FRS 115 Revenue from Contracts with Customers was issued on 19 Nov 2014 but the effective date was delayed until 1 Jan 2018. It supersede FRS 11 Construction Contracts and FRS 18 Revenue.
FRS 115: Five-Step Model
FRS 115 applies a five-step model to determine whether a contract falls within its scope, and also the timing and quantum of revenue recognition.
- Identifies whether there is a contract with a customer.
- Identifies the separate performance obligations.
- Determines the transaction price.
- Allocates the transaction price to the separate performance obligations.
- Recognise revenue when (or as) the entity satisfies a performance obligation.
Step 1: Identifies whether there is a contract with a customer.
FRS 115 para 9 provides that an entity shall account for a contract with a customer when five criteria are met:
(a) the parties to the contract have approved the contract and are committed to perform their respective obligations;
(b) the entity can identify each party’s rights regarding the goods or services to be transferred;
(c) the entity can identify the payment terms for the goods or services to be transferred;
(d) the contract has commercial substance, and
(e) it is probable that the entity will collect the consideration to which it will be entitled in exchange for the goods or services that will be transferred to the customer.
Combination of contracts
An entity shall combine two or more contracts entered into at or near the same time with the same customer (or related parties of the customer) and account for the contracts as a single contract if one or more of the following criteria are met:
(a) the contracts are negotiated as a package with a single commercial objective;
(b) the amount of consideration to be paid in one contract depends on the price or performance of the other contract; or
(c) the goods or services promised in the contracts (or some goods or services promised in each of the contracts) are a single performance
A contract modification is a change in the scope or price (or both) of a contract that is approved by the parties to the contract.
An entity shall account for contract modifications in whichever of the following ways is applicable:
(a) An entity shall account for the contract modification as if it were a termination of the existing contract and the creation of a new contract, if the remaining goods or services are distinct from the goods or services transferred on or before the date of the contract modification. The amount of consideration to be allocated to the remaining performance obligations is the sum of:
(i) the consideration promised by the customer (including amounts already received from the customer) that was included in the estimate of the transaction price and that had not been recognised as revenue; and
(ii) the consideration promised as part of the contract modification.
(b) An entity shall account for the contract modification as if it were a part of the existing contract if the remaining goods or services are not distinct and, therefore, form part of a single performance obligation that is partially satisfied at the date of the contract modification. The effect that the contract modification has on the transaction price, and on the entity’s measure of progress towards complete satisfaction of the performance obligation, is recognised as an adjustment to revenue (either as an increase in or a reduction of revenue) at the date of the contract modification (ie the adjustment to revenue is made on a cumulative catch-up basis).
(c) If the remaining goods or services are a combination of items (a) and (b), then the entity shall account for the effects of the modification on the unsatisfied (including partially unsatisfied) performance obligations in the modified contract in a manner that is consistent with the objectives of this paragraph.
Step 2: Identifies the separate performance obligations.
FRS 115 para 22 specifies that at contract inception, an entity shall assess the goods or services promised in a contract with a customer and shall identify as a performance obligation customer 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.
An entity, a software developer, enters into a contract with a customer to transfer a software licence, perform an installation service and provide unspecified software updates and technical support (online and telephone) for a two-year period. The entity sells the licence, installation service and technical support separately. The installation service includes changing the web screen for each type of user (for example, marketing, inventory management and information technology). The installation service is routinely performed by other entities and does not significantly modify the software. The software remains functional without the updates and the technical support.
The entity identifies four performance obligations in the contract for the following goods or services:
(a) the software licence;
(b) an installation service;
(c) software updates; and
(d) technical support.
An entity, a manufacturer, sells a product to a distributor (ie its customer) who will then resell it to an end customer.
Example B – Explicit promise of service
In the contract with the distributor, the entity promises to provide maintenance services for no additional consideration (ie ‘free’) to any party (ie the end customer) that purchases the product from the distributor. The entity outsources the performance of the maintenance services to the distributor and pays the distributor an agreed-upon amount for providing those services on the entity’s behalf. If the end customer does not use the maintenance services, the entity is not obliged to pay the distributor.
Because the promise of maintenance services is a promise to transfer goods or services in the future and is part of the negotiated exchange between the entity and the distributor, the entity determines that the promise to provide maintenance services is a performance obligation (see paragraph 26(g) of FRS 115). The entity concludes that the promise would represent a performance obligation regardless of whether the entity, the distributor, or a third party provides the service. Consequently, the entity allocates a portion of the transaction price to the promise to provide maintenance services.
Example B – Implicit promise of service
The entity has historically provided maintenance services for no additional consideration (ie ‘free’) to end customers that purchase the entity’s product from the distributor. The entity does not explicitly promise maintenance services during negotiations with the distributor and the final contract between the entity and the distributor does not specify terms or conditions for those services.
However, on the basis of its customary business practice, the entity determines at contract inception that it has made an implicit promise to provide maintenance services as part of the negotiated exchange with the distributor. That is, the entity’s past practices of providing these services create valid expectations of the entity’s customers (ie the distributor and end customers) in accordance with paragraph 24 of FRS 115. Consequently, the entity identifies the promise of maintenance services as a performance obligation to which it allocates a portion of the transaction price.
Step 3: Determines the transaction price.
Under FRS 115 para 47, variable consideration either as an expected value or most likely amount (FRS 115 para 53) may be recognised in the transaction price only when it is highly probable that a significant reversal of the cumulative revenue recognised will not occur when the uncertainty associated with the variable consideration is subsequently resolved (FRS 115 para 56). This may result in delayed recognition of variable consideration as compared to FRS 11.
Step 4: Allocates the transaction price to the separate performance obligations.
In the event that there are separate performance obligations within the construction contract, FRS 115 paras 73 and 74 require the entity to allocate the transaction price to each performance obligation identified in the contract on a relative standalone selling price basis.
An entity enters into a contract with a customer to sell Products A, B and C in exchange for CU100. The entity will satisfy the performance obligations for each of the products at different points in time. The entity regularly sells Product A separately and therefore the stand-alone selling price is directly observable.
Product B and C are not sold separately, hence stand-alone selling prices of Products B and C are not directly observable.
However it is identified as as separate performance obligations.
Because the stand-alone selling prices for Products B and C are not directly observable, the entity must estimate them. To estimate the stand-alone selling prices, the entity uses the adjusted market assessment approach for Product B and the expected cost plus a margin approach for Product C. In making those estimates, the entity maximises the use of observable inputs. The entity estimates the stand-alone selling prices as follows:
Product Stand-alone selling price Method
Product A 50 CU Directly observable
Product B 25 CU Adjusted market assessment
Product C 75 CU Expected cost plus a margin approach
Total 150 CU
The customer receives a discount for purchasing the bundle of goods because the sum of the stand-alone selling prices (CU150) exceeds the promised consideration (CU100). The entity considers whether it has observable evidence about the performance obligation to which the entire discount belongs and concludes that it does not. Consequently, the discount is allocated proportionately across Products A, B and C. The discount, and therefore the transaction price, is allocated as follows:
Product Allocated transaction price
Product A 33 (CU50 ÷ CU150 × CU100)
Product B 17 (CU25 ÷ CU150 × CU100)
Product C 50 (CU75 ÷ CU150 × CU100)
Total 100 CU
Step 5: Recognise revenue when (or as) the entity satisfies a performance obligation
Revenue is recognised, that is, when the entity satisfies a performance obligation or transfers control of a promised good or service to the customer. That can happen either over time or at a point in time.
FRS 115 para 35 states that an entity transfers control of a good or service over time and therefore, satisfies a performance obligation and recognises revenue over time if one of the following criteria is met:
(a) the customer simultaneously receives and consumes the benefits provided by the entity’s performance as the entity performs;
(b) the entity’s performance creates or enhances an asset that the customer controls as the asset is created or enhanced,
(c) the entity’s performance does not create an asset with an alternative use to the entity and the entity as an enforceable right to payment for performance completed to date.
When any of the criteria is satisfied, the contract revenue is recognised over time, that is, similar to the percentage-of-completion method. Otherwise, the contract revenue would be recognised at a point in time, that is, likely to be on completion of contract.
FRS 115 only provides two broad classifications for the methods to measure the progress of satisfaction of performance obligation over time:
- Input method
- Output method