IFRS 15 (ii): transaction price, contract costs and special arrangements

The five-step model is easy to state and hard to apply when the price is not fixed, the customer pays years later, the seller acts for someone else, goods can be returned, or the buyer holds the right to give the goods back. Most revenue questions in the exam are won or lost on these special cases.

This topic covers variable consideration and the constraint, refund liabilities, significant financing components, non-cash consideration and amounts paid to customers, costs to obtain and fulfil a contract, how contracts are presented (receivables, contract assets and contract liabilities), principal versus agent, sales with a right of return, repurchase agreements, bill-and-hold, consignment, licences and customer options such as vouchers. The previous topic covered the five steps. The next topics cover the standards on assets and liabilities.

Key terms in plain English

Syllabus check

This topic completes International Financial Reporting Standard (IFRS) 15 under the syllabus:

• B1(b) applying International Financial Reporting Standard (IFRS) 15 to the preparation of statements;
• B1(a) the effect of recognition and measurement bases and timing on reported performance;
• B4(a) where the financing arrangements interact with financial liabilities, covered in the later topics on financial instruments.

CAMA 2020 and these arrangements

The Companies and Allied Matters Act 2020 (CAMA 2020) does not deal with revenue detail.

Variable consideration

Consideration may vary because of discounts, price concessions, incentives, performance bonuses, penalties or rights of return, or because the amount depends on a future event. It is also variable if the customer has a valid expectation, from customary practice or published policy, that the entity will accept less than the stated price. The entity estimates the amount using:

• expected value (probability-weighted), suited to many similar contracts; or
• most likely amount, suited to two possible outcomes (for example, a bonus is either earned or not).

It uses whichever better predicts the result, and applies it consistently.

The constraint. Variable consideration is included in the transaction price only to the extent it is highly probable that a significant reversal of cumulative revenue will not occur when the uncertainty is resolved.

Allocation. A variable amount goes entirely to one obligation if it relates specifically to the effort on that obligation and the allocation is consistent with the allocation objective. Otherwise it is spread across all.

Royalties. For a licence of intellectual property, sales-based or usage-based royalties are recognised only when the later of (a) the sale or usage occurs and (b) the related obligation is satisfied.

Refund liabilities and sales with a right of return

If the entity expects to return some of the consideration, it recognises a refund liability measured at the amount it does not expect to keep, updated each reporting date.

Where a product is sold with a right of return, the entity recognises (i) revenue for products not expected to be returned, (ii) a refund liability and (iii) an asset, with a matching adjustment to cost of sales, for its right to recover the returned products.

Significant financing component

If the timing of payment gives either party a significant benefit of financing, the price is adjusted for the time value of money so revenue reflects the cash price. No adjustment is needed if the gap between delivery and payment is expected to be a year or less.

The discount rate is the rate in a separate financing transaction between the entity and the customer, reflecting the customer’s credit risk and any security. Interest is shown separately from revenue, as finance income or finance cost, using the effective interest method.

Other price adjustments

• Non-cash consideration is measured at fair value, or, if that cannot be measured reliably, by the stand-alone selling price of what is transferred.
• Consideration payable to the customer (cashback, vouchers to a retailer) reduces the price unless it is payment for a distinct good or service received from the customer.

Contract costs

Costs to obtain a contract

Incremental costs, which would not have arisen if the contract had not been obtained (for example a sales commission payable on signing), are capitalised if the entity expects to recover them, and amortised in line with the transfer of the goods or services.

Other costs, such as salaries of in-house sales staff and general bid costs, are expensed, unless they are chargeable to the customer even if the bid is lost. As a practical expedient, if the amortisation period is a year or less, the costs may be expensed.

Costs to fulfil a contract

First check whether the costs fall under another standard (inventory, property, intangibles). If not, capitalise only if all three apply:

• (a) they relate directly to an identified contract or specific anticipated contract
• (b) they create or enhance resources used to satisfy future obligations
• (c) they are expected to be recovered

Overheads, wasted resources and costs of obligations already satisfied are expensed.

Amortisation and impairment

Amortise the asset as the related goods or services transfer. At each reporting date test for impairment: if the carrying amount is more than the remaining consideration expected less the costs still to complete, recognise a loss in profit or loss. Reverse it if the indicator reverses, up to what the amount would have been.

Presentation: receivables, contract assets and contract liabilities

Example. X Ltd agrees to deliver Product A (allocated ₦400) on 28 February and Product B (allocated ₦600) on 31 March for ₦1,000. If payment is due only after both are delivered, on 28 February X records a contract asset of ₦400 and revenue of ₦400. On 31 March it records revenue of ₦600 and reclassifies the ₦400 and the ₦600 as a receivable of ₦1,000.

If instead X can invoice the whole ₦1,000 on 31 January, it records a receivable and a contract liability of ₦1,000 and releases ₦400 and ₦600 to revenue as each product is delivered.

Special arrangements

Principal or agent

A principal controls the good or service before it goes to the customer and recognises gross revenue. An agent arranges for another party to supply and recognises only the fee or commission. Holding legal title for a moment is not enough to be a principal.

Indicators of an agent:

• another party is mainly responsible for fulfilment
• the entity has no inventory risk
• it has no discretion over price
• its pay is a commission
• it has no credit risk on the customer

Sale with a right of return

Recognise revenue only for the goods not expected to be returned, with a refund liability and a return asset, as above. Re-estimate at each reporting date.

Repurchase agreements

If the seller has a call option or a forward obligation to buy the asset back, the customer does not obtain control. For a call option: if the repurchase price is less than the original selling price it is treated as a lease; if it is equal to or more, it is a financing.

The seller keeps the asset, records a financial liability for the cash received, and accrues the difference as interest. For a put option held by the customer, the answer depends on the repurchase price and the asset’s expected market value, so read the facts carefully.

Bill-and-hold

The goods are sold and held at the seller’s premises until the customer asks for delivery. Revenue is recognised when the customer obtains control, which requires all of:

• a substantive reason for the arrangement
• the goods separately identified as the customer’s
• the goods ready for transfer
• the seller unable to use them or redirect them

The storage service may be a separate obligation, with part of the price allocated to it.

Consignment

Goods delivered to a dealer for sale to end customers remain the seller’s inventory until control passes. Indicators: the seller controls the goods until a specified event (such as sale to the end customer) or a period expires; the seller can require return or transfer to another dealer; the dealer has no unconditional obligation to pay. Revenue is recognised when control passes. A separate fee for display or insurance is recognised over time.

Licences

First, is the licence distinct? If not, it is combined with the other promises.

If it is, ask whether it gives a right to use the intellectual property as it exists when granted (revenue at a point in time, for example perpetual software or film rights) or a right to access it as it changes over the licence period (revenue over time, for example a franchise with continuing branding and updates). Royalties follow the rule above.

Customer options and vouchers

An option to buy goods at a discount is a separate obligation, a material right, if it gives the customer a discount they would not otherwise get. Part of the price is allocated to it, in proportion to relative stand-alone selling prices, and deferred as a contract liability until the option is used or expires.

The stand-alone selling price of the option is estimated from the discount and the likelihood of use.

The rules in more depth

Why the constraint exists

Revenue that later reverses is worse than revenue booked late, because it means the earlier results were wrong. The constraint is a prudence-style check on estimates.

Why a financing component is separated

A customer who pays two years later gets a loan from the seller. If the whole amount were revenue, the loan interest would be disguised as sales. Separating it shows operating revenue at its cash value and interest income as income from lending.

Why an agent shows net revenue

An agent does not control the goods and carries little risk. Showing the whole sale price would overstate revenue and size, so only the fee is revenue.

Why a repurchase right blocks a sale

If the seller can take the asset back at a price that returns the buyer a lender’s profit, the buyer has lent money against the asset. The seller still uses and controls it.

Worked examples

1. Gross consideration.
   500 × ₦100 = ₦50,000.
   Expected returns = 8% × ₦50,000 = ₦4,000.
   Revenue = ₦46,000. Refund liability = ₦4,000.
2. Gross cost.
   500 × ₦50 = ₦25,000.
   Cost of returns = 8% × ₦25,000 = ₦2,000.
   Return asset = ₦2,000. Cost of sales = ₦23,000.
3. Entry: debit receivable ₦50,000; credit revenue ₦46,000 and refund liability ₦4,000. Debit return asset ₦2,000 and cost of sales ₦23,000; credit inventory ₦25,000.

1. Revenue at the cash price: ₦17,150 (debit receivable ₦17,150).
2. Finance income for 2027 = ₦17,150 × 8% = ₦1,372.
3. Receivable at 31 December 2027 = ₦17,150 + ₦1,372 = ₦18,522.
   In 2028 interest of about ₦1,478 brings it to ₦20,000.

1. X is an agent: Y keeps the main risks and sets the price.
2. Selling price of goods sold.
   90% × ₦1,200,000 = ₦1,080,000.
3. X’s revenue.
   5% × ₦1,080,000 = ₦54,000.
   X owes Y ₦1,080,000 − ₦54,000 = ₦1,026,000.

1. The call price (₦6m) is above the selling price (₦5m), so this is a financing. No sale and no revenue.
2. Debit cash ₦5,000,000; credit financing liability ₦5,000,000. The property stays at ₦4.5m.
3. Year 1 interest = ₦5,000,000 × 9.5% = ₦475,000.
   Liability at year end = ₦5,475,000.

1. The voucher is a material right.
2. Estimated stand-alone value of the vouchers.
   ₦20m × 20% = ₦4m.
3. Defer about ₦4 million as a contract liability and recognise about ₦296 million of revenue.
   (Strictly, relative stand-alone selling prices give 300 × 4 ÷ 304 = ₦3.95m deferred and ₦296.05m revenue.
   The practice solution of the Institute of Chartered Accountants of Nigeria (ICAN) rounds to ₦4m and ₦296m.)

These examples also meet s. 378 of CAMA 2020: the statements show the substance, not the form.

How to score full marks

• Name the arrangement first (agent, consignment, repurchase, bill-and-hold, licence) and give the test that decides it.
• For variable amounts, state the method (expected value or most likely) and the constraint.
• For returns, give three items: revenue net of returns, refund liability, return asset with cost adjustment.
• For financing, revenue is at the cash price. Interest is separate, by effective interest.
• For repurchase, compare the price with the original selling price before deciding between lease and financing.
• Show the entries with the correct labels (receivable, contract asset, contract liability).

Common mistakes in the exam

• Including all variable consideration without applying the constraint.
• Recognising full revenue and a provision for returns instead of revenue net of expected returns with a refund liability.
• Showing an agent’s whole sale as revenue.
• Treating a sale with a call option at or above the selling price as a sale.
• Putting interest from a financing component inside revenue.
• Expensing incremental commission on a long contract when it should be capitalised, or capitalising salaries.
• Calling an unconditional right a contract asset.

Quick revision

• Variable consideration: expected value or most likely. Constraint: highly probable no significant reversal.
• Return: revenue net, refund liability, return asset.
• Financing: over one year. Revenue at cash price. Interest separate.
• Costs to obtain: incremental and recoverable, capitalise. Costs to fulfil: three tests.
• Receivable (unconditional), contract asset (conditional), contract liability (paid in advance).
• Agent: commission only. Principal: gross.
• Call option at or above sale price: financing. Below: lease.
• Bill-and-hold: four criteria. Consignment: no sale until control passes.
• Licence: right to use (point in time) or right to access (over time). Vouchers: material right.
• CAMA 2020: ss. 378, 374(1), 405, 406.

Practice questions

These are original questions written in the style of the Institute of Chartered Accountants of Nigeria (ICAN) exam. Try each one before you open the answer. Full model answers follow the written questions.

Recall check: multiple choice

The real ICAN paper has no multiple-choice section. These questions are for quick recall. The written questions that follow are closer to the exam.

Written questions

Model answers

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