Accounting for non-cash consideration and payments to customers when recognising revenue

In the April 2018 edition of Accounting News we discussed the five step model for revenue recognition introduced by IFRS 15 Revenue from Contracts with Customers:

Step 1 Identify the contract(s) with the customer
Step 2 Identify the performance obligations in the contract
Step 3 Determine the transaction price
Step 4 Allocate the transaction price to the performance obligations
Step 5 Recognise revenue when a performance obligation is satisfied

Since then we have included a number of articles on IFRS 15 in Accounting News:

  • In the May and June 2018 editions we examined the first step of the five step process in greater depth
  • In the July and September 2018 editions we looked at the complexities of the second step of the five step process
  • In the November 2018 and February 2019 and March 2019 editions we looked at the third step of the five step process. 

In this article, we conclude our examination of step three of the IFRS 15 five step model.

Determining the transaction price in a contract with a customer

As outlined in more detail in the November 2018 edition of Accounting News, 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’.

The consideration promised in a contract with a customer may include fixed amounts, variable amounts, or both. When determining the transaction price, the entity needs to consider the effects of all of the following:

  • Variable consideration
  • The existence of a significant financing component in the contract
  • Non-cash consideration, and
  • Consideration payable to a customer.

Non-cash consideration

Although it is unusual to see non-cash consideration in contracts with customers, it does exist.

Where the transaction price in a contract with a customer includes non-cash consideration, the entity must measure that non-cash consideration at fair value.  If the fair value of the non-cash consideration cannot be reasonably estimated, the entity must measure it indirectly, by reference to the stand-alone selling price of the goods or services promised to the customer in exchange for the consideration.

The following example, taken from Illustrative Example 31 accompanying IFRS 15, illustrates the manner in which non-cash consideration is accounted for.

Example

Company A enters into a contract with a customer to provide a weekly payroll service for one year. The contract is signed on 1 January 2018 and work begins immediately.

Each week the same service is performed.  For reasons that we will examine more fully when we look at step five in the five step IFRS 15 revenue recognition model, this means that Company A should recognise the contract revenue on a straight line basis over the 52 weeks in the one-year contract period.

In exchange for Company A’s service, the customer promises 100 shares of its common stock per week of service (a total of 5,200 shares for the 52-week contract). The terms of the contract require the shares to be paid upon the successful completion of each week of service.
Assume that the share price at the end of week in January 2018 is as follows:

  • Week 1                  $10
  • Week 2                  $11
  • Week 3                  $12
  • Week 4                  $13.
To determine the transaction price (and the amount of revenue to be recognised), Company A must measure the fair value of the 100 shares that it receives upon completion of each weekly service. Company A must not reflect any subsequent changes in the fair value of the shares received (or receivable) in revenue.

The journal entries to recognise revenue in January 2018 are as follows:

Week 1

 

Dr
($)

Cr
($)

Shares

1,000

 

Revenue

 

1,000

Week 2

 

Dr
($)
Cr
($)
Shares 1,100  
Revenue   1,100

Week 3

 

Dr
($)
Cr
($)
Shares 1,200  
Revenue   1,200

Week 4

 

Dr
($)

Cr
($)

Shares

1,300

 

Revenue

 

1,300

A similar pattern of weekly journals will be processed for the remaining 48 weeks of the contract.

As noted above, Company A must not reflect any subsequent changes in the fair value of the shares received (or receivable) in revenue. Instead, any fair value changes on the share investments are recognised in profit or loss or other comprehensive income, depending on how Company A classifies such equity investments.

Consideration payable to a customer

Consideration payable to a customer includes:

  • Cash amounts that the entity pays, or expects to pay, to the customer (or to other parties that purchase the entity’s goods or services from the customer)
  • Credit or other items (for example, a coupon or voucher) that can be applied against amounts owed to the entity (or to other parties that purchase the entity’s goods or services from the customer).
Consideration payable to a customer is accounted for 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.

Payment for a distinct good or service

If consideration payable to a customer is a payment for a distinct good or service from the customer, then the entity must account for the purchase of the good or service separately in the same way that it accounts for other purchases from suppliers. 

If the amount of consideration payable to the customer exceeds the fair value of the distinct good or service that the entity receives from its customer, the entity must account for the excess as a reduction of the transaction price.

If the entity cannot reasonably estimate the fair value of the good or service received from its customer (that is not a distinct good or service), it must account for all of the consideration payable to the customer as a reduction of the transaction price.

Reduction in transaction price

If consideration payable to a customer is accounted for as a reduction of the transaction price, the entity must recognise the reduction of revenue when (or as) the later of either of the following events occurs:

  • The entity recognises revenue for the transfer of the related goods or services to the customer, or
  • The entity pays, or promises to pay, the consideration (even if the payment is conditional on a future event) – note that the promise to pay might be implied by the entity’s customary business practices.

The following example, taken from Illustrative Example 32 accompanying IFRS 15, illustrates the manner in which consideration payable to a customer is accounted for.

Example

Company B manufactures a food product.  It enters into a one-year contract to sell goods to a customer that is a nationwide chain of supermarkets.

The supermarket chain commits to buy at least $15 million of products during the year.

The contract also requires Company B to make a non-refundable payment of $1.5 million to the supermarket chain at the inception of the contract (the payment will compensate the supermarket chain for the changes it needs to make to its shelving to accommodate Company B’s products). 

Company B sells $2 million of goods to the supermarket chain in the first month of the contract. 

As Company B does not obtain control of any rights to the supermarket chain’s shelves, it concludes that the payment to the supermarket chain is not in exchange for a distinct good or service that is being provided by the supermarket chain.  Company B therefore determines that the $1.5 million payment is a reduction of the transaction price.

As Company B transfers goods to the customer, it must reduce the transaction price for each good by 10% ($1.5 million/$15 million). Therefore, in the first month of the contract, Company B must recognise revenue of $1.8 million, which is the $2 million invoiced less $0.2 million (for the consideration payable to the supermarket chain, calculated as 10% of the $2 million of goods sold). 

The journal entries to record the above in the books of Company B are illustrated below:

Payment to supermarket

 

Dr
($)
Cr
($)
Prepayment (reduction in revenue) 1,500,000  
Cash   1,500,000

Revenue for Month 1

 

Dr
($)
Cr
($)
Cash 2,000,000  
Revenue   1,800,000
Prepayment   200,000

Concluding thoughts

As we have seen in our recent articles on Step three of the five-step IFRS 15 revenue recognition model, the transaction price is impacted upon by the effects of variable consideration, the existence of a significant financing component in the contract, non-cash consideration and consideration payable to a customer.  Accurate determination of the transaction price therefore requires finance teams to have an in-depth understanding of the contractual terms that are common in their industry and the specific contracts that their sales staff enter into with customers.