customers will be presented in an entity’s statement of financial position as a contract liability, a contract asset or a receivable, depending on the relationship between the entity’s performance and the customer’s payment.

A contract liability is recognised and presented in the statement of financial position where a customer has paid an amount of consideration prior to the entity performing by transferring control of the related good or service to the customer.

When the entity has performed but the customer has not yet paid the related consideration, this will give rise to either a contract asset or a receivable. A contract asset is recognised when the entity’s right to consideration is conditional on something other than the passage of time, for instance future performance.

A receivable is recognised when the entity’s right to consideration is unconditional except for the passage of time.

In practice, this aligns with the previous IAS 11 treatment. Where revenue has been invoiced a receivable is recognised. Where revenue has been earned but not invoiced, it is recognised as a contract asset.

4.21 Disclosure

The following amounts should be disclosed unless they have been presented separately in the financial statements in accordance with other standards:

(a) Revenue recognised from contracts with customers, disclosed separately from other sources of revenue.

(b) Any impairment losses recognised (in accordance with IFRS 9) on any receivables or contract assets arising from an entity’s contracts with customers, disclosed separately from other impairment losses.

(c) The opening and closing balances of receivables, contract assets and contract liabilities from contracts with customers.

(d) Revenue recognised in the reporting period that was included in the contract liability balance at the beginning of the period; and

(e) Revenue recognised in the reporting period from performance obligations satisfied in previous periods (such as changes in transaction price).

Other information that should be provided;

(a) An explanation of significant changes in the contract asset and liability balances during the reporting period

(b) Information regarding the entity’s performance obligations, including when they are typically satisfied (upon delivery, upon shipment, as services are rendered etc.), significant payment terms (such as when payment is typically due) and details of any agency transactions, obligations for returns or refunds and warranties granted.

(c) The aggregate amount of the transaction price allocated to the performance obligations that are not fully satisfied at the end of the reporting period and an explanation of when the entity expects to recognise these amounts as revenue.

(d) Judgements, and changes in judgements, made in applying the standard that significantly affect the determination of the amount and timing of revenue from contracts with customers.

(e) Assets recognised from the costs to obtain or fulfil a contract with a customer. This would include pre-contract costs and set-up costs. The method of amortisation should also be disclosed.