Receivables & Revenue Text

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Overall

Receivables are financial assets representing claims to cash from third party customers.

As they are financial assets, if, just for fun, one asks an AI robot about receivables, one may get this answer.

Receivables are financial assets that represent amounts owed to a company by customers or other parties. Under IFRS, receivables are classified based on the business model and the characteristics of the financial asset. IFRS 9 requires companies to assess whether the receivables meet the Solely Payments of Principal and Interest (SPPI) test and whether they are held within a "hold to collect" business model. If both conditions are met, they are measured at amortized cost; otherwise, they may be measured at fair value through other comprehensive income (FVOCI) or fair value through profit or loss (FVTPL).

Under US GAAP, receivables are classified based on their legal form. They generally fall under ASC 310 (Receivables) or ASC 320 (Investments – Debt and Equity Securities). Receivables can be classified as:

• Held for investment, measured at amortized cost.
• Held for sale, measured at the lower of cost or fair value.
• Fair value option, where companies elect to measure them at fair value.

The classification differences between IFRS and US GAAP drive subsequent measurement differences, affecting financial reporting and decision-making.

Nice to know, but not particularly useful if one wants to account for a credit sale to a customer.

So, if one is actually referring to claims to cash arising from contracts with customers tied to the delivery of goods or rendering of services, one is better off using terms such as trade accounts, trade receivables, accounts receivable or, if one wants to be extra pedantic, trade accounts receivable.

While receivables are usually claims against third parties, at larger entities they may represent claims against subsidiaries, affiliates or other entities in a group (e.g. joint venture or joint operation).

While these receivables should be recognized and measured in the same way as third-party receivables, they are eliminated in consolidation (even though they may be reported in individual financial reports)

As keeping track of these items is important, the COAs on this page have a separate section devoted specifically to intercompany transactions and balances.

As such, this page addresses both the accounting for receivables and revenue recognition simultaneously.

With respect to revenue recognition, the two key issues are timing and amount.

Both of these are discussed on this page.

However, as the timing of revenue recognition coincides with the timing of inventory derecognition, an additional discussion of this issue is provided on the inventory page.

Besides receivables, an entity may also recognize contract assets.

The distinguishing feature, while receivables are "unconditional," contract assets are not.

Depending on perspective, this statement is either clear or misleading.

As stated in IFRS 15.108 | ASC 606-10-45-4 (edited): a right to consideration is unconditional if only the passage of time is required before payment of that consideration is due.

So there actually is a condition involved. With a receivable, the vendor can sell to a customer under the condition that they give the customer some time to remit payment.

Obviously, not all vendors are willing to submit to this condition and only sell to customers able and willing to pay cash on delivery.

IFRS 15 | ASC 606 distinguishes between receivables (above) and contract assets in that IFRS 15.107 | ASC 606-10-45-7 (edited, emphasis added) states: If an entity performs by transferring goods or services to a customer before the customer pays consideration or before payment is due, the entity shall present the contract as a contract asset..."

When introduced, this guidance caused some confusion. For example, one of our clients called in a panic because his company accounted for projects using percentage-of-completion (specifically cost-to-cost) accounting, and accounts such as contract in progress, billings, and recognized income. The new standard, however, required over time and contract assets. This would require a complete redesign of their accounts and hundreds, if not thousands, of man-hours.

Grr. Arg.

Fortunately, IFRS 15 | ASC 606 did not change POC accounting, just described it using updated terminology.

Thus, a "contract asset" is the difference between the contract in progress account(s) (including recognized income) and the billings account(s), if the difference is positive. If the difference is negative, a deferred revenue liability is reported instead.

Why did IFRS 15 | ASC 606 not say so in the first place?

Where is the fun in that?

Most importantly, trade receivables are the balancing item for revenue.

Trade receivables and revenue are inextricably linked. As the latter is significantly more important to financial statement users, the primary guidance for receivables comes from IFRS 15 not IFRS 9. Similarly, in US GAAP, it is ASC 606, even though receivables have their own, stand-alone topic (ASC 310).

This also implies, it is not possible to discuss receivables without, at the same time, discussing revenue recognition, both its timing and amount. As a corollary, revenue recognition, inventory derecognition and cost of sales are also intertwined. For this reason, the next page not only discusses these two issues, but also includes a section on revenue recognition timing.

Goods (point of time)

Credit sale

1/1/X1, XYZ delivered 10 units of product #123 to ABC and issued invoice #456 payable in 30 days. Product #123 costs 500 to produce and commonly sells for 1,000 per unit.

Dr/Cr

1/1/X1 / 1.1.X1
Trade receivable: ABC: #456		10,000
Cost of goods sold		5,000
	Revenue		10,000
	Inventory: Finished goods: #123		5,000

 

1/31/X1 / 31.1.X1
Cash		10,000
	Trade receivable: ABC: #456		10,000

Cash and charge card sales

1/1/X1, XYZ sold merchandise for 1,000 to a customer who paid cash.

Dr/Cr

1/1/X1 / 1.1.X1
Cash		1,000
Cost of goods sold		500
	Revenue		1,000
	Inventory: Merchandise		500

 

Same facts except the customer paid with a credit card. Credit card sales clear in two days.

1/1/X1 / 1.1.X1
Receivable from bank: Credit card sales		987
Cost of goods sold		500
Selling expenses: Credit card fees		3
	Revenue		1,000
	Inventory: Merchandise		500

 

1/3/X1 / .1.X1
Cash		987
	Receivable from bank: Credit card sales		987

 

Same facts except the customer paid with a debit card. Debit cards are subject to lower charges and clear the same day. XYZ uses a separate bank account (#123) for debit card sales.

1/1/X1 / 1.1.X1
Cash: Account 123		988
Cost of goods sold		500
Selling expenses: Debit card fees		2
	Revenue		1,000
	Inventory: Merchandise		500

Services (point of time vs. over time)

Specific performance (point of time)

XYZ provides equipment repair services. It applies a 100% markup to parts and labor to determine the price for those services.

1/1/X1, it accepted a repair and the same day a technician spent 1 hour (at 20 per hour) diagnosing the malfunction. Once the customer accepted the price and committed to the repair, an additional 4 hours (at 20 per hour) over the next two days were spent replacing parts that had cost 50.

1/4/X1, the customer picked up the repair and paid in cash.

Dr/Cr

1/4/X1 / 4.1.X1
Cash		300
Cost of services rendered		150
	Revenue		300
	Accrued wages and salaries		100
	Inventory: Spare parts		50

 

In general usage, cost of sales (COS) comprises: cost of goods sold (COGS), cost of merchandise sold and cost of services rendered.

FASB XBRL includes both a CostOfRevenueAbstract and CostOfGoodsAndServicesSoldAbstract. It also includes various items including: CostDirectMaterial, CostDirectLabor, CostOfGoodsAndServicesSoldOverhead, CostMaintenance, CostOfGoodsAndServicesSoldDepreciation, CostOfGoodsAndServicesSoldAmortization CostDepletion, etc.

IASB XBRL function of expense includes just CostOfSales while nature of expense includes CostOfMerchandiseSold and CostOfPurchasedEnergySold.

Receivable

For short duration services, it is common practice to recognize revenue when payment is received. Nevertheless, a service provider should recognize revenue when the service is completed if payment is probable.

As outlined in IFRS 15.31 | ASC 606-10-25-23, an entity recognizes revenue when (as) it transfers control of the promised service to the customer. As outlined in IFRS 15.35.b | ASC 606-10-25-27.b, the entity transfers control if its performance creates or enhances an asset controlled by the customer.

As the repair enhanced the customer's equipment, XYZ recognized revenue when it completed the repair.

Probability of payment (50% + IFRS | 75% + US GAAP) is one of several conditions that must be met for a contract with a customer to be recognized.

IFRS 15.9 | ASC 606-10-25-1 outlines 5 conditions to be met before a contract can be recognized.

Among them (sub-paragraph e), it must be probable that the entity will collect the consideration to which it will be entitled.

Same facts, except XYZ completed the repair on 12/28/X1 and the customer picked up the equipment on 1/2/X2.

12/28/X1 / 28.12.X1
Accounts receivable (Unbilled revenue)		300
Cost of services rendered		150
	Revenue		300
	Accrued wages and salaries		100
	Inventory: Spare parts		50

 

Instead of a receivable or contract asset, an unbilled revenue account can be used.

IFRS 15.105 | ASC 606-10-45-1 states (edited): ...An entity shall present any unconditional rights to consideration separately as a receivable.

IFRS 15.108 | ASC 606-10-45-4 states (edited): ...A right to consideration is unconditional if only the passage of time is required before payment of that consideration is due...

IFRS 15.107 | ASC 606-10-45-3 states (edited, emphasis added): If an entity performs by transferring goods or services to a customer before the customer pays consideration or before payment is due, the entity shall present the contract as a contract asset...

As written, the guidance in IFRS 15.105 to 109 | ASC 606-10-45-1 to 5 provides two options.

IFRS 15.105 | ASC 606-10-45-1 states (emphasis added): When either party to a contract has performed, an entity shall present the contract in the statement of financial position as a contract asset or a contract liability, depending on the relationship between the entity’s performance and the customer’s payment. An entity shall present any unconditional rights to consideration separately as a receivable.

IFRS 15.108 | ASC 606-10-45-4 explains (edited, emphasis added): A right to consideration is unconditional if only the passage of time is required before payment of that consideration is due.

Applied to this example, since XYZ has performed and the only condition associated with its right to consideration (the customer’s payment) is the passage of time, it should present a receivable, not a contract asset.

However, IFRS 15.107 | ASC 606-10-45-3 also states (edited, emphasis added): If an entity performs by transferring goods or services to a customer before the customer pays consideration or before payment is due, the entity shall present the contract as a contract asset, excluding any amounts presented as a receivable.

In practice, “before payment is due” is often interpreted to mean that the company has not only performed (transferred goods, rendered services) but has also billed (issued an invoice).

Using a separate, unbilled revenue account gives companies an option to cover the situation where they have performed but not yet billed.

At the end of the period, the unbilled revenue account can be taken directly to the balance sheet.

Although the ASC does not address unbilled revenue, FASB XBRL includes UnbilledRevenuesMember and UnbilledReceivablesCurrent. It defines the latter: "Amount received for services rendered and products shipped, but not yet billed, for non-contractual agreements due within one year or the normal operating cycle, if longer."

Although the IASB XBRL does not include a similar item, it may be extended to do so.

At the end of the period, the unbilled revenue account can be presented as a sub-classification of contract assets or receivables depending on if the right to consideration is conditional or not.

This option is especially useful for companies domiciled in (or with subsidiaries domiciled in) jurisdictions where national GAAP and/or tax law outlines different rules.

In some jurisdictions, besides IFRS | US GAAP, entities must apply statuary accounting (a.k.a. national GAAP). For example, the European Union has two separate accounting systems:

IFRS (required by the IAS regulation) and national GAAP (required by the accounting directive).

While IFRS is used for financial reporting, national GAAP is often used for taxation. For example, in the Czech Republic, while IFRS is required for financial reporting purposes, it may not be used as the basis for determining taxable income, which means the two must be reconciled at the end of each period.

Using an account like unbilled revenue is helpful because it can (if the right is unconditional) be presented as a receivable for IFRS reporting purposes and as accrued revenue for statutory reporting purposes (Czech national GAAP only allows receivables to be recognized if a formal invoice has been issued).

1/2/X2 / 2.1.X2
Cash		300
	Accounts receivable		300

 

Same facts except XYZ completed the diagnostic work on 12/28/X1, but began the repair work 1/1/X2.

As outlined in IFRS 15.92 | ASC 340-40-25-2, incremental costs of obtaining a contract are costs an entity incurs to obtain a contract ... (for example, a sales commission).

In this example, the contract was for a repair service and the diagnostic work was performed to gain that contract. It was, as a result, akin to a sales commission.

As outlined in IFRS 15.91 | ASC 340-40-25-1, an entity may only capitalize incremental costs if it expects to recover them.

In this example, XYZ concluded it was probable the customer would pay for the repair. Since this meant the cost was recoverable, XYZ capitalized it.

12/28/X1 / 28.12.X1
Inventory : WIP: Initial direct costs		20
	Accrued wages and salaries		20

 

Neither IFRS 15.91 to 94 nor ASC 340-40-25-1 to 4 specify how companies should recognize costs to obtain a contract, only that they recognize them as assets.

Some companies prefer to recognize them as work in process, others as accruals.

Either approach would be consistent with the guidance provided by the standards.

On 12/31/X1, the customer refused the repair but was still obligated to pay for the diagnostic work.

12/31/X1 / 31.12.X1
Cash		40
Cost of services rendered		20
	Revenue		40
	Inventory : WIP: Initial direct costs		20

 

Same facts except the customer refused the repair but was not obligated to pay for the diagnostic work.

12/31/X1 / 31.12.X1
Impairment loss (unrecovered costs of obtaining a contract)		20
	Inventory : WIP: Initial direct costs		20

 

As outlined in IFRS 15.91 | ASC 340-40-25-1, an entity capitalizes incremental costs of obtaining a contract if it expects to recover them.

In this example, XYZ initially determined it was probable the customer would pay for the repair, so it capitalized the cost.

Consequent, when it did not recover the cost, it recognized an impairment loss as outlined in IFRS 15.101 to 104 | ASC 340-40-35-3 to 6.

Note: unlike IFRS 15.104, ASC 340-40-35-6 does not allow impairment charges to be subsequently reversed.

Same facts except it was not probable the customer would pay for the repair.

12/28/X1 / 28.12.X1
Expenses: Selling (potentially unrecoverable costs of obtaining a contract)		20
	Accrued wages and salaries		20

 

As outlined in IFRS 15.91 | ASC 340-40-25-1, an entity may only capitalize an incremental cost of obtaining a contract if it expects to recover it.

In this example, XYZ performed the diagnostic work even though it was not probable the customer would contract for the repair.

The reason it performed the work was in the hope that the customer would contract for the repair.

Consequently, the cost incurred performing the diagnostic was analogous to a sales commission.

Full absorption costing

Although full absorption costing is required by IFRS and US GAAP, many companies, especially service providers, would prefer, for simplicity, to recognize only direct costs.

Full absorption costing (a.k.a. absorption costing or full costing) captures all of the costs that go into manufacturing a product (or providing a service).

These costs are subclassified as direct and indirect (a.k.a. overhead).

Direct costs are be further subclassified as direct material and direct wages while overhead as fixed (rent, depreciation, amortization, insurance, etc.) and variable (supervisor salaries, production supplies, utilities, quality control, repairs and maintenance, etc.)

Fixed does not necessarily mean linear.

For example, depreciation calculated using a diminishing balance method is still considered fixed. The difference between fixed and variable is that the latter correlates with production levels while the former does not.

Some overhead costs are, by their nature, always variable. For example the coke used to smelt iron or electricity used to power production machines.

Other overhead costs, for example supervisor salaries or maintenance, can be either fixed or variable (or a combination) depending on how they are determined.

For example, some companies compensate supervisors with fixed salary, others a wage, while still others combine a salary with bonuses when, for example, a production spike calls for extra hours.

Maintenance of production machinery is usually variable, while maintenance of production structures tends to be fixed.

Quality control (of products) tends to be variable, while quality inspection (of production processes) tends to be fixed.

Waste removal is also often fixed, but can become variable when extra production leads to extra trash.

The proper allocation of overheads thus requires both judgment and an accounting system sufficiently flexible to cope with the variations.

While neither IFRS nor US GAAP use the term “full absorption costing” both require its use.

IAS 2.10: The cost of inventories shall comprise all costs of purchase, costs of conversion and other costs incurred in bringing the inventories to their present location and condition.

IAS 2.12 (edited): ... [costs of conversion] include a systematic allocation of fixed and variable production overheads that are incurred in converting materials into finished goods. Fixed production overheads are those indirect costs of production that remain relatively constant regardless of the volume of production, such as depreciation and maintenance of factory buildings, equipment and right-of-use assets used in the production process, and the cost of factory management and administration. Variable production overheads are those indirect costs of production that vary directly, or nearly directly, with the volume of production, such as indirect materials and indirect labour.

While US GAAP guidance is (intentionally) less instructive, its requirements are comparable.

ASC 330-10-30-2 (emphasis added): Although principles for the determination of inventory costs may be easily stated, their application, particularly to such inventory items as work in process and finished goods, is difficult because of the variety of considerations in the allocation of costs and charges.

ASC 330-10-30-1 (edited, emphasis added): The primary basis of accounting for inventories is cost... As applied to inventories, cost means in principle the sum of the applicable expenditures and charges directly or indirectly incurred in bringing an article to its existing condition and location. It is understood to mean acquisition and production cost, and its determination involves many considerations.

ASC 330-10-30-3 (edited, emphasis added): For example, variable production overheads are allocated to each unit of production on the basis of the actual use of the production facilities. However, the allocation of fixed production overheads to the costs of conversion is based on the normal capacity of the production facilities...

This approach would only be consistent with IFRS and US GAAP if adjustments, allocating indirect costs (overhead) to cost of sales, were made at the end of each reporting period (see: Inventory / Direct costing for an example).

However, it is also possible to recognize overhead during the period.

XYZ allocates overhead at 20% of parts and labor.

1/4/X1 / 4.1.X1
Cash		300
Cost of services rendered		180
	Revenue		300
	Accrued wages and salaries		100
	Inventory: Spare parts		50
	Inventory: WIP: Unallocated overhead		30

In this example, overhead is recognized as work in process using an Unallocated overhead account.

The same result can be reached using an accrual account.

During the period, XYZ recognizes overhead costs to the Unallocated overhead account.

For example:

1/1/X1, XYZ paid January rent and made an advance payment on first quarter electricity.

1/1/X1 / 1.1.X1
Inventory: WIP: Unallocated overhead (rent)		1,500
Inventory: WIP: Unallocated overhead (pre-paid electricity)		500
	Cash		2,000

2/1/X1, it paid supervisor salaries.

2/1/X1 / 1.2.X1
Inventory: WIP: Unallocated overhead (supervisor salaries)		2,500
	Cash		2,500

31/3/X1, it paid for natural gas used during the first quarter (in arrears) and recognized Q1 depreciation.

3/31/X2 / 31.3.X2
Inventory: WIP: Unallocated overhead (gas consumed)		250
Inventory: WIP: Unallocated overhead (depreciation)		3,000
	Cash		250
	Accumulated depreciation		3,000

At the end of the period, unallocated overhead is reported on the balance sheet as either an asset or liability depending on its balance.

If it is reported as an asset, it can be presented as a sub-classification of work in process or in accruals as a pre-paid expense. If it is a liability, it would be presented as an accrued expense.

Note: since the procedure is analogous to standard costing (see the Inventory / Standard costing), the allocation of overhead to cost of sales must be periodically reviewed and adjusted to reflect actual costs.

Completed contract (point of time)

XYZ is a freight forwarder. It completes its deliveries with the help of sub-contractors. 12/15/X1, it agreed to ship equipment from Berlin to Sacramento for ABC. ABC paid an advance of 3,000, agreeing to pay an additional 3,000 after it accepted delivery.

12/16/X1, XYZ picked up the equipment, unloading it in Hamburg on 12/17/X1. It incurred direct costs: wages (500), fuel and consumables (400). It also allocated overhead (250) and paid 200 to HIG to insure the delivery. 12/18/X1, the shipment was loaded onto a container ship by HIJ. It was unloaded in Oakland on 1/21/X2. HIJ Charged 2,000 for its services. The next day, GHI completed the delivery charging 750 for its services.

ABC inspected the equipment and accepted the delivery on 1/25/X2. The same day, XYZ issued an invoice for 6,000.

The previous example includes a discussion of overhead allocation.

Acceptance is not a criterion for revenue recognition. Nevertheless, the guidance only allows revenue to be recognized after the contract has been completed.

Both IFRS 15.31 and ASC 606-10-25-23 specify that an entity shall recognize revenue when (or as) it transfers a promised good or service to a customer which is the moment the customer obtains control of that good or service.

The IFRS master glossary defines control as: The present ability to direct the use of the economic resource and obtain the economic benefits that may flow from it.

The US GAAP master glossary includes three definitions:

DEFINITION 1: The possession, direct or indirect, of the power to direct or cause the direction of the management and policies of an entity through ownership, by contract, or otherwise (topics 310, 850).

DEFINITION 2: The direct or indirect ability to determine the direction of management and policies through ownership, contract, or otherwise (topics 954, 958).

DEFINITION 3: The same as the meaning of controlling financial interest in paragraph 810-10-15-8.

Unfortunately, not one of them applies to goods or services.

The best definition thus comes from the text of IFRS 15.33 | ASC 606-10-25-25:

... Control of an asset refers to the ability to direct the use of, and obtain substantially all of the remaining benefits from, the asset. Control includes the ability to prevent other entities from directing the use of, and obtaining the benefits from, an asset. ...

Both IFRS 15.38 and ASC 606-10-25-30 outline "indicators" (a. right to payment, b. legal title, c. physical possession, d. risks and rewards of ownership and e. acceptance) that can be used to determine the exact point of time when control transfers.

However, indicators are not criteria. Control is.

This implies that if a company has transferred control to the customer, it should recognize revenue even if none of the indicators are present.

IFRS 15.35 | ASC 606-10-25-27 specifies that revenue can only be recognized over time if (a) customer simultaneously receives and consumes the benefits or (b) the entity’s performance creates or enhances a customer asset or (c) the entity has an enforceable right to payment for performance completed to date.

While XYZ did receive a payment from the customer, the payment was not compensation for performance, but an advance on future performance.

As outlined in IFRS 15.B9 | ASC 606-10-55-11, an entity must have a right to payment for the performance completed to date even if customer (or some other party) terminated the contract.

Obviously, no contract for a shipping service would require the customer to pay for the shipping service unless shipper delivered. This implies that any advance payment would be returnable and no other enforceable right to payment could exist prior to delivery.

While it is possible the shipper could still get paid, for example if the shipment were insured, such payment would not be from a customer for the service, but from an insurance carrier as an indemnification of losses. It would also, most likely be far exceed the amount that would have been paid for the shipping service and most, if not all, would be paid out to the customer.

As ABC would not receive the benefits until XYZ delivered the goods, as XYZ performance did not enhance any asset until XYZ delivered the goods and as ABC had no obligation to pay unless XYZ delivered the goods, XYZ's performance obligation was satisfied at the point of time it delivered the goods, no sooner.

Dr/Cr

12/15/X1 / 15.12.X1
Cash		3,000
	Deferred service revenue (contract liability)		3,000

 

IFRS 15.105 | ASC 606-10-45-1 specifies that, depending on the relationship between the entity’s performance and the customer’s payment, either a contract asset or a contract liability is presented on the balance sheet.

In practice, when a liability is presented, it is generally labeled as deferred (or unearned) revenue. This practice is reflected in the FASB XBRL where DeferredRevenue comprises ContractWithCustomerLiability and DeferredIncome. While the IASB XBRL does not include similar labels, as it would not contradict IFRS 15's guidance, it can be extended to do so.

12/16/X1 / 16.12.X1
Inventory: Work in process: Contract with ABC		1,250
	Liabilities: Accrued expenses: Wages payable		500
	Inventory: Work in process: Pre-paid fuel and consumables		300
	Inventory: Work in process: Unallocated overhead		250
	Cash (HIG)		200

 

The proper approach is to recognize the costs to fulfill a contract as Inventory: Work in process.

Nevertheless, many service providers prefer to recognize these costs as Accruals: Pre-paid expenses.

While both IFRS 15.97 and ASC 340-40-25-7 specify that the costs to fulfill a contract are to be recognized as assets (capitalized), neither specifies how.

This implies that either approach would be consistent with the guidance provided.

Both IFRS and US GAAP require that overhead be included in costs to fulfill a contract.

IFRS 15.97 | ASC 340-40-25-7 (emphasis added): Costs that relate directly to a contract (or a specific anticipated contract) include any of the following:

(a) direct labour (for example, salaries and wages of employees who provide the promised services directly to the customer);

(b) direct materials (for example, supplies used in providing the promised services to a customer);

(c) allocations of costs that relate directly to the contract or to contract activities (for example, costs of contract management and supervision, insurance and depreciation of tools, equipment and right-of-use assets used in fulfilling the contract);

(d) costs that are explicitly chargeable to the customer under the contract; and

(e) other costs that are incurred only because an entity entered into the contract (for example, payments to subcontractors)

Various methods, such as job costing, direct costing, standard costing can be used (see inventory for examples).

In this example, XYZ chose to allocate overhead using an Unallocated overhead account.

The previous example includes an additional discussion of this procedure.

12/18/X1 / 18.12.X1
Accrued service costs		1,000
	Payable: DEF		1,000

 

Why no Revenue in X1?

As outlined IFRS 15.35.a | ASC 606-10-25-27.a, to qualify for over time revenue recognition, the customer must simultaneously receive and consume the benefits of the service.

In BC126 to IFRS 15 | ASU 2014-09, the IASB | FASB discuss how this criterion would apply to a freight logistics contract where goods are transported from Vancouver to New York City concluding that, if the goods were delivered only part way, another entity could continue in (would not need to substantially reperform) the service.

However, in this illustration, if HIJ failed to perform because, for example, the shipment were lost at sea, no other entity could continue in the service.

While highly unlikely, it does mean ABC could receive the benefits associated with the service only after the second leg of the journey is completed.

As the boards also point out, in some cases "the assessment of whether another entity would need to substantially reperform the performance completed to date can be used as an objective basis for determining whether the customer receives benefit from the entity’s performance as it is provided."

Thus, in those cases where it is critically important for a portion of a service to be successfully completed before a different service provider is able to continue in that service, as in the example, revenue may only be recognized once that critical portion is completed (unless the entity decides to make it easy on itself).

While XYZ could elect to review every cross-period shipment for completeness, the accounting policy implied by BC126, it could also consider that such accounting policy might require employing a specialist(s) whose task would be to make these assessments.

In contrast, if it decided to simply recognize revenue when the customer signed an acceptance form, this process could be automated and would require no human intervention.

Comparing the cost, not opting for an accounting policy implied in the BC, with the benefit, not having to pay an additional salary(ies), it could conclude that recognizing revenue associated with a service where the final act is critically important for the service as a whole to have any value would not be a violation of the spirit of the guidance, even if the boards do have a different opinion.

While useful in interpreting the guidance, the basis for conclusion is not, itself, authoritative guidance.

As a result, entities may elect, but are not required, to make policy choices consistent with the discussion in the BC.

It may also consider, while a shipping service could theoretically be completed by a different freight forwarder if the first freight forwarder calls it quits in the middle, this practically never happens in practice implying that the opinion expressed in the BC may only reflect conjecture on the part of the board members rather than careful examination of the dynamics of a service where, without the final act being successfully completed, value is not created, but destroyed (regardless of what the popular opinion: link - PwC may be).

While useful in interpreting the guidance, the basis for conclusion is not, itself, authoritative guidance.

As a result, entities may elect, but are not required, to make policy choices consistent with the discussion in the BC.

However, since this is highly unusual in practice, practically all services whose duration extends from one reporting period to a subsequent period(s) are recognized over time.

This also implies that the key criterion for recognizing service revenue is not actually outlined in paragraph IFRS 15.35 | ASC 606-10-25-27, but rather IFRS 15.37 | ASC 606-10-25-29.

To put it simply, if the service provider can demand payment as it completes the work, it recognizes revenue, over time, as it provides the service (even if it only actually demands payment on completion).

Only in those rare situations where the customer has the right to stop the service without having to pay for work already performed, the service provider would recognize revenue at the point of time it is able to demand payment.

1/22/X2 / 22.1.X2
Deferred service revenue		3,000
Unbilled service revenue: ABC		3,000
Cost of sales		4,000
	Service revenue		6,000
	Inventory: Work in process: Contract with ABC		1,250
	Payable: HIJ		2,000
	Payable: GHI		750

 

While XYZ could have recognized revenue on 1/21/X2 / 21.1.X2, for cost benefit / reasons it only evaluates cross-period performance obligations for completeness. In situations where the service begins and ends during a single reporting period, it simply recognizes revenue when then service is completed.

Note: as outlined above, it could have also elected to recognize revenue on completion.

Rather than a receivable or contract asset, this example uses an unbilled revenue account.

IFRS 15.105 | ASC 606-10-45-1 states (edited): ...An entity shall present any unconditional rights to consideration separately as a receivable.

IFRS 15.108 | ASC 606-10-45-4 states (edited): ...A right to consideration is unconditional if only the passage of time is required before payment of that consideration is due...

IFRS 15.107 | ASC 606-10-45-3 states (edited, emphasis added): If an entity performs by transferring goods or services to a customer before the customer pays consideration or before payment is due, the entity shall present the contract as a contract asset...

As written, the guidance in IFRS 15.105 to 109 | ASC 606-10-45-1 to 5 gives two options.

IFRS 15.105 | ASC 606-10-45-1 states (emphasis added): When either party to a contract has performed, an entity shall present the contract in the statement of financial position as a contract asset or a contract liability, depending on the relationship between the entity’s performance and the customer’s payment. An entity shall present any unconditional rights to consideration separately as a receivable.

IFRS 15.108 | ASC 606-10-45-4 explains (edited, emphasis added): A right to consideration is unconditional if only the passage of time is required before payment of that consideration is due.

Applied to this example, since XYZ has performed and the only condition associated with its right to consideration (the customer’s payment) is having to wait a period of time, it should present a receivable, not a contract asset.

However, IFRS 15.107 | ASC 606-10-45-3 also states (edited, emphasis added): If an entity performs by transferring goods or services to a customer before the customer pays consideration or before payment is due, the entity shall present the contract as a contract asset, excluding any amounts presented as a receivable.

In practice, “before payment is due” is often interpreted to mean that the company has not only performed (transferred goods, rendered services) but has also billed (issued an invoice).

Using a separate, unbilled revenue account gives companies an option to cover the situation where they have performed but not yet billed.

At the end of the period, the unbilled revenue account can be taken directly to the balance sheet.

Although the ASC does not address unbilled revenue, FASB XBRL includes UnbilledRevenuesMember and UnbilledReceivablesCurrent. It defines the latter: "Amount received for services rendered and products shipped, but not yet billed, for non-contractual agreements due within one year or the normal operating cycle, if longer."

Although the IASB XBRL does not include a similar item, it may be extended to do so.

At the end of the period, the unbilled revenue account can be presented as a sub-classification of contract assets or receivables depending on if the right to consideration is conditional or not.

This option is especially useful for companies domiciled in (or with subsidiaries domiciled in) jurisdictions where national GAAP and/or tax law outlines different rules.

In some jurisdictions, besides IFRS and/or US GAAP, entities must apply statuary accounting (a.k.a. national GAAP). For example, in the European Union two separate accounting systems exist:

IFRS (required by the IAS regulation) and national GAAP (required by the accounting directive).

While IFRS is used for financial reporting, national GAAP is often used for taxation. For example, in the Czech Republic, while IFRS is required for financial reporting purposes, it may not be used as the basis for determining taxable income, which means the two must be reconciled at the end of each period.

Using an account like unbilled revenue is helpful because it can (if the right is unconditional) be presented as a receivable for IFRS reporting purposes and as accrued revenue for statutory reporting purposes (Czech national GAAP only allows receivables to be recognized if a formal invoice has been issued).

As outlined in IFRS 15.B84 | ASC 606-10-55-86, acceptance is a formality provided that an entity can objectively determine it transferred control to the customer as per the terms outlined in the contract.

1/25/X2 / 25.1.X2
Account Receivable: ABC		3,000
	Unbilled service revenue: ABC		3,000

Proportional performance, straight-line (over time)

XYZ provides technical support and maintenance (TSM) to software/hardware clients. 1/1/X1, ABC paid 12,000 for one year’s TSM. TSM is provided as needed and XYZ is unable to estimate the frequency, timing or total cost of individual acts.

In 1/X1 and 2/X1, ABC did not require any TSM. In 3/X1 it required TSM that cost 500 (wages, parts, etc.). From 4/X1 to 6/X1, ABC did not require any TSM. From 7/X1 to 8/X1 it required TSM that cost 1,500 in 7/X1 and 3,000 in 8/X1. From 9/X1 to 11/X1 it did not require any TSM. In 12/X1 it required TSM that cost 1,000.

Dr/Cr

 

1/1/X1 / 1.1.X1
Cash		12,000
	Deferred service revenue (contract liability)		12,000

 

IFRS 15.105 | ASC 606-10-45-1 specifies that, depending on the relationship between the entity’s performance and the customer’s payment, either a contract asset or a contract liability is presented on the balance sheet.

In practice, when a liability is presented, it is generally labeled as deferred (or unearned) revenue. This practice is reflected in the FASB XBRL where DeferredRevenue comprises ContractWithCustomerLiability and DeferredIncome. While the IASB XBRL does not include similar labels, as it would not contradict IFRS 15's guidance, it can be extended to do so.

1/31/X1 - 31.1.X1
Deferred service revenue		1,000
	Service revenue		1,000

 

2/28/X1 - 28.2.X1
Deferred service revenue		1,000
	Service revenue		1,000

 

3/31/X1 / 31.3.X1
Deferred service revenue		1,000
Cost of services rendered		500
	Service revenue		1,000
	Cash / Inventory / Payroll / etc.		500

 

etc.

7/31/X1 / 31.7.X1
Deferred service revenue		1,000
Cost of services rendered		1,500
	Service revenue		1,000
	Cash / Inventory / Payroll / etc.		1,500

 

8/31/X1 / 31.8.X1
Deferred service revenue		1,000
Cost of services rendered		3,000
	Service revenue		1,000
	Cash / Inventory / Payroll / etc.		3,000

 

etc.

12/31/X1 / 31.12.X1
Deferred service revenue		1,000
Cost of services rendered		1,000
	Service revenue		1,000
	Cash / Inventory / Payroll / etc.		1,000

 

Cost plus

Same facts except, the agreement specified the number of acts and XYZ was able to determine the cost of each.

Such a scenario is not particularly realistic. Not only is it fairly uncommon for TSM contracts to specify the number of individual acts, it is also relatively difficult to accurately estimate the cost of each individual act.

On the other hand, it is often possible to estimate the total cost to be incurred during the contract period.

However, in this case, one of the POC methods (see examples below) would be appropriate.

1/1/X1 / 1.1.X1
Cash		12,000
	Deferred service revenue		12,000

 

3/31/X1 / 31.3.X1
Deferred service revenue		1,000
Cost of services rendered		500
	Service revenue		1,000
	Cash / Inventory / Payroll / etc.		500

 

7/31/X1 / 31.7.X1
Deferred service revenue		3,000
Cost of services rendered		1,500
	Service revenue		3,000
	Cash / Inventory / Payroll / etc.		1,500

 

8/31/X1 / 31.8.X1
Deferred service revenue		6,000
Cost of services rendered		3,000
	Service revenue		6,000
	Cash / Inventory / Payroll / etc.		3,000

 

12/31/X1 / 31.12.X1
Deferred service revenue		2,000
Cost of services rendered		1,000
	Service revenue		2,000
	Cash / Inventory / Payroll / etc.		1,000

 

Cost-to-cost

While simple, linear revenue recognition can cause (in this example quarterly) gross profit to fluctuate dramatically.

This can be avoided by using a cost-to-cost method (see example below) instead.

Proportional performance, cost plus (over time)

10/1/X1, XYZ and ABC agreed that XYZ would offer to develop a machine to ABC’s specifications.

From 10/1/X1 to 10/15/X1, XYZ incurred costs (salaries) of 1,000 determining the scope of the project and preparing the offer. These costs were recoverable only if the ABC agreed to complete the project. In the past, ABC had agreed to complete similar projects over 80% of the time.

When evaluating the probability of variable consideration, a probability of 75% to 80% should be used under both IFRS and US GAAP.

IFRS 15.56 specifies that variable consideration can be recognized only if "it is highly probable that a significant reversal" will not occur, while ASC 606-10-32-11 specified "it is probable that a significant reversal" will not occur.

The reason for the difference is that IFRS considers "probable" to be a synonym for more "likely than not" (a likelihood of 50% or more) while US GAAP assigns it a higher likelihood of 75-80% (see: link - PwC and link - IASB).

10/15/X1, XYZ presented an estimate of 20,000 (labor) 10,000 (parts) + 50% markup, which ABC accepted. The agreement included clearly defined and objectively measurable milestones, which XYZ was certain it could reach. Implicit in the agreement was that ABC would be obliged to pay for work performed if it canceled the contract before its completion but would not be obligated to pay if XYZ failed to complete the project.

From 10/16/X1 to 12/31/X1, XYZ incurred costs: labor 15,000 and material 5,000. On 3/31/X2, it completed the project. During Q1/X2, it incurred labor costs of 5,000. However, due to an unpredictable shortage, material costs were 10,000. ABC agreed to pay an additional 5,000 to cover the cost overrun.

On 4/15/X2, after it completed testing the machine, ABC formally accepted delivery and XYZ issued an invoice

While IFRS and US GAAP both require full absorption costing, for simplicity, this example omits overhead.

see the Specific performance (point of time) example above and inventory page for a discussion of this issue.

Dr/Cr

10/15/X1 / 15.10.X1
Inventory: Work in process: Initial direct costs		1,000
	Accrued wages and salaries		1,000

 

As outlined in IFRS 15.91 | ASC 340-40-25-1, incremental costs of obtaining a contract (a.k.a. initial direct costs) may only be capitalized if they are recoverable.

As XYZ expected ABC to enter into the agreement with a high degree of probability, it capitalized the costs.

12/31/X1 / 31.12.X1
Contract asset: ABC		31,125
Cost of services rendered		20,750
	Revenue		31,125
	Accrued wages and salaries		15,000
	Inventory: Parts and materials		5,000
	Inventory: Work in process: Initial direct costs		750

 

As outlined in IFRS 15.105 | ASC 606-10-45-1, if the entity has performed or the customer has paid, a contract asset (performance precedes payment) or contract liability (payment precedes performance) is presented.

As outlined in IFRS 15.108 | ASC 606-10-45-4, a receivable may only be presented if the right to consideration is unconditional.

Since ABC had not paid and since completing the machine was a condition for it being able to claim payment, XYZ recognized a contract asset rather than a receivable.

While acceptance is an indicator that a performance obligation has been satisfied, is not a criterion. Consequently, XYZ only considered whether it had fulfilled its promise to ABC not whether ABC acknowledged that it had fulfilled its promise.

IFRS 15.38 | ASC 606-10-25-30 outlines 5 indicators that control has been transferred to the customer. The fifth is the customer has accepted.

IFRS 15.31 | ASC 606-10-25-23 specifies that revenue is recognize when (or as) the entity transfers a promised good or service to the customer.

For revenue recognized over time, IFRS 15.35 | ASC 606-10-25-27 outlines three conditions. If any one is met, revenue is recognized.

After evaluating both the terms of the agreement and its performance, XYZ determine that it had met two:

IFRS 15.35.b | ASC 606-10-25-27.b: its performance enhanced the customer’s asset.

IFRS 15.35.c | ASC 606-10-25-27.c: its performance did not create an asset with an alternative to XYZ and XYZ had an enforceable right to payment.

As outlined in IFRS 15.B84 | ASC 606-10-55-86, if an entity can demonstrate it has fulfilled its promise (has transferred control of the good or service) to the customer in an objective way, customer acceptance is merely a formality.

As outlined in IFRS 15.99 | ASC 340-40-35-1, capitalized costs are amortized on a systematic basis consistent with the transfer of the goods or services to the customer.

The most common allocation basis is parts (material) and labor.

However, because in its experience the costs of material fluctuated unpredictably, XYZ decided to allocate the costs on the basis of labor only.

3/31/X2 / 31.3.X2
Unbilled revenue: ABC		51,500
Cost of services rendered		15,250
	Revenue		20,375
	Accrued wages and salaries		5,000
	Inventory: Parts and materials		10,000
	Inventory: Work in process: Initial direct costs		250
	Contract asset: ABC		31,125

 

Instead of a receivable or contract asset, this example uses an unbilled revenue account.

IFRS 15.105 | ASC 606-10-45-1 states (edited): ...An entity shall present any unconditional rights to consideration separately as a receivable.

IFRS 15.108 | ASC 606-10-45-4 states (edited): ...A right to consideration is unconditional if only the passage of time is required before payment of that consideration is due...

IFRS 15.107 | ASC 606-10-45-3 states (edited, emphasis added): If an entity performs by transferring goods or services to a customer before the customer pays consideration or before payment is due, the entity shall present the contract as a contract asset...

As written, the guidance in IFRS 15.105 to 109 | ASC 606-10-45-1 to 5 gives two options.

IFRS 15.105 | ASC 606-10-45-1 states (emphasis added): When either party to a contract has performed, an entity shall present the contract in the statement of financial position as a contract asset or a contract liability, depending on the relationship between the entity’s performance and the customer’s payment. An entity shall present any unconditional rights to consideration separately as a receivable.

IFRS 15.108 | ASC 606-10-45-4 explains (edited, emphasis added): A right to consideration is unconditional if only the passage of time is required before payment of that consideration is due.

Applied to this example, since XYZ has performed and the only condition associated with its right to consideration (the customer’s payment) is having to wait a period of time, it should present a receivable, not a contract asset.

However, IFRS 15.107 | ASC 606-10-45-3 also states (edited, emphasis added): If an entity performs by transferring goods or services to a customer before the customer pays consideration or before payment is due, the entity shall present the contract as a contract asset, excluding any amounts presented as a receivable.

In practice, “before payment is due” is often interpreted to mean that the company has not only performed (transferred goods, rendered services) but has also billed (issued an invoice).

Using a separate, unbilled revenue account gives companies an option to cover the situation where they have performed but not yet billed.

At the end of the period, the unbilled revenue account can be taken directly to the balance sheet.

Although the ASC does not address unbilled revenue, FASB XBRL includes UnbilledRevenuesMember and UnbilledReceivablesCurrent. It defines the latter: "Amount received for services rendered and products shipped, but not yet billed, for non-contractual agreements due within one year or the normal operating cycle, if longer."

Although the IASB XBRL does not include a similar item, it may be extended to do so.

At the end of the period, the unbilled revenue account can be presented as a sub-classification of contract assets or receivables depending on if the right to consideration is conditional or not.

This option is especially useful for companies domiciled in (or with subsidiaries domiciled in) jurisdictions where national GAAP and/or tax law outlines different rules.

In some jurisdictions, besides IFRS and/or US GAAP, entities must apply statuary accounting (a.k.a. national GAAP). For example, in the European Union two separate accounting systems exist:

IFRS (required by the IAS regulation) and national GAAP (required by the accounting directive).

While IFRS is used for financial reporting, national GAAP is often used for taxation. For example, in the Czech Republic, while IFRS is required for financial reporting purposes, it may not be used as the basis for determining taxable income, which means the two must be reconciled at the end of each period.

Using an account like unbilled revenue is helpful because it can (if the right is unconditional) be presented as a receivable for IFRS reporting purposes and as accrued revenue for statutory reporting purposes (Czech national GAAP only allows receivables to be recognized if a formal invoice has been issued).

4/15/X2 / 15.4.X2
Accounts receivable: ABC		51,500
	Unbilled Revenue: ABC		51,500

 

Same facts except XYZ elected to expense the initial direct costs.

As outlined in IFRS 15.94 | ASC 340-40-25-4, as a practical expedient, costs of obtaining a contract may be expensed if their amortization period would be one year or less.

10/15/X1 / 15.10.X1
Selling expenses: Contract procurement costs		1,000
	Accrued wages and salaries		1,000

 

As outlined in IFRS 15.92 | ASC 340-40-25-2, incremental costs are costs an entity incurs to obtain a contract such as a sales commission.

In this example, XYZ made the estimate in the hope of gaining the contract. As a result, the estimate was akin to a sales commission.

Same facts except XYZ could not determine it was likely ABC would agree to the contract.

As outlined in IFRS 15.91 | ASC 340-40-25-1, an entity may only capitalize incremental costs if it expects to recover them.

In this example, XYZ could not determine if it could expect to recover the costs, so it expensed them.

10/15/X1 / 15.10.X1
Selling expenses: Contract procurement costs		1,000
	Accrued wages and salaries		1,000

 

Tax treatment

Same fact except, in XYZ’s tax jurisdiction, VAT/GST accrues on sale date as outlined in the contract (which is the same as the acceptance date), the tax effective date on the tax invoice or the cash receipt date whichever occurs earliest. Income tax accrues on the sales date as outlined in the contract. The VAT/GST rate is 20% and income tax rate is 15%.

While the United States does not have a value added tax (link : wikipedia.org) in the Europe its use is mandated by the European Union. The goods and services tax (link: investopedia.com) is a form of VAT used in India.

Dr/Cr

12/31/X1 / 31.12.X1
Contract asset: ABC		31,125
Cost of services rendered		20,750
Income tax expense		1,556
	Revenue		31,125
	Deferred income tax liability		1,556
	Accrued wages and salaries		15,000
	Inventory: Parts and materials		5,000
	Inventory: Initial direct costs		750

 

(31,125 - 20,750) x .15% = 1,556

3/31/X2 / 31.3.X2
Unbilled revenue: ABC		51,500
Cost of services rendered		15,250
Income tax expense		769
	Revenue		20,375
	Deferred income tax liability		769
	Accrued wages and salaries		5,000
	Inventory: Parts and materials		10,000
	Inventory: Initial direct costs		250
	Contract asset: ABC		31,125

 

(20,375 - 15,250) x .15% = 769

4/15/X2 / 15.4.X2
Accounts receivable: ABC		51,500
Deferred income tax liability		2,325
Accrued assets: Accrued VAT/GST (receivable from customer)		10,300
	Unbilled revenue: ABC		51,500
	Accrued income tax liability		2,325
	Accrued liabilities: Accrued VAT/GST (payable to taxation authority)		10,300

 

51,500 x 20% = 10,300

Goods bundled with services (both)

XYZ provides telecommunications services. New customers committing to a long-duration contract receive a free handset. XYZ charges a flat, monthly fee for its services.

1/1/X1, XYZ entered into a 1-year contract with customer 1234567. The customer agreed to pay 100 per month and received a handset that had cost 300. While XYZ does not sell giveaway handsets, handsets with comparable features available on the market for 400 on average.

As outlined in IFRS 15.76 | ASC 606-10-32-28, the transaction price is allocated to individual performance obligations on the basis of their stand-alone selling price.

In other words, under IFRS and US GAAP, "free" does not exist. A company needs to price all its goods and services, even those it "gives away."

If a company does not sell the same products (stand-alone selling price is not directly observable), it needs to estimate that stand-alone selling price.

IFRS 15.79 | ASC 606-10-32-34 specifies how.

In order: (a) the price on the market (how much other companies charge for the same or comparable goods or services), (b) cost plus, and (c) a residual approach.

Note: IFRS 15.79.c | ASC 606-10-32-34.c restricts the use of the residual approach to situations where the entity sells the item(s) for (1) a wide variety of prices, or (2) has never sold it (them) before and has not priced it (them) yet.

1/31/X1, it issued invoice # 1234567.01, which the customer paid 2/20/X1.

In this example, XYZ numbers invoices first by customer then sequentially.

This would not conflict with any IFRS | US GAAP guidance.

However, in many jurisdictions, national GAAP and/or tax regulation do specify how companies must number their invoices, which may not be consistent with this example.

To minimize the differences between their national GAAP/tax book and IFRS | US GAAP accounts, many companies would prefer to use the same numbering scheme for both.

Since IFRS | US GAAP does not go into bookkeeping details, companies are free to use whatever numbering scheme they like for IFRS | US GAAP purposes.

Dr/Cr

1/1/X1 / 1.1.X1
Unbilled revenue: 1234567		400
Cost of merchandise sold		300
	Revenue (merchandise)		400
	Inventory: Merchandise: Giveaway handsets		300

 

Instead of a receivable or contract asset, this example uses an unbilled revenue account.

IFRS 15.105 | ASC 606-10-45-1 states (edited): ...An entity shall present any unconditional rights to consideration separately as a receivable.

IFRS 15.108 | ASC 606-10-45-4 states (edited): ...A right to consideration is unconditional if only the passage of time is required before payment of that consideration is due...

IFRS 15.107 | ASC 606-10-45-3 states (edited, emphasis added): If an entity performs by transferring goods or services to a customer before the customer pays consideration or before payment is due, the entity shall present the contract as a contract asset...

As written, the guidance in IFRS 15.105 to 109 | ASC 606-10-45-1 to 5 gives two options.

IFRS 15.105 | ASC 606-10-45-1 states (emphasis added): When either party to a contract has performed, an entity shall present the contract in the statement of financial position as a contract asset or a contract liability, depending on the relationship between the entity’s performance and the customer’s payment. An entity shall present any unconditional rights to consideration separately as a receivable.

IFRS 15.108 | ASC 606-10-45-4 explains (edited, emphasis added): A right to consideration is unconditional if only the passage of time is required before payment of that consideration is due.

Applied to this example, since XYZ has performed and the only condition associated with its right to consideration (the customer’s payment) is having to wait a period of time, it should present a receivable, not a contract asset.

However, IFRS 15.107 | ASC 606-10-45-3 also states (edited, emphasis added): If an entity performs by transferring goods or services to a customer before the customer pays consideration or before payment is due, the entity shall present the contract as a contract asset, excluding any amounts presented as a receivable.

In practice, “before payment is due” is often interpreted to mean that the company has not only performed (transferred goods, rendered services) but has also billed (issued an invoice).

Using a separate, unbilled revenue account gives companies an option to cover the situation where they have performed but not yet billed.

At the end of the period, the unbilled revenue account can be taken directly to the balance sheet.

Although the ASC does not address unbilled revenue, FASB XBRL includes UnbilledRevenuesMember and UnbilledReceivablesCurrent. It defines the latter: "Amount received for services rendered and products shipped, but not yet billed, for non-contractual agreements due within one year or the normal operating cycle, if longer."

Although the IASB XBRL does not include a similar item, it may be extended to do so.

At the end of the period, the unbilled revenue account can be presented as a sub-classification of contract assets or receivables depending on if the right to consideration is conditional or not.

This option is especially useful for companies domiciled in (or with subsidiaries domiciled in) jurisdictions where national GAAP and/or tax law outlines different rules.

In some jurisdictions, besides IFRS and/or US GAAP, entities must apply statuary accounting (a.k.a. national GAAP). For example, in the European Union two separate accounting systems exist:

IFRS (required by the IAS regulation) and national GAAP (required by the accounting directive).

While IFRS is used for financial reporting, national GAAP is often used for taxation. For example, in the Czech Republic, while IFRS is required for financial reporting purposes, it may not be used as the basis for determining taxable income, which means the two must be reconciled at the end of each period.

Using an account like unbilled revenue is helpful because it can (if the right is unconditional) be presented as a receivable for IFRS reporting purposes and as accrued revenue for statutory reporting purposes (Czech national GAAP only allows receivables to be recognized if a formal invoice has been issued).

In general usage, cost of sales (COS) comprises: cost of goods sold (COGS), cost of merchandise sold and cost of services rendered.

FASB XBRL includes both a CostOfRevenueAbstract and CostOfGoodsAndServicesSoldAbstract. It also includes various items including: CostDirectMaterial, CostDirectLabor, CostOfGoodsAndServicesSoldOverhead, CostMaintenance, CostOfGoodsAndServicesSoldDepreciation, CostOfGoodsAndServicesSoldAmortization CostDepletion, etc.

IASB XBRL function of expense includes just CostOfSales while nature of expense includes CostOfMerchandiseSold and CostOfPurchasedEnergySold.

As outlined in IFRS 15.22 | ASC 606-10-25-14 entities must identify "performance obligations" which are defined as distinct goods or services.

IFRS 15.26 | ASC 606-10-25-18 provide a list of potentially distance goods and services (the list is not exhaustive) that includes (b) merchandise and (d) agreed upon tasks (a.k.a. services).

XYZ's contract with the customer thus includes two performance obligations: the handset and the telecommunication service.

Consequently, revenue associated with the handset must be recognized separately from the revenue associated with the telecommunication service.

Unfortunately, the guidance on when exactly to recognize the revenue for each is not particularly easy to interpret since it fails to explicitly state when to recognize at a point of time (e.g. when a customer receives a handset).

IFRS 15.38 | ASC 606-10-25-30: "If a performance obligation is not satisfied over time in accordance with paragraphs 35–37 | paragraphs 606-10-25-27 through 25-2, an entity satisfies the performance obligation at a point in time. ..."

This would not be a problem if the over-time guidance was usable right out of the box.

IFRS 15.35 | ASC 606-10-25-27: 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 (see paragraphs B3–B4 | paragraphs 606-10-55-5 through 55-6);

(b) the entity’s performance creates or enhances an asset (for example, work in progress) that the customer controls as the asset is created or enhanced (see paragraph B5 | paragraph 606-10-55-7); or

(c) the entity’s performance does not create an asset with an alternative use to the entity (see paragraph 36 | paragraph 606-10-25-28) and the entity has an enforceable right to payment for performance completed to date (see paragraph 37 | paragraph 606-10-25-29)

As is, like IKEA furniture, some assembly may be required.

Fortunately, the telecommunication service is straight forward.

IFRS 15.B3 | ASC 606-10-55-5 says routine or recurring services (like cleaning) are over time.

Since providing telecommunications connectivity is a routine or recurring service (like cleaning), this service is clearly recognized over time (it also helps that the customer consumes the service as it is provided).

But what about the handset?

Since it is used to access the telecommunication service, should it not also be recognized over time?

Here IFRS 15.B4 | ASC 606-10-55-6 states "For other types of performance obligations, an entity may not be able to readily identify whether a customer simultaneously receives and consumes the benefits from the entity’s performance as the entity performs."

Reading between the lines, "as the entity performs" clearly refers to a service, not a piece of equipment.

Fortunately, IFRS 15.35.b & c | ASC 606-10-25-27.b & c pose little difficulty as handing over a handset does not enhance an asset like work in process nor does it create an asset with an alternative use.

Also, the handset is distinct in that it can be used to access any other telecommunication network, not just XYZ's.

IFRS 15.26 | 606-10-25-18: Distinct goods or services ... may include (b) ... resale of goods purchased by an entity (for example, merchandise of a retailer); ...

Granted, XYZ did not strictly speaking resell the handset, but the whole point of the standard is to guide companies to present the true economic substance of transactions not merely their legal form.

IFRS 15.27 | 606-10-25-19: A good or service ... is distinct if (a) the customer can benefit from [it] on its own or together with other resources that are readily available to the customer [like another telecommunication provider's network] and (b) the entity’s promise to transfer the good or service to the customer is separately identifiable from other promises in the contract [like connectivity].

Finally, it also helps that XYZ gave of the handset to the customer.

IFRS 15.38 | ASC 606-10-25-30: ... an entity shall consider indicators of the transfer of control, which include ... (c) The entity has transferred physical possession of the asset ...

1/31/X1 / 31.1.X1
Accounts receivable: 1234567.01		100
	Revenue (telecommunication services)		77
	Unbilled revenue: 1234567		33

 

2/20/X1 / 20.2.X1
Cash		100
	Accounts receivable: 1234567.01		100

 

Not distinct

Same facts except XYZ gave the customer a handset locked to its network.

As outlined in IFRS 15.22 | ASC 606-10-25-14, entities must identify "performance obligations," which are defined as distinct goods or services.

Technically (IFRS 15.22 ASC 606-10-25-14), a distinct good or service can be a bundle of distinct goods and services or a series of distinct goods and services that are substantially the same, but in this example there are only two potentially distinct goods and services: the handset and the connectivity.

However, as outlined in IFRS 15.27 | ASC 606-10-25-19, a good or service can be distinct only if the customer can benefit from it by itself and it is separately identifiable from other goods and services (promises in the contract).

Technically (IFRS 15.27.a ASC 606-10-25-19..) by itself or with readily available resources.

In the context of this example, readily available resources would be if customers could connect the handset to any carrier’s service.

In this situation the customer cannot benefit from the handset by itself, as it can only be connected to XYZ's network, so the handset is not distinct.

Since it is not distinct from the service, the revenue from both the service and the handset are recognized together.

1/1/X1 / 1.1.X1
Inventory: CIP: Handsets given to customer: 1234567		300
	Inventory: Merchandise: Giveaway handsets		300

 

Many companies, especially service providers, prefer to report capitalized contract costs as accruals.

For example, in its 2021 10-K Verizon Communications states (edited, emphasis added): Contract assets primarily relate to our rights to consideration for goods or services provided to customers but for which we do not have an unconditional right at the reporting date. Under a fixed-term plan, total contract revenue is allocated between wireless service and equipment revenues. In conjunction with these arrangements, a contract asset is created, which represents the difference between the amount of equipment revenue recognized upon sale and the amount of consideration received from the customer when the performance obligation related to the transfer of control of the equipment is satisfied. The contract asset is reclassified to accounts receivable as wireless services are provided and billed. We have the right to bill the customer as service is provided over time, which results in our right to the payment being unconditional. The contract asset balances are presented in our consolidated balance sheets as Prepaid expenses and other and Other assets ...

However, as the handset was recognized by applying the guidance in IAS 2 | ASC 330, this example sub-classifies it as inventory.

IFRS 15.96 | ASC 340-40-25-6 (edited): For costs incurred in fulfilling a contract with a customer that are within the scope of another Standard | Topic [such as IAS 2 | Topic 330], an entity shall account for those costs in accordance with those other Standards | Topics or Subtopics.

While considered unusual, the procedure in this example better reflects the guidance.

As outlined in IFRS 15.99 | ASC 340-40-35-1, previously capitalized costs (IFRS 15.97.b | ASC 340-40-35-6) are amortized on a systematic basis.

Since the handsets were originally recognized by applying (as outlined IFRS 15.95 | ASC 340-40-35-1) the guidance in IAS 2 | ASC 330 , they should be derecognized using the same guidance.

IAS 2.34 specifies that capitalized inventory costs are expensed in the same period as the associated revenue.

While ASC 330 does not have a dedicated derecognition subtopic, the same procedure is implied by the guidance in ASC 330-10-30-10.

In this example, since the handset was associated with a service, XYZ reclassified it from Merchandise to Contract in progress where it carried it until the associated service revenue was recognized.

1/31/X1 / 31.1.X1
Accounts Receivable: 1234567.01		100
Cost of merchandise sold		25
	Revenue		100
	Inventory: CIP: Handsets given to customer: 1234567		25

Fulfillment costs

During Q1, XYZ incurred fulfillment costs: 1,000,000 (wages), 250,000 (material, primarily used in maintenance and repair) 1,250,000 (access charges and fees), 2,000,000 (depreciation, primarily equipment and structures) and 1,750,000 (amortization of licenses).

XYZ determined there was little correlation between the obligation to provide telecommunication services and the costs of fulfilling those obligations so it expensed the costs as it incurred them.

Generally, costs to fulfill a contract are first capitalized (IFRS 15.95 | ASC 340-40-25-5). Later, they are expensed (IFRS 15.99 | ASC 340-40-35-1) as revenue is recognized.

However, in some cases, it may be difficult or even impossible to match specific costs to specific revenue.

In these situations, an entity can apply the guidance in IFRS 15.98.d | ASC 340-40-25-8.d which "states costs for which an entity cannot distinguish whether the costs relate to unsatisfied performance obligations or to satisfied performance obligations (or partially satisfied performance obligations)" are expensed as incurred.

1/1/X1 / 1.1.X1
Cost of services rendered (direct labor)		1,000,000
Cost of services rendered (material and supplies)		250,000
Cost of services rendered (third party services)		1,250,000
Cost of services rendered (depreciation)		3,000,000
Cost of services rendered (amortization)		500,000
	Cash, Payables, Accruals, etc.		6,000,000

Discounting

 

Same facts except the contract was for 2 years and discount rate was 8%.

As outlined in IFRS 15.60 to 65 | ASC 606-10-32-15 to 20, discounting is required if the contract provides either the buyer or seller with financing.

A contract provides financing if payments extend (in total or part) over a year (IFRS 15.63 | ASC 606-10-32-18) and the delay is not (IFRS 15.62 | ASC 606-10-32-17) because a. the customers paid in advance in a bill and hold scenario, b. the payments are variable or c. the difference between stand-alone selling price and sum of payments is a security deposit, hold back or similar form or assurance.

As outlined in IFRS 15.61 | ASC 606-10-32-16, if the financing is implied (the contract does not explicitly include reasonable interest rate), an implicit rate "that reflects the price that a customer would have paid for the promised goods or services if the customer had paid cash" is used to determine present value.

If the contract does include a reasonable interest rate (an interest rate prevailing in the relevant market), that explicit rate is used instead.

1/1/X1 / 1.1.X1
Unbilled revenue: 1234567		449
Cost of merchandise sold		300
	Revenue		400
	Unbilled revenue: Deferred interest revenue: 1234567		49
	Inventory: Merchandise: Giveaway handsets		300

 

To determine revenue, XYZ calculated what it would have received in two annual installments:

In excel syntax: =A1/((1-(1/(1+((1+A4)^(1/A3)-1))^(A2*A3)))/((1+A4)^(1/A3)-1))

Where A1 = stand alone selling price, A2 = annual periods, A3 = interim periods and A4 = annual rate.

It amortized the deferred revenue using this schedule:

P	Net unbilled revenue	Discount rate	Interest income	Payment	Amortization
A	B (B+1) = B - F	C = 8%	D = B x C	E	F = E - D
1	400	8.00%	32	224	192
2	208	8.00%	17	224	208
				449	400

 

Alternatively, XYZ could have calculated revenue as if the installments had been monthly.

 

P	Net unbilled revenue	Discount rate	Interest income	Payment	Amortization
A	B (B+1) = B - F	C = (1 + 8%)1/12  - 1	D = B x C	E	F = E - D
1	400.00	0.64%	2.57	18.04	15.47
2	384.53	0.64%	2.47	18.04	15.57
-	-	-	-	-	-
23	35.73	0.64%	0.23	18.04	17.81
24	17.92	0.64%	0.12	18.04	17.92
				433	400

12/31/X1 / 31.12.X1
Unbilled revenue: Deferred interest revenue: 1234567		32
	Interest Revenue		32

 

12/31/X2 / 31.12.X2
Unbilled revenue: Deferred interest revenue: 1234567		17
	Interest Revenue		17

Additional goods and services

Same facts except, XYZ provides additional services not covered by the flat fee. In addition, it operates retail outlets where it sells hardware and an online store where third parties sell their hardware and software. XYZ charges a flat fee of 10% for hardware and 25% for software sales made online.

During 1/X1, customer 123456 purchased a handset for 1,000 (which had cost 750) in XYZ's retail outlet while customer 345678 purchased the same a handset in XYZ's online store. The handset purchased online was supplied to the customer by ABC. Customer 345678 purchased software for 20 from DEF. Customer 456789 made 60 minutes of international calls. XYZ charged 1 per minute and agreed to pay .25 per minute to EFG (the carrier completing the call). Customer 567890 made 90 minutes of roaming calls and used 2 GB of roaming data in a region where regulations prohibit roaming fees. XYZ participates in a roaming pool, paying an annual fee for unlimited access other pool participant networks. Customer 678901 made 10 minutes of roaming calls and used 4 GB of roaming data in a region where roaming is not regulated. XYZ charged 1 per minute of and 3.5 per GB respectively. XYZ and HIJ (the completing carrier) have agreed to pay each other .25 per minute and .375 per GB. One of HIJ 's customers made 25 minutes of calls and used 2 GB of data. During the quarter XYZ accrued charges of 20,000 with respect to HIJ , while HIJ accrued charges of 21,000 with respect to XYZ. They settled on 4/15/X1.

Accounts receivable: 123456		1,000
Cost of merchandise sold		750
	Revenue (merchandise)		1,000
	Inventory: Merchandise		750

 

Accounts receivable: 234567		1,000
	Accounts payable: ABC		900
	Revenue (commission)		100

 

As outlined IFRS 15.B36 | ASC 606-10-55-38, when an agent satisfies a performance obligation, it recognizes net revenue (the amount of the fee or commission it receives for arranging the sale) and no cost of sales.

In contrast, when a principal satisfies a performance obligation (IFRS 15.B35 | ASC 606-10-55-37), it recognizes gross revenue (the total amount of consideration received from the customer) and cost of sales.

IFRS 15.B34 to B38 | ASC 606-10-55-36 to 40 provide guidance on how to determine if an entity is acting as a principal or agent.

Accounts receivable: 345678		20
	Accounts payable: DEF		15
	Revenue (commission)		5

 

Accounts receivable: 456789		60
Cost of services rendered		15
	Revenue (international calls)		60
	Accounts payable: EFG		15

 

Accounts receivable: 567890		0
Cost of services rendered		0
	Revenue (roaming)		0
	Accounts payable		0

 

This entry is provided simply to illustrate that no entry is required.

As XYZ is prohibited from charging roaming fees, there is no revenue associated with this service.

As XYZ pays a flat fee to the roaming pool, cost of this service is included in the fulfillment costs shown in the previous example.

Accounts receivable: 678901		24
Cost of services rendered (HIJ)		4
	Revenue (roaming)		24
	Accounts payable: HIJ		4

 

Accounts receivable: HIJ		7
	Revenue (HIJ)		7

 

3/31/X1 / 31.3.X1
Accounts payable: HIJ		20,000
	Accounts receivable: HIJ		20,000

 

IFRS and US GAAP allow companies to offset assets and liabilities provided they have a legally enforceable right to offset and intend to do so.

While the guidance in IAS 32.42 is not identical to ASC 210-20-45-1, it is comparable.

 

4/15/X1 / 15.4.X1
Cash		1,000
	Accounts receivable: HIJ		1,000

Percentage of completion (over time)

Cost-to-cost method

1/1/X1, XYZ Co. was retained by ABC for a long-term construction project (to which it assigned contract number 01). Upon successful completion, XYZ was entitled to a total fee of 4,000,000. While the contract included clear and binding conditions for both sides, no intermediate performance criteria (benchmarks or milestones) were stipulated. XYZ estimated the cost to complete at 3,000,000 and elected to use a cost-to-cost, project accounting method. ABC pre-paid 850,000 and XYZ periodically billed additional progress payments. In the first quarter, XYZ incurred contract costs of 420,000.

Traditionally, project accounting relies on special accounts (not taken directly to the financial statements):

Billings on contract, Contract in progress and Recognized income.

Each project should have its own special accounts, which are closed one the contract is completed.

In practice, three percentage of completion methods are used: cost-to-cost, efforts-expended and units-of-delivery (this page, link: accountingtools.com, provides a good discussion of each).

In contrast, IFRS 15.41 | ASC 606-10-25-33 outlines two possibilities: output methods and input methods.

However, IFRS 15.B15 | ASC 606-10-55-17 states: ... Output methods include methods such as surveys of performance completed to date, appraisals of results achieved, milestones reached, time elapsed and units produced or units delivered...

This implies that both efforts-expended (generally based on surveys, appraisals, milestones or time elapsed) and units-of-delivery are output methods while cost-to-cost is an input method.

IFRS 15.B18 | ASC 606-10-55-20: Input methods recognise revenue on the basis of the entity’s efforts or inputs to the satisfaction of a performance obligation (for example, resources consumed, labour hours expended, costs incurred, time elapsed or machine hours used)...

Since output methods generally yield superior results, companies should use them when possible and only resort to cost-to-cost when a contract fails to specify benchmarks, milestones or production targets.

Nevertheless, cost-to-cost is preferred by many companies for all their projects.

However, due to its shortcomings, the standards provide additional guidance on inputs to be excluded from costs and situations where zero profit is recognized.

IFRS 15.B19 | ASC 606-10-55-21 (emphasis added): A shortcoming of input methods is that there may not be a direct relationship between an entity’s inputs and the transfer of control of goods or services to a customer. Therefore, an entity shall exclude from an input method the effects of any inputs that, in accordance with the objective of measuring progress in paragraph 39 | 606-10-25-31, do not depict the entity’s performance in transferring control of goods or services to the customer. For instance, when using a cost-based input method, an adjustment to the measure of progress may be required in the following circumstances:

1. When a cost incurred does not contribute to an entity’s progress in satisfying the performance obligation. For example, an entity would not recognise revenue on the basis of costs incurred that are attributable to significant inefficiencies in the entity’s performance that were not reflected in the price of the contract (for example, the costs of unexpected amounts of wasted materials, labour or other resources that were incurred to satisfy the performance obligation).
2. When a cost incurred is not proportionate to the entity’s progress in satisfying the performance obligation. In those circumstances, the best depiction of the entity’s performance may be to adjust the input method to recognise revenue only to the extent of that cost incurred. For example, a faithful depiction of an entity’s performance might be to recognise revenue at an amount equal to the cost of a good used to satisfy a performance obligation if the entity expects at contract inception that all of the following conditions would be met:
   1. the good is not distinct;
   2. the customer is expected to obtain control of the good significantly before receiving services related to the good;
   3. the cost of the transferred good is significant relative to the total expected costs to completely satisfy the performance obligation; and
   4. the entity procures the good from a third party and is not significantly involved in designing and manufacturing the good (but the entity is acting as a principal in accordance with paragraphs B34–B38 | 606-10-55-36 through 55-40)

As the pre-payment was for less than a year, XYZ applied the practical expedient outlined in IFRS 15.63 | ASC 606-10-32-18 and did not consider the time value of money as outlined in IFRS 15.60 | ASC 606-10-32-15.

The next section gives examples of extended payment terms.

For clarity, individual transactions and disclosures are aggregated.

The accounting for interest is presented in the efforts-expended method example.

ASC 835-20-15-5 specifies that interest shall be capitalized for: a. self-constructed assets, b. assets manufactured for sale or lease and c. investments accounted for by the equity method.

IAS 23.8 likewise specifies that interest shall be capitalized for qualifying asset, which include (IAS 23.5) assets intended sale.

Dr/Cr

1/1/X1 | 1.1.X1
Cash		850,000
	Billings on contract #X1-01		850,000

 

3/31/X1 | 31.3.X1
Contract in progress #X1-01		420,000
	Cash, payables, accruals, etc.		420,000

 

Contract in progress #X1-01		140,000
	Recognized income #X1-01		140,000

 

Q1 Income statement (#X1-01)
Revenue		560,000
Cost of Sales		420,000
Gross profit		140,000

 

For illustration purposes, a separate income statement is presented for contract #X1-01.

 

End of quarter:	1	2	3
Costs and expenses in period	420,000	240,000	390,000
Costs and expenses to date	420,000	660,000	1,050,000
Estimated cost to complete	3,000,000	3,000,000	3,000,000
% complete	14.00%	22.00%	35.00%
Total contract revenue	4,000,000	4,000,000	4,000,000
% complete	14.00%	22.00%	35.00%
Revenue to date (total)	560,000	880,000	1,400,000
Prior period revenue	0	(560,000)	(880,000)
Current period revenue	560,000	320,000	520,000

 

14% = 420,000 / 3,000,000

560,000 = 4,000,000 x 14%

4	5	6	7	8	Σ
450,000	360,000	480,000	450,000	210,000	3,000,000
1,500,000	1,860,000	2,340,000	2,790,000	3,000,000
3,000,000	3,000,000	3,000,000	3,000,000	3,000,000
50.00%	62.00%	78.00%	93.00%	100.00%
4,000,000	4,000,000	4,000,000	4,000,000	4,000,000
50.00%	62.00%	78.00%	93.00%	100.00%
2,000,000	2,480,000	3,120,000	3,720,000	4,000,000
(1,400,000)	(2,000,000)	(2,480,000)	(3,120,000)	(3,720,000)
600,000	480,000	640,000	600,000	280,000	4,000,000

Q1 Balance sheet (#X1-01)
Liabilities
	-	-
	Deferred revenue (contract liability)	290,000
	-	-

 

For illustration purposes, a separate balance sheet is presented for contract #X1-01.

IFRS 15.105 | ASC 606-10-45-1 specifies that, depending on the relationship between the entity’s performance and the customer’s payment, either a contract asset or a contract liability is presented on the balance sheet.

In practice, when a liability is presented, it is generally labeled as deferred (or unearned) revenue. This practice is reflected in the FASB XBRL where DeferredRevenue comprises ContractWithCustomerLiability and DeferredIncome. While the IASB XBRL does not include similar labels, as it would not contradict IFRS 15's guidance, it can be extended to do so.

(290,000) = 420,000 + 140,000 - 850,000

In the second quarter, XYZ incurred contract costs of 240,000 and did not collect any payments from ABC.

6/30/X1 | 30.6.X1
Contract in progress #X1-01		240,000
	Cash, payables, accruals, etc.		240,000

 

Contract in progress #X1-01		80,000
	Recognized income #X1-01		80,000

 

Q2 Income statement (#X1-01)
Revenue		320,000
Cost of Sales		240,000
Gross profit		80,000

 

End of quarter:	1	2	3
Costs and expenses in period	420,000	240,000	390,000
Costs and expenses to date	420,000	660,000	1,050,000
Estimated cost to complete	3,000,000	3,000,000	3,000,000
% complete	14.00%	22.00%	35.00%
Total contract revenue	4,000,000	4,000,000	4,000,000
% complete	14.00%	22.00%	35.00%
Revenue to date (total)	560,000	880,000	1,400,000
Prior period revenue	0	(560,000)	(880,000)
Current period revenue	560,000	320,000	520,000

 

4	5	6	7	8	Σ
450,000	360,000	480,000	450,000	210,000	3,000,000
1,500,000	1,860,000	2,340,000	2,790,000	3,000,000
3,000,000	3,000,000	3,000,000	3,000,000	3,000,000
50.00%	62.00%	78.00%	93.00%	100.00%
4,000,000	4,000,000	4,000,000	4,000,000	4,000,000
50.00%	62.00%	78.00%	93.00%	100.00%
2,000,000	2,480,000	3,120,000	3,720,000	4,000,000
(1,400,000)	(2,000,000)	(2,480,000)	(3,120,000)	(3,720,000)
600,000	480,000	640,000	600,000	280,000	4,000,000

 

Q2 Balance sheet (#X1-01)
Assets
	-	-
	Contract asset (contract in progress)	30,000
	-	-

 

IFRS 15.105 | ASC 606-10-45-1 specifies that, depending on the relationship between the entity’s performance and the customer’s payment, either a contract asset or a contract liability is presented on the balance sheet.

In practice, when an asset is presented, it is often labeled as a Contract in progress.

30,000 = 880,000 - 850,000

In the third quarter, XYZ incurred contract costs of 390,000 and collected 600,000 from ABC.

9/30/X1 | 30.9.X1
Contract in progress #X1-01		390,000
	Cash, payables, accruals, etc.		390,000

 

Contract in progress #X1-01		130,000
	Recognized income #X1-01		130,000

 

Q3 Income statement
Revenue (#X1-01)		520,000
Cost of Sales (#X1-01)		390,000
Gross profit (#X1-01)		130,000

 

End of quarter:	1	2	3
Costs and expenses in period	420,000	240,000	390,000
Costs and expenses to date	420,000	660,000	1,050,000
Estimated cost to complete	3,000,000	3,000,000	3,000,000
% complete	14.00%	22.00%	35.00%
Total contract revenue	4,000,000	4,000,000	4,000,000
% complete	14.00%	22.00%	35.00%
Revenue to date (total)	560,000	880,000	1,400,000
Prior period revenue	0	(560,000)	(880,000)
Current period revenue	560,000	320,000	520,000

 

4	5	6	7	8	Σ
450,000	360,000	480,000	450,000	210,000	3,000,000
1,500,000	1,860,000	2,340,000	2,790,000	3,000,000
3,000,000	3,000,000	3,000,000	3,000,000	3,000,000
50.00%	62.00%	78.00%	93.00%	100.00%
4,000,000	4,000,000	4,000,000	4,000,000	4,000,000
50.00%	62.00%	78.00%	93.00%	100.00%
2,000,000	2,480,000	3,120,000	3,720,000	4,000,000
(1,400,000)	(2,000,000)	(2,480,000)	(3,120,000)	(3,720,000)
600,000	480,000	640,000	600,000	280,000	4,000,000

 

Q3 Balance sheet (#X1-01)
Liabilities
	-	-
	Deferred revenue	50,000
	-	-

 

(50,000) = 1,400,000 - 1,450,000

Etc.

Same facts, except that, during period 4, contracts costs increased.

 

End of quarter:	1	2	3
Costs and expenses in period	420,000	240,000	390,000
Costs and expenses to date	420,000	660,000	1,050,000
Cost to complete (estimated)	3,000,000	3,000,000	3,000,000
% complete	14.00%	22.00%	35.00%
Total contract revenue	4,000,000	4,000,000	4,000,000
% complete	14.00%	22.00%	35.00%
Total revenue recognized to date	560,000	880,000	1,400,000
Revenue recognized in prior periods	0	(560,000)	(880,000)
Current period revenue	560,000	320,000	520,000

 

4	5	6	7	8	Σ
500,000	380,000	510,000	550,000	260,000	3,250,000
1,550,000	1,930,000	2,440,000	2,990,000	3,250,000
3,250,000	3,250,000	3,250,000	3,250,000	3,250,000
47.69%	59.38%	75.08%	92.00%	100.00%
4,000,000	4,000,000	4,000,000	4,000,000	4,000,000
47.69%	59.38%	75.08%	92.00%	100.00%
1,907,692	2,375,385	3,003,077	3,680,000	4,000,000
(1,400,000)	(1,907,692)	(2,375,385)	(3,003,077)	(3,680,000)
507,692	467,692	627,692	676,923	320,000	4,000,000

 

Same facts, except the costs increased to 4,250,000 leading to an overall contract loss.

 

12/31/X1 | 31.12.X1
Contract in progress #X1-01		460,000
	Cash, payables, accruals, etc.		460,000

 

Recognized income #X1-01		438,824
	Contract in progress #X1-01		438,824

 

Q2 income statement
Revenue		21,176
Cost of Sales		460,000
Loss on contract		(438,824)

 

(438,824) = 21,176 - 460,000

IFRS 15.101: An entity shall recognise an impairment loss in profit or loss to the extent that the carrying amount of an asset recognised in accordance with paragraph 91 or 95 exceeds:

(a) the remaining amount of consideration that the entity expects to receive in exchange for the goods or services to which the asset relates; less

(b) the costs that relate directly to providing those goods or services and that have not been recognised as expenses (see paragraph 97).

US GAAP provided comparable guidance.

ASC 340-40-35-3: An entity shall recognize an impairment loss in profit or loss to the extent that the carrying amount of an asset recognized in accordance with paragraph 340-40-25-1 or 340-40-25-5 exceeds:

a. The remaining amount of consideration that the entity expects to receive in exchange for the goods or services to which the asset relates, less

b. The costs that relate directly to providing those goods or services and that have not been recognized as expenses (see paragraph 340-40-25-7).

End of quarter:	1	2	3
Costs and expenses in period	420,000	240,000	390,000
Costs and expenses to date	420,000	660,000	1,050,000
Cost to complete (estimated)	3,000,000	3,000,000	3,000,000
% complete	14.00%	22.00%	35.00%
Total contract revenue	4,000,000	4,000,000	4,000,000
% complete	14.00%	22.00%	35.00%
Total revenue recognized to date	560,000	880,000	1,400,000
Revenue recognized in prior periods	0	(560,000)	(880,000)
Current period revenue	560,000	320,000	520,000

 

4	5	6	7	8	Σ
460,000	600,000	560,000	725,000	855,000	4,250,000
1,510,000	2,110,000	2,670,000	3,395,000	4,250,000
4,250,000	4,250,000	4,250,000	4,250,000	4,250,000
35.53%	49.65%	62.82%	79.88%	100.00%
4,000,000	4,000,000	4,000,000	4,000,000	4,000,000
35.53%	49.65%	62.82%	79.88%	100.00%
1,421,176	1,985,882	2,512,941	3,195,294	4,000,000
(1,400,000)	(1,421,176)	(1,985,882)	(2,512,941)	(3,195,294)
21,176	564,706	527,059	682,353	804,706	4,000,000

Same facts, except that, during period 6, contracts costs decreased.

An example of a retainage is presented in the next example.

 

End of quarter:	1	2	3
Costs and expenses in period	420,000	240,000	390,000
Costs and expenses to date	420,000	660,000	1,050,000
Cost to complete (estimated)	3,000,000	3,000,000	3,000,000
% complete	14.00%	22.00%	35.00%
Total contract revenue	4,000,000	4,000,000	4,000,000
% complete	14.00%	22.00%	35.00%
Total revenue recognized to date	560,000	880,000	1,400,000
Revenue recognized in prior periods	0	(560,000)	(880,000)
Current period revenue	560,000	320,000	520,000

 

4	5	6	7	8	Σ
500,000	380,000	450,000	510,000	260,000	3,150,000
1,550,000	1,930,000	2,380,000	2,890,000	3,150,000
3,250,000	3,250,000	3,150,000	3,150,000	3,150,000
47.69%	59.38%	75.56%	91.75%	100.00%
4,000,000	4,000,000	4,000,000	4,000,000	4,000,000
47.69%	59.38%	75.56%	91.75%	100.00%
1,907,692	2,375,385	3,022,222	3,669,841	4,000,000
(1,400,000)	(1,907,692)	(2,375,385)	(3,022,222)	(3,669,841)
507,692	467,692	646,838	647,619	330,159	4,000,000

 

Efforts-expended method

1/1/X1, XYZ Co. was retained by DEF for a long-term construction project (to which it assigned contract number 2). Upon successful completion, XYZ was entitled to a total fee of 4,000,000. The contract included clear and binding conditions for both sides including intermediate performance criteria (milestones) that allowed XYZ to determine the exact percentage of completion. Consequently, XYZ elected to apply an efforts-expended method. DEF pre paid 1,000,000 and XYZ financed the remainder using a dedicated line of credit. During X1, XYZ completed 35% of the contract, incurring costs (including 2,000 interest) of 1,200,000. During X2 it incurred costs (including Interest of 80,000) of 1,800,000 and completed the contract on 12/31/X2 and issued an invoice which DEF paid on 1/31/X3.

Traditionally, project accounting relies on special accounts (not taken directly to the financial statements):

Billings on contract, Contract in progress and Recognized income.

Each project should have its own special accounts, which are closed one the contract is completed.

In practice, three percentage of completion methods are used: cost-to-cost, efforts-expended and units-of-delivery (this page, link: accountingtools.com, provides a good discussion of each).

In contrast, IFRS 15.41 | ASC 606-10-25-33 outlines two possibilities: output methods and input methods.

However, IFRS 15.B15 | ASC 606-10-55-17 states: ... Output methods include methods such as surveys of performance completed to date, appraisals of results achieved, milestones reached, time elapsed and units produced or units delivered...

This implies that both efforts-expended (generally based on surveys, appraisals, milestones or time elapsed) and units-of-delivery are output methods while cost-to-cost is an input method.

IFRS 15.B18 | ASC 606-10-55-20: Input methods recognise revenue on the basis of the entity’s efforts or inputs to the satisfaction of a performance obligation (for example, resources consumed, labour hours expended, costs incurred, time elapsed or machine hours used)...

Since output methods generally yield superior results, companies should use them when possible and only resort to cost-to-cost when a contract fails to specify benchmarks, milestones or production targets.

Nevertheless, cost-to-cost is preferred by many companies for all their projects.

However, due to its shortcomings, the standards provide additional guidance on inputs to be excluded from costs and situations where zero profit is recognized.

IFRS 15.B19 | ASC 606-10-55-21 (emphasis added): A shortcoming of input methods is that there may not be a direct relationship between an entity’s inputs and the transfer of control of goods or services to a customer. Therefore, an entity shall exclude from an input method the effects of any inputs that, in accordance with the objective of measuring progress in paragraph 39 | 606-10-25-31, do not depict the entity’s performance in transferring control of goods or services to the customer. For instance, when using a cost-based input method, an adjustment to the measure of progress may be required in the following circumstances:

1. When a cost incurred does not contribute to an entity’s progress in satisfying the performance obligation. For example, an entity would not recognise revenue on the basis of costs incurred that are attributable to significant inefficiencies in the entity’s performance that were not reflected in the price of the contract (for example, the costs of unexpected amounts of wasted materials, labour or other resources that were incurred to satisfy the performance obligation).
2. When a cost incurred is not proportionate to the entity’s progress in satisfying the performance obligation. In those circumstances, the best depiction of the entity’s performance may be to adjust the input method to recognise revenue only to the extent of that cost incurred. For example, a faithful depiction of an entity’s performance might be to recognise revenue at an amount equal to the cost of a good used to satisfy a performance obligation if the entity expects at contract inception that all of the following conditions would be met:
   1. the good is not distinct;
   2. the customer is expected to obtain control of the good significantly before receiving services related to the good;
   3. the cost of the transferred good is significant relative to the total expected costs to completely satisfy the performance obligation; and
   4. the entity procures the good from a third party and is not significantly involved in designing and manufacturing the good (but the entity is acting as a principal in accordance with paragraphs B34–B38 | 606-10-55-36 through 55-40)

As the pre-payment was for less than a year, XYZ applied the practical expedient outlined in IFRS 15.63 | ASC 606-10-32-18 and did not consider the time value of money as outlined in IFRS 15.60 | ASC 606-10-32-15.

The next section gives examples of extended payment terms.

ASC 835-20-15-5 specifies that interest shall be capitalized for: a. self-constructed assets, b. assets manufactured for sale or lease and c. investments accounted for by the equity method.

IAS 23.8 likewise specifies that interest shall be capitalized for qualifying asset, which include (IAS 23.5) assets intended sale.

For simplicity, this example assumes XYZ estimated the costs exactly. The accounting for changes in costs is presented in the previous, cost-to-cost example.

Dr/Cr

1/1/X1 | 1.1.X1
Cash		1,000,000
	Billings on contract #X1-02		1,000,000

 

1/1/X1 to 12/31/X1 | 1.1.X1 to 31.12.X1
Contract in progress #X1-02		1,200,000
Cash		198,000
	Cash, payables, accruals, etc.		1,198,000
	Line of credit (interest)		2,000
	Line of credit (principle)		198,000

 

12/31/X1 | 31.12.X1
Contract in progress #X1-02		350,000
	Recognized income #X1-02		350,000

 

Contract amount x % of completion = revenue	4.000.000 x 35% =	1,400,000
Cost to complete x % of completion = cost of sales	3,000,000 x 35% =	1,050,000
Revenue - cost of sales = recognized income	1,400,000 - 1,050,000 =	350,000

X1 Profit and loss statement (#X1-02)
Revenue		1,400,000
Cost of Sales		1,050,000
Gross profit		350,000

 

For illustration purposes, a separate profit and loss statement is presented for contract #X1-02.

X1 Balance sheet (#X1-02)
Assets
	Contract asset (contract in progress)		550,000

 

For illustration purposes, a separate balance sheet is presented for contract #X1-02.

IFRS 15.105 | ASC 606-10-45-1 specifies that, depending on the relationship between the entity’s performance and the customer’s payment, either a contract asset or a contract liability is presented on the balance sheet.

In practice, when an asset is presented, it is often labeled as a Contract in progress.

Contract in progress [1,550,000] - billings [1,000,000]= receivable [550,000]

1/1/X2 to 12/31/X2 | 1.1.X2 to 31.12.X2
Contract in progress #X1-02		1,800,000
Cash		1,720,000
	Cash, payables, accruals, etc.		1,720,000
	Line of credit (interest)		80,000
	Line of credit (principle)		1,720,000

 

12/31/X2 | 31.12.X2
Accounts receivable: DEF		3,000,000
	Billings on contract #X1-02		3,000,000
Line of credit		2,000,000
	Cash		2,000,000

 

X2 Income statement
Revenue		2,600,000
Cost of Sales		1,950,000
Gross profit		650,000

 

1/31/X3 | 31.1.X3
Cash		3,000,000
	Accounts receivable: DEF		3,000,000

 

Retainage (hold-back)

Same facts except DEF held back 250,000 as surety that the project met specifications. In the past, the retainage amount was paid to XYZ in full 95% of the time. After confirming the project met specifications, DEF paid out the retained amount on 1/1/X4.

12/31/X2 | 31.12.X2
Accounts receivable: DEF		2,750,000
Contract asset: Retainage: DEF		250,000
	Billings on contract #X1-02		3,000,000
Line of credit (interest)		2,000,000
	Cash		2,000,000

 

As outlined in IFRS 15.108 | ASC 606-10-45-4, a receivable is an unconditional right to consideration. As meeting specifications is a condition, XYZ recognized a contract asset (IFRS 15.107 | ASC 606-10-45-3) instead.

As outlined in IFRS 15.51 | ASC 606-10-32-6, consideration is variable if, among other things, it is subject to a contract penalty. As the retainage amount, if not paid, would be a penalty, XYZ applied the guidance in IFRS 15.50 to 59 | ASC 606-10-32-5 to 14.

As it was (highly) unlikely (IFRS 15.56 | ASC 606-10-32-11) the retainage amount would not be paid, it was "(highly) probable that a significant reversal in the amount of cumulative revenue recognized" would not occur.

Consequently, XYZ recognized revenue in the amount it expected to be entitled to as shown above.

1/1/X4 | 1.1.X4
Cash		250,000
	Contract asset: Retainage: DEF		250,000

As outlined in IFRS 15.60 | ASC 606-10-32-15 "an entity shall adjust the promised amount of consideration for the effects of the time value of money."

Since the payment term exceeded 365 days, XYZ could not apply the practical expedient outlined in IFRS 15.63 | ASC 606-10-32-18.

Nevertheless, since the payment terms simply provided the customer with protection from XYZ's failing to adequately perform, it could apply IFRS 15.61.c | ASC 606-10-32-16.c to avoid discounting.

Units-of-delivery method

10/15/X0, XYZ was retained by GHI to produce 100,000 units of a part GHI would use in its product. GHI agreed to pay 100 for each unit, provided XYZ the specifications and paid a non-refundable advance of 1,500,000. XYZ agreed to begin delivering the parts on 1/1/X1 and expected to deliver the last part by 6/30/X1. XYZ incurred a sales commission of 10,000 and additional set-up costs of 990,000. XYZ completed the setup on 12/31/X0, XYZ delivered the first batch of 50,000 units on 3/31/X1 and issued an invoice payable 4/30/X1. It had incurred direct per unit costs: 20 material and 30 labor. It allocated overhead (rent and depreciation) at 40% of material and labor (rent 10%, depreciation 30%). On 6/30/X1, XYZ delivered the remaining units (its costs did not change).

As XYZ expected the deposit term to be less than a year, it applied the practical expedient outlined in IFRS 15.63 | ASC 606-10-32-18 and did not consider the time value of money as outlined in IFRS 15.60 | ASC 606-10-32-15.

In practice, three percentage of completion methods are used: cost-to-cost, efforts-expended and units-of-delivery (this page, link: accountingtools.com, provides a good discussion of each).

In contrast, IFRS 15.41 | ASC 606-10-25-33 outlines two possibilities: output methods and input methods.

However, IFRS 15.B15 | ASC 606-10-55-17 states: ... Output methods include methods such as surveys of performance completed to date, appraisals of results achieved, milestones reached, time elapsed and units produced or units delivered...

This implies that both efforts-expended (generally based on surveys, appraisals, milestones or time elapsed) and units-of-delivery are output methods while cost-to-cost is an input method.

IFRS 15.B18 | ASC 606-10-55-20: Input methods recognise revenue on the basis of the entity’s efforts or inputs to the satisfaction of a performance obligation (for example, resources consumed, labour hours expended, costs incurred, time elapsed or machine hours used)...

Since output methods generally yield superior results, companies should use them when possible and only resort to cost-to-cost when a contract fails to specify benchmarks, milestones or production targets.

Nevertheless, cost-to-cost is preferred by many companies for all their projects.

However, due to its shortcomings, the standards provide additional guidance on inputs to be excluded from costs and situations where zero profit is recognized.

IFRS 15.B19 | ASC 606-10-55-21 (emphasis added): A shortcoming of input methods is that there may not be a direct relationship between an entity’s inputs and the transfer of control of goods or services to a customer. Therefore, an entity shall exclude from an input method the effects of any inputs that, in accordance with the objective of measuring progress in paragraph 39 | 606-10-25-31, do not depict the entity’s performance in transferring control of goods or services to the customer. For instance, when using a cost-based input method, an adjustment to the measure of progress may be required in the following circumstances:

1. When a cost incurred does not contribute to an entity’s progress in satisfying the performance obligation. For example, an entity would not recognise revenue on the basis of costs incurred that are attributable to significant inefficiencies in the entity’s performance that were not reflected in the price of the contract (for example, the costs of unexpected amounts of wasted materials, labour or other resources that were incurred to satisfy the performance obligation).
2. When a cost incurred is not proportionate to the entity’s progress in satisfying the performance obligation. In those circumstances, the best depiction of the entity’s performance may be to adjust the input method to recognise revenue only to the extent of that cost incurred. For example, a faithful depiction of an entity’s performance might be to recognise revenue at an amount equal to the cost of a good used to satisfy a performance obligation if the entity expects at contract inception that all of the following conditions would be met:
   1. the good is not distinct;
   2. the customer is expected to obtain control of the good significantly before receiving services related to the good;
   3. the cost of the transferred good is significant relative to the total expected costs to completely satisfy the performance obligation; and
   4. the entity procures the good from a third party and is not significantly involved in designing and manufacturing the good (but the entity is acting as a principal in accordance with paragraphs B34–B38 | 606-10-55-36 through 55-40)

Direct costs incurred (allocated) prior to delivery
Wages and salaries		330,000
Subcontractors and consultants		122,000
Raw material and parts		290,000
Rent		62,000
Depreciation		186,000
Total		990,000

 

As outlined in IFRS 15.97.a | ASC 340-40-25-7.a, direct labor is capitalized XYZ pays its employees at the end of each month.

To allocate overhead, XYZ used a direct costing method. See the inventory page for an discussion.

To simplify this example, only two overhead costs, rent and depreciation, are shown.

Dr/Cr

10/15/X0 | 15.10.X0
Cash		1,500,000
Inventory: Contract in progress: #X0/10/15 (initial direct cost)		10,000
	Deferred revenue: #X0/10/15		1,500,000
	Accrued salaries and commissions		10,000

 

As outlined in IFRS 15 91 | ASC 340-40-25-1, an entity can capitalize costs of obtaining a contract (initial direct costs).

As outlined in IFRS 15 94 | ASC 340-40-25-4, an entity may, as a practical expedient, simply expense these costs.

As outlined in IFRS 15 92 | ASC 340-40-25-2, initial direct costs include, for example, sales commissions.

Unlike cost-to-cost and efforts-expended, the units-of-delivery method does not require the use of special accounts.

Instead, this account is taken directly to the balance sheet.

IFRS 15.105 | ASC 606-10-45-1 specifies that, depending on the relationship between the entity’s performance and the customer’s payment, either a contract asset or a contract liability is presented on the balance sheet.

In practice, when a liability is presented, it is generally labeled as deferred (or unearned) revenue. This practice is reflected in the FASB XBRL where DeferredRevenue comprises ContractWithCustomerLiability and DeferredIncome. While the IASB XBRL does not include similar labels, as it would not contradict IFRS 15's guidance, it can be extended to do so.

10/15/X0 to 12/31/X0 | 15.10.X0 to 31.12.X0
Inventory: Contract in progress: #X0/10/15 (direct costs)		990,000
	Cash, Payables, Inventory, Accruals		990,000

 

As outlined in IFRS 15.95 & 96 | ASC 340-40-25-5 & 6, costs to fulfill a contract (direct costs) are usually capitalized using guidance provided by other standards.

In most cases, costs to fulfill a contract are comparable to costs incurred to manufacture products (acquire inventory), which is why IFRS 15 | ASC 606 references IAS 2 | ASC 330.

In some cases, for example buildings, ships or production lines, the more detailed guidance provided by IAS 16 | ASC 360 is more relevant.

In other situations, such as software development or research, IAS 38 and ASC 350 provides the better guidance.

Occasionally, it is possible that a company can run into costs that do not fall neatly into any of these three standards.

In these situations, the costs are capitalized (IFRS 15.95 | ASC 340-40-25-5) if:

a. they are specifically identifiable with the project

b. bring future value and (most importantly)

c. are billable to the customer.

In this example, the setup costs were capitalized to inventory because guidance in IAS 2 | ASC 330 was applied.

3/31/X1 | 31.3.X1
Accounts receivable: GHI		3,500,000
Deferred revenue: #X0/10/15		1,500,000
Cost of sales		3,550,000
	Revenue		5,000,000
	Inventory: Contract in progress: #X0/10/15		50,000
	Payables, Accruals, Cash, Rent, Accumulated depreciation		3,500,000

 

Direct costs related to delivered units
Wages and salaries		1,500,000
Raw material and parts		1,000,000
Rent		250,000
Depreciation		750,000
Total		3,500,000

3/31/X1 | 31.3.X1
Accounts receivable: GHI		5,000,000
Cost of sales		3,525,000
	Revenue		5,000,000
	Inventory: Contract in progress: #X0/10/15		50,000
	Payables, Accruals, Cash, Rent, Accumulated depreciation		3,475,000

Discounts (variable consideration)

Prompt payment discount

1/1/X1, XYZ delivered 10 units a product to ABC. While it commonly sells the product for 1,000 per unit, it also offers customers 2/10, net 30 credit terms. In its experience, customers take advantage of these terms 80% of the time.

A 2% discount if the payment is made in 10 days, otherwise the balance is due in 30 days.

When evaluating the probability of variable consideration, a probability of 75% to 80% should be used under both IFRS and US GAAP.

IFRS 15.56 specifies that variable consideration can be recognized only if "it is highly probable that a significant reversal" will not occur, while ASC 606-10-32-11 specified "it is probable that a significant reversal" will not occur.

The reason for the difference is that IFRS considers "probable" to be a synonym for more "likely than not" (a likelihood of 50% or more) while US GAAP assigns it a higher likelihood of 75-80% (see: link - PwC and link - IASB).

Dr/Cr

1/1/X1 / 1.1.X1
Trade receivables: ABC: 456		10,000
	Revenue (net of discounts)		9,800
	Trade receivables: Discount allowances: ABC: 456		200

 

Since XYZ has not received any consideration from the customer, it does not recognize a liability (IFRS 15.55 | 606-10-32-10). Instead, it recognizes a receivable in the amount it expects to (probably) receive.

This can be accomplished by either recognizing the gross amount plus an adjustment (allowance) or simply recognizing the net amount:

1/1/X1 / 1.1.X1
Trade receivables: ABC: 456 (net of discounts)		9,800
	Revenue (net of discounts)		9,800

Alternatively:

1/1/X1 / 1.1.X1
Trade receivables: ABC: 456		10,000
Revenue: Prompt payment discount		200
	Revenue (gross)		10,000
	Trade receivables: Discount allowances: ABC: 456		200

1/10/X1 / 10.1.X1
Cash		9,800
Trade receivables: Discount allowances: ABC: 456		200
	Trade receivables: ABC: 456		10,000

 

Discount not likely

Same facts except only 25% of customers take advantage of the discount and XYZ had no experience with ABC.

Had XYZ had experience with this particular customer taking advantage of the discount over 75% of the time, it would have proceeded as outlined above.

1/1/X1 / 1.1.X1
Trade receivables: ABC: 456		10,000
	Revenue		10,000

 

1/11/X1 / 11.1.X1
Cash		9,800
Revenue: Prompt payment discount		200
	Trade receivables: ABC: 456		10,000

Quantity discount

XYZ commonly offers a 10% discount on purchases of 100 or more units. 1/1/X1, ABC bought 100 units of a product with a stand-alone, cash selling price of 1,000 per unit. Payment terms were 30 days. XYZ uses a periodic inventory method.

Dr/Cr

1/1/X1 / 1.1.X1
Trade receivables: ABC		90,000
	Revenue (net of discounts)		90,000

 

	Alternatively
	Trade receivables: ABC		90,000
	Revenue: Quantity discount		10,000
		Revenue		100,000

 

1/31/X1 / 31.1.X1
Cash		90,000
	Trade receivable		90,000

Quantity rebate

While not contractually obligated to do so, XYZ commonly offers a 10% rebate on purchases exceeding 100 plus during a calendar year. In the past five years, ABC has received the discount four times. 1/1/X1, ABC purchased 10 units for 1,000 each, XYZ issued a 30-day invoice and ABC paid on 2/1/X1.

When evaluating the probability of variable consideration, a probability of 75% to 80% should be used under both IFRS and US GAAP.

IFRS 15.56 specifies that variable consideration can be recognized only if "it is highly probable that a significant reversal" will not occur, while ASC 606-10-32-11 specified "it is probable that a significant reversal" will not occur.

The reason for the difference is that IFRS considers "probable" to be a synonym for more "likely than not" (a likelihood of 50% or more) while US GAAP assigns it a higher likelihood of 75-80% (see: link - PwC and link - IASB).

Dr/Cr

1/1/X1 / 1.1.X1
Trade receivables: ABC		10,000
	Revenue (net of discounts)		9,000
	Rebate liability (provision): ABC		1,000

 

IFRS 15.55 | ASC 606-10-32-10 requires a refund liability to be recognized if consideration received from a customer is expected to be refunded (in all or part).

However, offering a rebate also creates an obligation that falls under IAS 37 | ASC 450, so a provision | contingent liability could be recognized instead.

Some national GAAPs require refund liabilities to be recognized and reported as provisions. Doing so for IFRS | US GAAP purposes as well would minimalize the differences entities domiciled jurisdictions with a national GAAP mandate need to contend with.

However, rebate liabilities are often constructive obligations recognized, as in this example, only because the customer expects a refund.

IFRS 15.52 | ASC 606-10-32-7 (edited, emphasis added): ... In addition to the terms of the contract, the promised consideration is variable if ... the customer has a valid expectation arising from an entity’s customary business practices, published policies or specific statements that the entity will accept an amount of consideration that is less than the price stated in the contract. That is, it is expected that the entity will offer a price concession. Depending on the jurisdiction, industry or customer this offer may be referred to as a discount, rebate, refund or credit.

Note: while ASC 450 does not provide explicit guidance on constructive obligations, they are discussed in CON 8.E50 to E52. As the CON should be considered when applying explicit guidance, the procedures under US GAAP is comparable to IFRS.

Some national GAAPs only allow provisions to be recognized if they are explicitly spelled out in a contract.

Alternatively:

1/1/X1 / 1.1.X1
Trade receivables: ABC		10,000
Revenue: Quantity discounts		1,000
	Revenue		10,000
	Rebate liability: ABC		1,000

2/1/X1 / 1.2.X1
Cash		10,000
	Trade receivables: ABC		10,000

 

Up to 11/31/X1, ABC purchased and paid for 90 units. On 12/1/X1, it received its 10 free units.

12/1/X1 / 1.12.X1
Rebate liability: ABC		9,000
	Revenue (net of discounts)		9,000

 

Same facts except ABC purchased 10 additional units.

12/1/X1 / 1.12.X1
Trade receivables: ABC		9,000
Rebate liability: ABC		9,000
	Revenue (net of discounts)		18,000

 

Same facts except, by 12/31/X1, ABC purchased only 80 units.

12/31/X1 / 31.12.X1
Rebate liability: ABC		8,000
	Revenue		8,000

 

Same fact except DEF, a first-time customer, purchased 2 units for cash and XYZ did not consider it likely it would purchase another 98 units by 12/31/X1.

1/1/X1 / 1.1.X1
Cash		2,000
	Revenue (net of discounts)		2,000

 

By 6/30/X1, DEF had bought 40 units and, on 6/30/X1, another 10. At this point, XYZ re-evaluated and concluded it was now at least 75% likely DEF would buy another 50 by year-end, and also granted DEF 30-day credit.

As outlined in example 24 (IFRS 15.IE127 | ASC 606-10-55-219), in light of new facts, if the entity estimates that the customer’s purchases will exceed the threshold, it will be required to retrospectively reduce the price per unit.

As outlined in IFRS 15.128 | ASC 606-10-55-220, it recognizes the adjustment on 6/30/X1 (but does not restate Q1).

6/30/X1 / 30.6.X1
Trade receivables: DEF		10,000
	Revenue (net of discounts)		5,000
	Rebate liability: DEF		5,000

Bonus units

Rather than a rebate, XYZ gives customers that buy 100 units per year 10 bonus units at no charge. 1/1/X1, ABC bought 10 units. XYZ estimated ABC was 80% likely to buy another 90 within the year.

IFRS 15.B39 to 41 | ASC 606-10-55-41 to 43 discuss options for additional goods or services: sales incentives, award credits, points, contract renewal options, discounts on future goods or services, etc.

Note: these "options" would not be accounted for as derivative financial instruments as they are outside the scope of IFRS 9 (IFRS 9.21.g) | cannot be settled net (ASC 815-10-15-83.c).

IFRS 15.B40 | ASC 606-10-55-42 specifies that these options give rise to separate performance obligations, but only if they provide "a material right", such as a discount on the stand-alone selling price, to the customer.

As outlined in IFRS 15.76 | ASC 606-10-32-28, the transaction price is allocated to individual performance obligations on the basis of their stand-alone selling price.

In other words, under IFRS and US GAAP, "free" does not exist. A company needs to price all its goods and services, even those it "gives away."

If a company does not sell the same products (stand-alone selling price is not directly observable), it needs to estimate that stand-alone selling price.

IFRS 15.79 | ASC 606-10-32-34 specifies how.

In order: (a) the price on the market (how much other companies charge for the same or comparable goods or services), (b) cost plus, and (c) a residual approach.

Note: IFRS 15.79.c | ASC 606-10-32-34.c restricts the use of the residual approach to situations where the entity sells the item(s) for (1) a wide variety of prices, or (2) has never sold it (them) before and has not priced it (them) yet.

Options that do not include a discount are "... a marketing offer that [the entity] shall account for in accordance with this Standard only when the customer exercises the option ..."

When evaluating the probability of variable consideration, a probability of 75% to 80% should be used under both IFRS and US GAAP.

IFRS 15.56 specifies that variable consideration can be recognized only if "it is highly probable that a significant reversal" will not occur, while ASC 606-10-32-11 specified "it is probable that a significant reversal" will not occur.

The reason for the difference is that IFRS considers "probable" to be a synonym for more "likely than not" (a likelihood of 50% or more) while US GAAP assigns it a higher likelihood of 75-80% (see: link - PwC and link - IASB).

Dr/Cr

1/1/X1 / 1.1.X1
Trade receivable: ABC		10,000
Cost of goods sold		5,000
	Revenue (net of discounts)		9,091
	Deferred revenue (contract liability): Customer Bonuses: ABC		909
	Inventory: Finished goods		5,000

 

IFRS 15.105 | ASC 606-10-45-1 specifies that, depending on the relationship between the entity’s performance and the customer’s payment, either a contract asset or a contract liability is presented on the balance sheet.

In practice, when a liability is presented, it is generally labeled as deferred (or unearned) revenue. This practice is reflected in the FASB XBRL where DeferredRevenue comprises ContractWithCustomerLiability and DeferredIncome. While the IASB XBRL does not include similar labels, as it would not contradict IFRS 15's guidance, it can be extended to do so.

909.09 = 1,000 x 100 ÷ 110

 

By 6/30/X1, ABC purchased 90 units. 6/30/X1, it purchased 10 and XYZ shipped 20.

6/30/X1 / 30.6.X1
Trade receivable: ABC		10,000
Cost of goods sold		10,000
Deferred revenue: Customer Bonuses: ABC		8,182
	Revenue: Net of discounts		18,182
	Inventory: Finished goods		10,000

Alternatively

6/30/X1 / 30.6.X1
Trade receivable: ABC		10,000
Cost of goods sold		5,000
	Revenue: Net of discounts		9,091
	Deferred revenue: Customer Bonuses: ABC		909
	Inventory: Finished goods		5,000
Deferred revenue: Customer Bonuses: ABC		9,091
Cost of goods sold		5,000
	Revenue: Net of discounts		9,091
	Inventory: Finished goods		5,000

Deferred tax

Same facts except XYZ also maintains a national GAAP book for tax purposes. This national GAAP follows the letter of the contract.

US GAAP / IFRS book: 1/1/X1 / 1.1.X1
Trade receivable		10,000
Cost of goods sold		5,000
Deferred tax asset		182
	Revenue: Net of discounts		9,091
	Deferred revenue: Customer Bonuses: ABC		909
	Inventory: Finished goods: #123		5,000
	Income tax expense		182
National GAAP book: 1/1/ - 3/31/X1 / 1.1. - 31.3.X1
Trade receivable		10,000
Material consumed		5,000
	Product revenue		10,000
	Products		5,000

 

US GAAP / IFRS book: 6/30/X1 / 30.6.X1
Trade receivable		10,000
Cost of goods sold		5,000
Income tax expense		2,000
	Revenue: Net of discounts		9,091
	Deferred revenue: Customer Bonuses: ABC		909
	Inventory: Finished goods		5,000
	Deferred tax asset		2,000
Deferred revenue: Customer Bonuses: ABC		9,091
Cost of goods sold		5,000
	Revenue: Net of discounts		9,091
	Inventory: Finished goods		5,000
National GAAP book: 1/1/ - 3/31/X1 / 1.1. - 31.3.X1
Trade receivable		10,000
Material consumed		10,000
	Product revenue		10,000
	Products		10,000

Loyalty points

Rather than bonus units, XYZ (a retailer) gives customers loyalty points. 1 point is granted for each 10-currency unit purchase. Customers may deduct the points from future purchases at a 1 : 1 ratio. In the first quarter, XYZ sold goods for 1,000,000 and issued 100,000 points. For reporting purposes, it recognizes a portfolio of sales and points each quarter.

IFRS 15.B39 to 41 | ASC 606-10-55-41 to 43 discuss options for additional goods or services: sales incentives, award credits, points, contract renewal options, discounts on future goods or services, etc.

Note: these "options" would not be accounted for as derivative financial instruments as they are outside the scope of IFRS 9 (IFRS 9.21.g) | cannot be settled net (ASC 815-10-15-83.c).

IFRS 15.B40 | ASC 606-10-55-42 specifies that these options give rise to separate performance obligations, but only if they provide "a material right", such as a discount on the stand-alone selling price, to the customer.

As outlined in IFRS 15.76 | ASC 606-10-32-28, the transaction price is allocated to individual performance obligations on the basis of their stand-alone selling price.

In other words, under IFRS and US GAAP, "free" does not exist. A company needs to price all its goods and services, even those it "gives away."

If a company does not sell the same products (stand-alone selling price is not directly observable), it needs to estimate that stand-alone selling price.

IFRS 15.79 | ASC 606-10-32-34 specifies how.

In order: (a) the price on the market (how much other companies charge for the same or comparable goods or services), (b) cost plus, and (c) a residual approach.

Note: IFRS 15.79.c | ASC 606-10-32-34.c restricts the use of the residual approach to situations where the entity sells the item(s) for (1) a wide variety of prices, or (2) has never sold it (them) before and has not priced it (them) yet.

Options that do not include a discount are "... a marketing offer that [the entity] shall account for in accordance with this Standard only when the customer exercises the option ..."

IFRS 15.4 | ASC 606-10-10-4 specifies it applies to individual contracts (sales). Nevertheless, as a practical expedient, it allows entities to apply it to a portfolio provided its constituents have similar characteristics.

Dr/Cr

3/31/X1 / 31.3.X1
Cash, Credit card sales, Customer credit, etc.		1,000,000
	Revenue (cash sales)		909,091
	Deferred revenue (contract liability): Q1 loyalty points		90,909

 

909,091 = 1,000,000 ÷ (1+10%); 90,909 = 1,000,000 - (1,000,000 ÷ (1+10%))

IFRS 15.105 | ASC 606-10-45-1 specifies that, depending on the relationship between the entity’s performance and the customer’s payment, either a contract asset or a contract liability is presented on the balance sheet.

In practice, when a liability is presented, it is generally labeled as deferred (or unearned) revenue. This practice is reflected in the FASB XBRL where DeferredRevenue comprises ContractWithCustomerLiability and DeferredIncome. While the IASB XBRL does not include similar labels, as it would not contradict IFRS 15's guidance, it can be extended to do so.

During the second quarter, XYZ sold goods valued at 2,000,000 and 50,000 loyalty points were redeemed.

6/30/X1 / 30.6.X1
Cash, Credit card sales, Customer credit, etc.		1,950,000
Deferred revenue: Q1 loyalty points		50,000
	Revenue (sales)		1,772,727
	Revenue (loyalty points)		50,000
	Deferred revenue: Q2 loyalty points		177,273

 

Partial redemption

Same facts except, XYZ estimated that only 90% of the points would eventually be redeemed.

3/31/X1 / 31.3.X1
Cash, Credit card sales, Customer credit, etc.		1,000,000
	Revenue (cash)		917,431
	Deferred revenue: Q1 loyalty points		82,569

Dealer incentives

XYZ is a manufacturer. To motive its dealers, it offers them incentives: 2% for purchases over 1,000,000, 3% for purchases over 5,000,000 and 4% for purchases over 10,000,000 (control passes to dealers).

1/1/X1, ABC bought goods for 100,000. In the past, XYZ’s purchases never exceeded 1,000,000. DEF bought goods for 500,000. In the past five years, its purchases were between 2,000,000 and 3,000,000. Finally, EFG bought goods for 1,000,000. In each the past five years, it purchases were (approximately) 8,000,000, 11,000,000, 9,000,000, 12,000,000 and 7,000,000. XYZ gives all customers 30-day credit.

Dr/Cr

1/1/X1 / 1.1.X1
Trade receivable: ABC		100,000
Trade receivable: DEF		500,000
Trade receivable: EFG		1,000,000
	Revenue		1,560,000
	Deferred revenue (contract liability): Dealer incentives: DEF		10,000
	Deferred revenue (contract liability): Dealer incentives: EFG		30,000

 

IFRS 15.105 | ASC 606-10-45-1 specifies that, depending on the relationship between the entity’s performance and the customer’s payment, either a contract asset or a contract liability is presented on the balance sheet.

In practice, when a liability is presented, it is generally labeled as deferred (or unearned) revenue. This practice is reflected in the FASB XBRL where DeferredRevenue comprises ContractWithCustomerLiability and DeferredIncome. While the IASB XBRL does not include similar labels, as it would not contradict IFRS 15's guidance, it can be extended to do so.

Up to 12/1/X1, ABC purchased 800,000 and, on 12/15/X1, 50,000 more. Up to 12/1/X1, DEF purchased 4,000,000 but made no additional X1 purchases. Up to 12/1/X1, EFG purchased 7,000,000 and, on 12/15/X1, another 3,000,000. On 12/31/X1, XYZ credited EFG’s account and, on 1/1/X2, paid out DEF’s incentive.

12/15/X1 / 15.12.X1
Trade receivable: ABC		50,000
Trade receivable: EFG		3,000,000
	Revenue: ABC		50,000
	Revenue: EFG		2,810,000
	Deferred revenue (contract liability): Dealer incentives: EFG		190,000

 

12/31/X1 / 31.12.X1
Deferred revenue (contract liability): Dealer incentives: EFG		400,000
	Trade receivable: EFG		400,000

 

1/1/X2 / 1.1.X2
Deferred revenue (contract liability): Dealer incentives: DEF		80,000
	Cash		80,000

 

Probability-weighted amounts

Same facts except, even though there were only two outcomes, XYZ elected to use the sum of probability-weighted amounts.

IFRS 15.53 | ASC 606-10-32-8 discusses estimating variable consideration outlining two general approaches.

Approach a. involves estimating a probability weighted cash flow while approach b. simply takes the most likely amount.

Although not strictly required, the standard strongly suggests using approach b. is only appropriate when there are, as in this example, only two possible outcomes.

Approach a, on the other hand, can be used in any situation.

1/1/X1 / 1.1.X1
Trade receivable: EFG		1,000,000
	Revenue: EFG		966,000
	Deferred revenue (contract liability): Dealer incentives: EFG		34,000

 

3.4% = (3% x 60%) + (4% x 40%).

12/15/X1 / 15.12.X1
Trade receivable: EFG		3,000,000
	Revenue: EFG		2,838,000
	Deferred revenue (contract liability): Dealer incentives: EFG		162,000

 

162,000 = 400,000 - 238,000; 400,000 = 10,000,000 x 4%; 238,000 = 7,000,000 x 3.4%

Sales support

XYZ is a manufacturer. In additional to a fixed dealer rebate of (20% off from suggested retail) if offers other forms of sales support such as joint marketing and sales staff training. If a dealer participates in a joint marketing program and its turnover increases by 10%, it is entitled to an additional 1% rebate. If it increases by 20%, 2% and if it increases by 30% or more, 3%. The same incentive structure applies sales staff training. Also, if a dealer redecorates or renovates incorporating XYZ's promotional material, it can claim a rebate equal to 25% of its cost, up to 20% of its annual turnover.

1/1/X1, a dealer bought goods with a retail price of 100,000. Over the past ten years, it participated in marketing programs 8 times. Its turnover increasing more than 10% twice, more than 20% once, and more than 30% five times. Over the same period, its sales staff was trained 6 times. Its purchases increased by more than 10% once, more than 20% four times and more than 30% twice. During the past 10 years, the dealer renovated 4 times incurring costs of 10%, 7% and 30% of its annual purchases.

1/1/X1 / 1.1.X1
Trade receivables		80,000
	Revenue (net of discounts)		76,347
	Deferred revenue (contract liability): Sales support		3,653

 

IFRS 15.105 | ASC 606-10-45-1 specifies that, depending on the relationship between the entity’s performance and the customer’s payment, either a contract asset or a contract liability is presented on the balance sheet.

In practice, when a liability is presented, it is generally labeled as deferred (or unearned) revenue. This practice is reflected in the FASB XBRL where DeferredRevenue comprises ContractWithCustomerLiability and DeferredIncome. While the IASB XBRL does not include similar labels, as it would not contradict IFRS 15's guidance, it can be extended to do so.

 

				Marketing	Training
	A		Turnover	100,000	100,000
	B		Probability	80%	60%
	C		Incentive	0%	0%
	D		Probability	20%	30%
	E		Incentive	1%	1%
	F		Probability	20%	10%
	G		Incentive	2%	2%
	H		Probability	10%	40%
	I		Incentive	3%	3%
	J		Probability	50%	20%
	H=AxBx((CxD)+(ExF)+(GxH)+(IxJ))		Total	1,520	900

 

Remodeling	Cost %	Eligible cost %	Support %	Turnover	Rebate
	A	B=IF(A<20%,A,20%)	C	D	E=BxCxD
1	10%	10%	25%	100,000	2,500
2	7%	7%	25%	100,000	1,750
3	30%	20%	25%	100,000	5,000
					9,250
Average					÷ 3
Probability					x 60%
Estimated remodeling incentive					1,850
Estimated marketing incentive					1,520
Estimated training incentive					900
Total estimated incentive					3,653

Performance bonus

1/1/X1, XYZ sold and agreed to assemble, install, test and break-in a production line for ABC. The total price of the line was 300,000 and XYZ’s cost 225,000. The contract included a performance bonus of 30,000 provided the line was finished by 9/30/X1. In the past, XYZ was able to finish 4 out of 5 similar projects on time (XYZ’s costs were linear, accrued to inventory as incurred and revenue recognized quarterly).

Dr/Cr

3/31/X1 / 31.3.X1
Contract in progress: ABC		110,000
Cost of Sales		75,000
	Revenue		110,000
	Inventory: Contract in progress		75,000

 

As outlined in IFRS 15.105 | ASC 606-10-45-1, if the entity has performed or the customer has paid, a contract asset (performance precedes payment) or contract liability (payment precedes performance) is presented.

As outlined in IFRS 15.108 | ASC 606-10-45-4, a receivable may only be presented if the right to consideration is unconditional.

Since ABC had not paid and since completing the installation was a condition for it being able to claim payment, XYZ recognized a contract asset rather than a receivable.

XYZ completed the installation on 9/27/X1, the customer accepted it on 9/30/X1 and XYZ issued an invoice.

9/30/X1 / 30.9.X1
Accounts receivable: ABC		330,000
Cost of Sales		75,000
	Contract in progress: ABC		220,000
	Revenue		110,000
	Inventory: Contract in progress		75,000

 

Same facts except XYZ’s generally completes one out of two projects on time.

3/31/X1 / 31.3.X1
Contract in progress: ABC		100,000
Cost of Sales		75,000
	Revenue		100,000
	Inventory: Contract in progress		75,000

 

9/30/X1 / 30.9.X1 it completed the project.
Accounts receivable: ABC		330,000
Cost of Sales		75,000
	Contract in progress: ABC		200,000
	Revenue		130,000
	Inventory: Contract in progress		75,000

 

Same facts except, the contract included a late penalty of 10%.

3/31/X1 / 31.3.X1
Contract in progress: ABC		90,000
Cost of Sales		75,000
	Revenue		90,000
	Inventory: Contract in progress		75,000

 

Same facts except ABC formally accepted the line 10/1/X1.

As outlined in IFRS 15.B84 / ASC 606-10-55-86, If an entity can objectively determine that control has been transferred to the customer as agreed-upon, customer acceptance is a formality, which will not prevent revenue from being recognized.

9/27/X1 / 27.9.X1
Unbilled revenue: ABC		330,000
Cost of Sales		75,000
	Contract in progress: ABC		200,000
	Revenue		130,000
	Inventory: Contract in progress		75,000

 

Instead of a receivable or contract asset, this example uses an unbilled revenue account.

IFRS 15.105 | ASC 606-10-45-1 states (edited): ...An entity shall present any unconditional rights to consideration separately as a receivable.

IFRS 15.108 | ASC 606-10-45-4 states (edited): ...A right to consideration is unconditional if only the passage of time is required before payment of that consideration is due...

IFRS 15.107 | ASC 606-10-45-3 states (edited, emphasis added): If an entity performs by transferring goods or services to a customer before the customer pays consideration or before payment is due, the entity shall present the contract as a contract asset...

As written, the guidance in IFRS 15.105 to 109 | ASC 606-10-45-1 to 5 gives two options.

IFRS 15.105 | ASC 606-10-45-1 states (emphasis added): When either party to a contract has performed, an entity shall present the contract in the statement of financial position as a contract asset or a contract liability, depending on the relationship between the entity’s performance and the customer’s payment. An entity shall present any unconditional rights to consideration separately as a receivable.

IFRS 15.108 | ASC 606-10-45-4 explains (edited, emphasis added): A right to consideration is unconditional if only the passage of time is required before payment of that consideration is due.

Applied to this example, since XYZ has performed and the only condition associated with its right to consideration (the customer’s payment) is having to wait a period of time, it should present a receivable, not a contract asset.

However, IFRS 15.107 | ASC 606-10-45-3 also states (edited, emphasis added): If an entity performs by transferring goods or services to a customer before the customer pays consideration or before payment is due, the entity shall present the contract as a contract asset, excluding any amounts presented as a receivable.

In practice, “before payment is due” is often interpreted to mean that the company has not only performed (transferred goods, rendered services) but has also billed (issued an invoice).

Using a separate, unbilled revenue account gives companies an option to cover the situation where they have performed but not yet billed.

At the end of the period, the unbilled revenue account can be taken directly to the balance sheet.

Although the ASC does not address unbilled revenue, FASB XBRL includes UnbilledRevenuesMember and UnbilledReceivablesCurrent. It defines the latter: "Amount received for services rendered and products shipped, but not yet billed, for non-contractual agreements due within one year or the normal operating cycle, if longer."

Although the IASB XBRL does not include a similar item, it may be extended to do so.

At the end of the period, the unbilled revenue account can be presented as a sub-classification of contract assets or receivables depending on if the right to consideration is conditional or not.

This option is especially useful for companies domiciled in (or with subsidiaries domiciled in) jurisdictions where national GAAP and/or tax law outlines different rules.

In some jurisdictions, besides IFRS and/or US GAAP, entities must apply statuary accounting (a.k.a. national GAAP). For example, in the European Union two separate accounting systems exist:

IFRS (required by the IAS regulation) and national GAAP (required by the accounting directive).

While IFRS is used for financial reporting, national GAAP is often used for taxation. For example, in the Czech Republic, while IFRS is required for financial reporting purposes, it may not be used as the basis for determining taxable income, which means the two must be reconciled at the end of each period.

Using an account like unbilled revenue is helpful because it can (if the right is unconditional) be presented as a receivable for IFRS reporting purposes and as accrued revenue for statutory reporting purposes (Czech national GAAP only allows receivables to be recognized if a formal invoice has been issued).

Warranties

Assurance

XYZ is a retailer. By law it must provide a 2-year repair/replace warranty for defects. From 1/1/X1 to 3/31/X1, it sold goods for 1,000,000. In its experience, the costs associated with repairing or replacing defective goods are 3% of sales (these costs are not recoverable).

As outlined in IFRS 15.B30 | ASC 606-10-55-32, if a warranty is not sold separately and does not provide a service in additional to assurance, it is accounted for as a provision (IAS 37) | guarantee (ASC 460-10).

As outlined in IFRS 15.B29 & B32 | ASC 606-10-55-31 & 34, if a warranty is sold separately or provides a service in additional to assurance, it is accounted for as a separate performance obligation, which generally means the portion of revenue associated with the warranty is deferred.

IFRS 15.B31 | ASC 606-10-55-33 gives guidance on how to determine if a warranty provides a service in addition to assurance, but fails to explicitly state what assurance is. However, sub-paragraph c provides a clue by mentioning the cost of shipping defective products.

IFRS 15.B31 | ASC 606-10-55-33: In assessing whether a warranty provides a customer with a service in addition to the assurance that the product complies with agreed-upon specifications, an entity shall consider factors such as:

1. Whether the warranty is required by law—if the entity is required by law to provide a warranty, the existence of that law indicates that the promised warranty is not a performance obligation because such requirements typically exist to protect customers from the risk of purchasing defective products.
2. The length of the warranty coverage period—the longer the coverage period, the more likely it is that the promised warranty is a performance obligation because it is more likely to provide a service in addition to the assurance that the product complies with agreed-upon specifications.
3. The nature of the tasks that the entity promises to perform—if it is necessary for an entity to perform specified tasks to provide the assurance that a product complies with agreed-upon specifications (for example, a return shipping service for a defective product), then those tasks likely do not give rise to a performance obligation.

Reading between the lines, an assurance warranty is a promise by the seller (manufacturer) to repair defective merchandise (products) or replace them if they cannot be repaired for a term not exceeding one year (common practice) unless a term of longer than one year is mandated by law (in jurisdictions that have such mandates).

The same logic applies to services except, instead or replace/repair, the service would be reperformed.

Note: if, instead of repair/replace/reperform, the promise involves a refund, the guidance on warranties no longer applies.

Instead, the transaction(s) should be accounted for as a right to return (see below).

Dr/Cr

1/1/ - 3/31/X1 / 1.1. - 31.3.X1
Cash, Payment card receivables, etc.		1,000,000
Selling (distribution) expenses: Warranties		30,000
	Revenue		1,000,000
	Provision (contingent liability): Assurance warranty: Q1/X1		30,000

 

The cost associated with providing assurance type warranties should be classified as a selling expense regardless of whether it is required by law or not.

If required by law, it is a condition the seller must meet to be allowed to sell its goods.

If not required by law, it is a (non-monetary) incentive to the customer which helps facilitate the sale.

Also see the Consideration paid to the customer example for a discussion of monetary incentives.

IFRS prefers the term Distribution (DistributionCosts), while US GAAP uses Selling (SellingExpense).

The advantage of using Selling instead of Distribution is that Selling can combined with General and Administrative expenses to make SG&A. An acronym like DG&A would, on the other hand, not mean anything to anyone.

As outlined in IFRS 15.B30, obligations arising from product warranties are accounted for as provisions (IAS 37).

As outlined in ASC 606-10-55-32, product warranties should be accounted for as guarantees (ASC 460). However, 460-10-25-1 states it does not apply to product warranties ¯\_(?)_/¯. Fortunately, ASC 460-10-25-5 does point to ASC 450-20-25-2, which results in the guidance provided by ASC 606-10-55-32 being comparable to IFRS 15.B30.

ASC 460-10-25-1 (emphasis added): The following types of guarantees are not subject to the recognition provisions of this Subsection: ... b. A product warranty or other guarantee for which the underlying is related to the performance (regarding function, not price) of nonfinancial assets that are owned by the guaranteed party ...

The only potentially significant difference, unlike ASC 450, IAS 37.45 requires provisions to be discounted when "the effect of the time value of money is material."

However, since often "the effect of discounting is not material" (IAS 37.Example 1 Warranties), discounting warranty obligations is rare in practice.

If it ever does become an issue, since ASC 450 does not specifically disallow discounting contingent liabilities, it can be overcome.

As stated in IAS 37.14 "A provision shall be recognised when: ..."

As stated in IAS 37.27 "An entity shall not recognise a contingent liability."

As stated in ASC 450-20-25-2 "An estimated loss from a loss contingency shall be accrued ..."

Nowhere in ASC 450 are provisions mentioned.

At face value, the guidance provided by IFRS and US GAAP is incompatible.

However, as the FASB explains in CON 8.4, this seeming difference is simply caused by a misunderstanding to what US GAAP means by "contingent liability."

According to the FASB, it is not the liability that is contingent; the liability exists. What is contingent is the future event(s) that will determine the amount of that liability.

CON 8.4.E60. Sometimes present obligations with uncertain amounts and timing are referred to as contingent liabilities. The term contingent liability has been a source of confusion because it is often thought to refer to circumstances in which the existence of an obligation depends on the occurrence or nonoccurrence of a future event. Absent a present obligation, the occurrence or nonoccurrence of a future event does not by itself give rise to a liability. Some items commonly described as contingent liabilities satisfy the definition of a liability because the contingency does not relate to whether a present obligation exists but instead relates to one or more uncertain future events that affect the amount that will be required to settle the present obligation. For those obligations, the fact that the outcome is unknown affects the measurement but not the existence of the liability.

If the term contingency is interpreted in this way, then the guidance provided by IAS 37 and ASC 450 is comparable.

A provision shall be recognised when:

1. an entity has a present obligation (legal or constructive) as a result of a past event;
2. it is probable that an outflow of resources embodying economic benefits will be required to settle the obligation; and
3. a reliable estimate can be made of the amount of the obligation. ...

ASC 450-20-25-2: An estimated loss from a loss contingency shall be accrued by a charge to income if both of the following conditions are met:

1. Information available before the financial statements are issued or are available to be issued ... indicates that it is probable that an asset had been impaired or a liability had been incurred at the date of the financial statements. ... It is implicit in this condition that it must be probable that one or more future events will occur confirming the fact of the loss.
2. The amount of loss can be reasonably estimated. ...

The only difference is that IFRS calls the resulting liabilities "provisions" while US GAAP refers to them as "contingent liabilities".

As outlined in IAS 37.61, a provision may only be used only for expenditures associated with that provision.

XYZ interpreted this guidance by setting up a separate provision account for each quarter's sales.

Note: while ASC 450-20 does not provide similarly explicit guidance, cookie jar reserves are seriously frowned upon by the SEC and should be avoided at all cost.

As outlined in ASC 835-30-15-3.g, "contractual or other obligations assumed in connection with sales of property, goods, or service, for example, a warranty for product performance" need not be discounted. This is consistent with the guidance in ASC 450, which also does not require contingent liabilities to be discounted.

Unfortunately, IFRS does not include a similar, blanket exception and, as outlined in IAS 37.45, provisions do need to be discounted if the time value of money is material.

Nevertheless, in both examples C 1 and D 1 (where the warrantee term is three and two years respectively) the provision is not discounted because, as specified in example D 1, the amounts involved are not material. As a result, discounting warrantee obligation is not common practice in IFRS either.

5/1/X1, a customer returned defective merchandise that was repaired at a cost of 10 (XYZ outsourcers its repairs to DEF). 5/15/X1, a customer returned defective merchandise that XYZ replaced. XYZ’s cost was 30. 9/30/X2, a customer returned defective merchandise that would have been too expensive to repair, was no longer in stock and could not be purchased. The merchandise was originally sold for 50.

5/1/X1 / 1.5.X1
Provision: Assurance warranty: Q1/X1		10
	Account payable: DEF		10

 

5/15/X1 / 15.5.X1
Provision: Assurance warranty: Q1/X1		30
	Inventory: Merchandise		30

 

9/30/X2 / 30.9.X2
Provision: Assurance warranty: Q1/X1		50
	Cash		50

 

Although the standards do not specifically address this issue, as the provision was originally recognized to cover the costs of repair or replacement, it was recognized correctly. Provided the reasons for the cash refund are substantive, it would not need to be reevaluated as a right to return.

From 4/1/X1 to 3/31/X3, XYZ incurred costs of 29,000 related to X1.Q1 warrantees leaving a 1,000 balance.

3/31/X3 / 31.3.X3
Provision: Assurance warranty: Q1/X1		1,000
	Selling expenses: Warranties		1,000

 

While it does not give explicit guidance on the action to take when the provision term ends, IAS 37.59 does state (emphasis added) "Provisions shall be reviewed at the end of each reporting period and adjusted to reflect the current best estimate. If it is no longer probable that an outflow of resources embodying economic benefits will be required to settle the obligation, the provision shall be reversed."

In this example, XYZ deemed it to be "no longer probable that an outflow of resources embodying economic benefits will be required to settle the obligation" day the warrantee term ended.

Note: while ASC 450-20 does not provide similarly explicit guidance, the same approach would be consistent with the guidance it does provide.

No liability
 

Same facts except XYZ could claim compensation from or return the goods to the manufacturer.

1/1/ - 3/31/X1 / 1.1. - 31.3.X1
Cash, Payment card receivables, etc.		1,000,000
Accrued warranty claim		30,000
	Revenue		1,000,000
	Allowance: Assurance warranty		30,000

 

In this situation, XYZ recognizes both its claim to the compensation (from the manufacturer) and its obligation to the customer in assets (the latter as an adjustment).

As outlined in IAS 37.23: "For a liability to qualify for recognition there must be not only a present obligation but also the probability of an outflow of resources embodying economic benefits to settle that obligation."

Similarly, for a liability to be recognized under ASC 450-20-25-2, it must be "probable that an asset had been impaired or a liability had been incurred at the date of the financial statements."

Since the costs are recoverable from the product's manufacturer, the outflow of resources will accrue to the manufacturer so it, not XYZ, recognizes the liability.

5/1/X1 / 1.5.X1
Allowance: Assurance warranty		10
	Account payable: DEF		10
Receivable: Accrued warranty claim		10
	Accrued warranty claim		10

 

5/15/X1 / 15.5.X1
Allowance: Assurance warranty		30
	Inventory: Merchandise		30
Contract asset: inventory claim		30
	Accrued warranty claim		30

 

5/17/X1 / 17.5.X1
Inventory: Merchandise		30
	Contract asset: inventory claim		30

 

6/1/X1 / 1.6.X1
Allowance: Assurance warranty		50
	Cash		50
Receivable: Accrued warranty claim		50
	Accrued warranty claim		50

 

7/1/X1 / 1.7.X1
Cash		50
	Receivable: Accrued warranty claim		50

Extended

XYZ is a retailer. By law it must provide a 2-year repair/replace warranty for defects. In its experience, the costs associated with repairing or replacing defective merchandise during this two-year period are 3% of sales.

In addition, XYZ also sells an extended 3-year warranty for 10% of the merchandise's stand-alone sales price. The replacements may involve identical or comparable merchandise. Cash refunds are not given. The costs associated with the extended warranty vary considerably and it is not possible for XYZ to estimate the amounts, and especially timing, of individual repair/replace events. However, historically the costs have never exceeded 50% nor been below 10% of the recognized revenue.

As outlined in IFRS 15.B30 | ASC 606-10-55-32, if a warranty is not sold separately and does not provide a service in additional to assurance, it is accounted for as a provision (IAS 37) | guarantee (ASC 460-10).

As outlined in IFRS 15.B29 & B32 | ASC 606-10-55-31 & 34, if a warranty is sold separately or provides a service in additional to assurance, it is accounted for as a separate performance obligation, which generally means the portion of revenue associated with the warranty is deferred.

IFRS 15.B31 | ASC 606-10-55-33 gives guidance on how to determine if a warranty provides a service in addition to assurance, but fails to explicitly state what assurance is. However, sub-paragraph c provides a clue by mentioning the cost of shipping defective products.

IFRS 15.B31 | ASC 606-10-55-33: In assessing whether a warranty provides a customer with a service in addition to the assurance that the product complies with agreed-upon specifications, an entity shall consider factors such as:

1. Whether the warranty is required by law—if the entity is required by law to provide a warranty, the existence of that law indicates that the promised warranty is not a performance obligation because such requirements typically exist to protect customers from the risk of purchasing defective products.
2. The length of the warranty coverage period—the longer the coverage period, the more likely it is that the promised warranty is a performance obligation because it is more likely to provide a service in addition to the assurance that the product complies with agreed-upon specifications.
3. The nature of the tasks that the entity promises to perform—if it is necessary for an entity to perform specified tasks to provide the assurance that a product complies with agreed-upon specifications (for example, a return shipping service for a defective product), then those tasks likely do not give rise to a performance obligation.

Reading between the lines, an assurance warranty is a promise by the seller (manufacturer) to repair defective merchandise (products) or replace them if they cannot be repaired for a term not exceeding one year (common practice) unless a term of longer than one year is mandated by law (in jurisdictions that have such mandates).

The same logic applies to services except, instead or replace/repair, the service would be reperformed.

Note: if, instead of repair/replace/reperform, the promise involves a refund, the guidance on warranties no longer applies.

Instead, the transaction(s) should be accounted for as a right to return (see below).

During the first quarter of X1, XYZ sold merchandise for 1,000,000.

Dr/Cr

1/1/ - 3/31/X1 / 1.1. - 31.3.X1
Cash, Payment card receivables, etc.		1,100,000
Sales (distribution) expense: Warranties		30,000
	Revenue (merchandise)		1,000,000
	Deferred revenue (contract liability): Extended warranty: Q1/X1		100,000
	Provision (contingent liability): Assurance warranty: Q1/X1		30,000

 

IFRS prefers the term Distribution (DistributionCosts), while US GAAP uses Selling (SellingExpense).

The advantage of using Selling instead of Distribution is that Selling can combined with General and Administrative expenses to make SG&A. An acronym like DG&A would, on the other hand, not mean anything to anyone.

As outlined in IFRS 15.B29 | ASC 606-10-55-31, separately priced assurance warranties are subject to IFRS 15.22-30 and 73-86 | ASC 606-10-25-14 to 22 and 32 to 41. The associated liability is a contract liability (deferred revenue).

IFRS 15.105 | ASC 606-10-45-1 specifies that, depending on the relationship between the entity’s performance and the customer’s payment, either a contract asset or a contract liability is presented on the balance sheet.

In practice, when a liability is presented, it is generally labeled as deferred (or unearned) revenue. This practice is reflected in the FASB XBRL where DeferredRevenue comprises ContractWithCustomerLiability and DeferredIncome.

While the IASB XBRL does not include similar labels, as it would not contradict IFRS 15's guidance, it can be extended to do so.

As outlined in IFRS 15.B30, obligations arising from product warranties are accounted for as provisions (IAS 37).

As outlined in ASC 606-10-55-32, product warranties should be accounted for as guarantees (ASC 460). However, 460-10-25-1 states it does not apply to product warranties ¯\_(?)_/¯. Fortunately, ASC 460-10-25-5 does point to ASC 450-20-25-2, which results in the guidance provided by ASC 606-10-55-32 being comparable to IFRS 15.B30.

ASC 460-10-25-1 (emphasis added): The following types of guarantees are not subject to the recognition provisions of this Subsection: ... b. A product warranty or other guarantee for which the underlying is related to the performance (regarding function, not price) of nonfinancial assets that are owned by the guaranteed party ...

The only potentially significant difference, unlike ASC 450, IAS 37.45 requires provisions to be discounted when "the effect of the time value of money is material."

However, since often "the effect of discounting is not material" (IAS 37.Example 1 Warranties), discounting warranty obligations is rare in practice.

If it ever does become an issue, since ASC 450 does not specifically disallow discounting contingent liabilities, it can be overcome.

As stated in IAS 37.14 "A provision shall be recognised when: ..."

As stated in IAS 37.27 "An entity shall not recognise a contingent liability."

As stated in ASC 450-20-25-2 "An estimated loss from a loss contingency shall be accrued ..."

Nowhere in ASC 450 are provisions mentioned.

At face value, the guidance provided by IFRS and US GAAP is incompatible.

However, as the FASB explains in CON 8.4, this seeming difference is simply caused by a misunderstanding to what US GAAP means by "contingent liability."

According to the FASB, it is not the liability that is contingent; the liability exists. What is contingent is the future event(s) that will determine the amount of that liability.

CON 8.4.E60. Sometimes present obligations with uncertain amounts and timing are referred to as contingent liabilities. The term contingent liability has been a source of confusion because it is often thought to refer to circumstances in which the existence of an obligation depends on the occurrence or nonoccurrence of a future event. Absent a present obligation, the occurrence or nonoccurrence of a future event does not by itself give rise to a liability. Some items commonly described as contingent liabilities satisfy the definition of a liability because the contingency does not relate to whether a present obligation exists but instead relates to one or more uncertain future events that affect the amount that will be required to settle the present obligation. For those obligations, the fact that the outcome is unknown affects the measurement but not the existence of the liability.

If the term contingency is interpreted in this way, then the guidance provided by IAS 37 and ASC 450 is comparable.

A provision shall be recognised when:

1. an entity has a present obligation (legal or constructive) as a result of a past event;
2. it is probable that an outflow of resources embodying economic benefits will be required to settle the obligation; and
3. a reliable estimate can be made of the amount of the obligation. ...

ASC 450-20-25-2: An estimated loss from a loss contingency shall be accrued by a charge to income if both of the following conditions are met:

1. Information available before the financial statements are issued or are available to be issued ... indicates that it is probable that an asset had been impaired or a liability had been incurred at the date of the financial statements. ... It is implicit in this condition that it must be probable that one or more future events will occur confirming the fact of the loss.
2. The amount of loss can be reasonably estimated. ...

The only difference is that IFRS calls the resulting liabilities "provisions" while US GAAP refers to them as "contingent liabilities".

As outlined in IAS 37.61, a provision may only be used only for expenditures associated with that provision.

XYZ interpreted this guidance by setting up a separate provision account for each quarter's sales.

Note: while ASC 450-20 does not provide similarly explicit guidance, cookie jar reserves are seriously frowned upon by the SEC and should be avoided at all cost.

The preceding example discusses assurance warranties in more detail.

During the first quarter of X3, customers returned merchandise that cost 2,100 to repair or replace.

3/31/X3 / 31.3.X3
Deferred revenue: Extended warranty: Q1/X1		8,333
Cost of Sales (repairs & replacements)		2,100
	Revenue (extended warranty)		8,333
	Cash, Inventory, Payables		2,100

 

As it is unable to predict and estimate the timing and amount of individual repair/replace events, XYZ recognizes expenses as they accrue.

If it could predict and estimate the timing and amount of individual repair/replace events, it would match these expenses to revenue.

As it is unable to predict and estimate the timing and amount of individual repair/replace events, XYZ recognizes revenue on a straight-line basis.

If it could predict and estimate the timing and amount of individual repair/replace events, it would match revenue and expenses.

Deferred tax

Same facts except XYZ is subsidiary located in a jurisdiction where, because it is a separate legal entity, it is required to apply national GAAP for statutory reporting purposes. The national GAAP also serves as the basis for determining taxable income. Rather than reconciling national GAAP and IFRS/US GAAP, it maintains separate accounts for the two systems.

A cost effective, and fairly common, way to accomplish this is to outsource the national GAAP to a certified accounting service provider. Not only does this eliminate the need for reconciliation or two sets of books, but these providers also often provide tax advice, payroll processing, document archival and various other useful services. In addition, they commonly carry liability insurance.

Per national GAAP, if a warrantee is legally required, a provision may be recognized and the associated expense is tax deductible. However, if a warrantee is not required by law and the entity is not a licensed insurance provider, a liability may not be recognized and the associated revenue may not be deferred. The income tax rate is 20%.

US GAAP / IFRS book: 1/1/ - 3/31/X1 / 1.1. - 31.3.X1
Cash, Payment card receivables, etc.		1,100,000
Sales (distribution) expense: Warranties		30,000
Deferred tax asset		20,000
	Revenue (merchandise)		1,000,000
	Deferred revenue (contract liability): Extended warranty: Q1/X1		100,000
	Provisions (contingent liabilities): Assurance warranty		30,000
	Income tax expense		20,000

 

National GAAP book: 1/1/ - 3/31/X1 / 1.1. - 31.3.X1
Cash, Payment card receivables, etc.		1,100,000
Creation of legal reserve (expense)		30,000
	Revenue		1,100,000
	Legal reserves (assurance warranty)		30,000

 

In this jurisdiction, the national GAAP refers to provisions (liabilities) as reserves. It refers to reserves (retained earnings appropriations) as funds.

In Q1.X2, XYZ recognized costs of 3,750 fulfilling its obligations under the assurance warranty.

US GAAP / IFRS book: 3/31/X2 / 31.3.X2
Provision: Assurance warranty		3,750
	Cash, Inventory, Payables		3,750

 

National GAAP book: 3/31/X2 / 31.3.X2
Materials, Services (expense)		3,750
Legal reserves (assurance warranty)		3,750
	Cash, Inventory, Payables		3,750
	Liquidation of legal reserve (expense reversal)		3,750

 

In Q1.X3, XYZ recognized revenue and the costs of 2,100 fulfilling its obligations under the extended warranty.

US GAAP / IFRS book: 3/31/X3 / 31.3.X3
Deferred revenue: Extended warranty: Q1/X1		8,333
Cost of Sales (repairs & replacements)		2,100
Income tax expense		1,667
	Revenue (extended warranty)		8,333
	Cash, Inventory, Payables		2,100
	Deferred tax asset		1,667

 

National GAAP book: 3/31/X3 / 31.3.X3
Materials, Services (expense)		2,100
	Cash, Inventory, Payables		2,100

Assurance and maintenance

XYZ is an automobile manufacturer. Per law, it provides a 2-year assurance warranty at a historical cost of 1% of a vehicle’s sales price. In addition, it offers retail customers “free” servicing. The work is performed by independent dealers per XYZ’s schedule and price list at a cost of 2% of a vehicle’s sales price. XYZ sells identical servicing to fleet customers for 2.5% of a vehicle’s sales price. During the first quarter, XYZ sold 50,000 vehicles for 20,000 each for a total of 1,000,000,000.

Dr/Cr

1/1/ - 3/31/X1 / 1.1. - 31.3.X1
Cash, Receivables		1,000,000 t
Sales (distribution) expense: Warranties		10,000 t
	Revenue		975,610 t
	Deferred revenue: Servicing obligation		24,390 t
	Provision: Assurance warranty		10,000 t

975,609,756 = 1,000,000,000 ÷ (1+2.5%)

24,390,244 = 1,000,000,000 - (1,000,000,000 ÷ (1+2.5%))

 

4/15/X1, dealer DEF invoiced 500 for servicing and 250 for replacing defective parts.

4/15/X1 / 15.4.X1
Cost of Sales (servicing)		500
Deferred revenue: Maintenance obligations		625
Provision: Assurance warranty		250
	Revenue		625
	Accounts payable: DEF		750

Bundle of services

XYZ manufactures and sells computers to consumers and businesses. On average, consumer computers cost 200 to produce and business computers cost 300 excluding software licenses, which cost 200 for both customer classes.

By law, consumers receive a 2-year warranty covering all defects. While the law does not extend the same rights to businesses, XYZ provides the same warranty to this customer class and this practice is widely known. The cost of fulfilling this obligation varies by unit, averages 2% of total sales for both consumer and business computers.

XYZ also sells consumers two and five-year extended Warranties. Extended Warranties include cleaning, inspection and light damage repair. If purchased with a computer, XYZ charges 4% of the computers cost for a two-year extended warranty and 10% for a five-year. XYZ also sells similar Warranties separately. In this case, they are priced at 15 for a one-year warranty, 25 for a two-year warranty and 60 for a five-year warranty. XYZ does not sell extended Warranties to businesses. Instead, business customers automatically receive the same services for two years without any, extra change. The costs of providing extended Warranties vary, but average 5 per warranty per year.

XYZ also sells five-year full Warranties to both consumers and businesses. These include repair / replacement of heavily damaged or misused computers. They also allow one replacement of a lost or stolen computer. The Warranties are priced at 30% of a computer's sales price for consumers and 35% for businesses, and are only sold together with new computers.

During the first quarter of X1, XYZ sold 2,000 consumer computers at an average price of 500 per unit. Together with these, it sold 100 two-year extended Warranties, 1,000 five-year extended warranties and 100 full Warranties. Separately, it also sold 100 one-year, 100 two-year and 200 five-year extended Warranties. In the same period, XYZ also sold 1,500 business computers, at an average price of 1,000 per unit, and 500 full Warranties.

For clarity, consumer sales are recognized against cash, businesses sales against receivables and only aggregate, quarterly entries are made.

Dr/Cr

3/31/X1 / 31.3.X1
Cash		1,083,000
Receivables		1,675,000
Cost of Sales (hardware)		850,000
Cost of Sales (licenses)		200,000
Sales and Distribution: Warranties		50,000
	Revenue (hardware, retail)		1,000,000
	Revenue (hardware, corporate)		1,470,588
	Liabilities: Deferred revenue: Extended warranty (1-year)		1,500
	Liabilities: Deferred revenue: Extended warranty (2-year)		33,912
	Liabilities: Deferred revenue: Extended warranty (5-year)		62,000
	Liabilities: Deferred revenue: Full warranty		190,000
	Inventory: Finished goods: Retail		850,000
	Inventory: Pre-paid licenses		200,000
	Liabilities: Provision: Assurance		50,000

 

1,083,000 = (2,000 x 500) + (100 x 500 x 4%) + (1,000 x 500 x 10%) + (100 x 500 x 30%) + (100 x 15) + (100 x 25) + (200 x 60)

1,650,000 = (1,500 x 1,000) + (500 x 1,000 x 35%)

1,470,588 = 1,500,000 ÷ (1 + 2%)

XYZ allocated revenue to the no charge warranty component by considering the stand-alone selling price of comparable distinct services.

IFRS 15.74 | ASC 606-10-32-29: ... an entity shall allocate the transaction price to each performance obligation identified in the contract ...

IFRS 15.76 | ASC 606-10-32-31: To allocate the transaction price to each performance obligation on a relative standalone selling price basis, an entity shall determine the standalone selling price at contract inception of the distinct good or service underlying each performance obligation in the contract and allocate the transaction price in proportion to those standalone selling prices.

It could not consider the 25 price as this is the price of Warranties sold separately and thus not comparable to the price of Warranties sold with computers.

It could not simply use the 4% price of Warranties sold to consumers, as consumer computers sell for significantly less than business computers, but the costs or providing extended Warranties are the same for both businesses and consumers.

Consequently, it adjusted the price used to estimate the revenue associated extended warranties (from 4% to 2%) to maintain the same margin of profit.

IFRS 15.79 | ASC 606-10-32-34: Suitable methods for estimating the standalone selling price of a good or service include, but are not limited to, the following: ... b. Expected cost plus a margin approach—An entity could forecast its expected costs of satisfying a performance obligation and then add an appropriate margin for that good or service. ...

33,912 = (100 x 500 x 4%) + (25 x 100) + 29,412; 29,412 = 1,500,000 - (1,500,000 ÷ (1 + 2%))

62,000 = (1,000 x 500 x 10%) + (60 x 200)

190,000 = (100 x 500 x 30%) + (500 x 1,000 x 35%)

During the second quarter, XYZ repaired defects at a cost of 5,000. It also performed servicing that cost 125 under one-year warranty, 2,030 under two-year warranty and 1,500 five-year warranty. Finally, it replaced 6 lost or stolen business computers (transferring the licenses from the previous machines) and made major repairs at a cost of 1,431.

6/30/X1 / 30.6.X1
Provision: Assurance warranty		5,000
Liabilities: Deferred revenue: Extended warranty (1-year)		375
Liabilities: Deferred revenue: Extended warranty (2-year)		4,239
Liabilities: Deferred revenue: Extended warranty (5-year)		3,100
Liabilities: Deferred revenue: Full warranty		9,500
Cost of Sales (warranty services)		6,886
	Revenue (warranties)		17,214
	Inventory: Finished goods		1,800
	Cash, Wages, Inventory, etc.		10,086

17,214 = 1,500 ÷ 4 + (2,000 + 2,500 +29,412) ÷ 8 + (62,000 + 15,000 + 175,000) ÷ 20

 

Same facts except XYZ evaluated its full warranty performance obligation more thoroughly.

To do so, it estimated that 25% of consumers and 60% of businesses require major repairs at a cost of between 50 to 150 per unit, 60 on average for consumers and 50 for businesses. It also determined that 5% of all repairs occur in the first year after sale, 20% in the second, 25% in the third and 35% in the fourth and 15% in the fifth.

It also estimated that 10% of consumers and 40% of businesses claim replacements of lost or stolen computers. Of the consumer replacements, 5% occur in the first year, 10% in the second, 25% in the third, 50% in the fourth and 10% in the fifth year after sale. Business replacements do not, in general, fluctuate significantly.

6/30/X3 / 30.6.X3
Provision: Assurance warranty		5,000
Liabilities: Deferred revenue: Extended warranty (1-year)		375
Liabilities: Deferred revenue: Extended warranty (2-year)		4,239
Liabilities: Deferred revenue: Extended warranty (5-year)		3,100
Liabilities: Deferred revenue: Full warranty		7,821
Cost of Sales (warranty services)		6,886
	Revenue (warranties)		15,535
	Inventory: Finished goods		1,800
	Cash, Wages, Inventory, etc.		10,086

 

7,821 = 31,283 ÷ 4

	Warranties sold	Claim %	Unit cost	Total cost
Repairs: consumer	100	25%	60	1,500
Repairs: business	500	60%	50	15,000
Replacements: consumer	100	10%	200	2,000
Replacements: business	500	40%	300	60,000
Total cost				78,500

 

	Consumer repair	In period	Consumer replace	In period	Consumer cost
	A	B	C = 100 x 200	D	F = (A x B) + (C x D)
X1	1,500	5%	2,000	5%	175
X2	1,500	20%	2,000	10%	500
X3	1,500	25%	2,000	25%	875
X4	1,500	35%	2,000	50%	1,525
X5	1,500	15%	2,000	10%	425

 

	Business repair	In period	Business replace	In period	Business cost
	A	B	C = 500 x 300	D	F = (A x B) + (C x D)
X1	15,000	5%	60,000	20%	12,750
X2	15,000	20%	60,000	20%	15,000
X3	15,000	25%	60,000	20%	15,750
X4	15,000	35%	60,000	20%	17,250
X5	15,000	15%	60,000	20%	14,250

 

	Consumer cost	Business cost	Revenue	Allocation	Period revenue
	A	B	C	D = (A + B) ÷ 78,500	E = C x D
X1	175	12,750	190,000	16%	31,283
X2	500	15,000	190,000	20%	37,516
X3	875	15,750	190,000	21%	40,239
X4	1,525	17,250	190,000	24%	45,443
X5	425	14,250	190,000	19%	35,519

Right to return

Customers

XYZ sells machines to industrial customers, allowing them to return unused machines for up to 180 days for a full refund. 1/1/X1, it sold three machines to customers: ABC, DEF and GHI. In its experience, ABC has never returned a machine, DEF returns 1 in 5 and GHI 1 in 2. The machines sell for 100,000 and cost 75,000 to manufacture. XYZ uses a perpetual inventory method and gives 30-day credit. GHI returned the machine on 3/31/X1.

XYZ's policy reflects the nature of its industry. In this industry, customers estimate demand with a 3 to 6-month lead time. If the demand materializes, they keep the machines. If it does not, they return them. In its experience, XYZ's flexibility with returns of unused machines, since it reduces customer risk, has led to higher overall sales in the long term.

When evaluating the probability of variable consideration, a probability of 75% to 80% should be used under both IFRS and US GAAP.

IFRS 15.56 specifies that variable consideration can be recognized only if "it is highly probable that a significant reversal" will not occur, while ASC 606-10-32-11 specified "it is probable that a significant reversal" will not occur.

The reason for the difference is that IFRS considers "probable" to be a synonym for more "likely than not" (a likelihood of 50% or more) while US GAAP assigns it a higher likelihood of 75-80% (see: link - PwC and link - IASB).

As noted above, IFRS generally uses 50% or higher likelihood threshold.

However, IFRS 15.B23 specifies that rights to return are variable consideration (paragraphs 56-58).

Consequently, the higher 75-80%, threshold, applies.

Dr/Cr

1/1/X1 / 1.1.X1
Receivable: ABC		100,000
Receivable: DEF		100,000
Receivable: GHI		100,000
Cost of Sales		150,000
	Revenue: ABC		100,000
	Revenue: DEF		100,000
	Deferred revenue (refund liability): GHI		100,000
	Inventory: Finished goods		150,000

 

As outlined in IFRS 15.B21.b | ASC 606-10-55-23.b, when an entity sells goods with a right to return, it recognizes a refund liability.

The refund liability can be recognized as a separate item or included in deferred revenue.

While the IASB XBRL does not include a RefundLiability item that would correspond to the guidance in IFRS 15.B21.b, it does include a RefundsProvision item. However, the reference for RefundsProvision is IAS 37 example 4, not IFRS 15. While, from a practical perspective, it would make little difference, recognizing the refund liability in its own account would be a cleaner option.

Although, the FASB XBRL does include a ContractWithCustomerRefundLiability item, it is part of 606000 Disclosure, with no exact corresponding item in 104000 Statement of Financial Position.

104000 does include CustomerRefundLiabilityCurrent, but its description states "Current regulatory liabilities generally represent obligations to make refunds to customers for various reasons including overpayment" with no reference to the ASC provided.

Thus, the closest item to ContractWithCustomerRefundLiability is ContractWithCustomerLiability (which includes multiple references to ASC 606).

ContractWithCustomerLiability is aggregated with DeferredIncome to form DeferredRevenue.

This implies that, for XBRL tagging purposes, an entity can either add an extension (e.g. RefundRebateLiabilities_Extension) or include this item in DeferredRevenue.

In this example, as XYZ expected GHI would, more likely than not, keep the machine, it recognized Deferred revenue.

As outlined in IFRS 15.B21 | ASC 606-10-55-23, when an entity sells goods with a right to return, it is recognizes a. the revenue (if any) it does not expect to return, b. a refund liability, c. an asset that corresponds to the asset it expects to recover and (no letter) an adjustment to cost of sales.

As outlined in IFRS 15.B21 | ASC 606-10-55-23, when an entity sells goods with a right to return, it is recognizes a. the revenue (if any) it does not expect to return, b. a refund liability, c. an asset that corresponds to the asset it expects to recover and (no letter) an adjustment to cost of sales.

If it had applied the guidance as written, XYZ would have recognized:

1/1/X1 / 1.1.X1
Receivable: ABC		100,000
Receivable: DEF		100,000
Receivable: GHI		100,000
Cost of Sales		225,000
Inventory: Right to recover products from customers		75,000
	Revenue: ABC		100,000
	Revenue: DEF		100,000
	Deferred revenue: Refund liability: GHI		100,000
	Inventory: Finished goods		225,000
	Cost of Sales: Adjustment		75,000

 

However, since this procedure would have no effect on net reported results, XYZ concluded the extra entries were not worth the extra effort.

Note: in IFRS, the cost of sales guidance only applies if a function of expense P&L is presented.

As outlined in IFRS 15.53 | ASC 606-10-32-8, variable consideration is either the most likely amount (if there are only two alternatives) or the sum of probability weighted amounts (over two alternatives).

As the most likely of the two amounts was 100,000, XYZ recognized revenue of 100,000.

As outlined in IFRS 15.53 | ASC 606-10-32-8, variable consideration is either the most likely amount (if there are only two alternatives) or the sum of probability weighted amounts (over two alternatives).

As the most likely of the two amounts was zero, XYZ recognized no revenue.

1/31/X1 / 31.1.X1
Cash		300,000
	Receivable: ABC		100,000
	Receivable: DEF		100,000
	Receivable: GHI		100,000

 

 

3/31/X1 / 31.3.X1
Deferred revenue: GHI		100,000
	Cash		100,000

 

No return

Same facts except GHI did not return the machine.

3/31/X1 / 31.3.X1
Deferred revenue: GHI		100,000
Cost of Sales		75,000
	Revenue		100,000
	Inventory: Finished goods		75,000

Consumers

XYZ sells merchandise to consumers. It recognizes sales at the end of each month (using a perpetual inventory method) and allows customers to return unused merchandise within 30 days for a full refund. Its December sales were 1,000,000 and, historically, 10% of December sales are returned. Unlike the previous example, XYZ accounts for returns using a portfolio approach. By 1/31/X2, customers returned 85,000 in goods.

XYZ's policy reflects the nature of its industry. In this industry, consumers buy gifts before Christmas. If the gifts are welcome, they are kept. If they are not, they are returned. In its experience, XYZ's flexibility with returns of unused merchandise, since it reduces consumer discomfort, has led to higher overall sales in the long term.

While IFRS 15.4 | ASC 606-10-10-4 specifies that it applies to individual contracts, as a practical expedient, it allows entities to apply it to a portfolio of contracts, provided they have similar characteristics and effects on the financial statements are not material.

Dr/Cr

12/31/X1 / 31.12.X1
Cash, Charge cards, etc.		1,000,000
Cost of Sales		450,000
Inventory: Goods expected to be returned		50,000
	Revenue		900,000
	Refund liability (deferred revenue)		100,000
	Inventory: Merchandise		500,000

 

As outlined in IFRS 15.B21 | ASC 606-10-55-23, when an entity sells goods with a right to return, it is recognizes a. the revenue (if any) it does not expect to return, b. a refund liability, c. an asset that corresponds to the asset it expects to recover and (no letter) an adjustment to cost of sales.

As outlined in IFRS 15.B21 | ASC 606-10-55-23, when an entity sells goods with a right to return, it is recognizes a. the revenue (if any) it does not expect to return, b. a refund liability, c. an asset that corresponds to the asset it expects to recover and (no letter) an adjustment to cost of sales.

As outlined in IFRS 15.B21 | ASC 606-10-55-23, when an entity sells goods with a right to return, it is recognizes a. the revenue (if any) it does not expect to return, b. a refund liability, c. an asset that corresponds to the asset it expects to recover and (no letter) an adjustment to cost of sales.

As outlined in IFRS 15.B21 | ASC 606-10-55-23, when an entity sells goods with a right to return, it is recognizes a. the revenue (if any) it does not expect to return, b. a refund liability, c. an asset that corresponds to the asset it expects to recover and (no letter) an adjustment to cost of sales.

As outlined in IFRS 15.B21.b | ASC 606-10-55-23.b, when an entity sells goods with a right to return, it recognizes a refund liability.

The refund liability can be recognized as a separate item or included in deferred revenue.

While the IASB XBRL does not include a RefundLiability item that would correspond to the guidance in IFRS 15.B21.b, it does include a RefundsProvision item. However, the reference for RefundsProvision is IAS 37 example 4, not IFRS 15. While, from a practical perspective, it would make little difference, recognizing the refund liability in its own account would be a cleaner option.

Although, the FASB XBRL does include a ContractWithCustomerRefundLiability item, it is part of 606000 Disclosure, with no exact corresponding item in 104000 Statement of Financial Position.

104000 does include CustomerRefundLiabilityCurrent, but its description states "Current regulatory liabilities generally represent obligations to make refunds to customers for various reasons including overpayment" with no reference to the ASC provided.

Thus, the closest item to ContractWithCustomerRefundLiability is ContractWithCustomerLiability (which includes multiple references to ASC 606).

ContractWithCustomerLiability is aggregated with DeferredIncome to form DeferredRevenue.

This implies that, for XBRL tagging purposes, an entity can either add an extension (e.g. RefundRebateLiabilities_Extension) or include this item in DeferredRevenue.

Unlike the previous example, since XYZ did not expect customers to keep the goods, it recognized the refund liability separately from deferred revenue.

1/31/X2 / 31.1.X2
Refund liability		100,000
Cost of Sales		7,500
Inventory: Merchandise		42,500
	Revenue		15,000
	Cash		85,000
	Inventory: Goods expected to be returned		50,000

 

As the difference was 15% of the original estimate, XYZ reevaluated its methodology (see: IFRS 15.53 | ASC 606-10-32-8) to try to get a more accurate result (a difference of less than 10%) next time.

However, the difference was not significant enough to qualify as a mistake in applying accounting principles (IAS 8 definitions | ASC 250-10-20) so XYZ did not reopen X1 to make the adjustment retrospectively.

Unlimited uncertainty

XYZ manufactures and sells luxury goods, exclusively in its own retail stores. As a customer service, it has an unwritten, though well known, policy of accepting returns for an unlimited time. Given the nature of its customer base, store managers have the discretion to evaluate individual cases and offer an exchange, a refund or reject the claim. Over the past 20 years, returns have averaged 10% of sales, though they fluctuate period to period. Q1 sales and actual returns were 1,000,000 and 95,000 respectively.

Dr/Cr

3/31/X1 / 31.3.X1
Cash, Charge cards, etc.		1,000,000
Cost of Sales		400,000
	Revenue		900,000
	Refund liability		100,000
	Inventory		400,000

 

IFRS 15.56 / 606-10-32-11 states: An entity shall include in the transaction price some or all of an amount of variable consideration estimated in accordance with paragraph 53 | 606-10-32-8 only to the extent that it is highly probable that a significant reversal in the amount of cumulative revenue recognised will not occur when the uncertainty associated with the variable consideration is subsequently resolved.

In this example, as the return is not time limited, the uncertainty associated with the variable consideration will NEVER be subsequently resolved.

Since, theoretically, every item could be returned over an unlimited period of time, if the guidance were interpreted literally, no revenue could be recognized.

Obviously, this interpretation of the guidance would not make any practical sense.

However, XYZ did need to contend with the unlimited nature of its return policy.

It did so by estimating returns over a significant period of time (20 years) in that, while it is theoretically possible goods could be returned even after this time, it would be highly unlikely and the amounts would be immaterial.

3/31/X1 / 31.3.X1
Refund liability		95,000
	Cash, Inventory		95,000

 

In Q2 to Q4.X1, sales and returns were 1,100,000 & 121,000, 1,200,000 & 108,000, and 1,600,000 & 168,000.

12/31/X1 / 31.12.X1
Cash, Charge cards, etc.		1,600,000
Cost of Sales		640,000
	Revenue		1,440,000
	Refund liability		160,000
	Inventory		640,000

 

12/31/X1 / 31.12.X1
Refund liability		2,000
	Revenue		2,000

 

Since total recognized X1 revenue and returns were was 4,900,000 and 492,000 respectively, XYZ adjusted the liability to reflects its 20-year average.

Or simply:

12/31/X1 / 31.12.X1
Cash, Charge cards, etc.		1,600,000
Cost of Sales		640,000
	Revenue		1,442,000
	Refund liability		158,000
	Inventory		640,000

Resellers

XYZ distributes its product through various third parties: agents and principals, regular customers and consignees.

The product costs 50 per unit to manufacture.

IFRS 15 and ASC 606 give detailed guidance on how to distinguish an agent from a principal and a regular sale from a consignment sale.

However, boiled down, the key issue is risk.

If the customer is a reseller, its before sale risk is that it will not be able to re-sell the goods to its customers.

Its after sale risk is that its customer will return the goods.

If the cost associated with these risks can be passed on to the vendor, the customer has no risk.

The same principal applies to service providers in that agents only arrange for services to be provided, while principals guarantee that the services meet customer expectations.

If the customer does not bear risk, either before or after the sale, the customer is an agent.

If the customer does bear risk, either before or after the sale, the customer is a principal.

If the customer is a principal and has risk after the sale but not before, the sale is a consignment.

If the customer is a principal and has risk both before and after the sale, the sale is a regular sale.

On 1/1/X1:

ABC took delivery of 1,000 units of the product. ABC agreed to pay XYZ 110 per unit (50% on delivery and the balance on 6/30/X1), sell the goods at MSRP and inform XYZ of each quarter’s sales. XYZ agreed to accept the return of (repurchase) any unsold goods on 6/30/X1 for full credit. However, once ABC sold a unit to its customer, it could no longer return that unit to XYZ even if it accepted a return from that customer.

MSRP (manufacturer's suggested retail price) was 150 per unit.

As outlined in IFRS 15.B65.c | ASC 606-10-55-67.c, if the entity must repurchase the asset on customer request, the customer has a put option.

If the strike price of the put option is equal to or higher than the sales price, IFRS 15.B72 | ASC 606-10-55-74 refers back to IFRS 15.B20 to 27 | ASC 606-10-55-22 to 29 (right to return).

This results in accounting not substantially different this example.

As outlined in IFRS 15.B65.a & b | ASC 606-10-55-67.a & b, the entity can also have an obligation to repurchase (a forward) or right to repurchase (a call option).

In this situation, as outlined in IFRS 15.B66 | ASC 606-10-55-68, the arrangement is accounted for as a lease (repurchase price lower than sale price) or financing arrangement (repurchase price equal to or higher than sale price).

XYZ / ABC During Q1 and Q2, ABC sold 350 and 450 units, returning the rest. XYZ / ABC

Consignment sale

1/1/X1 / 1.1.X1
Cash		55,000
Inventory: Consigned goods: ABC		50,000
	Refund liability: ABC		55,000
	Inventory: Finished goods		50,000

 

As ABC was a third party involved in providing goods to a customer:

As outlined in IFRS 15.B34 | ASC 606-10-55-36, whenever a third party is involved in providing goods or services to a customer, the reporting entity must consider if that party is acting as a principal or agent.

As outlined in IFRS 15.B77 | ASC 606-10-55-79, whenever a third party is involved in providing goods or services to a customer, the reporting entity must consider if the arrangements is a consignment.

Sales to third parties often also involve a right to return (IFRS 15.20 | ASC 606-10-55-22) which may cause them to fall under the above guidance.

XYZ first evaluated whether ABC was acting as a principal. It was.

To make its determination, XYZ considered IFRS 15.B37.a to c | ASC 606-10-55-39.a to c.

While it did not have pricing discretion (c) or inventory risk (b) before the sale, ABC had inventory risk after the sale.

It had inventory risk because its customer could return the goods they bought to ABC. However, once ABC had sold the them, ABC could no longer return the goods to XYZ.

Likewise, ABC had primary responsibility for meeting customer expectations (a).

This was demonstrated by the fact that, once it sold a good, ABC could not return it to XYZ, even if it failed to meet the customer’s expectations.

Note: subparagraph IFRS 15.B37.a | ASC 606-10-55-39.a states (edited, emphasis added) "the entity is primarily responsible for fulfilling the promise to provide the specified good or service. This typically includes responsibility for the acceptability of the specified good or service (for example, primary responsibility for the good or service meeting customer specifications)."

After carefully considering the guidance, XYZ concluded that specifications and expectations were close enough.

Next, XYZ evaluated whether the sale was a consignment. It was.

To make its determination, XYZ considered IFRS 15.B78.a to c | ASC 606-10-55-80.a to c.

First, XYZ concluded that it controlled the goods until ABC sold them it its customers.

Second, while it could not require the goods to be returned at any time, XYZ could (unless they had been sold) eventually require their return.

Third, as ABC's payment was contingent on its re-sale of the goods (and the deposit was refundable), ABC did not have unconditional obligation to pay.

Note: XYZ could also have classified the consigned goods: Inventory: Finished goods: Finished goods on consignment

As outlined in IFRS 15.B21.b | ASC 606-10-55-23.b, when an entity sells goods with a right to return, it recognizes a refund liability.

While the refund liability can be included in deferred revenue, XYZ recognized it in a separate account to avoid implying that the revenue associated with goods that could be returned is merely deferred.

Although, the FASB XBRL does include a ContractWithCustomerRefundLiability item, it is part of 606000 Disclosure, with no exact corresponding item in 104000 Statement of Financial Position.

104000 does include CustomerRefundLiabilityCurrent, but its description states "Current regulatory liabilities generally represent obligations to make refunds to customers for various reasons including overpayment" with no reference to the ASC provided.

Thus, the closest item to ContractWithCustomerRefundLiability is ContractWithCustomerLiability (which includes multiple references to ASC 606).

ContractWithCustomerLiability is aggregated with DeferredIncome to form DeferredRevenue.

This implies that, for XBRL tagging purposes, an entity can either add an extension (e.g. RefundRebateLiabilities_Extension) or include this item in DeferredRevenue.

IASB XBRL does not include a RefundLiability item that would correspond to the guidance in IFRS 15.B21.b. It does include a RefundsProvision item. However, the reference for RefundsProvision is IAS 37 example 4, not IFRS 15. While, from a practical perspective, it would make little difference, recognizing the refund liability in its own account would be cleaner.

XYZ also concluded it could not estimate the eventual level of returns and so could not determine the amount of consideration it would be entitled to (IFRS 15.55 | ASC 606-10-32-10). Consequently, it measured the liability at the full amount of the advance.

Finally, XYZ considered if the transaction included a significant financing component (IFRS 15.60 | ASC 606-10-32-15) but decided, since the term was less than one year, to apply the practical expedient (IFRS 15.63 | ASC 606-10-32-18) instead.

1/1/X1 / 1.1.X1
Pre-paid expenses: Returnable advances paid: XYZ		55,000
	Cash		55,000

3/31/X1 / 31.3.X1
Refund liability: ABC		38,500
Cost of sales		17,500
	Revenue		38,500
	Inventory: Consigned goods: ABC		17,500

 

6/30/X1 / 30.6.X1
Cash		33,000
Refund liability: ABC		16,500
Cost of sales		22,500
Inventory: Finished goods (returned)		10,000
	Revenue		49,500
	Inventory: Consigned goods: ABC		32,500

3/31/X1 / 31.3.X1
Cash, Charge cards, etc.		52,500
Cost of sales		38,500
	Revenue		52,500
	Pre-paid expenses: Returnable advances paid: XYZ		38,500

 

6/30/X1 / 30.6.X1
Cash, Charge cards, etc.		67,500
Cost of sales		49,500
	Revenue		67,500
	Pre-paid expenses: Returnable advances paid: XYZ		16,500
	Cash		33,000

DEF took delivery of 2,000 units. It could set its own prices, had neither the right nor obligation to return unsold goods and agree to pay 110 per unit in 30 days. XYZ also paid DEF 20,000 to advertise the product in its in-store catalog.

XYZ / DEF During Q1 and Q2, DEF sold all 2,000 units and did not buy more. XYZ / DEF

Principal, consideration paid to customer

1/1/X1 / 1.1.X1
Accounts receivable: DEF		220,000
Cost of Sales		100,000
	Revenue		200,000
	Cash		20,000
	Inventory: Finished goods		100,000

 

As DEF was a third party involved in providing goods to a customer:

As outlined in IFRS 15.B34 | ASC 606-10-55-36, whenever a third party is involved in providing goods or services to a customer, the reporting entity must consider if that party is acting as a principal or agent.

As outlined in IFRS 15.B77 | ASC 606-10-55-79, whenever a third party is involved in providing goods or services to a customer, the reporting entity must consider if the arrangements is a consignment.

Sales to third parties often also involve a right to return (IFRS 15.20 | ASC 606-10-55-22) which may cause them to fall under the above guidance.

XYZ first evaluated whether DEF was acting as a principal. It was.

To make the determination, XYZ considered IFRS 15.B37.a to c | ASC 606-10-55-39.a to c.

First, DEF sold the goods to its own customers, making it primarily responsible for meeting their expectations.

This was demonstrated by the fact that, once it bought the goods, DEF could not return them to XYZ.

Note: subparagraph IFRS 15.B37.a | ASC 606-10-55-39.a states (edited, emphasis added) "the entity is primarily responsible for fulfilling the promise to provide the specified good or service. This typically includes responsibility for the acceptability of the specified good or service (for example, primary responsibility for the good or service meeting customer specifications)."

After carefully considering the guidance, XYZ concluded that specifications and expectations were close enough.

Second, as DEF could not return the goods, it had inventory risk both before and after the sale.

Third, DEF had discretion to establish its prices.

Next, just for fun, XYZ evaluated whether the sale was a consignment. It was not.

IFRS 15.B77 | ASC 606-10-55-79 states (edited, emphasis added): When an entity delivers a product to another party (such as a dealer or a distributor) for sale to end customers, the entity shall evaluate whether that other party has obtained control of the product at that point in time. A product that has been delivered to another party may be held in a consignment arrangement if that other party has not obtained control of the product...

As the guidance suggests failing the control test usually results in a consignment sale, it is prudent to evaluate every sale to a reseller even when, as in this example, it is obviously not a consignment sale.

To make this determination, as outlined in IFRS 15.B78 | ASC 606-10-55-80, XYZ considered that DEF:

1. controlled the goods from the moment it accepted delivery until it sold them to its customers
2. could not compel DEF to return the goods at any time and
3. had an unconditional obligation to pay.

Finally, XYZ confirmed DEF did not have a right to return.

The guidance on right to return applies to two general situations:

1. the return is by a customer dissatisfied with the product.

"Dissatisfaction" should be interpreted broadly.

In the second right to return example, consumers bought the merchandise as gifts that wound up being unappreciated.

While it could be argued that they were dissatisfied, this was in no way the seller's fault.

In the first right to return example, GHI bought the machine as insurance.

Again, dissatisfaction had nothing to do with its return.

2. the return is by a re-seller unable to re-sell the product.

In both cases, the right to return triggers a revenue deferral.

IFRS 15.B21.a | ASC 606-10-55-23 simply states "revenue would not be recognized for the products expected to be returned." It does not specify a reason.

However, when the counterparty is a re-seller, the right to return often results in a consignment sale (see ABC above).

As it would have not bought the advertising had it not also sold the product, XYZ deducted the cost from revenue.

According to EITF 00-14 (and later EITF 01-09), when a vendor bought a good or service from a customer, the vendor deducted the purchase price of that good or service from revenue unless the purchased the good or service was unrelated to the related sale.

In this example, it would have been pointless for XYZ to pay DEF for in-store advertising if its product was not sold in those stores. Consequently, XYZ deducted the payment from revenue instead of recognizing an expense.

Unfortunately, EITF 00-14 was superseded by ASC 606 which, while having the advantage of being comparable to IFRS 15, does not provide nearly as straightforward guidance.

Previously, IFRS (IAS 18) did not address consideration payable to a customer.

To evaluate a payment as outlined in IFRS 15.70 to 72 | ASC 606-10-32-25 to 27, an entity first considers, as outlined in IFRS 15.70 | ASC 606-10-32-25, whether the good or service is distinct.

As outlined in IFRS 15.27.a | ASC 606-10-25-19.a, a good or service is distinct of the entity can benefit from its on its own (or with readily available resources).

As outlined in IFRS 15.27.b | ASC 606-10-25-19.b, to be distinct, the good or service must also be separately identifiable from other goods and services promised in the contract.

As outlined in IFRS 15.29 | ASC 606-10-25-21, to be separate, the goods and services cannot be (a) inputs to produce or deliver the combined output or outputs specified by the customer, (b) do not significantly modify or customize, or be significantly modified or customized by, another good or service or (c) one be highly interdependent or highly interrelated.

In this example, the advertising would have been pointless had XYZ's products not appeared in DEF's stores

Since condition c was not met, XYZ deducted the payment from revenue as outlined in IFRS 15.72 | ASC 606-10-32-27.

Alternatively, XYZ could have recognized:

1/1/X1 / 1.1.X1
Accounts receivable: DEF		220,000
Cost of Sales		100,000
Revenue: Payments made to vendors (co-advertising fees)		20,000
	Revenue		220,000
	Inventory: Finished goods		100,000
	Cash		20,000

1/31/X1 / 31.1.X1
Cash		220,000
	Accounts receivable: DEF		220,000

 

Rather than sending cash back and forth, XYZ could have simply credited DEF's account.

Could have from an IFRS or US GAAP perspective.

However, in some jurisdictions, national GAAP recognizes transactions formally and does not distinguish between co-advertising fees (paid to customers) and regular advertising fees (paid to third parties) provided they are billed separately.

1/1/X1 / 1.1.X1
Accounts receivable: DEF		220,000
Cost of Sales		100,000
	Revenue		220,000
	Inventory: Finished goods		100,000

 

1/31/X1 / 31.1.X1
Cash		200,000
Revenue: Vendor credits (co-advertising fee)		20,000
	Accounts receivable: DEF		220,000

 

Or, even more simply:

1/1/X1 / 1.1.X1
Accounts receivable: DEF (net of vendor credit)		200,000
Cost of Sales		100,000
	Revenue (net of co-advertising fee)		200,000
	Inventory: Finished goods		100,000

1/1/X1 / 1.1.X1
Inventory: Merchandise		200,000
Cash		20,000
	Accounts payable: XYZ		220,000

 

As accounting should be symmetrical, just as XYZ deducted the payment from revenue, DEF deducted it from inventory (thereby reducing cost of sales). While IFRS does not include explicit guidance requiring this procedure, in US GAAP it is required under ASC 705-20.

Interpreting IFRS does not mean, as some practitioners surmise, that as long as IFRS does not explicitly prescribe or proscribe something, anything goes.

Above all, companies should select reasonable accounting policy or risk finding out



can bring consequences (link).

Alternatively:

1/1/X1 / 1.1.X1
Inventory: Merchandise		220,000
Cash		20,000
	Accounts payable: XYZ		220,000
	Inventory: Merchandise: Vendor payment adjustment		20,000

DEF resold the goods on 1/15/X1 (for illustration purposes in total):

1/5/X1 / 15.1.X1
Cost of sales		220,000
Inventory: Merchandise: Vendor payment adjustment		20,000
	Inventory: Merchandise		220,000
	Cost of sales: Vendor payment adjustment		20,000

1/31/X1 / 31.1.X1
Accounts payable: XYZ		220,000
	Cash		220,000

As DEF did not buy more units, XYZ made no additional entries.

DEF recognized revenue as it sold the goods to its customers. See: Goods (point of time) for an example.

GHI agreed to promote and sell the product on its online stores until 6/30/X1. GHI agreed to list the goods at MSRP but reserved the right to offer discounts. It also agreed to process the purchases and pay XYZ 120 per unit. XYZ agreed to deliver the product directly to GHI's customers and accept returns from those customers. XYZ also paid GHI 10,000 to give the products preferential placement and prominent display.

XYZ / GHI During Q1 and Q2, GHI sold 1,000 and 2,000 units for 150 and 140 per unit. XYZ / GHI

Agent, consideration paid to customer

1/1/X1 / 1.1.X1
Pre-paid co-advertising		10,000
	Cash		10,000

 

As GHI was a third party involved in providing goods to a customer, XYZ evaluated whether it was acting as a principal. It was not.

As outlined in IFRS 15.B34 | ASC 606-10-55-36, whenever a third party is involved in providing goods or services to a customer, the reporting entity must consider if that party is acting as a principal or agent.

As outlined in IFRS 15.B77 | ASC 606-10-55-79, whenever a third party is involved in providing goods or services to a customer, the reporting entity must consider if the arrangements is a consignment.

Sales to third parties often also involve a right to return (IFRS 15.20 | ASC 606-10-55-22) which may cause them to fall under the above guidance.

To make the determination, XYZ considered IFRS 15.B37.a to c | ASC 606-10-55-39.a to c.

First, while GHI offered XYZ's products and arranged their sale, XYZ was responsible for ensuring its products had the promoted features. Consequently, XYZ had the primary responsibility for ensuring its products met customer specifications.

Second, while GHI arranged the sale, it neither took possession nor was responsible for returns. Consequently, it had no inventory risk either before and after that sale.

Finally, while GHI did have some discretion in establishing prices, pricing flexibility in and of itself does not preclude the entity from being classified as an agent.

Because GHI was acting as an agent, XYZ did not recognize any revenue.

Unlike the previous two examples, XYZ did not consider the guidance for condiment sales because it only applies (IFRS 15.B77 | ASC 606-10-55-79) if delivery occurs.

As it would have not bought the advertising had it not also listed the product, XYZ accrued the cost so it could deduct it from future revenue.

According to EITF 00-14 (and later EITF 01-09), when a vendor bought a good or service from a customer, the vendor deducted the purchase price of that good or service from revenue unless the purchased the good or service was unrelated to the related sale.

In this example, it would have been pointless for XYZ to pay DEF for in-store advertising if its product was not sold in those stores. Consequently, XYZ deducted the payment from revenue instead of recognizing an expense.

Unfortunately, EITF 00-14 was superseded by ASC 606 which, while having the advantage of being comparable to IFRS 15, does not provide nearly as straightforward guidance.

Previously, IFRS (IAS 18) did not address consideration payable to a customer.

To evaluate a payment as outlined in IFRS 15.70 to 72 | ASC 606-10-32-25 to 27, an entity first considers, as outlined in IFRS 15.70 | ASC 606-10-32-25, whether the good or service is distinct.

As outlined in IFRS 15.27.a | ASC 606-10-25-19.a, a good or service is distinct of the entity can benefit from its on its own (or with readily available resources).

As outlined in IFRS 15.27.b | ASC 606-10-25-19.b, to be distinct, the good or service must also be separately identifiable from other goods and services promised in the contract.

As outlined in IFRS 15.29 | ASC 606-10-25-21, to be separate, the goods and services cannot be (a) inputs to produce or deliver the combined output or outputs specified by the customer, (b) do not significantly modify or customize, or be significantly modified or customized by, another good or service or (c) one be highly interdependent or highly interrelated.

In this example, the advertising would have been pointless had XYZ's products not appeared in DEF's stores

Since condition c was not met, XYZ deducted the payment from revenue as outlined in IFRS 15.72 | ASC 606-10-32-27.

1/1/X1 / 1.1.X1
Cash		10,000
	Deferred revenue		10,000

 

To classify payment, GHI likewise considered IFRS 15.26 to 30 | ASC 606-10-25-18 to 22.

As outlined in IFRS 15.27.a | ASC 606-10-25-18.a, it concluded XYZ would benefit from the promotion even if no sales occurred and, as outlined in IFRS 15.27.b | ASC 606-10-25-18.b), the promotion was separately identifiable from the other promises (the sale and sale processing) in the contract.

GHI also considered, since it was acting as an agent, there was no cost of sales which could be (as outlined in ASC 705-20-15-1) reduced.

Finally, as XYZ would receive and consume the promotion as GHI provided it (IFRS 15.35.a | ASC 606-10-25-27.a), GHI deferred the revenue so it could be recognized over time.

3/31/X1 / 31.3.X1
Cash		120,000
Cost of sales		50,000
	Revenue		115,000
	Inventory: Merchandise		50,000
	Pre-paid co-advertising		5,000

 

6/30/X1 / 30.6.X1
Cash		240,000
Cost of sales		100,000
	Revenue		235,000
	Inventory: Merchandise		100,000
	Pre-paid co-advertising		5,000

3/31/X1 / 31.3.X1
Cash (received from customers)		150,000
Deferred Revenue (advertising)		5,000
	Revenue (commission)		30,000
	Revenue (advertising)		5,000
	Cash (paid to XYZ)		120,000

 

6/30/X1 / 30.6.X1
Cash (received from customers)		280,000
Deferred Revenue (advertising)		5,000
	Revenue (commission)		40,000
	Revenue (advertising)		5,000
	Cash (paid to XYZ)		240,000

JKL agreed to buy 1,000 units and pay 100 per unit in 30 days. JKL did not have a warehouse, so XYZ agreed to deliver the goods just in time, per JKL's instructions. As XYZ could not estimate when shipment would occur, it assigned 1,000 finished goods to JKL (by serial number).

XYZ / JKL During Q1 and Q2, JKL sold 700 and 300 units for 140. XYZ / JKL.

Bill and hold, revenue recognized

1/1/X1 / 1.1.X1
Accounts receivable: JKL		100,000
Cost of Sales		50,000
	Revenue		100,000
	Inventory: Finished goods		50,000

 

As JKL was a third party involved in providing goods to a customer, XYZ considered the same guidance as in the previous examples concluding that JKL was a principal, the arrangement was not a consignment and JKL did not have a right to return.

However, as JKL did not take delivery, XYZ also considered IFRS 15.B79 to B82 | ASC 606-10-55-81 to 84.

It concluded that JKL requested the bill-and-hold arrangement (B81.a | 83.a) and, since it did not have a warehouse, had a valid business reason for doing so.

Specifically, IFRS 15.B81.a | ASC 606-10-55-83.a states: "The reason for the bill-and-hold arrangement must be substantive (for example, the customer has requested the arrangement)."

In contrast, SEC guidance (link) stated "The buyer, not the seller, must request that the transaction be on a bill and hold basis. The buyer must have a substantial business purpose for ordering the goods on a bill and hold basis;"

While similar, the IFRS | US GAAP guidance suggests that it is sufficient for the customer to have requested the arrangement.

On the other hand, the SEC guidance not only stated the customer must have requested the arrangement, but must have had a valid reason to doing so.

Although the SEC guidance was superseded by ASC 606, it would still be prudent to evaluate the customer’s reasons for the request.

"Topic 13 is no longer applicable upon a registrant’s adoption of ASC Topic 606. Topic 13 provides the staff’s views regarding the general revenue recognition guidance codified in ASC Topic 605."

It also concluded the product was separately identified (B81.b | 83.b), in stock (B81.c | 83.c), and could not be shipped to any other customer (B81.d | 83.d).

While IFRS 15.B81.b | ASC 606-10-55-83.b states: the product must be identified separately as belonging to the customer; it does not specify how it should be identified.

In this example, XYZ kept track of its inventory by serial number so it was simple to include those numbers in the contract with the customer.

While this procedure is fairly uncommon with small ticket, homogenous items, it is standard practice for products, such as motor vehicles, which are often made to order.

When small ticket items are involved, auditors look for them to be on specifically labeled shelves or otherwise marked as belonging to particular customers.

Based on these conclusions, XYZ recognized the revenue associated with this bill-and-hold arrangement.

XYZ could have also used additional accounts.

Inventory: Assigned goods: JKL		50,000
Cost of Sales		50,000
	Inventory: Finished goods		50,000
	Inventory: Finished goods: Allowance for assigned goods: JKL		50,000

1/31/X1 / 31.1.X1
Cash		100,000
	Accounts receivable: JKL		100,000

1/1/X1 / 1.1.X1
Inventory: Merchandise to be delivered just-in-time		100,000
	Accounts payable: XYZ		100,000

 

JKL could have used an accrual account, such as Pre-paid merchandise, instead.

1/31/X1 / 31.1.X1
Accounts payable: XYZ		100,000
	Cash		100,000

Had XYZ used the additional accounts:

3/31/X1 / 31.3.X1
Inventory: Finished goods: Allowance for assigned goods: JKL		35,000
	Inventory: Assigned goods: JKL		35,000

 

6/30/X1 / 30.6.X1
Inventory: Finished goods: Allowance for assigned goods: JKL		15,000
	Inventory: Assigned goods: JKL		15,000

3/31/X1 / 31.3.X1
Cash (received from customers)		98,000
Cost of sales		70,000
	Revenue		98,000
	Inventory: Merchandise to be delivered just-in-time		70,000

 

6/30/X1 / 30.6.X1
Cash (received from customers)		42,000
Cost of sales		30,000
	Revenue		42,000
	Inventory: Merchandise to be delivered just-in-time		30,000

MNO agreed to sell the product in its online store, estimating sales between 500 and 1,000 per month. It agreed to pay a 200,000 non-refundable deposit and 100 for each additional unit (any balance was payable at the end of each quarter). As MNO did not have its own warehouse, XYZ agreed to deliver the goods to MNO's customers. Given the estimated timing of the sales, XYZ decided to not pre-manufacture the goods, but take them out of general stock as needed.

XYZ / MNO During Q1 and Q2, MNO sold 2,500 and 4,500 for 135 and 125. XYZ / MNO

Bill and hold, revenue not recognized

1/1/X1 / 1.1.X1
Cash		200,000
	Deferred Revenue (contract liability)		200,000

 

As MNO was a third party involved in providing goods to a customer, XYZ considered the same guidance as in the previous examples concluding that MNO was a principal, the arrangement was not a consignment and MNO did not have a right to return.

However, as MNO did not take delivery, XYZ also considered IFRS 15.B79 to B82 | ASC 606-10-55-81 to 84.

It concluded that MNO requested the bull-and-hold arrangement (B81.a | 83.a) and, since it did not have a warehouse, had a valid business reason for doing so.

However, the product was not separately identified (B81.b | 83.b), in stock (B81.c | 83.c), and the finished goods in stock could be shipped to shipped to any other customer (B81.d | 83.d).

Based on these conclusions, XYZ deferred the revenue associated with this bill-and-hold arrangement.

IFRS 15.105 | ASC 606-10-45-1 specifies that, depending on the relationship between the entity’s performance and the customer’s payment, either a contract asset or a contract liability is presented on the balance sheet.

In practice, when a liability is presented, it is generally labeled as deferred (or unearned) revenue. This practice is reflected in the FASB XBRL where DeferredRevenue comprises ContractWithCustomerLiability and DeferredIncome. While the IASB XBRL does not include similar labels, as it would not contradict IFRS 15's guidance, it can be extended to do so.

Same facts except MNO did not make an advance payment, but agreed to pay XYZ 200,000 on 12/31/X1.

1/1/X1 / 1.1.X1
Accounts receivable: JKL		200,000
	Deferred Revenue		200,000

 

As outlined in IFRS 15.106 | ASC 606-10-45-2, a contract liability is presented when payment is made or payment is due if the entity has a receivable (an unconditional right to consideration).

1/1/X1 / 1.1.X1
Inventory: Merchandise to be delivered just-in-time		200,000
	Cash		200,000

 

MNO could have used an accrual account, such as Pre-paid merchandise, instead.

Same facts except MNO did not make an advance payment, but agreed to pay XYZ 200,000 on 12/31/X1.

1/1/X1 / 1.1.X1
Inventory: Merchandise to be delivered just-in-time		200,000
	Accounts payable: XYZ		200,000

 

As outlined in IFRS 15.106 | ASC 606-10-45-2, a contract liability is presented when payment is made or payment is due if the entity has a receivable (an unconditional right to consideration).

Although, this guidance relates to the seller, as accounting should be symmetrical, the buyer should use a comparable procedure.

3/31/X1 / 31.3.X1
Cash		50,000
Deferred Revenue		200,000
Cost of sales		125,000
	Revenue		250,000
	Inventory: Finished goods:		125,000

 

6/30/X1 / 30.6.X1
Cash		450,000
Cost of sales		225,000
	Revenue		450,000
	Inventory: Finished goods:		225,000

3/31/X1 / 31.3.X1
Cash (received from customers)		337,500
Cost of sales		250,000
	Revenue		337,500
	Pre-paid expenses: Cost of sales		200,000
	Cash (paid to XYZ)		50,000

 

6/30/X1 / 30.6.X1
Cash (received from customers)		562,500
Cost of sales		450,000
	Revenue		562,500
	Cash (paid to XYZ)		450,000

Extended payment terms (significant financing component)

Implicit rate

1/1/X1, XYZ delivered 10 units of its product to ABC. ABC agreed to pay 11,920 on 12/31/X2.

Whenever payment is delayed (in whole or in part) for more than one year, the receivable must be discounted.

As outlined in IFRS 15.60 | ASC 606-10-32-15, if a contract includes a "significant financing component", the receivable must be must be discounted.

Regular receivables (30 to 90 days) are practically never discounted because their financing component is practically always insignificant.

While the financing component of longer-term receivables (90 to 365 days) can be significant, IFRS 15.63 | ASC 606-10-32-18 sets out a practical expedient which extends the limit to one year.

Consequently, entities are not required to discount receivables if the payment(s) are received within one year.

Also, in addition to the practical expedient, IFRS 15.62 | ASC 606-10-32-18 allows entities to skip discounting when:

The delayed portion is a security deposit, holdback or similar item.

The customer requested a bill and hold arrangement (see example: Right to return / Resellers / JKL).

A substantial portion of the payment is variable (contingent on events beyond the buyer or seller's control).

Discounting is required if the financing is explicitly outlined in the contract or, as in this example, implied by its terms.

Discounting is also required if the seller, rather than buyer, receives financing (see example: Discounted deposits).

The agreement did not specify an explicit interest rate, so XYZ used the implicit rate instead.

As outlined in IFRS 9.B5.1.1, when interest is not specified, the receivable is measured by discounting future cash flows using prevailing market rates (rates on comparable instruments with comparable credit characteristics).

As outlined in ASC 835-30-25-10 (and 310-10-30-5), when interest is not specified, the specified rate is unreasonable, or the difference between the amount receivable and cash selling price of the item is materially different, the receivable is measured at the fair value of the sold item.

This guidance implies, while they approach the issue from opposite ends, both IFRS 9 and ASC 835 require companies to base their measurements on external information sources: prevailing market interest rates or fair value.

However, IFRS 15.64 | ASC 606-10-32-19 specifies that an entity may determine the discount rate on the basis of the item's cash selling price.

Therefore, providing an entity is able to determine cash selling price, it does not need to go to the trouble of evaluating either market interest rates or fair value.

As outlined in IFRS 15.64 | ASC 606-10-32-19, the discount (interest) rate can be determined by comparing the amount the customer agreed to pay and the item's cash (near cash) selling price.

XYZ determined the item's selling price by averaging the previous quarter’s cash and standard, 30-day credit sales.

To determine the rate, it used this calculation (in excel format): 9.18% = (1+(11920-10000)/10000)^(1/2) - 1

 

Date	Payment terms	Quantity	Unit price	Total price
10/1/X0 / 1.10.X0	30 days	4	950	3,800
10/17/X0 / 17.10.X0	COD	4	1,025	4,100
11/8/X0 / 8.11.X0	30 days	5	1,015	5,075
11/4/X0 / 4.11.X0	COD	4	995	3,980
11/15/X0 / 15.11.X0	30 days	5	995	4,975
11/26/X0 / 26.11.X0	30 days	3	990	2,970
12/2/X0 / 2.12.X0	30 days	6	1,025	6,150
12/3/X0 / 3.12.X0	30 days	3	1,050	3,150
12/4/X0 / 4.12.X0	COD	3	950	2,850
12/5/X0 / 5.12.X0	30 days	2	975	1,950
		39		39,000

Dr/Cr

1/1/X1 / 1.1.X1
Receivable: ABC		11,920
	Revenue		10,000
	Receivable: ABC: Deferred interest revenue		1,920

 

As implied by IFRS 15.65 | outlined in ASC 835-30-45-1A, deferred interest is presented as a contra asset, not liability.

12/31/X1 / 31.12.X1
Receivable: ABC: Deferred interest revenue		918
	Interest revenue		918

 

Both IFRS and US GAAP require entities to use an effective interest method.

While IFRS (IFRS 9 defined terms) uses the term effective interest method and US GAAP (ASC master glossary) the term interest method, both define it comparably:

"The method that is used in the calculation of the amortized cost of a financial asset or a financial liability and in the allocation and recognition of the interest revenue or interest expense in profit or loss over the relevant period."

"The method used to arrive at a periodic interest cost (including amortization) that will represent a level effective rate on the sum of the face amount of the debt and (plus or minus) the unamortized premium or discount and expense at the beginning of each period."

As neither specify the periodicity, in practice, it is usually applied on an annual basis.

However, it should be applied to interim periods if the difference is material.

For example, XYZ could also have applied it on a quarterly basis.

P	Receivable	Interest rate	Interest
A	B = B(B+1) + D	C= (1+9.18%)(1/4) - 1	D = B x C
X1.Q1	10,000	2.18%	222
X1.Q2	10,222	2.18%	227
X1.Q3	10,449	2.18%	232
X1.Q4	10,681	2.18%	237
X2.Q1	10,918	2.18%	242
X2.Q2	11,160	2.18%	248
X2.Q3	11,408	2.18%	253
X2.Q4	11,661	2.18%	259
	11,920		1,920

 

While it is common (lazy) practice to simply divide the annual rate, it leads to inaccurate results:

P	Receivable	Interest rate	Interest
A	B = B(B+1) + D	C = 9.18% / 4	D = B x C
X1.Q1	10,000	2.30%	230
X1.Q2	10,230	2.30%	235
X1.Q3	10,464	2.30%	240
X1.Q4	10,704	2.30%	246
X2.Q1	10,950	2.30%	251
X2.Q2	11,201	2.30%	257
X2.Q3	11,458	2.30%	263
X2.Q4	11,721	2.30%	269
	11,990		1,990

P	Receivable	Interest rate	Interest
A	B = B(B+1) + D	C	D = B x C
X1	10,000	9.18%	918
X2	10,918	9.18%	1,002
	11,920		1,920

 

The discount rate can be determined with Excel's =rate function, 19.20%=RATE(1,-11920,10000,0,0,0.1), if the result is scaled to the annual period: 9.18%=(19.20%)^1÷2 - 1

In Excel syntax (not rounded): 9.17875251164944%=(1+RATE(1,-11920,10000,0,0,0.1))^(1/2)-1.

It can also be determined using the =IRR or =XIRR function or the above schedule and trial-and-error.

12/31/X2 / 31.12.X2
Cash		11,920
Receivable: ABC: Deferred interest revenue		1,002
	Receivable: ABC		11,920
	Interest revenue		1,002

Explicit rate

1/1/X1, XYZ sold a machine to ABC in 16 quarterly installments. It sells the same machine on 30-day credit for 100,000.

The contract stipulated both the interest rate (9.25%) and payments (7,504).

As outlined in IFRS 9.B5.1.1, the fair value of a receivable should reflect prevailing market rates for similar instruments with a similar characteristics and credit ratings.

As outlined in ASC 835-30-10-1, the interest rate should reflect what an independent borrower and an independent lender would have negotiated for a loan.

As XYZ commonly provides customer credit, it has a department dedicated to determining interest rates.

IFRS 15.64 | ASC 606-10-32-19: ... [The] rate would reflect the credit characteristics of the party receiving financing in the contract ...

As outlined in IFRS 15.64 | ASC 606-10-32-19, adjusting for a significant financing component requires a discount rate reflecting the credit characteristics of the party receiving financing including any collateral or security.

Similarly, IFRS 9.B5.1.1 outlines that receivables should be discounted using prevailing market rate for a similar instruments with a similar credit ratings while ASC 835-30-25-12.b specifies that prevailing rates for similar instruments of issuers with similar credit ratings will normally help determine the appropriate interest rate.

Obviously, for accountants working at banks, lessors and similar companies, determining and using credit ratings to establish discounts rates is all in a day's work.

For accountants working at industrial companies that only occasionally provide financing, it can be a challenge.

To assist, US GAAP provides the following (helpful) advice:

ASC 835-30-25-12: Paragraph 835-30-10-1 identifies the objective of the guidance in this Subtopic for approximating an interest rate. The variety of transactions encountered precludes any specific interest rate from being applicable in all circumstances. However, this paragraph provides the following general guidelines:

1. The choice of a rate may be affected by the credit standing of the issuer, restrictive covenants, the collateral, payment and other terms pertaining to the debt, and, if appropriate, the tax consequences to the buyer and seller.
2. The prevailing rates for similar instruments of issuers with similar credit ratings will normally help determine the appropriate interest rate for determining the present value of a specific note at its date of issuance.
3. In any event, the rate used for valuation purposes shall be the rate at which the debtor can obtain financing of a similar nature from other sources at the date of the transaction.

ASC 835-30-25-13: The selection of a rate may be affected by many considerations. For instance, where applicable, the choice of a rate may be influenced by the following:

1. An approximation of the prevailing market rates for the source of credit that would provide a market for sale or assignment of the note
2. The prime or higher rate for notes that are discounted with banks, giving due weight to the credit standing of the maker
3. Published market rates for similar-quality bonds
4. Current rates for debentures with substantially identical terms and risks that are traded in open markets
5. The current rate charged by investors for first or second mortgage loans on similar property.

One way to meet the challenge is evaluating rates paid by comparable companies.

When selling to a rated company, this task is simple since, for example, all BBB rated companies tend to borrow at, or very close to, published (link: ycharts.com) BBB rates.

For an unrated company, the task is somewhat more difficult.

The way it is usually done is to first determine how the company compares to a rated company and then extrapolate.

A more detailed discussion of how rates can be extrapolated is provided in the fair value section.

Another way, models such as: (H(k(t),B(t))) = (α1 ÷ (α2 + N(t) ÷ k(t))μ x θB(t).

Creditworthiness and Thresholds in a Credit Market Model with Multiple Equilibria (link: springer, mirror), Lars Grune, Willi Semmler and Malte Sieveking (2003).

However, by far the easiest (and most common) method is a third-party offer.

Obviously, the easiest and most common method is to use the cash selling price, which XYZ did in the first example.

However, in this example, XYZ used the cash selling price as the basis for calculating the payment after it determined the interest rate warranted by the customer’s credit standing.

Some banks publish their lending rates by client type, while others are willing to make offers as a customer service.

However, whenever a bank offer is used, it is imperative it reflect the credit situation of the entity receiving the financing (in this case the customer) not the entity providing the financing (the seller).

Determining interest in this way, ensures that it reflects what an independent lender (e.g. bank) would require for comparable cash loans without the necessity of having to back up any assumptions and calculations.

XYX commonly sells the product for 100,000 in cash (near cash) transactions.

Using this sales price, it calculated a payment of 7,503.62 (rounded).

In Excel syntax (not rounded): 7503.61838736337=100000/((1-(1/(1+((1+9.25%)^(1/4)-1))^(4*4)))/((1+9.25%)^(1/4)-1)).

For illustration purposes, the payment was rounded even more to 7,504.

For this reason, the receivable in the example is 120,058 = 7503.62 x 16 not 120,064 = 7,504 x 16.

Dr/Cr

1/1/X1 / 1.1.X1
Receivables: Installment sales		120,058
	Revenue		100,000
	Receivable: ABC: Deferred interest revenue		20,058

 

As implied by IFRS 15.65 | outlined in ASC 835-30-45-1A, deferred interest is presented as a contra asset, not liability.

3/31/X1 / 31.3.X1
Cash		7,504
Receivable: ABC: Deferred interest revenue		2,236
	Receivables: Installment sales		7,504
	Interest revenue		2,236

 

P	Principal	Discount rate	Interest	Payment	Amortization
A	B, (B = B - F)	C = (1 + 9.25%)1/4 - 1	D = B x C	E	F = E – D
Q1	100,000	2.24%	2,236	7,504	5,267
Q2	94,733	2.24%	2,119	7,504	5,385
-	-	-	-	-	-
Q16	7,339	2.24%	164	7,504	7,339
			20,058	120,058	100,000

Imputed rate

1/1/X1, XYZ sold a machine made to ABC's specifications. Using the expected manufacturing costs (50,000) and XYZ's average profit margin (50%) as a guide, the sales department drafted a sales contract stipulating a sales price of 100,000 to be paid in 5 annual installments of 22,000.

XYZ’s accounting department evaluated the terms of the contract and concluded they implied an unrealistic discount rate of 3.26%. Taking into consideration of ABC's credit characteristics, it imputed a reasonable rate of 7.5%.

As outlined in ASC 310-10-30-6, an entity must use an imputed interest rate when the rate stated or implied in the contract is unreasonable.

ASC 310-10-30-6 states: Paragraph 835-30-25-11 explains that, in the absence of established exchange prices for the related property, goods, or services or evidence of the fair value of the note (as described in paragraph 835-30-25-2), the present value of a note that stipulates either no interest or a rate of interest that is clearly unreasonable shall be determined by discounting all future payments on the notes using an imputed rate of interest as described in Subtopic 835-30...

Note: ASC 835-30-25-11's text is practically identical to ASC 310-10-30-6.

While IFRS does not include guidance specifically addressing interest imputation, IFRS 9.B5.1.1 requires loans and receivables carrying no interest to be discounted using prevailing market (a.k.a. reasonable) rates. By implication, the guidance also applies to loans and receivables carrying unreasonable interest.

Note: unreasonable interest rates are often encountered at companies where sales commission, management incentives or other forms of compensation are tied to gross sales. At such companies, the accounting department must be extra vigilant and adjust sales prices to reflect the economic substance of the transactions even in the face of pressure from the sales department or (non-financial) management.

The rate was determined using Excel's =RATE function (rounded): 3.26%=Rate(5,-22000,100000,0,0,0.1).

It can also be calculated using an =IRR or =XIRR function or a present value schedule and trial and error.

As outlined in IFRS 15.64 | ASC 606-10-32-19, adjusting for a significant financing component requires a discount rate reflecting the credit characteristics of the party receiving financing including any collateral or security.

Similarly, IFRS 9.B5.1.1 outlines that receivables should be discounted using prevailing market rate for a similar instruments with a similar credit ratings while ASC 835-30-25-12.b specifies that prevailing rates for similar instruments of issuers with similar credit ratings will normally help determine the appropriate interest rate.

Obviously, for accountants working at banks, lessors and similar companies, determining and then using credit ratings to establish discounts rates is all in a day's work.

For accountants working at industrial companies which occasionally provide financing, it can be a challenge.

To assist, US GAAP provides the following (helpful) advice:

ASC 835-30-25-12: Paragraph 835-30-10-1 identifies the objective of the guidance in this Subtopic for approximating an interest rate. The variety of transactions encountered precludes any specific interest rate from being applicable in all circumstances. However, this paragraph provides the following general guidelines:

1. The choice of a rate may be affected by the credit standing of the issuer, restrictive covenants, the collateral, payment and other terms pertaining to the debt, and, if appropriate, the tax consequences to the buyer and seller.
2. The prevailing rates for similar instruments of issuers with similar credit ratings will normally help determine the appropriate interest rate for determining the present value of a specific note at its date of issuance.
3. In any event, the rate used for valuation purposes shall be the rate at which the debtor can obtain financing of a similar nature from other sources at the date of the transaction.

ASC 835-30-25-13: The selection of a rate may be affected by many considerations. For instance, where applicable, the choice of a rate may be influenced by the following:

1. An approximation of the prevailing market rates for the source of credit that would provide a market for sale or assignment of the note
2. The prime or higher rate for notes that are discounted with banks, giving due weight to the credit standing of the maker
3. Published market rates for similar-quality bonds
4. Current rates for debentures with substantially identical terms and risks that are traded in open markets
5. The current rate charged by investors for first or second mortgage loans on similar property.

One way to meet the challenge is to evaluate rates paid by comparable companies.

When selling to a rated company, this task is simple since, for example, all BBB rated companies tend to borrow at, or very close to, published (link: ycharts.com) BBB rates.

For an unrated company, the task is somewhat more difficult.

The way it is usually done is to first determine how the company compares to a rated company and then extrapolate.

A more detailed discussion of how rates can be extrapolated is provided in the fair value section.

Another way, models such as: (H(k(t),B(t))) = (α1 ÷ (α2 + N(t) ÷ k(t))μ x θB(t).

Creditworthiness and Thresholds in a Credit Market Model with Multiple Equilibria (link: springer, mirror), Lars Grune, Willi Semmler and Malte Sieveking (2003).

However, by far the easiest (and most common) method is a third-party offer.

Obviously, the most common method is cash selling price as in the first example.

However, in this example, a cash selling price is not determinable because the item was made to the customer's specifications so there was no objective point of reference.

Determining interest in this way, ensures that it reflects what an independent lender (e.g. bank) would require for comparable cash loans without the necessity of having to back up any assumptions and calculations.

Some banks publish their lending rates by client type, while others are willing to make offers as a customer service.

However, whenever a bank offer is used, it is imperative it reflect the credit situation of the entity receiving the financing (in this case the customer) not the entity providing the financing (the seller).

Dr/Cr

1/1/X1 / 1.1.X1
Receivables: Installment sale		110,000
Cost of goods sold		50,000
	Revenue		89,009
	Receivables: Deferred interest revenue		20,991
	Finished goods		50,000

 

Present value was calculated (in Excel syntax): 89009=22000*(1-(1+7.5%)^-5)/7.5% (rounded).

As implied by IFRS 15.65 | outlined in ASC 835-30-45-1A, deferred interest is recognized and reported as a contra asset, not liability.

12/31/X1 / 31.12.X1
Cash		22,000
Receivables: Deferred interest revenue		6,667
	Receivables: Installment sale		22,000
	Interest revenue		6,667

 

P	Principal	Discount rate	Interest	Payment	Amortization
A	B, (B = B(B-1) - F)	C = 7.5%	D = B x C	E	F = E – D
1	89,009	7.50%	6,676	22,000	15,324
2	73,685	7.50%	5,526	22,000	16,474
3	57,212	7.50%	4,291	22,000	17,709
4	39,502	7.50%	2,963	22,000	19,037
5	20,465	7.50%	1,535	22,000	20,465
					89,009

 

Had XYZ collected the payment in X2:

12/31/X1 / 31.12.X1
Receivables: Deferred interest revenue		6,667
	Interest revenue		6,667

 

1/1/X2 / 1.1.X2
Cash		22,000
	Receivables: Installment sale		22,000

Discounted deposits

On 1/1/X0, XYZ agreed to deliver an asset to ABC on 12/31/X1. ABC agreed to pre-pay 10,000 for the asset. ABC's credit adjusted interest rate was 8% and XYZ incremental borrowing rate was 6%.

This example is based on example 29 (IFRS 15. IE148 to 151 | ASC 606-10-55-204 to 243), which does not consider the borrowing costs | interest eligible for capitalization as outlined in IAS 23.8 | ASC 835-20-15-5.b.

As outlined in IFRS 15.64 | ASC 606-10-32-19, the discount rate reflects the credit characteristics of the party receiving financing, in this case XYZ.

Dr/Cr

 

1/1/X0 / 1.1.X0
Cash		10,000
	Contract liability		10,000

 

12/31/X0 / 31.12.X0
Interest expense		600
	Contract liability		600

 

P	Production cost	Discount rate	Interest expense
A	B	C	G = C x F
1	10,000	6%	600
2	10,600	6%	636
			11,236

12/31/X1 / 31.12.X1
Interest expense		636
Contract liability		11,236
	Contract liability		636
	Revenue		11,236

 

P	Production cost	Discount rate	Interest expense
A	B	C	G = C x F
1	10,000	6%	600
2	10,600	6%	636
			11,236

Additional issues

Consideration paid to the customer

1/1/X1, XYZ paid ABC 6,000 to register as a vendor for 5 years. It also agreed to pay an annual listing fee of 12,000 and a 1.25 per unit slotting fee. In return, ABC committed to buy 12,000 units of XYZ's products each year although it estimated annual purchases between 14,000 to 28,000 units, an estimate it shared with XYZ.

The same day, XYZ also paid 24,000 to rent the display area where its products would be presented and 12,000 to include the products in ABC's in-store catalog, both for one year. XYZ also paid 5,000 to rent floor space for a kiosk for one month and 16,000 to include the services sold through the kiosk in ABC's in store catalog for one year. Finally, XYZ and ABC agreed they would pay 36,000 to DEF to promote the products and services on social media for a year, sharing the cost evenly. DEF agreed to bill monthly, in arrears.

During January, XYZ sold ABC 1,300 products at an average price of 22 per unit. It also collected 25,000 for the services it sold through the kiosk.

This example assumes XYZ bills ABC monthly with 30-day credit.

For simplicity, it does not show XYZ's accounting for either cost of sales or inventory.

Dr/Cr

1/1/X1 / 1.1.X1
Pre-paid consideration: Registration fee		6,000
Pre-paid consideration: Listing fee		12,000
Pre-paid consideration: Shelf space arrangement		24,000
Pre-paid consideration: Co-advertising (products)		12,000
Pre-paid expenses: Advertising (services)		18,000
Pre-paid expenses: Rent (kiosk)		5,000
	Cash		77,000

 

IFRS 15.72 | ASC 606-10-32-27 requires entities to deduct consideration payable to a customer from revenue when (a) the revenue is recognized or (b) the entity pays or promises to pay, whichever happens later.

Therefore, when the payment is made before revenue is recognized, as in this example, the payment must be accrued. However, as this payment will never the recognized as an expense, it would be inappropriate to aggregate it with pre-paid expenses. For this reason, XYZ recognized it as Pre-paid consideration (a separate account group included in Accrued assets but excluded from Pre-paid expenses).

Since this payment will be recognized as an expense, it is accrued in Pre-paid expenses.

Any agreement giving an entity the right to use an asset belonging to another entity should be evaluated using the guidance in IFRS 16 | ASC 842 (leases). In this example, as the rent did not have any term nor could XYZ estimate a term, it did not capitalize it as a financial lease. See the lease page for a discussion of this issue.

1/31/X1 / 31.1.X1
Receivable: ABC		28,600
Cash (kiosk services)		25,000
Rental expense		5,000
Advertising expense		2,833
Revenue		5,725

16,000 ÷ 12 + 36,000 ÷ 2 ÷ 12 = 2,833

When a company both sells goods or services to a customer and buys good or services from the customer, it should deduct the amount it paid from the amount it received in determining revenue. The only exception: it would have bought the goods or services regardless of the associated sale.

At least that was the gist of EITF 00-14 (later EITF 01-09).

According to this guidance, whenever a vendor bought a good or service from a customer, the vendor deducted the purchase price of that good or service from revenue unless the purchase was unrelated to the sale.

Unfortunately, EITF 00-14 was superseded by ASC 606 which, while having the advantage of being comparable to IFRS 15, does not provide nearly as straightforward guidance.

Previously, IFRS (IAS 18) did not address consideration payable to a customer.

To evaluate a payment as outlined in IFRS 15.70 to 72 | ASC 606-10-32-25 to 27, an entity first considers, as outlined in IFRS 15.71 | ASC 606-10-32-26, whether the good or service is distinct.

As outlined in IFRS 15.27.a | ASC 606-10-25-19.a, a good or service is distinct of the entity can benefit from its on its own (or with readily available resources).

As outlined in IFRS 15.27.b | ASC 606-10-25-19.b, to be distinct, the good or service must also be separately identifiable from other goods and services promised in the contract.

As outlined in IFRS 15.29 | ASC 606-10-25-21, to be separate, the goods and services cannot be (a) inputs to produce or deliver the combined output or outputs specified by the customer, (b) do not significantly modify or customize, or be significantly modified or customized by, another good or service or (c) one be highly interdependent or highly interrelated.

In this example, the listing and slotting fees, shelf space rent, and in store advertising did not meet condition c, so XYZ deducted those payments from revenue as outlined in IFRS 15.72 | ASC 606-10-32-27.

On the other hand, the rent associated with the kiosk was for a stand-alone service and would have been paid to ABC regardless of ABC's buying XYZ's products.

Likewise, the advertising associated with the services sold in that kiosk also had separate, stand-alone value.

Since these payments did meet condition c, they were not deducted from revenue.

In this example, it would have been pointless for XYZ to pay registration, listing or slotting fees, rent display space or, buy in-store advertising, had it not also sold ABC its products, so it deducted these from revenue.

Both IFRS 15 and ASC 606 include an example (IFRS 15.IE160 | ASC 606-10-55-253) of how to account for consideration payable to the customer.

However, in the example, the justification for deducting the payment is that the entity did not obtain control of any rights to the customer’s shelves implying that control is the criterion to be used to evaluate consideration payable to a customer.

However, as outlined in IFRS 15.70 | ASC 606-10-32-25, the criterion that should be used is distinct.

IFRS 15.70 | ASC606-10-32-25 (edited emphasis added): ... An entity shall account for consideration payable to a customer as a reduction of the transaction price and, therefore, of revenue unless the payment to the customer is in exchange for a distinct good or service (as described in paragraphs 26–30 | 606-10-25-18 through 25-22) that the customer transfers to the entity...

Paragraphs 27 states (edited emphasis added): 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); ...

Note: In this example, ABC is the customer with respect to the products while XYZ is the customer with respect to the display area.

This implies that even though XYZ paid ABC a fee to ensure its product would be displayed exclusively in the agreed upon display area, giving it control over that area, this right was not distinct from the sale because XYZ could not benefit from the display area either on its own or together with other resources that are readily available to it.

In contrast, since the rent and advertising associated with the kiosk did have distinct value, it did not deduct these from revenue.

Since XYZ could use the rented space, together with its own kiosk, to generate sales, the rent fulfilled the first criteria in IFRS 15.27 | ASC 606-10-25-19.

Since the advertising drove customers to XYZ's kiosk where, it also fulfilled the first criteria in IFRS 15.27 | ASC 606-10-25-19.

Since the rent and advertising were separately identified (see above), both fulfilled the second criteria in IFRS 15.27 | ASC 606-10-25-19.

6,000 ÷ 60 + 12,000 ÷ 12 + 24,000 ÷ 12 + 12,000 ÷ 12 + 1,300 x 1.25 = 5,725

	Revenue (products)		28,600
	Revenue (services)		25,000
	Pre-paid consideration: Registration fee		100
	Pre-paid consideration: Listing fee		1,000
	Pre-paid consideration: Shelf space agreement		2,000
	Pre-paid consideration: Co-advertising		1,000
	Pre-paid expenses: Rent		5,000
	Pre-paid expenses: Advertising		1,333
	Cash (slotting fee)		1,625
	Payable: DEF		1,500

 

Or simply

1/31/X1 / 31.1.X1
Receivable: ABC		28,600
Cash (kiosk services)		25,000
Rental expense		5,000
Advertising expense		2,833

	Revenue (products)		22,875
	Revenue (services)		25,000
	Pre-paid consideration: Registration fee		100
	Pre-paid consideration: Listing fee		1,000
	Pre-paid consideration: Shelf space agreement		2,000
	Pre-paid consideration: Co-advertising		1,000
	Pre-paid expenses: Rent		5,000
	Pre-paid expenses: Advertising		1,333
	Cash (slotting fee)		1,625
	Payable: DEF		1,500

Value added tax

Neither IFRS nor US GAAP provides any specific guidance for VAT (GST).

The US does not have a value added tax, so it would be pointless for US GAAP to address it.

IFRS, as the acronym suggests, is international and, internationally, not every jurisdiction has a VAT or GST.

Besides, the guidance provided by IFRS can be applied to any tax, including VAT.

This point was (implicitly) made by the IFRIC when it considered adding VAT (in the context of cash flows and leases) to its agenda, but decided against it (link - iasplus).

VAT does, however, appear in both IFRS and US GAAP XBRL.

ValueAddedTaxReceivables and ValueAddedTaxPayables in IFRS XBRL and ValueAddedTaxReceivable in US GAAP XBRL.

However, neither the descriptions (The amount of receivables related to a value added tax; The amount of payables related to a value added tax; and Carrying amount as of the balance sheet date of value added taxes due either from customers arising from sales on credit terms, or as previously overpaid to tax authorities) nor references (IAS 1.78.b and ASC 210-10-S99-1) are particularly useful.

In an interesting side note, while IFRS XBRL at least acknowledges that VAT can be either a payable or a receivable, US GAAP XBRL only has a receivable, illustrating the general lack of appreciation of how VAT actually works, not only in the US practitioner community, but also among US standard setters.

Value added tax (VAT) is applied throughout the European Union while Goods and services tax (GST) is applied in countries such as Canada, South Africa or India.

In short, VAT is a multiple-step sales tax.

VAT legislation can be complex and vary from jurisdiction to jurisdiction.

Consequently, this example is no substitute for a detailed study of the pertinent regulations.

Transactions between payors:

When a VAT "payor" (a company registered to collect VAT) sells goods or services to another payor in the same jurisdiction, it issues a VAT invoice (a.k.a. "tax document").

It thus collects the VAT on behalf of the taxation authority.

When a payor buys from another payor in the same jurisdiction, it receives a tax document and so pays VAT to that other payor (who collects it on behalf of the taxation authority).

If a payor buys from a non-payor, the non-payor issues a regular invoice without VAT.

Non-payors are small enterprises or individuals who have not crossed the threshold for VAT registration or registered voluntarily.

At the end of the period, generally month or quarter, each payor offsets VAT received against VAT expended and pays (the reason they are called a payors) the difference to the taxation authority or claims a refund.

Cross border transactions work differently.

When a payor sells to a payor in a different jurisdiction, it issues a "reverse charge" invoice without VAT.

While reverse charge most often applies to cross broader transactions to limit so called missing trader (a.k.a. MTIC or carousel) fraud, some jurisdictions also require reverse charge in selected domestic transactions.

Thus the buyer, not seller, is obligated to pay the VAT to its domestic taxation authority.

However, as a VAT payor may also claim a deduction, the effect is zero net tax.

VAT is not deductible in every situation. The issue was discussed by the IFRIC in the context of IFRS 17 (link - ifric).

Transactions with non-payors:

When a payor sells to a domestic non-payor (a consumer or entity not registered as a VAT payor), it proceeds in the same manner as with a payor and issues a tax document including VAT.

In some jurisdictions, VAT payors are obligated to report both sales to and purchases from other VAT payors. These reports generally include VAT ID number, invoice number and amount.

Some jurisdictions require reports on all sales, including cash sales, regardless of whether they are to payors or non-payors, though this requirement can be based on different tax legislation.

Such reports do not, however, change the amount of VAT paid or refunded.

The difference, as the non-payor cannot claim a VAT refund, the remitted tax stays with the taxation authority.

However, when a payor sells to a non-payor in a different jurisdiction (cross boarder), it is generally obligated to remit VAT not its own taxation authority, but the taxation authority in the jurisdiction where the non-payor is domiciled.

This implies that companies selling across borders generally need to register as payers in each country where they have non-payor customers, though there are exceptions.

This page outlines current EU VAT requirements and exceptions: link - europa.

See (link - gocardless) for a discussion of VAT vs. GST.

The following examples simply illustrate how VAT could be treated in an IFRS | US GAAP context.

12/14/X1, XYZ purchased goods for 5,000 from ABC. 12/15/X1, it sold goods for 10,000 to DEF. In its jurisdiction, the VAT rate is 21% and the balance must be remitted to the tax collection authority no later than the 25th day of the month following the transaction or event.

12/14/X1 / 14.12.X1
Inventory		5,000
Tax other than income: Q4 VAT		1,050
	Accounts payable: ABC		5,000
	Accrued liabilities: VAT: ABC		1,050

 

Procedurally, the same account is used for both sales and purchases in that, at the end of the taxation period, the balance is either remitted to or refunded by the taxation authority.

Note: as VAT is generally refundable, it cannot be included in the measurement of assets or expenses. However, in situations where it is not refundable, it would be treated in the same manner as a sales or excise tax.

Also note: In IFRS XBRL, VAT is presented as a sub-classification of taxes other than income (illustrating the experience international standard setters have with VAT).

In US GAAP XBRL, VAT only appears as a subclassification of non-trade receivables (illustrating the opposite).

Both IFRS and US GAAP XBRL suggest that VAT should be presented as other or non-trade receivables/payables. However, since VAT is a tax, we at ifrs-gaap.com would much rather recognize it as an accrual to keep it as far away from receivables/payables as possible.

This is the VAT to be remitted to suppliers.

As it is not consideration for goods or services acquired, it should not be classified as an account payable.

12/15/X1 / 15.12.X1
Accounts receivable: DEF		10,000
Accrued assets: VAT: DEF		2,100
	Revenue		10,000
	Tax other than income: Q4 VAT		2,100

 

Both IFRS and US GAAP XBRL suggest that VAT should be presented as other or non-trade receivables/payables. However, since VAT is a tax, we at ifrs-gaap.com would much rather recognize it as an accrual to keep it as far away from receivables/payables as possible.

Under IFRS and US GAAP, revenue is clearly measured net of VAT.

IFRS 15.47 | ASC 606-10-32-2 state: ... The transaction price is the amount of consideration to which an entity expects to be entitled in exchange for transferring promised goods or services to a customer, excluding amounts collected on behalf of third parties ...

While IFRS 15.47 | ASC 606-10-32-2 does not mention VAT by name, it clearly alludes to it, which becomes clear when the reasoning behind the paragraph is examined.

In IFRS 15 BC187 | ASC 606 BC187 the boards state: The boards also clarified that the amounts to which the entity has rights under the present contract can be paid by any party (ie not only by the customer). ... However, it would not include amounts collected on behalf of another party such as some sales taxes and value added taxes in some jurisdictions.

Likewise, in IFRIC 21.BC6 the IFRIC states: ... Amounts that are collected by entities on behalf of governments (such as value added taxes) and remitted to governments are not outflows of resources embodying economic benefits for the entities that collect and remit those amounts. ...

Further, to address concerns of US practitioners who feared that ASC 606-10-32-2 would require them to evaluate VAT on a jurisdiction-by-jurisdiction basis, the FASB amended ASC 606.

In ASU_2016-12 it added ASC 606-10-32-2A: An entity may make an accounting policy election to exclude from the measurement of the transaction price all taxes assessed by a governmental authority that are both imposed on and concurrent with a specific revenue producing transaction and collected by the entity from a customer (for example, sales, use, value added, and some excise taxes). Taxes assessed on an entity’s total gross receipts or imposed during the inventory procurement process shall be excluded from the scope of the election. An entity that makes this election shall exclude from the transaction price all taxes in the scope of the election and shall comply with the applicable accounting policy guidance, including the disclosure requirements in paragraphs 235-10-50-1 through 50-6.

As a result, companies applying US GAAP need not evaluate VAT and similar taxes country by country, but can exclude all VAT and similar taxes from the measurement regardless of where they are received or paid.

For its part, the IASB concluded that companies applying IFRS internationally are accustomed to evaluating jurisdictions separately, have no trouble distinguishing principal from agent and so did not feel the need for a similar policy election.

The reason is that VAT is not an economic resource controlled by the company that collects it, but by the tax collection authority on whose behalf it is collected.

In other words, a company that collects VAT from its customers is acting an agent, collecting the tax on behalf of government.

Obviously, this only applies to VAT payors.

Companies, for example health care providers in some jurisdictions, do not collect VAT from their customers. Thus, since they are not agents of the government, they treat the VAT they pay to suppliers as a sales tax, which they include in the acquisition cost of assets / measurement of expenses.

Less clear, in the eyes of some (primarily IFRS ) accountants, is whether this also applies to the receivable.

For accountants that apply US GAAP outside of the United States, this generally is a non-issue. While a few exceptions exist, practically all US GAAP companies disaggregate VAT from both the transaction price and the receivable.

In other words, since VAT is commonly recognized as part of a receivable / payable per national GAAP, accountants accustomed applying such a GAAP would very much like to use the same procedure for IFRS | US GAAP purposes.

However, IFRS 15.108 | ASC 606-10-45-4 clearly states: A receivable is an entity's right to consideration ...

While IFRS and US GAAP do not specifically define "consideration", its meaning is generally understood to be the reward a company receives in exchange for delivering goods / rendering services, or whatever else it promises in a contract.

Interestingly, while both US GAAP and IFRS use the term consideration, neither define it.

This is not because its general meaning is unclear: it is the cash (or something of value like shares) paid in a transaction for something else of value (a product, service or, in this case, a company).

It is because its precise meaning is surprisingly difficult to pin down.

For example, entering "consideration" into Black's online law dictionary (link: thelawdictionary.org) brings up a blank page while Britannica (link: britannica.com), although it does define it, quickly goes off on a tangent about, among other things, love and affection.

... This definition, however, leaves unanswered the question of what is sufficient consideration. During certain periods of history, nominal consideration was held to be sufficient—even a cent or a peppercorn. Gradually, the courts came to require that the consideration be valuable, although not necessarily equal in value to what is received. The courts have had to decide specifically whether acts of forbearance on the faith of a promise, the giving of a counterpromise, money payments, preexisting duties to the promisor, preexisting duties to third parties, moral obligations, love and affection, surrender of another legal claim, or performance of a legal duty were sufficient, and the answer has varied considerably over time...

Fortunately, a quick google search (link: google.com) quickly brings up perhaps the best definition "Consideration is a promise, performance, or forbearance bargained by a promisor in exchange for their promise. Consideration is the main element of a contract. Without consideration by both parties, a contract cannot be enforceable." (link: law.cornell.edu).

US GAAP comes closest defining:

Cash Consideration

Cash payments and credits that the customer can apply against trade amounts owed to the vendor. In addition, as indicated in Section 718-10-25, consideration in the form of share-based payment awards is recognized in the same period or periods and in the same manner (that is, capitalize versus expense) as if the entity had paid cash for the goods or services instead of paying with or using the share-based payment awards. Accordingly, guidance with respect to cash consideration is applicable to consideration that consists of equity instruments.

Consideration in the Contract

See paragraph 842-10-15-35 for what constitutes the consideration in the contract for lessees and paragraph 842-10-15-39 for what constitutes consideration in the contract for lessors.

ASC: 842-10-15-35 The consideration in the contract for a lessee includes all of the payments described in paragraph 842-10-30-5, as well as all of the following payments that will be made during the lease term:

a. Any fixed payments (for example, monthly service charges) or in substance fixed payments, less any incentives paid or payable to the lessee, other than those included in paragraph 842-10-30-5

b. Any other variable payments that depend on an index or a rate, initially measured using the index or rate at the commencement date.

Since a company cannot retain the VAT it collects, it is not, and cannot be, a reward.

If anything, VAT is a government's reward for allowing companies to deliver goods / render services in its territory.

This implies that recognizing VAT as a receivable is not consistent with the logic behind IFRS or US GAAP even when it does not, technically, violate its letter.

Provided an entity clearly reports receivables from contracts with customers (as defined by IFRS 15.108 | ASC 606-10-45-4) separately from other "receivables", its reporting would not be inconsistent with the letter of IFRS and US GAAP (nor with their respective XBRL taxonomies).

Nevertheless, indicating that taxes like VAT are similar to accounts receivable or accounts payable could never be called good accounting.

Procedurally, the same account is used for both sales and purchases in that, at the end of the taxation period, the balance is either remitted to or refunded by the taxation authority.

Note: as VAT is generally refundable, it cannot be included in the measurement of assets or expenses. However, in situations where it is not refundable, it would be treated in the same manner as a sales or excise tax.

Also note: In IFRS XBRL, VAT is presented as a sub-classification of taxes other than income (illustrating the experience international standard setters have with VAT).

In US GAAP XBRL, VAT only appears as a subclassification of non-trade receivables (illustrating the opposite).

1/14/X2 / 14.1.X2
Cash		12,100
	Accounts receivable: DEF		10,000
	Accrued assets: VAT: DEF		2,100

 

1/15/X2 / 15.1.X2
Accounts payable: ABC		5,000
Accrued liabilities: VAT: ABC		1,050
	Cash		6,050

 

12/31/X1 / 31.12.X1

 

XYZ Balance sheet 12/31/X1 / 31.12.X1
Current assets*
	Trade receivables	10,000
	Accrued assets: VAT	2,100
Current liabilities*
	Trade payables	5,000
	Accrued liabilities: VAT	1,050
	Taxes other than income: Net VAT	1,050
* Only the pertinent items are presented.

 

1/25/X2 / 25.1.X2
Tax other than income: Q4 VAT		1,050
	Cash		1,050

 

For illustration purposes, only the VAT remittance associated with the two transactions is presented.

Alternatively

Habits die hard and bad habits die hardest.

As a result, in countries where national GAAP recognizes gross receivables, accountants would like to do this:

12/14/X1 / 14.12.X1
Inventory		5,000
Value added tax		1,050
	Accounts payable: ABC		6,050

 

12/15/X1 / 15.12.X1
Accounts receivable: DEF		12,100
	Revenue		10,000
	Value added tax		2,100

 

While hardly good accounting, provided that the receivable and VAT are clearly segregated on the balance sheet, it would not be an error.

Provided an entity clearly reports receivables from contracts with customers (as defined by IFRS 15.108 | ASC 606-10-45-4) separately from other "receivables", its reporting would not be inconsistent with the letter of IFRS and US GAAP (nor with their respective XBRL taxonomies).

Nevertheless, indicating that taxes like VAT are similar to accounts receivable or accounts payable could never be called good accounting.

Proper segregation is also in a company's best interest.

If users fail to notice that VAT and receivables are separate items, they could conclude that the company has trouble collecting on time.

For example, if XYZ had annual revenues of 120,000 and users calculated days of sales outstanding using the gross receivable, the ratio would appear to be 36.3 days, not the 30 days it actually is.

36.3 = 12,100 ÷ 120,000 x 360

Reverse charge

Same facts except ABC was an international supplier.

Since reverse charge sales are VAT free, VAT is often recognized only in reverse charge purchases.

However, reverse charge sales generally need to be reported to the taxation authority even when they are not given accounting recognition.

12/14/X1 / 14.12.X1
Inventory		5,000
Tax other than income: Q4 VAT		1,050
	Accounts payable: ABC		5,000
	Tax other than income: Q4 VAT		1,050

 

In the VAT report filed with the taxation authority, the asset and liability would be reported as separate items. Consequently, many companies keep separate accounts for VAT assets and VAT liabilities.

For IFRS | US GAAP purposes, since the amounts are offset, they would not be reported, so it makes no difference how or if they are given accounting recognition.

Also note, in some jurisdictions, all reverse charge transactions must be reported. In some jurisdictions, only transactions over a set amount. In some, jurisdiction just sales transactions. In some jurisdictions, multiple reports require the reporting of the same transactions (just on different forms and at different times). These reports generally include the VAT #, invoice # and amount.

This example is no substitute for knowledge of the specific requirements of each jurisdiction.

Advance payment

Same facts except DEF paid an advance and XYZ delivered the product 1/31/X2.

VAT is generally due when consideration is received (as in this example) or receivable (previous examples).

12/15/X1 / 15.12.X1
Cash		12,100
	Deferred revenue		10,000
	Tax other than income: Q4 VAT		2,100

 

1/25/X2 / 25.1.X2
Tax other than income: Q4 VAT		2,100
	Cash		2,100

 

For illustration purposes, only the VAT remittance associated with this transaction is presented.

1/31/X2 / 31.1.X2
Deferred revenue		10,000
	Revenue		10,000

Related parties

IFRS and US GAAP give substantially different related party guidance.

IFRS requires disclosure of related parties even if there have been no transactions and the entities are consolidated.

Edited, emphasis added: IAS 24.3: This Standard requires disclosure of related party relationships, transactions and outstanding balances, including commitments; IAS 24.13: Relationships between a parent and its subsidiaries shall be disclosed irrespective of whether there have been transactions between them; IAS 24.14: ... it is appropriate to disclose the related party relationship when control exists, irrespective of whether there have been transactions between the related parties. IAS 24.15: The requirement to disclose related party relationships between a parent and its subsidiaries is in addition to the disclosure requirements in IAS 27 and IFRS 12 Disclosure of Interests in Other Entities.

IAS 24.9:

1. A person or a close member of that person’s family is related to a reporting entity if that person:
   1. has control or joint control of the reporting entity;
   2. has significant influence over the reporting entity or
   3. is a member of the key management personnel of the reporting entity or of a parent of the reporting entity.
2. An entity is related to a reporting entity if any of the following conditions applies:
   1. The entity and the reporting entity are members of the same group (which means that each parent, subsidiary and fellow subsidiary is related to the others).
   2. One entity is an associate or joint venture of the other entity (or an associate or joint venture of a member of a group of which the other entity is a member).
   3. Both entities are joint ventures of the same third party.
   4. One entity is a joint venture of a third entity and the other entity is an associate of the third entity.
   5. The entity is a post-employment benefit plan for the benefit of employees of either the reporting entity or an entity related to the reporting entity. If the reporting entity is itself such a plan, the sponsoring employers are also related to the reporting entity.
   6. The entity is controlled or jointly controlled by a person identified in (a).
   7. A person identified in (a)(i) has significant influence over the entity or is a member of the key management personnel of the entity (or of a parent of the entity).
   8. The entity, or any member of a group of which it is a part, provides key management personnel services to the reporting entity or to the parent of the reporting entity.

IAS 24.3 (edited, emphasis added): This Standard requires disclosure of related party relationships, transactions and outstanding balances, including commitments, in the consolidated and separate financial statements of a parent....

US GAAP only requires disclosure of transactions between relate parties and only when not eliminated.

ASC 850-10-50-1 (edited, emphasis added): Financial statements shall include disclosures of material related party transactions, other than compensation arrangements, expense allowances, and other similar items in the ordinary course of business...

ASC 850-10-20:

 

ASC 850-10-20: A party that, directly or indirectly through one or more intermediaries, controls, is controlled by, or is under common control with an entity.

1. Affiliates of the entity
2. Entities for which investments in their equity securities would be required, absent the election of the fair value option under the Fair Value Option Subsection of Section 825-10-15, to be accounted for by the equity method by the investing entity
3. Trusts for the benefit of employees, such as pension and profit-sharing trusts that are managed by or under the trusteeship of management d. Principal owners of the entity and members of their immediate families e. Management of the entity and members of their immediate families
4. Other parties with which the entity may deal if one party controls or can significantly influence the management or operating policies of the other to an extent that one of the transacting parties might be prevented from fully pursuing its own separate interests
5. Other parties that can significantly influence the management or operating policies of the transacting parties or that have an ownership interest in one of the transacting parties and can significantly influence the other to an extent that one or more of the transacting parties might be prevented from fully pursuing its own separate interests.

ASC 850-10-50-1 (edited, emphasis added): ... However, disclosure of [related party] transactions that are eliminated in the preparation of consolidated or combined financial statements is not required in those statements....

While these differences effect practice, they are not as pronounced as the guidance suggests they should be.

While IFRS companies do disclose more related party transactions than US GAAP companies, many fail to disclose a list of related party relationships as they should.

For example:

- Siemens
- SAP
- Deutsche Telekom

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Visitors to this site are advised to search for and download the originals from their source.

For example:

- Berkshire Hathaway
- Oracle
- AT&T

These files have been downloaded to a local server to avoid potential broken links.

Visitors to this site are advised to search for and download the originals from their source.

Edited, emphasis added: IAS 24.3: This Standard requires disclosure of related party relationships, transactions and outstanding balances, including commitments; IAS 24.13: Relationships between a parent and its subsidiaries shall be disclosed irrespective of whether there have been transactions between them; IAS 24.14: ... it is appropriate to disclose the related party relationship when control exists, irrespective of whether there have been transactions between the related parties. IAS 24.15: The requirement to disclose related party relationships between a parent and its subsidiaries is in addition to the disclosure requirements in IAS 27 and IFRS 12 Disclosure of Interests in Other Entities.

Similarly, the model financial statements published by audit firms also focus on transactions, suggesting that listing all individual related parties is unnecessary.

- Deloitte
- KPMG
- E & Y
- PwC
- Grant Thorton

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Visitors to this site are advised to search for and download the originals from their source.

Related person recognized as if arm's length.

1/1/X1, XYZ lent the wife of its CEO 100,000 for two years at 2%. The interest and principal were payable at the end of the term. XYZ elected to recognize the loan as if were at arm's length so it could disclose this fact. As neither the nominal (2%) nor implicit (1.91%) rates were reasonable, it imputed a discount rate by determining a bank would have required 12% for a similar loan without any guarantee from XYZ.

A loan to a close family member of key management personnel as outlined in IFRS 24.9 | ASC 850.10.20.

Both IFRS and US GAAP presume related party transactions are not made at arm's length.

IAS 24.23 (emphasis added): Disclosures that related party transactions were made on terms equivalent to those that prevail in arm’s length transactions are made only if such terms can be substantiated.

ASC 850-10-50-5 (emphasis added): Transactions involving related parties cannot be presumed to be carried out on an arm's-length basis, as the requisite conditions of competitive, free-market dealings may not exist. Representations about transactions with related parties, if made, shall not imply that the related party transactions were consummated on terms equivalent to those that prevail in arm's-length transactions unless such representations can be substantiated.

However, if they are recognized as if they were made at arm's length, this fact can be disclosed in addition to the disclosures required by the standards.

IAS 24.18: If an entity has had related party transactions during the periods covered by the financial statements, it shall disclose the nature of the related party relationship as well as information about those transactions and outstanding balances, including commitments, necessary for users to understand the potential effect of the relationship on the financial statements. These disclosure requirements are in addition to those in paragraph 17. At a minimum, disclosures shall include:

1. the amount of the transactions;
2. the amount of outstanding balances, including commitments, and:
   1. their terms and conditions, including whether they are secured, and the nature of the consideration to be provided in settlement; and
   2. details of any guarantees given or received;
3. provisions for doubtful debts related to the amount of outstanding balances; and
4. the expense recognised during the period in respect of bad or doubtful debts due from related parties.

ASC 850-10-50-1: Financial statements shall include disclosures of material related party transactions, other than compensation arrangements, expense allowances, and other similar items in the ordinary course of business. However, disclosure of transactions that are eliminated in the preparation of consolidated or combined financial statements is not required in those statements. The disclosures shall include:

1. The nature of the relationship(s) involved
2. A description of the transactions, including transactions to which no amounts or nominal amounts were ascribed, for each of the periods for which income statements are presented, and such other information deemed necessary to an understanding of the effects of the transactions on the financial statements
3. The dollar amounts of transactions for each of the periods for which income statements are presented and the effects of any change in the method of establishing the terms from that used in the preceding period
4. Amounts due from or to related parties as of the date of each balance sheet presented and, if not otherwise apparent, the terms and manner of settlement
5. The information required by paragraph 740-10-50-17.

While some companies try to mitigate the stigma attached to off market, related party transactions by disclosing they have been accounted for as if arm’s length, the preferred strategy is avoiding them in the first place.

As outlined in ASC 310-10-30-6, an entity must use an imputed interest rate when the rate stated or implied in the contract is unreasonable.

ASC 310-10-30-6 states: Paragraph 835-30-25-11 explains that, in the absence of established exchange prices for the related property, goods, or services or evidence of the fair value of the note (as described in paragraph 835-30-25-2), the present value of a note that stipulates either no interest or a rate of interest that is clearly unreasonable shall be determined by discounting all future payments on the notes using an imputed rate of interest as described in Subtopic 835-30...

Note: ASC 835-30-25-11's text is practically identical to ASC 310-10-30-6.

While IFRS does not include guidance specifically addressing interest imputation, IFRS 9.B5.1.1 requires loans and receivables carrying no interest to be discounted using prevailing market (a.k.a. reasonable) rates. By implication, the guidance also applies to loans and receivables carrying unreasonable interest.

As unreasonable interest rates are often encountered in intercompany loans and receivables (between parent and subsidiary, between parent and associate, between and among subsidiaries and associates, etc.) or situations where companies lend to or borrow from insiders (management, family members, etc.), these transactions should always be evaluated to confirm that the associated implicit or explicit interest rates are reasonable.

1/1/X1 / 1.1.X1
Loan		100,000
Deferred related party compensation		17,092
	Cash		100,000
	Deferred interest income		17,092

 

17,092 = 100,000 - 104,000 ÷ (1 + 12%)²

12/31/X1 / 31.12.X1
Deferred interest income		7,949
Interest receivable		2,000
Related party compensation		8,546
	Interest income		9,949
	Deferred related party compensation		8,546

 

P	Discount rate	Net loan amount	Interest income	Interest receivable	Discount amortization
A	B	C=C(C+1)+F	D = C x B	E=100,000 x 2%	F=D-E
1	12%	82,908	9,949	2,000	7,949
2	12%	92,857	11,143	2,000	9,143
			21,092	4,000	17,092

As the off-market loan made provided compensation to the related party, XYZ would need to outline the service it received in exchange.

12/31/X2 / 31.12.X2
Deferred interest income		9,143
Interest receivable		2,000
Related party compensation		8,546
	Interest income		11,143
	Deferred related party compensation		8,546
Cash		104,000
	Loan		100,000
	Interest receivable		4,000

 

Loss		104,000
	Loan		100,000
	Interest receivable		4,000

Related entity recognized as if arm's length.

1/1/X1, XYZ lent XYZ-A 100,000 for two years at 2%. The interest and principal were payable at the end of the term. XYZ elected to recognize the loan as if were at arm's length so it could disclose this fact. As neither the nominal (2%) nor implicit (1.91%) rates were reasonable, it imputed a discount rate by determining a bank would have required 12% for a similar loan to an entity not affiliated with XYZ.

To illustrate, this example uses a loan to an associate | (unconsolidated) affiliate as outlined in IFRS 24.9.b.ii | ASC 850.10.20.a

IFRS 24.9.b.ii: One entity is an associate or joint venture of the other entity ...

ASC 850.10.20: A party that, directly or indirectly through one or more intermediaries, controls, is controlled by, or is under common control with an entity.

Both IFRS and US GAAP presume related party transactions are not made at arm's length.

IAS 24.23 (emphasis added): Disclosures that related party transactions were made on terms equivalent to those that prevail in arm’s length transactions are made only if such terms can be substantiated.

ASC 850-10-50-5 (emphasis added): Transactions involving related parties cannot be presumed to be carried out on an arm's-length basis, as the requisite conditions of competitive, free-market dealings may not exist. Representations about transactions with related parties, if made, shall not imply that the related party transactions were consummated on terms equivalent to those that prevail in arm's-length transactions unless such representations can be substantiated.

However, if they are recognized as if they were made at arm's length, this fact can be disclosed in addition to the disclosures required by the standards.

IAS 24.18: If an entity has had related party transactions during the periods covered by the financial statements, it shall disclose the nature of the related party relationship as well as information about those transactions and outstanding balances, including commitments, necessary for users to understand the potential effect of the relationship on the financial statements. These disclosure requirements are in addition to those in paragraph 17. At a minimum, disclosures shall include:

1. the amount of the transactions;
2. the amount of outstanding balances, including commitments, and:
   1. their terms and conditions, including whether they are secured, and the nature of the consideration to be provided in settlement; and
   2. details of any guarantees given or received;
3. provisions for doubtful debts related to the amount of outstanding balances; and
4. the expense recognised during the period in respect of bad or doubtful debts due from related parties.

ASC 850-10-50-1 (emphasis added): Financial statements shall include disclosures of material related party transactions, other than compensation arrangements, expense allowances, and other similar items in the ordinary course of business. However, disclosure of transactions that are eliminated in the preparation of consolidated or combined financial statements is not required in those statements. The disclosures shall include:

1. The nature of the relationship(s) involved
2. A description of the transactions, including transactions to which no amounts or nominal amounts were ascribed, for each of the periods for which income statements are presented, and such other information deemed necessary to an understanding of the effects of the transactions on the financial statements
3. The dollar amounts of transactions for each of the periods for which income statements are presented and the effects of any change in the method of establishing the terms from that used in the preceding period
4. Amounts due from or to related parties as of the date of each balance sheet presented and, if not otherwise apparent, the terms and manner of settlement
5. The information required by paragraph 740-10-50-17.

While some companies try to mitigate the stigma attached to off market, related party transactions by disclosing they have been accounted for as if arm’s length, the preferred strategy is avoiding them in the first place.

As outlined in ASC 310-10-30-6, an entity must use an imputed interest rate when the rate stated or implied in the contract is unreasonable.

ASC 310-10-30-6 states: Paragraph 835-30-25-11 explains that, in the absence of established exchange prices for the related property, goods, or services or evidence of the fair value of the note (as described in paragraph 835-30-25-2), the present value of a note that stipulates either no interest or a rate of interest that is clearly unreasonable shall be determined by discounting all future payments on the notes using an imputed rate of interest as described in Subtopic 835-30...

Note: ASC 835-30-25-11's text is practically identical to ASC 310-10-30-6.

While IFRS does not include guidance specifically addressing interest imputation, IFRS 9.B5.1.1 requires loans and receivables carrying no interest to be discounted using prevailing market (a.k.a. reasonable) rates. By implication, the guidance also applies to loans and receivables carrying unreasonable interest.

As unreasonable interest rates are often encountered in intercompany loans and receivables (between parent and subsidiary, between parent and associate, between and among subsidiaries and associates, etc.) or situations where companies lend to or borrow from insiders (management, family members, etc.), these transactions should always be evaluated to confirm that the associated implicit or explicit interests rates are reasonable.

1/1/X1 / 1.1.X1
Loan		100,000
Deferred related party compensation		17,092
	Cash		100,000
	Deferred interest income		17,092

 

17,092 = 100,000 - 104,000 ÷ (1 + 12%)²

12/31/X1 / 31.12.X1
Deferred interest income		7,949
Interest receivable		2,000
Related party compensation		8,546
	Interest income		9,949
	Deferred related party compensation		8,546

 

P	Discount rate	Net loan amount	Interest income	Interest receivable	Discount amortization
A	B	C=C(C+1)+F	D = C x B	E=100,000 x 2%	F=D-E
1	12%	82,908	9,949	2,000	7,949
2	12%	92,857	11,143	2,000	9,143
			21,092	4,000	17,092

As the off-market loan made provided compensation to the related party, XYZ would need to outline the service it received in exchange.

12/31/X2 / 31.12.X2
Deferred interest income		9,143
Interest receivable		2,000
Related party compensation		8,546
	Interest income		11,143
	Deferred related party compensation		8,546
Cash		104,000
	Loan		100,000
	Interest receivable		4,000

 

Loss		104,000
	Loan		100,000
	Interest receivable		4,000

Factoring and pledging

XYZ sold (factored) receivables with a book value of 100,000 payable in 90 days at a discount.

For illustration, this example assumes a 10% discount, which may or may not be realistic.

In practice, the cost of factoring, pledging and assigning varies considerably depending mostly on the quality of the receivables being factored, pledged or assigned.

Dr/Cr

Cash (received from factor)		90,000
Loss on sale of receivables		10,000
	Accounts receivable		100,000

 

In some jurisdictions, national GAAP requires companies to recognize:

For example, some time ago an EU based company decided to list its shares on a US exchange.

After retaining an underwriter, the underwriter retained us to draft a financial report consistent with US GAAP.

After reviewing the preliminary results, the underwater decided against pursuing a listing.

Our first step was to eliminate the major differences and draft a preliminary report.

Up to then, the company had only applied CZ GAAP, the statutory accounting standards applicable in its jurisdiction, the Czech Republic.

As the company used the procedure outlined below, almost half its previously reported revenue was eliminated.

In and of itself, this would have been enough to dissuade a listing, but there was more.

1. In addition to the revenue eliminated by applying US GAAP guidance to factored receivables, revenue further declined because, at the time, CZ GAAP required increases in inventory and self-manufactured asset costs to be capitalized with a credit to revenue.


2. The company also did not recognize the full value of its lease assets nor any associated liabilities because CZ GAAP does not require leased assets to capitalized nor liabilities to be recognized. It only requires the capitalization of advance payments, which are amortized over the lease term.


3. The company also did not recognize all of its leased assets because CZ GAAP does not require capitalization of operating leases even if their term is for substantially all the underlying asset's economic life.


4. The company also did not recognize all its contingent liabilities because CZ GAAP does not generally require recognition of constructive obligations.


5. The company also failed to distinguish between cost of sales, selling and administrative expenses as this distinction is not required by CZ GAAP.


6. The company also capitalized both development and some research as well as employee training which, at the time, was consistent with CZ GAAP.


7. The company also misapplied CZ GAAP guidance, for example by using tax depreciation periods for financial reporting purposes, but an examination of these issues was beyond the scope of our engagement.

A second step was not necessary.

After reviewing our preliminary report, the underwater decided to terminate its relationship with the company, which eventually wound up in receivership.

Cash		90,000
Expense		100,000
	Revenue		90,000
	Accounts receivable		100,000

 

This procedure is not consistent with either IFRS or US GAAP.

IFRS 9.3.2.12 (emphasis added): On derecognition of a financial asset in its entirety, the difference between:

1. the carrying amount (measured at the date of derecognition) and
2. the consideration received (including any new asset obtained less any new liability assumed)

shall be recognised in profit or loss.

ASC 860-20-40-1A (edited, emphasis added): Upon completion of a transfer ... to be accounted for as a sale, the transferor(seller) shall: ... (d) Recognize in earnings any gain or loss on the sale...

Doubtful accounts

Same facts except XYZ had recognized an allowance for doubtful accounts.

Cash		90,000
Loss on sale of receivables		10,000
Allowance for doubtful accounts		2,000
	Accounts receivable		100,000
	Bad debt expense		2,000

 

As the sale was without recourse, XYZ reversed the previously recognized expense.

As outlined in IFRS 15.113 | ASC 606-10-50-4, for each reporting period entities must disclose (b) impairments of receivables.

IFRS 9 | ASC 310 provide additional guidance on how to fulfill this requirement.

As outlined IFRS 9.5.5.15 and 16 receivables are always measured net of expected lifetime credit losses.

As outlined in ASC 310-10-35-8, a loss is accrued if it is probable it has occurred and can be estimated while, as outlined in ASC 310-10-35-9, this requirement applies to both individual receivables and groups of similar receivables.

To apply this guidance, companies generally recognize the impairments in the same period as the revenue, matching one to the other.

As matching traditionally applies to expenses (losses are recognized as incurred), the allowance should have been recognized with a debit to bad debt expense (for illustrations, go to the doubtful accounts section below).

If the allowance is no longer pertinent, proper accounting is to reverse the expense.

Alternatively

Cash		90,000
Loss on sale of receivables		8,000
Allowance for doubtful accounts		2,000
	Accounts receivable		100,000

 

As outlined in IFRS 15.113 | ASC 606-10-50-4, for each reporting period entities must disclose (b) impairments of receivables.

IFRS 9 | ASC 310 provide additional guidance on how to fulfill this requirement.

As outlined IFRS 9.5.5.15 and 16 receivables are always measured net of expected lifetime credit losses.

As outlined in ASC 310-10-35-8, a loss is accrued if it is probable it has occurred and can be estimated while, as outlined in ASC 310-10-35-9, this requirement applies to both individual receivables and groups of similar receivables.

This implies that companies should match the impairment to revenue.

Traditionally, only expenses are matched (losses are recognized as incurred).

Also traditionally, the proper procedure for adjusting expenses is to reverse them.

However, both IFRS and US GAAP refer to the income statement item related to uncollectible receivables as a loss (this is also mirrored in their respective taxonomies).

IFRS XBRL: ImpairmentLossImpairmentGainAndReversalOfImpairmentLossDeterminedInAccordanceWithIFRS9

US GAAP XBRL: ProvisionForDoubtfulAccounts

Note: while US GAAP XBRL presents impairments of receivables separately from other impairments, IFRS XRBL aggregates all impairments made according to IFRS 9 including receivables.

This implies, since the accounting for losses is more flexible, simply netting the loss would not be inconsistent with the letter of the guidance.

Servicing asset

Same facts except XYZ agreed to collects payments and the factor agreed to pay a 2% servicing fee.

As outlined in IFRS 93.2.10 to 14 | ASC 860-50-25-1 to 10, if a company sells a financial asset but retains the right to service the asset for a fee, it recognizes a servicing asset.

Theoretically, it could also recognize a servicing liability if the fee does not adequately compensate the company for its service, but this is not common.

Cash		90,000
Loss on sale of receivables		10,000
Servicing asset (due from factor)		2,000
	Accounts receivable		100,000
	Deferred revenue (servicing fee)		2,000

 

In 90 days

Cash		2,000
Deferred revenue		2,000
	Revenue		2,000
	Servicing asset		2,000

Interest + fee

Same facts except, instead of a discount, the agreement stipulated 5,000 interest and a 5,000 fee.

For illustration, this example assumes the total cost (interest plus fee) was the same 10% as in the discount example. This may or not be realistic.

In practice, the cost of factoring, pledging and assigning varies considerably depending mostly on the quality of the receivables being factored, pledged or assigned.

In most agreements, this cost is a outlined as a benchmark rate plus points.

Note: IFRS | US GAAP uses IBOR (inter-bank offered rates) | SOFR (Secured Overnight Financing Rate) as its benchmark rate.

However, companies are free to use whatever benchmark they like in agreements they sign between themselves.

Cash		90,000
Interest expense		5,000
Factor fee		5,000
Allowance for doubtful accounts		2,000
	Accounts receivable		100,000
	Loss on uncollectible receivables		2,000

 

As neither IFRS nor US GAAP specifically addresses how to classify the costs associated with factored receivable, in practice they are commonly recognized as outlined in the agreement.

Neither IFRS nor US GAAP specifically address how these fees should be classified.

Consequently, the fee is commonly treated like interest and sub-classified in non-operating (other) expense.

In US GAAP XBRL, it should thus be presented as an extension to OtherNonoperatingIncomeExpense.

As IFRS XBRL does not define a similar label, it should be presented as an extension to FinanceCosts.

Note: as this fee is akin to interest, it would not be an error to present it as an extension to InterestExpense.

While IFRS XBRL does not include an InterestExpense label under IncomeStatementAbstract, it does under AnalysisOfIncomeAndExpenseAbstract.

Pledging

Same facts except, XYZ pledged (assigned) the receivables at a 10% discount.

In general, pledging involves a pool of receivables being used as collateral for a loan.

In contrast, assigning generally involves specific receivables being assigned to a lender.

While not set in stone, receivables are usually pledged at a discount.

In contrast, receivables are generally assigned at face value plus interest and/or a fee.

For example, XYZ transferred the receivables at face value agreeing to pay 5,000 interest and a 5,000 fee in 90 days.

Cash (received from assignee)		100,000
	Loan (secured by receivables)		100,000

 

In 90 days

Cash (received from customers)		100,000
Loan (secured by receivables)		100,000
Interest expense		5,000
Assignment fee		5,000
	Receivables		100,000
	Cash (paid to assignee)		110,000

 

In excel syntax: 5,000 = 100000*((1+21.55%)^(1/4)-1).

Cash (received from pledgee)		90,000
	Loan (secured by receivables)		90,000

 

In 90 days

Cash (received from customers)		100,000
Loan (secured by receivables)		90,000
Loss on pledged receivables		10,000
	Receivables		100,000
	Cash (paid to pledgee)		100,000

 

Same facts except XYZ agreed to pay interest and a fee.

Cash		100,000
Loan		90,000
Interest expense		5,000
Pledging fee		5,000
	Receivables		100,000
	Cash		100,000

 

As neither IFRS nor US GAAP specifically addresses how to classify the costs associated with factored receivable, they are commonly recognized as outlined in the agreement.

If the agreement includes a fee, it is commonly treated like interest and sub-classified in non-operating (other) expense.

In US GAAP XBRL, it should thus be presented as an extension to OtherNonoperatingIncomeExpense.

As IFRS XBRL does not define a similar label, it should be presented as an extension to FinanceCosts.

Note: as this fee is akin to interest, it would not be an error to present it as an extension to InterestExpense.

While IFRS XBRL does not include an InterestExpense label under IncomeStatementAbstract, it does under AnalysisOfIncomeAndExpenseAbstract.

Recourse

Same facts except the factor had the right to return uncollectible receivables.

If the transferee can return the receivables to the transferor, the transferee has recourse. Recourse transaction do not generally qualify for sale accounting. Instead, they are recognized as a secured borrowings.

While they provide similar guidance, IFRS is more straight forward than and US GAAP.

As outlined in IFRS 9.3.2.6.a, if the entity transfers risks are rewards of ownership, it derecognizes the receivable and recognizes the consideration received (plus a gain or, more likely, a loss). As outlined in IFRS 9.3.2.6.b, if it does not transfer risks are rewards of ownership, it continues to recognize the receivable and to recognizes the consideration received as a liability.

To evaluate if it has transferred risk and rewards, the entity applies IFRS 9.3.2.7: "...An entity has retained substantially all the risks and rewards of ownership of a financial asset if its exposure to the variability in the present value of the future net cash flows from the financial asset does not change significantly as a result of the transfer (eg because the entity has sold a financial asset subject to an agreement to buy it back at a fixed price or the sale price plus a lender’s return)..."

If the likelihood of default is high, the likelihood the factor will exercise its option is also high. As a result, the entity will continue to be exposed to the variability of cash flows and it cannot recognize the transfer as a sale. Instead, it would recognize the transaction as a secured borrowing.

As outlined in ASC 860-10-40-5, the transfer will recognize a sale if it surrenders control. It surrenders control if all these three conditions are met:

1. The transferred financial assets have been isolated from the transferor and its creditors (see paragraph 860-10-55-17D)
2. Transferee has the right to sell, exchange or pledge the transferred financial assets
3. The transferor does maintain effective control over the transferred financial assets

When transferee has the right but not obligation to return the assets to the transferor conditions a and b are clearly met.

However, for condition c to be met the agreement would need to permit "the transferee to require the transferor to repurchase the transferred financial assets at a price that is so favorable to the transferee that it is probable that the transferee will require the transferor to repurchase them."

To interpret this guidance, additional guidance is provided by ASC 860-10-55-42D:

This implementation guidance addresses the application of paragraph 860-10-40-5(c)(3) through the following examples:

1. A put option written to the transferee generally does not provide the transferor with effective control over the transferred financial asset under paragraph 860-10-40-5(c)(3).
2. A put option that is sufficiently deep in the money when it is written would, under that paragraph, provide the transferor effective control over the transferred financial asset because it is probable that the transferee will exercise the option and the transferor will be required to repurchase the transferred financial asset.
3. A sufficiently out-of-the-money put option held by the transferee would not provide the transferor with effective control over the transferred financial asset if it is probable when the option is written that the option will not be exercised.
4. A put option held by the transferee at fair value would not provide the transferor with effective control over the transferred financial asset.

Interpreting this guidance, if the receivable(s) becomes uncollectible, its fair value will be zero, the option will be in the money and will be exercised.

Thus, if it is probable the receivable(s) will become uncollectible, the transaction is recognized as a secured borrowing, not sale.

The same guidance applies when factor has an option to return the receivables for reasons other than un-collectability.

Cash		90,000
	Loan (secured by receivables)		90,000

 

In 90 days (no receivables were uncollectible)

Loan		90,000
Loss		10,000
	Accounts receivable		100,000

 

Factoring with recourse recognized as sale

Same facts except, the default rate was insignificant.

In general, if the transferee (factor) can only return the receivables if they become uncollectible and the probability that a significant portion of the receivables will become uncollectible is low, the company may recognize the transaction as a sale rather than secured borrowing.

Note: while they provide similar guidance, IFRS is more straight forward than and US GAAP.

As outlined in IFRS 9.3.2.6.a, if the entity transfers risks are rewards of ownership, it derecognizes the receivable and recognizes the consideration received (plus a gain or, more likely, a loss). As outlined in IFRS 9.3.2.6.b, if it does not transfer risks are rewards of ownership, it continues to recognize the receivable and to recognizes the consideration received as a liability.

To evaluate if it has transferred risk and rewards, the entity applies IFRS 9.3.2.7: "...An entity has retained substantially all the risks and rewards of ownership of a financial asset if its exposure to the variability in the present value of the future net cash flows from the financial asset does not change significantly as a result of the transfer (eg because the entity has sold a financial asset subject to an agreement to buy it back at a fixed price or the sale price plus a lender’s return)..."

If the likelihood of default is low, the likelihood the factor will exercise its option is also low. As a result, the entity will not be exposed to the variability of cash flows so it can recognize the transfer as a sale.

As outlined in ASC 860-10-40-5, the transfer will recognize a sale if it surrenders control. It surrenders control if all these three conditions are met:

1. The transferred financial assets have been isolated from the transferor and its creditors
2. Transferee's has the right to sell, exchange or pledge the transferred financial assets
3. The transferor does maintain effective control over the transferred financial assets

When transferee has the right but not obligation to return the assets to the transferor conditions a and b are clearly met.

However, for condition c to be met the agreement would need to permit "the transferee to require the transferor to repurchase the transferred financial assets at a price that is so favorable to the transferee that it is probable that the transferee will require the transferor to repurchase them."

To interpret this guidance, additional guidance is provided by ASC 860-10-55-42D.

ASC 860-10-55-42D.a states: a option written to the transferee generally does not provide the transferor with effective control over the transferred financial asset.

However, ASC 860-10-55-42D.b states: a put option that is sufficiently deep in the money when it is written would, under that paragraph, provide the transferor effective control over the transferred financial asset because it is probable that the transferee will exercise the option and the transferor will be required to repurchase the transferred financial asset.

Finally, ASC 860-10-55-42D.d states: a put option held by the transferee at fair value would not provide the transferor with effective control over the transferred financial asset.

This implies that if the receivable becomes uncollectible its fair value will be zero and so the option held by the transferee is sufficiently in the money to give the transferee effective control. But this applies only if it is probable the receivable will become uncollectible.

If it is not probable the receivable will become uncollectible, the transferee does not have effective control so the transferor can recognize a sale (unless it is probable, for some other reason, the transferee will return the receivable).

Caveat: as recourse transaction can create off-balance sheet financing, they do attract regulatory attention.

Consequently, before recognizing any recourse transaction as a sale, companies should be prepared to answer questions like:

We [the SEC] note that in 2010 you engaged in factoring of specific accounts receivables and accounted for the transfer as a sale in accordance with FASB ASC 860. We note that you have credit insurance in order to mitigate credit risk related to the Company’s factoring of accounts receivable. In this regard, it appears that you are transferring the receivables with recourse. We refer you to ASC 860-10-55-46. Provide your analysis of why the transfer represents a sale under ASC 860-10-40-5. Indicate whether you recorded a recourse obligation. In addition, tell us whether you are receiving a fee for acting as the collection agent and explain why you did not recognize a service obligation. See ASC 860-50-25-1.

Link - SEC letter

Cash		90,000
Loss on sale of receivables		10,000
Allowance for doubtful accounts		2,000
	Accounts receivable		100,000
	Recourse provision		2,000

 

As XYZ had the obligation to reacquire uncollectible receivables, it reclassified the allowance (contra asset) as a provision (liability).

Doubtful accounts

Under IFRS and US GAAP, doubtful accounts are recognized in the period a loss is expected.

As outlined in IFRS 9.5.5.15, a loss allowance equal to lifetime expected credit losses is recognized for trade receivables, lease receivables and contract assets.

As outlined in IFRS 9.5.4.4, when a receivable is deemed uncollectible, it is derecognized against this allowance.

These requirements generally lead to the charge being recognize in the same period as the associated revenue.

US GAAP (ASC 310-10-35-47, 326-20-30-1, 362-20-15-2-a.3, 326-20-35-8, etc.) provides comparable guidance.

In contrast to IFRS and US GAAP, many national GAAPs/tax codes only allow a charge to earnings if a receivable is deemed legally uncollectible.

In a jurisdiction where tax law does not apply the same criteria to bad debts as IFRS and US GAAP, the issue of deferred tax will need to be addressed.

For example:

12/31/X1, XYZ’s net trade receivable balance was 1,086,312.

For IFRS | US GAAP purposes, it estimated uncollectible receivable of 32,875.

The income and value added tax rates in XYZ’s jurisdiction are 20% and 21% respectively.

 

Trade Receivables Aging Schedule
Age in days	0 > 30	30 > 60	60 > 90	90 > 180	Over 180	Σ
Balance	1,000,000	60,000	14,400	6,336	5,576	1,086,312
Factor	2.00%	5.00%	20.00%	40.00%	80.00%
Allowance	20,000	3,000	2,880	2,534	4,461	32,875

Dr/Cr

IFRS / US GAAP book: 12/31/X1 / 31.12.X1
Loss on uncollectible receivables		32,875
	Allowance for doubtful accounts		32,875
Deferred income tax: X1		7,956
	Income tax expense		7,956

 

National GAAP book: 12/31/X1 / 31.12.X1
--		--
	--		--

 

In XYZ's jurisdiction, creditors may recognize a tax-deductible expense for uncollectible accounts over a three-year period provided they have initiated formal, legal collection proceedings against the debtor.

If they have not initiated these proceedings, they may only recognize a tax-deductible expense of 20%, unless bankruptcy proceedings against the debtor have been initiated, in which case they may recognize 100%.

VAT remitted to taxation authorities but not collected from the debtor is not generally refundable. In limited circumstances, it is refundable if bankruptcy proceedings against the debtor have been initiated.

In all cases, the measurement basis is the gross invoiced amount including VAT.

To cope with these requirements, XYZ maintains separate accounts for national GAAP purposes.

The national GAAP in XYZ's jurisdiction prescribes a chart of accounts, financial statement formats and accounting procedures that are, in many cases, fundamentally at odds with IFRS | US GAAP guidance.

To cope with the conflicting requirements and avoid potential errors, XYZ employs separate recognition, measurement and disclosure policies for each standard, the optimal approach to dealing with this situation.

Another approach is to maintain one set of accounts and make reconciliations.

However, since this policy opens the door to material errors, it is not recommended by this web site.

As does the hybrid approach of using separate accounts only for those items that are subject to differing IFRS | US GAAP and national GAAP recognition and measurement requirements.

Another option (permissible in some jurisdictions) is to maintain an IFRS book as a primary set of accounts and make adjustments to national GAAP.

As this procedure starts with IFRS , there is little potential for errors so it is not objectionable.

This procedure does, however, open the door to errors in applying the national GAAP.

However, the focus of this web site is not national GAAP, so this issue is not relevant to this discussion.

For companies applying US GAAP outside of the United States, local legislation must explicitly permit reconciling US GAAP to national GAAP for this policy to be appropriate.

2/15/X2, XYZ deemed receivable # 123 for 300 (363 including VAT) to be uncollectible.

IFRS / US GAAP book: 2/15/X2 / 15.2.X2
Allowance for doubtful accounts		300
	Accounts receivable: # 123		300

 

Under IFRS and US GAAP, revenue is measured net of VAT/GST.

IFRS 15.47 | ASC 606-10-32-2: ... The transaction price is the amount of consideration to which an entity expects to be entitled in exchange for transferring promised goods or services to a customer, excluding amounts collected on behalf of third parties (for example, some sales taxes). ...

A separate example, including a discussion of why VAT/GST is a form of sales tax, is provided below.

The same logic should be applied to the associated receivable.

National GAAP book: 2/15/X2 / 15.2.X2
--		--
	--		--

 

During X2, XYZ initiated formal collection proceedings, filing the required legal motions.

National GAAP book: 12/31/X2 to 12/31/X4 / 31.12.X2 to 31.12.X4
558 - Creation and clearing of legal allowances in operating activities		121
	391 - Allowance to receivables: Invoice # 123		121

 

As noted above, in XYZ's tax jurisdiction, companies are allowed to claim a tax deduction over a three-year period provided they initiate formal collection proceedings.

The prescribed national GAAP accounting procedure is to debit account 558 (the "legal" in its title signifies that it is recognizable per tax law) and credit account 391 (which must be associated with the particular receivable by invoice number).

Account 558 is taken to the national GAAP P&L, where it is presented as an expense.

This is done in each of the three years over which the expense may be claimed for tax purposes.

121 = 300 x 1.21 ÷ 3

In XYZ’s tax jurisdiction, while companies cannot claim a refund of the VAT remitted on uncollectible accounts, the gross invoiced amount (including VAT) serves as the measurement basis for this expense.

IFRS / US GAAP book: 12/31/X2 to 12/31/X4 / 31.12.X2 to 31.12.X4
Income tax payable		24
	Deferred income tax: X1		24

 

24 = 363 x 20% ÷ 3

National GAAP book: 12/31/X4 / 31.12.X4
558 - Creation and clearing of legal allowances in operating activities		363
391 - Allowance to receivables: Invoice # 123		363
	558 - Creation and clearing of legal allowances in operating activities		363
	311 - Receivables from business relationships: Invoice # 123		363

 

In the third year, the prescribed national GAAP accounting procedure is to debit account 558 (presented as an expense in the P&L) and also credit account 558 (presented as revenue in the P&L).

The receivable (account 311) is then written off against the allowance (account 391).

Why not simply debit account 391, credit account 311 and omit account 558 altogether?

Besides feeling no need to match the original revenue and expense, XYZ's national GAAP has no qualms with double counting that revenue and expense, even throwing in some tax, just for good measure.

One of the quirks that makes reconciling national GAAP to IFRS  | US GAAP interesting, though not for the timid.

Obviously, as national GAAPs vary by jurisdiction, a detailed discussion of all their quirks is far beyond the scope of this web site.

This is generally accomplished one of two ways:

ASC 326-20-30-3 states: The allowance for credit losses may be determined using various methods. For example, an entity may use discounted cash flow methods, loss-rate methods, roll-rate methods, probability-of-default methods, or methods that utilize an aging schedule...

This guidance, however, applies to financial assets in general.

When it comes to accounts receivable, an aging schedule (a.k.a. provision matrix) is the preferred alternative although the percentage of sales method, mostly do to its relative simplicity, is also popular.

As outlined in IFRS 9.B5.5.35, an entity may, as a practical expedient, use a "provision matrix".

Operationally, a provision matrix works like an aging schedule, even though it includes buckets. This page (link / local link) provides an example.

Note: the term "provision" as used in IFRS 9.B5.5.35 refers to the act of making an adjustment. While clear to English native speakers, non-native speakers occasionally interpret it to mean that a provision, a liability under IAS 37, should be recognized. this is not the case.

For its part, IFRS 9.5.5.17 only requires companies make unbiased, probability-weighted estimates reflecting the time value of money using reasonable and supportable information acquired without undue cost or effort.

Since it does not explicitly single out any particular approach, both the aging schedule and percentage of sales methods would be consistent with this guidance.

Aging-schedule method

12/31/X1, XYZ’s trade receivable balance was 1,086,312.

Using an aging schedule (a.k.a. provision matrix), it estimated uncollectible receivables at 32,875.

As outlined in IFRS 9.B5.5.35, an entity may, as a practical expedient, use a "provision matrix".

Operationally, a provision matrix works like an aging schedule, even though it includes buckets. This page (link / local link) provides an example.

Note: the term "provision" as used in IFRS 9.B5.5.35 refers to the act of making an adjustment. While clear to English native speakers, non-native speakers occasionally interpret it to mean that a provision, a liability under IAS 37, should be recognized. this is not the case.

 

Trade receivables aging schedule: X1
Age in days	0 > 30	30 > 60	60 > 90	90 > 180	Over 180	Σ
X1 Balances	1,000,000	60,000	14,400	6,336	5,576	1,086,312
Factor	2.00%	5.00%	20.00%	40.00%	80.00%
Allowance	20,000	3,000	2,880	2,534	4,461	32,875

 

XYZ based its estimates on its own historical experience.

In evaluating this experience, its accounts receivable manager considered that, over the last three years, 2% of all invoiced amounts had become uncollectible. Of the amounts not collected in 30 days, 5% had become uncollectible. Of the amounts not collected in 60 days, 20% had become uncollectible and so on.

How many periods should be examined when evaluating historical experience is not specified. Three to five years generally lead to acceptably accurate results. However, once a pattern of collectability has been established, the schedule need only be adjusted if it fails to yield acceptably accurate results.

Dr/Cr

12/31/X1 / 31.12.X1
Bad debt expense (loss on uncollectible accounts)		32,875
	Allowance for doubtful accounts		32,875

 

IFRS 15 and ASC 606 both stipulate that uncollectible accounts should be recognized as losses.

IFRS 15.113 (edited, emphasis added): An entity shall disclose ... any impairment losses recognised (in accordance with IFRS 9) on any receivables or contract assets arising from an entity’s contracts with customers, which the entity shall disclose separately from impairment losses from other contracts.

ASC 606-10-50-4 (edited, emphasis added): An entity shall disclose all of the following amounts ... Credit losses recorded (in accordance with Subtopic 326-20 on financial instruments measured at amortized cost) on any receivables or contract assets arising from an entity's contracts with customers, which the entity shall disclose separately from credit losses from other contracts.

This is mirrored in the respective XBRL taxonomies:

ImpairmentLossImpairmentGainAndReversalOfImpairmentLossDeterminedInAccordanceWithIFRS9

ProvisionForDoubtfulAccounts

Note: while US GAAP XBRL presents impairments of receivables separately from other impairments, in IFRS XRBL all impairments made according to IFRS 9 (including receivables) are presented in aggregate.

However, as these losses are recognized at each reporting date, they are generally matched with revenue as if they were expenses.

Further, many companies consider uncollectible accounts be expenses.

The difference between expenses and losses is explored in the Accounting elements section.

Specifically, if a company wants to avoid bad debts, it can sell COD.

Many companies avoid this because the drop in revenue will often more than offset any savings.

For the same reason, they also classify the expense as selling or distribution.

Nevertheless, since both IFRS and US GAAP state that these losses are losses, many companies report them as such.

Consequently, both approaches are encountered in practice (example one, example two).

Note: these annual reports have been copied to a local server to avoid potentially broken links.

Readers are advised to download the originals from the company pages.

Both US GAAP and IFRS require companies to estimate credit losses (doubtful accounts, uncollectible accounts, bad debts) and recognize an allowance whenever there is any indication that a credit loss has occurred.

In other words, if historical experience shows that some accounts become uncollectible every period, an allowance is estimated and recognized in every period.

More importantly, this shall be done on a collective (pool) basis even if individual impaired accounts cannot be identified.

The only real difference between, US GAAP gives more detailed guidance than IFRS .

ASC 326-20-30-1: The allowance for credit losses is a valuation account that is deducted from the amortized cost basis of the financial asset(s) to present the net amount expected to be collected on the financial asset. At the reporting date, an entity shall record an allowance for credit losses on financial assets within the scope of this Subtopic. An entity shall report in net income (as a credit loss expense) the amount necessary to adjust the allowance for credit losses for management's current estimate of expected credit losses on financial asset(s).

The previous guidance on Impairment of Loans and Receivables (ASC 310-10-35-1 to 43) was superseded by Accounting Standards Update No. 2016-13 (ASC 326).

ASC 326-20-30-2 (emphasis added): An entity shall measure expected credit losses of financial assets on a collective (pool) basis when similar risk characteristic(s) exist (as described in paragraph 326-20-55-5). If an entity determines that a financial asset does not share risk characteristics with its other financial assets, the entity shall evaluate the financial asset for expected credit losses on an individual basis. If a financial asset is evaluated on an individual basis, an entity also should not include it in a collective evaluation. That is, financial assets should not be included in both collective assessments and individual assessments.

ASC 326-20-30-3: The allowance for credit losses may be determined using various methods. For example, an entity may use discounted cash flow methods, loss-rate methods, roll-rate methods, probability-of-default methods, or methods that utilize an aging schedule. An entity is not required to utilize a discounted cash flow method to estimate expected credit losses. Similarly, an entity is not required to reconcile the estimation technique it uses with a discounted cash flow method.

ASC 326-20-35-1: At each reporting date, an entity shall record an allowance for credit losses on financial assets (including purchased financial assets with credit deterioration) within the scope of this Subtopic. An entity shall compare its current estimate of expected credit losses with the estimate of expected credit losses previously recorded. An entity shall report in net income (as a credit loss expense or a reversal of credit loss expense) the amount necessary to adjust the allowance for credit losses for management's current estimate of expected credit losses on financial asset(s). The method applied to initially measure expected credit losses for the assets included in paragraph 326-20-30-14 generally would be applied consistently over time and shall faithfully estimate expected credit losses for financial asset(s).

Writeoffs and Recoveries of Financial Assets

ASC 326-20-35-8: Writeoffs of financial assets, which may be full or partial writeoffs, shall be deducted from the allowance. The writeoffs shall be recorded in the period in which the financial asset(s) are deemed uncollectible. Recoveries of financial assets and trade receivables previously written off shall be recorded when received.

IFRS 15: Simplified approach for trade receivables, Contract assets and lease receivables

IFRS 15.5.5.15: Despite paragraphs 5.5.3 and 5.5.5, an entity shall always measure the loss allowance at an amount equal to lifetime expected credit losses for:

IFRS 9.5.3: ... at each reporting date, an entity shall measure the loss allowance for a financial instrument at an amount equal to the lifetime expected credit losses if the credit risk on that financial instrument has increased significantly since initial recognition.

IFRS 9.5.5.5 ... at the reporting date, the credit risk on a financial instrument has not increased significantly since initial recognition, an entity shall measure the loss allowance for that financial instrument at an amount equal to 12-month expected credit losses.

(a) trade receivables or Contract assets that result from transactions that are within the scope of IFRS 15, and that:

     (i) do not contain a significant financing component in accordance with IFRS 15 (or when the entity applies the practical expedient in accordance with paragraph 63 of IFRS 15); or

     (ii) contain a significant financing component in accordance with IFRS 15, if the entity chooses as its accounting policy to measure the loss allowance at an amount equal to lifetime expected credit losses. That accounting policy shall be applied to all such trade receivables or Contract assets but may be applied separately to trade receivables and Contract assets.

(b) lease receivables that result from transactions that are within the scope of IFRS 16, if the entity chooses as its accounting policy to measure the loss allowance at an amount equal to lifetime expected credit losses. That accounting policy shall be applied to all lease receivables but may be applied separately to finance and operating lease receivables.

1/16/X2, XYZ determined that it had no reasonable expectations of recovering receivable #123 for 300 from ABC.

In other words, the receivable had become uncollectible.

1/16/X2 / 16.1.X2
Allowance for doubtful accounts		300
	Trade receivable: ABC: 123		300

 

ASC 326-20-35-8: Writeoffs of financial assets, which may be full or partial writeoffs, shall be deducted from the allowance. The writeoffs shall be recorded in the period in which the financial asset(s) are deemed uncollectible. Recoveries of financial assets and trade receivables previously written off shall be recorded when received.

IFRS 9.5.4.4: An entity shall directly reduce the gross carrying amount of a financial asset when the entity has no reasonable expectations of recovering a financial asset in its entirety or a portion thereof. ...

Note, even though paragraph 5.4.4 states "directly reduce", this should not be intenerated to mean that an allowance is not necessary, since paragraph 5.5.15 specifies that an allowance is necessary.

IFRS 9.5.5.15 ... an entity shall always measure the loss allowance at an amount equal to lifetime expected credit losses for: (a) trade receivables or contract assets that result from transactions that are within the scope of IFRS 15 ...

1/24/X2, XYZ determined that receivable #456 for 750 from DEF was impaired.

1/24/X2 / 24.1.X2
Allowance for doubtful accounts		750
	Trade receivable: DEF: 456		750

 

etc.

Even though it had been written off on 1/16/X2, receivable #123 was collected on 20/6/X2.

Dr/Cr

XYZ reversed the write-off.

6/20/X2 / 20.6.X2
Trade receivable: ABC: 123		300
	Allowance for doubtful accounts		300
Cash		300
	Trade receivable: ABC: 123		300
	Alternatively
	Alternatively

 

Although a reversal is clearly the best procedure, crediting the recovery to the allowance account is not inconsistent with the guidance.

ASC 326-20-35-8: Writeoffs of financial assets, which may be full or partial writeoffs, shall be deducted from the allowance. The writeoffs shall be recorded in the period in which the financial asset(s) are deemed uncollectible. Recoveries of financial assets and trade receivables previously written off shall be recorded when received.

ASC 326-20-35-9: Practices differ between entities as some industries typically credit recoveries directly to earnings while financial institutions typically credit the allowance for credit losses for recoveries. The combination of this practice and the practice of frequently reviewing the appropriateness of the allowance for credit losses results in the same credit to earnings in an indirect manner.

As IFRS guidance is less detailed than US GAAP, it does not specifically address the procedure that should be used to recognize recoveries.

However, since the above is not disallowed, it is allowed.

Nevertheless, it is not recommended by this web site.

Cash		300
	Allowance for doubtful accounts		300

 

Similarly, crediting recoveries directly to earnings (presumably as gain) is downright ugly accounting and highly unrecommended by this web site.

Cash		300
	Gain (recovered uncollectible accounts)		300

Voiding entries, common procedure under some national GAAPs, while not explicitly disallowed, are :-(

Allowance for doubtful accounts		(300)
	Trade receivable: ABC: 123		(300)
Cash		300
	Trade receivable: ABC: 123		300

During X2, receivables with a total carrying value of 30,417 were written off leaving a 2,458 balance on the allowance account.

Dr/Cr

As this balance (at 7.48%) was deemed to be insignificant (less than 10%), XYZ simply re-used the X1 uncollectability estimates.

 

Trade Receivables Aging Schedule: X2
Age in days	0 > 30	30 > 60	60 > 90	90 > 180	Over 180	Σ
X2 Balances	1,100,000	66,000	15,840	6,970	6,133	1,194,943
Factor	2.00%	5.00%	20.00%	40.00%	80.00%
Allowance	22,000	3,300	3,168	2,788	4,907	36,162

12/31/X2 / 31.12.X2
Loss on uncollectible receivables		33,704
	Allowance for doubtful accounts		33,704

 

33,704 = 36,162 - 2,458

Same facts except only 23,899 was written off during X2.

As the difference (8,976) was (at 27.30%) significant, XYZ not only carried forward the balance, but adjusted the collectability assessment to reflect its new experience.

 

Trade Receivables Aging Schedule: X2
Age in days	0 > 30	30 > 60	60 > 90	90 > 180	Over 180	Σ
X2 Balances	1,100,000	66,000	15,840	6,970	6,133	1,194,943
Factor	1.50%	3.00%	14.00%	25.00%	60.00%
Allowance	16,500	1,980	2,218	1,742	3,680	26,120

 

While an annual adjustment is generally sufficient, the schedule should also be adjusted in any interim period where it becomes evident that the collectability of receivables has significantly changed.

12/31/X2 / 31.12.X2
Loss on uncollectible receivables		17,144
	Allowance for doubtful accounts		17,144

 

17,144 = 26,120 - (32,875 - 23,899)

 

Same facts except only 5,000 was written off during X2.

The difference was not only material but also due to a misuse of facts, so XYZ corrected the prior period.

IAS 8 (definitions): Prior period errors are omissions from, and misstatements in, the entity’s financial statements for one or more prior periods arising from a failure to use, or misuse of, reliable information that:

(a) was available when financial statements for those periods were authorised for issue; and

(b) could reasonably be expected to have been obtained and taken into account in the preparation and presentation of those financial statements. Such errors include the effects of mathematical mistakes, mistakes in applying accounting policies, oversights or misinterpretations of facts, and fraud. ASC 250-10

ASC 250-10-20: An error in recognition, measurement, presentation, or disclosure in financial statements resulting from mathematical mistakes, mistakes in the application of generally accepted accounting principles (GAAP), or oversight or misuse of facts that existed at the time the financial statements were prepared. A change from an accounting principle that is not generally accepted to one that is generally accepted is a correction of an error.

12/31/X2 / 31.12.X2 correction of error: 12/31/X1 / 31.12.X1
Allowance for doubtful accounts		32,875
	Loss on uncollectible receivables		32,875
Loss on uncollectible receivables		5,000
	Allowance for doubtful accounts		5,000

 

IAS 8.42 ... an entity shall correct material prior period errors retrospectively in the first set of financial statements authorised for issue after their discovery by:

(a) restating the comparative amounts for the prior period(s) presented in which the error occurred; or ...

ASC 250-10-45-23: Any error in the financial statements of a prior period discovered after the financial statements are issued or are available to be issued (as discussed in Section 855-10-25) shall be reported as an error correction, by restating the prior-period financial statements. ...

Percentage of sales method

During X1, XYZ sold goods worth 13,035,744 on credit.

Applying a factor of 0.252%, it estimated uncollectible receivables at 32,875.

The aging schedule method is superior because leads to better results.

In practice, a simple percentage of receivables method is also occasionally used.

However, this method is so unreliable that no example of how it should be applied is presented.

Its additional advantage is that it is specifically mentioned in the guidance.

ASC 326-20-30-3: The allowance for credit losses may be determined using various methods. For example, ... aging schedule. ...

Since ASC 326 deals with more than just trade receivables, paragraph 30-3 gives more guidance than needed for just trade receivables.

ASC 326-20-30-3: The allowance for credit losses may be determined using various methods. For example, an entity may use discounted cash flow methods, loss-rate methods, roll-rate methods, probability-of-default methods, or methods that utilize an aging schedule. An entity is not required to utilize a discounted cash flow method to estimate expected credit losses. Similarly, an entity is not required to reconcile the estimation technique it uses with a discounted cash flow method.

It also mentions loss-rate methods (commonly used by insurance providers), roll-rate methods (credit card issuers) and probability-of-default methods (banks).

As IFRS provides less procedural guidance than US GAAP, it does not give any examples of the methods that should be used to determine expected credit losses.

Simplified approach for trade receivables, contract assets and lease receivables

IFRS 15.5.5.15: Despite paragraphs 5.5.3 and 5.5.5, an entity shall always measure the loss allowance at an amount equal to lifetime expected credit losses for:

IFRS 9.5.3: ... at each reporting date, an entity shall measure the loss allowance for a financial instrument at an amount equal to the lifetime expected credit losses if the credit risk on that financial instrument has increased significantly since initial recognition.

IFRS 9.5.5.5 ... at the reporting date, the credit risk on a financial instrument has not increased significantly since initial recognition, an entity shall measure the loss allowance for that financial instrument at an amount equal to 12-month expected credit losses.

(a) trade receivables or contract assets that result from transactions that are within the scope of IFRS 15, and that:

    (i) do not contain a significant financing component in accordance with IFRS 15 (or when the entity applies the practical expedient in accordance with paragraph 63 of IFRS 15); or

    (ii) contain a significant financing component in accordance with IFRS 15, if the entity chooses as its accounting policy to measure the loss allowance at an amount equal to lifetime expected credit losses. That accounting policy shall be applied to all such trade receivables or contract assets but may be applied separately to trade receivables and contract assets.

(b) lease receivables that result from transactions that are within the scope of IFRS 16, if the entity chooses as its accounting policy to measure the loss allowance at an amount equal to lifetime expected credit losses. That accounting policy shall be applied to all lease receivables but may be applied separately to finance and operating lease receivables.

The percentage of sales method is thus not recommended by this web site, even though it is common in practice.

32,875 = 13,035,744 x 0.25219%

Dr/Cr

12/31/X1 / 31.12.X1
Bad debt expense (loss on uncollectible accounts)		32,875
	Allowance for doubtful accounts		32,875

 

IFRS 15 and ASC 606 both stipulate that uncollectible accounts should be recognized as losses.

IFRS 15.113 (edited, emphasis added): An entity shall disclose ... any impairment losses recognised (in accordance with IFRS 9) on any receivables or contract assets arising from an entity’s contracts with customers, which the entity shall disclose separately from impairment losses from other contracts.

ASC 606-10-50-4 (edited, emphasis added): An entity shall disclose all of the following amounts ... Credit losses recorded (in accordance with Subtopic 326-20 on financial instruments measured at amortized cost) on any receivables or contract assets arising from an entity's contracts with customers, which the entity shall disclose separately from credit losses from other contracts.

This is mirrored in the respective XBRL taxonomies:

ImpairmentLossImpairmentGainAndReversalOfImpairmentLossDeterminedInAccordanceWithIFRS9

ProvisionForDoubtfulAccounts

Note: while US GAAP XBRL presents impairments of receivables separately from other impairments, in IFRS XRBL all impairments made according to IFRS 9 (including receivables) are presented in aggregate.

However, as these losses are recognized at each reporting date, they are generally matched with revenue as if they were expenses.

Further, many companies consider uncollectible accounts be expenses.

The difference between expenses and losses is explored in the Accounting elements section.

Specifically, if a company wants to avoid bad debts, it can sell COD.

Many companies avoid this because the drop in revenue will often more than offset any savings.

For the same reason, they also classify the expense as selling or distribution.

Nevertheless, since both IFRS and US GAAP state that these losses are losses, many companies report them as such.

Consequently, both approaches are encountered in practice (example one, example two).

Note: these annual reports have been copied to a local server to avoid potentially broken links.

Readers are advised to download the originals from the company pages.

During X2, it actually wrote off receivables of 35,875. To reflect this, it adjusted the factor to 0.275%.

The procedure for writing off individual receivables is the same as in the above example.

0.275% = 35,875 ÷ 13,045,635.

The factor should be re-examined each period, adjusted to reflect the actual uncollectible accounts from the previous period. Unless the situation begins to change significantly, an annual adjustment should be sufficient to prevent materially inaccurate results.

Its X2 sales were 14,340,000.

12/31/X2 / 31.12.X2
Loss on uncollectible receivables		39,435
	Allowance for doubtful accounts		39,435

 

39,435 = 14,340,000 x 0.275%