2.1.1 Combining contracts

IFRS 15 provides more stringent requirements on when to combine contracts than the requirements in the superseded IFRSs. IAS 11 (superseded) allowed an entity to combine contracts with several customers, provided the relevant criteria for combination were met. In contrast, the contract combination requirements in IFRS 15 only apply to contracts with the same customer or related parties of the customer. Unlike IFRS 15, IAS 11 (superseded) did not require that contracts be entered into at or near the same time.

Overall, the criteria are generally consistent with the underlying principles in the superseded IFRSs on combining contracts. However, IFRS 15 explicitly requires an entity to combine contracts if one or more of the criteria in IFRS 15 are met.

2.1.2 Contract modification

The requirement in IFRS 15 to determine whether to treat a change in contractual terms as a separate contract or a modification to an existing contract is similar to the requirements in IAS 11 (superseded) for construction contracts. In contrast, IAS 18 (superseded) did not provide detailed application guidance on how to determine whether a change in contractual terms should be treated as a separate contract or a modification to an existing contract. Despite there being some similarities to superseded IFRSs, the requirements in IFRS 15 for contract modifications are much more detailed.

2.1.3 Customer options

Section 23 or the superseded IFRSs did not provide application guidance on how to distinguish between an option and a marketing offer (i.e. as an expense). Nor did they address how to account for options that provide a material right. IFRS 15 requires on the amount of the transaction price to be allocated to the customer option. IFRS 15 includes a requirement to identify and allocate contract consideration to an option (that has been determined to be a performance obligation) on a relative stand-alone selling price basis.

2.1.4 Sale with a right of return

IFRS 15 is not expected to materially change the net impact of arrangements involving sale of products with a right of return. However, there may be some differences as Section 23 or IAS 18 (superseded) did not specify the presentation of a refund liability or the corresponding debit. IFRS 15 requires that a return asset be recognised in relation to the inventory that may be returned. In addition, the refund liability is required to be presented separately from the corresponding asset (i.e. on a gross basis, rather than a net basis).

2.1.5 Variable consideration

Under Section 23 and superseded IFRSs, preparers often deferred measurement of variable consideration until revenue was reliably measurable, which could be when the uncertainty is removed or when payment is received. Furthermore, superseded IFRSs permitted recognition of contingent consideration, but only if it was probable that the economic benefits associated with the transaction would flow to the entity and the amount of revenue could be reliably measured. Some entities, therefore, deferred recognition until the contingency was resolved. In contrast, the constraint on variable consideration in IFRS 15 is an entirely new way of evaluating variable consideration and is applicable to all types of variable consideration in all transactions.

2.1.6 Revenue recognised over time

Under IFRS 15, for each performance obligation identified in the contract, an entity is required to consider at contract inception whether it satisfies the performance obligation over time (i.e. whether it meets one of the three criteria for over-time recognition) or at a point in time. This evaluation requires entities to perform analyses that might differ from Section 23 or superseded IFRSs. For example, entities that enter into contracts to construct real estate for a customer no longer need to determine whether the contract either meets the definition of a construction contract (in order to apply Section 23 or superseded IAS 11) or is for the provision of services (under superseded IAS 18) so as to recognise revenue over time. Instead, under IFRS 15, an entity needs to determine whether its performance obligation is satisfied over time by evaluating the three criteria for over-time recognition. If an entity does not satisfy a performance obligation over time, the performance obligation is satisfied at a point in time.

2.1.7 Licences of intellectual properties

IFRS 15 provides more detailed application guidance than the superseded IFRSs for recognising revenue from licences of intellectual property that differs in some respects from the requirements for other promised goods or services.

Revenue recognition under IFRS 15 depends on the classification of licences. According to IFRS 15, a licence provides either (i) A right to access the entity's intellectual property throughout the licence period, which results in revenue that is recognised over time or (ii) A right to use the entity's intellectual property as it exists at the point in time in which the licence is granted, which results in revenue that is recognised at a point in time.

2.1.8 Warranties

IFRS 15 provides more detailed guidance on accounting for warranties than Section 23 or IAS 18 (superseded). Under IFRS 15, warranties are classified either as assurance-type warranties or as service-type warranty. The requirements for assurance-type warranties are essentially the same as the in practice IAS 18 (superseded). The requirements for service-type warranties may differ, particularly in relation to the amount of transaction price that is allocated to the warranty performance obligation. Under Section 23 and IAS 18 (superseded), entities that provided separate extended warranties often defer an amount equal to the stated price of the warranty and recorded that amount as revenue evenly over the warranty period. IFRS 15 requires an entity to defer an allocated amount, based on a relative stand-alone selling price allocation.

2.1.9 Contract costs

IFRS 15 represents a significant change in practice for entities that previously expensed the costs of obtaining a contract and are required to capitalise them under IFRS 15. Entities need to evaluate all sales commissions paid to employees and capitalise any costs that are incremental, regardless of how directly involved the employee was in the sales process or the level or title of the employee.

In addition, this may be a change for entities that previously capitalised costs to obtain a contract, particularly if the amounts capitalised were not incremental and, therefore, would not be eligible for capitalisation under IFRS 15, unless explicitly chargeable to the customer regardless of whether the contract is obtained.

2.1.10 Presentation and disclosures

IFRS 15 provides explicit presentation and disclosure requirements that are more detailed than under Section 23 or superseded IFRSs. Key areas that could be impacted with presentation and disclosure requirements in IFRS 15 include, but are not limited to, the following:

• disaggregation of revenue;
• contract balances;
• performance obligations;
• significant judgement;
• assets recognised from the costs to obtain or fulfil a contract; and
• accounting policy disclosures.

3.2.1 Discounts, rebates and sales incentives

Where an entity provides sales incentives to a customer when entering into a contract, these are usually treated as rebates and will be included in the measurement of (i.e. deducted from) revenue when the goods are delivered or services provided.

Where the incentive is in the form of cash, revenue will be recognised at a reduced amount taking into account the rebate factor from the cash incentive.

Prompt settlement discounts (for example, customers are offered a reduction of 5% of the selling price for paying an invoice within 7 days instead of the usual 60 days) should be estimated at the time of sale and deducted from revenues.

Non-cash incentives take a variety of forms. Where the seller provides ‘free postage’ this would impose an additional cost on the entity but would not impact revenue. However, where the seller provides free delivery and undertakes this service itself, this would either be a separate component of a multiple element transaction to which some of the transaction price should be allocated (see 3.3.1 below), or more commonly, where risks and rewards of the goods are not transferred to the customer until delivery, the total revenue will not be recognised until that point.

Non-cash incentives may comprise products or services from third parties. If these are provided as part of a sales transaction they will represent separate components of a multiple element transaction to which revenue must be attributed. The seller will need to determine whether they are acting as an agent or principal for that element of the transaction. If the seller is acting as agent and has no further obligations in respect of that component, then it will immediately recognise the margin on that element as its own revenue. If acting as principal, it will recognise the full transaction price as revenue but it will need to defer any element that relates to the provision of the good or service by the third party if that party still needs to provide that good or service (for example where the incentive is in the form of a voucher that is redeemable by the third party at a later date). Principal versus agent and multiple element arrangements are discussed in further detail below at 3.2.2 and 3.3 respectively.

Some of these non-cash incentives e.g. money off vouchers, air miles or loyalty cards, may fall under the scope of loyalty awards which is discussed at 3.3.2 below.

3.2.2 Principal versus agent

An entity shall include in revenue only the gross inflows of economic benefits received and receivable by the entity on its own account and not the revenue collected on behalf of any third parties. If the entity is an agent, it shall include in revenue only the amount of its commission as any amounts collected on behalf of the principal are not revenue of the entity. [FRS 102.23.4].

FRS 102 provides the following definitions for identifying whether an entity is acting as principal or agent.

‘An entity is acting as a principal when it has exposure to the significant risks and rewards associated with the sale of goods or the rendering of services. Features that indicate that an entity is acting as a principal include:

• the entity has the primary responsibility for providing the goods or services to the customer or for fulfilling the order, for example by being responsible for the acceptability of the products or services ordered or purchased by the customer;
• the entity has inventory risk before or after the customer order, during shipping or on return;
• the entity has latitude in establishing prices, either directly or indirectly, for example by providing additional goods or services; and
• the entity bears the customer's credit risk for the amount receivable from the customer.’ [FRS 102.23A.38, Appendix I].

‘An entity is acting as an agent when it does not have exposure to the significant risks and rewards associated with the sale of goods or the rendering of services. One feature indicating that an entity is acting as an agent is that the amount the entity earns is predetermined, being either a fixed fee per transaction or a stated percentage of the amount billed to the customer.’ [FRS 102.23A.39, Appendix I].

Further guidance, added by the Triennial review 2017, is provided in the Appendix to Section 23 which notes that determining whether an entity is acting as a principal or as an agent requires judgement and consideration of all relevant facts and circumstance. [FRS 102.23A.37].

When an entity has entered into a contract as an undisclosed agent, it is normally acting as principal. [FRS 102.23A.40].

Amounts collected by an agent on behalf of a principal are not revenue for the agent. Instead, revenue for the agent is the amount of commission. [FRS 102.23A.41].

3.2.3 Deferred payments

If the consideration receivable from the sale of goods or services is deferred, and the arrangement is in effect a financing transaction, the fair value of the consideration is the present value of all the future receipts calculated using an imputed rate of interest. Examples of a financing transaction are when an entity provides interest-free credit to the buyer or the entity accepts a note receivable bearing a below-market interest rate from the buyer as consideration.

Section 23 sets out two methods to arrive at the appropriate rate of interest. The imputed rate of interest is, depending on which is the more clearly determinable, either:

• the prevailing rate for a similar instrument of an issuer with a similar credit rating; or
• a rate of interest that discounts the nominal amount of the instrument to the current cash sales price of the goods or services. [FRS 102.23.5].

The difference between the nominal amount of the consideration and the present value of all future receipts is recognised as interest revenue using the effective interest method. [FRS 102.23A.13].

3.2.4 Exchanges of goods and services

Entities may enter into transactions which involve exchanging or the swapping of goods or services, also known as barter transactions. An example is the exchange of commodities such as oil or milk where suppliers exchange inventories in different locations to fulfil demand. Other examples include exchanges of capacity in the telecommunications sector and barter of advertising services.

An entity shall not recognise revenue if: [FRS 102.23.6]

• the entity exchanges goods or services for goods and services that are of a similar nature and value; or
• the transaction lacks commercial substance even if the goods or services are dissimilar.

Hence an entity shall recognise revenue from the exchange of goods or services for dissimilar goods or services as long as the transaction has commercial substance. The entity shall then measure the transaction at: [FRS 102.23.7]

• the fair value of the goods or services received adjusted by the amount of any cash or cash equivalents transferred; or
• if the above cannot be measured reliably, at the fair value of the goods or services given up adjusted by the amount of any cash or cash equivalents transferred; or
• if the fair value of neither the goods or services received nor the goods or services given up can be measured reliably, then revenue is recognised at the carrying amount of the goods or services given up adjusted by the amount of any cash or cash equivalents transferred.

3.3.1 Separately identifiable components

The revenue recognition criteria in Section 23 are usually applied separately to each transaction. However, if there are ‘separately identifiable components’ of a single transaction, the revenue recognition criteria will be applied to each component to reflect the substance of the transaction. Entities should analyse the transactions in accordance with their economic substance to determine whether there are separately identifiable components and whether they should be combined or separated for revenue recognition purposes. In assessing whether there are separately identifiable components, an entity should consider whether it has in the past sold the individual components separately or plans to do so in the future. However, absent such evidence, the components may still be deemed to be separately identifiable if the individual components are sold separately by others in the market.

For example, if the sale of a product included an identifiable amount for subsequent servicing, the entity would apply the recognition criteria to the separately identifiable components i.e. the sale of the product and the sale of the servicing element. [FRS 102.23.8]. The Appendix to Section 23 includes an example which sets out that the seller defers the identifiable amount for subsequent servicing and recognises it as revenue over the period the service is performed. The amount that is deferred will cover the expected costs of the services together with a reasonable profit on those services. [FRS 102.23A.19]. Section 23 does not explain what constitutes a ‘reasonable profit’.

If two or more transactions are linked in such a way that the commercial effect cannot be understood without reference to the series of transactions as whole, then the recognition criteria would be applied to the linked transactions together. For example, if an entity sells goods and at the same time enters into a separate agreement to repurchase the goods at a later date, the entity would apply the recognition criteria to the two transactions together. [FRS 102.23.8].

The basic principle for measurement of revenue under FRS 102 requires that revenue is measured at its fair value. Therefore, the separately identifiable components should be recorded at their fair value. However a contract with multiple elements may have a contract fair value that is lower than the aggregate of the fair values of the separately identifiable components. The difference between these two fair values should be allocated to the separable identifiable components, using an appropriate allocation method.

FRS 102 does not provide additional guidance in identifying the separate components of a transaction and how revenue should be allocated to these components. An allocation of revenue based on relative fair values would be considered an appropriate basis but this is not an explicit requirement of FRS 102 and other bases may be appropriate. As such, an entity must use its judgement to select the most appropriate methodology, taking into consideration all relevant facts and circumstances.

See 3.5 below for discussion on accounting for revenue from rendering of services. Some of the practical implementation issues in accounting for revenue on the separation (unbundling) and linking (bundling) of contractual arrangements, including accounting for contracts that include the receipt of initial fees are discussed at 4 below.

3.3.2 Loyalty awards

An entity may grant its customers a loyalty award, as part of a sales transaction, that the customer may redeem in the future for free or discounted goods or services. For example, money-off vouchers, air miles offered by airlines and retail stores that provide loyalty cards used to earn points as purchases are made, which can be used against future purchases. The award credit shall be accounted for as a separately identifiable component of the initial sales transaction, as discussed at 3.3.1 above. The fair value of the consideration received, or receivable, shall be allocated between the award credits and the other components of the sale. The consideration allocated to the award credits shall be their fair value which is the amount for which the award credits could be sold separately. [FRS 102.23.9].

The appendix to Section 23 provides an example that illustrates how Section 23 may be applied in practice. [FRS 102.23A.16-17].

The example illustrates that a number of factors should be taken into account including:

• the percentage of awards expected to be redeemed;
• the normal selling price of the initial sales of goods or service when the loyalty award is not available; and
• the normal selling price for the goods or service for which the voucher is being offered against.

The entity would then allocate the total consideration received or receivable, between the initial sales goods or service and the award credit according to their relative fair values.

If the sales incentive is in the form of a voucher that is issued independently of a sales transaction (e.g. one that entitles the customer to money off if they choose to make a purchase) there will be no impact on revenue at this time. They also do not give rise to a liability unless the products or services would be sold at a loss, in which case a provision for an onerous contract may be required in accordance with Section 21 – Provisions and Contingencies.

3.4.1 Goods with a right of return

Where an entity sells goods with a right of return, as commonly seen for clothing or on-line retailers, the entity recognises the revenue in full, if the entity can estimate the returns reliably. A provision for the returns would then be recognised against revenue, in accordance with Section 21. [FRS 102.23.13].

If the entity cannot estimate the returns reliably, the revenue is recognised when the shipment has been formally accepted by the buyer or the goods have been delivered and the time period for rejection has elapsed (see 3.4.3(b) below).

3.4.2 ‘Bill and hold’ sales

The term ‘bill and hold’ sale is used to describe a transaction where delivery is delayed at the buyer's request, but the buyer takes title and accepts billing.

Under the guidance provided in the Appendix to Section 23, revenue is recognised when the buyer takes title, provided: [FRS 102.23A.3]

1. it is probable that delivery will be made;
2. the item is on hand, identified and ready for delivery to the buyer at the time the sale is recognised;
3. the buyer specifically acknowledges the deferred delivery instructions; and
4. the usual payment terms apply.

Revenue is not recognised when there is simply an intention to acquire or manufacture the goods in time for delivery.

3.4.3 Goods shipped subject to conditions

The Appendix to Section 23 identifies scenarios where goods are shipped subject to various conditions: [FRS 102.23A.4-7]

1. Installation and inspection
2. Revenue is normally recognised when the buyer accepts delivery, and installation and inspection are complete. Revenue is recognised immediately upon the buyer's acceptance of delivery when:
   1. the installation process is simple in nature, e.g. the installation of a factory-tested television receiver which only requires unpacking and connection of power and antennae; or
   2. the inspection is performed only for purposes of final determination of contract prices, for example, shipments of iron ore, sugar or soya beans.
3. On approval when the buyer has negotiated a limited right of return
4. If there is uncertainty about the possibility of return, revenue is recognised when the shipment has been formally accepted by the buyer or the goods have been delivered and the time period for rejection has elapsed.
5. Consignment sales under which the recipient (buyer) undertakes to sell the goods on behalf of the shipper (seller)
6. Revenue is recognised by the shipper when the goods are sold by the recipient to a third party.
7. Cash on delivery sales
8. Revenue is recognised when delivery is made and cash is received by the seller or its agent.

3.4.4 Layaway sales (goods delivered when final payment made)

The term ‘layaway sales’ applies to transactions where the goods are delivered only when the buyer makes the final payment in a series of instalments. Revenue from such sales is recognised when the goods are delivered. However, when experience indicates that most sales are ultimately completed, revenue may be recognised when a significant deposit is received, provided the goods are on hand, identified and ready for delivery to the buyer. [FRS 102.23A.8].

3.4.5 Payments in advance

In certain sectors, for example, furniture and kitchen retail, payment or partial payment is received from the customer when an order is placed for the goods. This is often well in advance of delivery for goods which are not presently held in inventory, if, for example, the goods are still to be manufactured or will be delivered directly to the customer by a third party. In such cases, revenue is recognised when the goods are delivered to the customer. [FRS 102.23A.9].

In other sectors, for example, utilities, companies receive advance payments from customers for services to be provided in the future. In some cases, these advance payments are long term in nature. The issue that arises is whether or not interest should be accrued on these advances and if so, how revenue should be measured in these circumstances.

Section 23 requires entities to measure revenue ‘at the fair value of the consideration received or receivable’. [FRS 102.23.3]. It also refers to the situations in which an entity either provides interest-free credit to the buyer or accepts a note receivable bearing a below-market interest rate from the buyer as consideration for the sale of goods. If the arrangement effectively constitutes a financing transaction, Section 23 requires that the entity determines the fair value of the consideration by discounting all future receipts using an imputed rate of interest. [FRS 102.23.5]. However, Section 23 does not address the reverse situation of the receipt of interest-free advances from customers. A similar rationale may be applied to justify the accruing of interest, i.e. there is a financing element to the transaction and this must be taken into account, if revenue is to be measured at the fair value of the consideration at the time the good or service is provided.

Given this lack of clarity we believe it is a policy choice under FRS 102 of whether to accrue interest on advance payments received from customers. If interest is accrued it will be calculated based upon the incremental borrowing rate of the entity and revenue will ultimately be recognised based upon the nominal value of the advance payments received from customers plus this accrued interest. Whichever accounting policy is adopted, it should be applied consistently. Alternatively, an entity could apply the guidance in IFRS 15 following the hierarchy in Section 10. IFRS 15 states that an entity should adjust the promised amount of consideration for the effects of the time value of money if the timing of payments agreed to by the parties to the contract (either explicitly or implicitly) provides the customer or the entity with a significant benefit of financing the transfer of goods or services to the customer. [IFRS 15.60]. Accordingly, IFRS 15 clarifies the accounting for significant financing benefit is consistent for both the benefit obtained by the customer and the entity.

3.4.6 Sale and repurchase agreements

Sale and repurchase agreements take many forms: the seller concurrently agrees to repurchase the same goods at a later date, or the seller has a call option to repurchase, or the buyer has a put option to require the repurchase, by the seller, of the goods.

In a sale and repurchase agreement for an asset other than a financial asset, the terms of the agreement need to be analysed to determine whether, in substance, the seller has transferred the risks and rewards of ownership to the buyer hence revenue is recognised. When the seller has retained the risks and rewards of ownership, even though legal title has been transferred, the transaction is a financing arrangement and does not give rise to revenue. [FRS 102.23A.10]. Sale and leaseback arrangements, repurchase agreements and options are discussed in Chapter 18. For a sale and repurchase agreement on a financial asset, the derecognition provisions of Section 11 apply (see Chapter 10 at 9).

3.4.7 Subscriptions to publications

Publication subscriptions are generally paid in advance and are non-refundable. As the publications will still have to be produced and delivered to the subscriber, the subscription revenue cannot be regarded as having been earned until production and full delivery takes place. This is the approach adopted by Section 23, which requires that revenue is recognised on a straight-line basis over the period in which the items are despatched when the items involved are of similar value in each time period. When the items vary in value from period to period, revenue is recognised on the basis of the sales value of the item despatched in relation to the total estimated sales value of all items included in the subscription. [FRS 102.23A.12].

3.4.8 Consignment sales

The Appendix to Section 23 provides examples for consignment sales and sales to intermediate parties. When goods are shipped subject to conditions e.g. consignment sales under which the buyer agrees to sell the goods on behalf of the seller, the seller recognises the revenue only when the goods are sold by the buyer to a third party. [FRS 102.23A.6]. Another example is when sales are made to intermediate parties such as distributors, dealers or others for resale. The seller generally recognises revenue from such sales when the risks and rewards of ownership have been transferred. However, if the buyer is acting, in substance, as an agent, the sale is treated as a consignment sale. [FRS 102.23A.11].

3.5.1 Contingent fee arrangements

When a specific act is much more significant than any other act, the entity shall postpone the recognition of revenue until that significant act is executed. [FRS 102.23.15]. For example, when fees are contingent on the performance of a significant act.

3.6.1 Installation fees

Installation fees are recognised as revenue by reference to the stage of completion of the installation, unless they are incidental to the sale of a product in which case they are recognised when the goods are sold. [FRS 102.23A.18]. However, in certain circumstances where the installation fees are linked to a contract for future services (for example, in the telecommunications industry: see 4.3 below) it may be more appropriate to defer such fees over either the contract period or the average expected life of the customer relationship, depending on the circumstances.

3.6.2 Advertising commissions

Performance of the service is considered as the critical event for the recognition of revenue derived from the rendering of advertising services. Consequently, media commissions are recognised when the related advertisement or commercial appears before the public. Production commissions are recognised by reference to the stage of completion of the project. [FRS 102.23A.20]. Barter transactions involving advertising services are addressed at 3.2.4 above.

3.6.3 Insurance agency commissions

The critical event for the recognition of insurance agency commissions is the commencement or renewal date of the policy. Hence, insurance agency commissions received or receivable which do not require the agent to render further service are recognised as revenue on the effective commencement or renewal dates of the related policies. However, when it is probable that the agent will be required to render further services during the life of the policy, the commission, or part of it, is deferred and recognised as revenue over the period of the policy. [FRS 102.23A.21].

3.6.4 Financial services fees

The recognition of revenue for financial service fees depends on the purpose of the fees and the basis of accounting for any associated financial instrument. The description of the fee may not be indicative of the nature and substance of the services provided therefore entities will need to distinguish the fees that are an integral part of the effective interest rate, fees that are earned over the period the services are provided and fees that are earned on the occurrence of a significant act. [FRS 102.23A.21A].

3.6.5 Admission fees

Admission fees to ‘artistic performances, banquets and other special events’ are recognised when the event takes place. If there is a subscription to a number of events, fees may be allocated on a basis that reflects the extent to which services are performed at each event. [FRS 102.23A.22].

3.6.6 Tuition fees

Tuition fee revenue is recognised over the period of instruction. [FRS 102.23A.23].

3.6.7 Initiation, entrance and membership fees

Revenue recognition depends on the nature of the services provided. If the fee permits membership only, and all other services or products are paid for separately, or if there is a separate annual subscription, the fee is recognised as revenue immediately as long as no significant uncertainty as to its collectability exists. If the fee entitles the member to services or publications to be provided during the membership period, or to purchase goods or services at prices lower than those charged to non-members, it is recognised on a basis that reflects the timing, nature and value of the benefits provided. [FRS 102.23A.24].

3.8.1 Licence fees and royalties

Fees and royalties paid for the use of an entity's assets (such as trademarks, patents, software, music copyright, record masters and motion picture films) are normally recognised in accordance with the substance of the agreement. As a practical matter, this may be on a straight-line basis over the life of the agreement, for example, when a licensee has the right to use certain technology for a specified period of time. [FRS 102.23A.34].

Therefore, under normal circumstances, the accounting treatment of advance royalties or licence receipts is straightforward; under the accruals concept the advance should be treated as deferred income when received, and released to the profit and loss account when earned under the terms of the licence or royalty agreement.

Companies in the media sector often enter into arrangements in which one party receives upfront sums of a similar nature, e.g. a music company may receive fees from another party for content that will be accessed via the internet, e.g. digital downloading or streaming of music. If so, the same considerations apply and revenue will be recognised when earned under the terms of the licence or royalty agreement. Often the terms of such arrangements call for the music company to make its current product (past recordings) available and may also require that the future product be made available to the other party in exchange for an upfront payment (often called a ‘minimum guarantee’) that is recouped against future amounts owed to the music company by the other party. This revenue will generally be recognised over the term of the arrangement. However, in cases where there is no expectation or obligation to provide future content (arrangement is for past recordings only), revenue would generally be recognised by the music company once its product has been made available to the other party. In the latter instance, the arrangement would likely be viewed as an in-substance sale, as discussed below.

Advance receipts may comprise a number of components that may require revenue to be recognised on different bases. Advance royalty or licence receipts have to be distinguished from assignments of rights that are, in substance, sales. The Appendix to Section 23 explains the following:

‘An assignment of rights for a fixed fee or non-refundable guarantee under a non-cancellable contract which permits the licensee to exploit those rights freely and the licensor has no remaining obligations to perform is, in substance, a sale. An example is a licensing agreement for the use of software when the licensor has no obligations subsequent to delivery. Another example is the granting of rights to exhibit a motion picture film in markets where the licensor has no control over the distributor and expects to receive no further revenues from the box office receipts. In such cases, revenue is recognised at the time of sale.’ [FRS 102.23A.35].

Software revenue recognition and the granting of rights to exhibit motion pictures are discussed at 4.2 and 4.5 below respectively, but in-substance sales are not restricted to these sectors. Some arrangements in the pharmaceutical sector can also be accounted for as in-substance sales.

Licence fees or royalties may be receivable only on the occurrence of a future event, in which case revenue will be recognised only when it is probable that the fee or royalty will be received. This is normally when the event has occurred. [FRS 102.23A.36].

3.8.2 Dividends

Dividends are recognised when the shareholder's right to receive payment is established. [FRS 102.23.29(c)].

3.9.1 Differences to IAS 11 (superseded) for construction contracts

Although the construction contracts section of Section 23 is based on IAS 11 (superseded), there are a number of paragraphs of IAS 11 (superseded) which have been omitted from FRS 102. In general these provided further guidance on specific areas.

3.9.2 Whether an arrangement is a construction contract

Determining whether an arrangement is a construction contract is critical as this determines whether revenue is recognised using the percentage of completion method under Section 23. Otherwise revenue is not recognised until the risks and rewards of ownership and control have passed. The definition of a construction contract is at 3.1 above.

The underlying principle of Section 23 is that, once the outcome of a construction contract can be estimated reliably, revenue (and costs) associated with the construction contract should be recognised by reference to the stage of completion of the contract activity at the end of the reporting period. [FRS 102.23.17].

3.9.3 Combination and segmentation of contracts

The requirements in Section 23 should usually be applied separately to each construction contract. However, in order to reflect the substance of the transaction it may be necessary for a contract to be sub-divided and apply Section 23 individually to each component, or to a group of contracts to be treated as one. [FRS 102.23.18]. FRS 102 provides guidance on two separate cases. The first case is where a single contract covers the construction of a number of separate assets, each of which is in substance a separate asset. This would be treated as a separate contract for each asset provided that the following criteria are met: [FRS 102.23.19]

• separate proposals have been submitted for each asset;
• each asset has been subject to separate negotiation, and the contractor and customer are able to accept or reject that part of the contract relating to each asset; and
• the costs and revenues of each asset can be identified.

The second case is effectively the reverse of the first and deals with situations where in substance there is only a single contract with a customer, or a group of customers. A group of contracts should be treated as a single contract where: [FRS 102.23.20]

• the group of contracts is negotiated as a single package;
• the contracts are so closely interrelated that they are, in effect, part of a single project with an overall profit margin; and
• the contracts are performed concurrently or in a continuous sequence.

3.9.4 Contract revenue

FRS 102 does not define what should be included in contract revenue, therefore preparers could refer to the guidance in IAS 11 (superseded). Alternatively, preparers could follow IFRS 15 – see Chapter 28 of EY International GAAP 2019 – for further guidance using the hierarchy in Section 10. Under IAS 11 (superseded) contract revenue comprises the amount of revenue initially agreed by the parties together with any variations, claims and incentive payments as long as it is probable that they will result in revenue and can be measured reliably. It is also worth noting that the overriding principles of Section 23 are that revenue must be able to be reliably measured and that a flow of economic benefits to the entity is probable, and that these are the same principles as noted above in IAS 11 (superseded). Section 23 states that such revenue is to be measured at the fair value of the consideration received and receivable. [FRS 102.23.3]. In this context, measurement of fair value includes the process whereby the consideration is to be revised as events occur and uncertainties are resolved. These may include contractual matters such as increases in revenue in a fixed price contract as a result of cost escalation clauses or, when a contract involves a fixed price per unit of output, contract revenue may increase as the number of units is increased. Penalties for delays may reduce revenue. In addition variations and claims must be taken into account. Variations are instructions by the customer to change the scope of the work to be performed under the contract, including changes to the specification or design of the asset or to the duration of the contract. Variations may only be included in contract revenue when it is probable that the customer will approve the variation and the amount to be charged for it, and the amount can be reliably measured.

Given the extended periods over which contracts are carried out and changes in circumstances prevailing whilst the work is in progress, it is quite normal for a contractor to submit claims for additional sums to a customer. Claims may be made for costs not included in the original contract or arising as an indirect consequence of approved variations, such as customer caused delays, errors in specification or design or disputed variations. Because their settlement is by negotiation (which can in practice be very protracted), they are subject to a high level of uncertainty; consequently, no credit should be taken for these items unless negotiations have reached an advanced stage such that:

• it is probable that the customer will accept the claim; and
• the amount that it is probable will be accepted by the customer can be measured reliably.

This means that, as a minimum, the claims must have been agreed in principle and, in the absence of an agreed sum, the amount to be accrued must have been carefully assessed.

Contracts may provide for incentive payments, for example, for an early completion or superior performance. They may only be included in contract revenue when the contract is at such a stage that it is probable the required performance will be achieved and the amount can be measured reliably.

3.9.5 Contract costs

The Triennial review 2017 clarified that costs that relate directly to a contract and are incurred in securing the contract are also included as part of the contract costs if they can be separately identified and measured reliably and it is probable that the contract will be obtained. When costs incurred in securing a contract are recognised as an expense in the period in which they are incurred, they are not included in contract costs if the contract is obtained in a subsequent period. [FRS 102.23.17A].

Section 23 only covers revenue from construction contracts, and does not cover the amounts that should be included in contract costs in the percentage of completion method calculation.

Although Section 13 – Inventories – excludes from its scope work in progress arising under construction contracts, this can be used to determine the costs to be included in the percentage of completion method. This is due to the hierarchy in Section 10 that requires users to consider the requirements of other Sections in FRS 102 in developing and applying an accounting policy for an event or transaction. [FRS 102.10.5]. Under Section 13 costs of inventories include all costs of purchase, costs of conversion and other costs incurred in bringing the inventories to their present location and condition. [FRS 102.13.5]. Costs of conversion include costs directly related to the units of production, such as direct labour. They also include a systematic allocation of fixed and variable production overheads that are incurred in converting materials into finished goods. [FRS 102.13.8]. Although not dealing directly with construction contracts the above guidance can be applied in broad terms to construction contracts.

Again, preparers could refer to IAS 11 (superseded) for further guidance in this area as that standard deal specifically with construction contract costs. Alternatively, preparers could follow IFRS 15 – see Chapter 28 of EY International GAAP 2019 for further guidance using the hierarchy in Section 10. The following details the relevant guidance in IAS 11 (superseded) which have been omitted from FRS 102.

Directly related costs would normally include:

• site labour costs, including site supervision;
• costs of materials used in construction;
• depreciation of plant and equipment used on the contract;
• costs of moving plant, equipment and materials to and from the contract site;
• costs of hiring plant and equipment;
• costs of design and technical assistance that is directly related to the contract;
• the estimated costs of rectification and guarantee work, including expected warranty costs; and
• claims from third parties.

If the contractor generates incidental income from any directly related cost, e.g. by selling surplus materials and disposing of equipment at the end of the contract, this is treated as a reduction of contract costs.

The second category of costs comprises those attributable to contract activity in general that can be allocated to a particular contract. These include design and technical assistance not directly related to an individual contract, insurance, and construction overheads such as the costs or preparing and processing the payroll for the personnel working on the contract. These must be allocated using a systematic and rational method, consistently applied to all costs having similar characteristics. Allocation must be based on the normal level of construction activity.

There are various costs that, in most circumstances, were specifically precluded by IAS 11 (superseded) from being attributed to contract activity or allocated to a contract. These are general administration costs, selling costs, research and development costs and the depreciation of idle plant and equipment that is not used on a particular contract. However, the entity is allowed to classify general administration costs and research and development as contract costs if they are specifically reimbursable under the terms of the contract.

Costs may be attributed to a contract from the date on which it is secured until its final completion. Additionally, the costs relating directly to the contract, which have been incurred in gaining the business, may be included in contract costs if they have been incurred once it is probable the contract will be obtained. These costs must be separately identified and measured reliably. Costs that have been written off cannot be reinstated if the contract is obtained in a subsequent period.

3.9.6 Percentage of completion method

FRS 102 requires the percentage of completion method to be used in order to recognise revenue from construction contracts. Estimates of revenue and costs should be reviewed and, when necessary, revised as the construction contract progresses. [FRS 102.23.21]. This will include any contract inefficiencies which do not relate to a specific period (see 3.9.5.B above).

The percentage of completion method is applied on a cumulative basis in each accounting period to the current estimates of revenue and costs. FRS 102 does not specify how to use these revised estimates, however IAS 11 (superseded) clarified that revised estimates must be used in determining the amount of revenue and expenses recognised in profit or loss in the period in which the change is made, and in subsequent periods. Alternatively, preparers could follow IFRS 15 – see Chapter 28 of EY International GAAP 2019 for further guidance using the hierarchy in Section 10. Refer to section 2.1.6 above that highlights over time recognition of revenue under IFRS 15.

Section 23 allows the stage of completion of a transaction or contract to be determined in a number of ways, including: [FRS 102.23.22]

• the proportion that costs incurred for work performed to date bear to the estimated total costs. Costs incurred for work performed to date do not include costs relating to future activity, such as for materials or prepayments;
• surveys of work performed; and
• completion of a physical proportion of the contract work or completion of a proportion of the service contract.

These could, of course, give different answers regarding the stage of completion of the contract as demonstrated in the following example:

In each of the above scenarios the computation of the amount of revenue is quite independent of the question of how much profit (if any) should be taken. This is as it should be, because even if a contract is loss making the sales price will be earned and this should be reflected by recording revenue as the contract progresses. In the final analysis, any loss arises because costs are greater than revenue, and costs should be reflected through cost of sales. Different methods of determining revenue will, as disclosed above, produce different results, which highlights the importance of disclosing the method adopted by the entity.

Where an entity uses a method of determining the stage of completion other than by measuring the proportion of costs incurred to date compared to the total estimated contract costs, an entity may find that the profit margin recognised is not in line with expectations due to the timing of the recognition of costs. For example, a survey of work performed may indicate that the work is 70% complete, but significantly more costs have been incurred, resulting in a lower than expected profit margin and costs that cannot be expensed under this method recorded as an asset. It is not clear in FRS 102 how such costs could be treated as work in progress. Likewise, if costs incurred are lower than expected, it would normally be inappropriate for entities to accrue for costs not yet incurred. In this circumstance, entities may need to reassess whether the method selected for determining the stage of completion is the most appropriate. The method chosen should accurately reflect the progress in the contract and should be applied consistently.

There are of course other ways of measuring work done, e.g. labour hours, which depending upon the exact circumstances might lead to a more appropriate basis for computing revenue.

If the stage of completion is determined by reference to the contract costs incurred to date, it is fundamental that this figure includes only those contract costs that reflect work actually performed so far. Any contract costs that relate to future activity on the contract must be excluded from the calculation.

3.9.7 The determination of contract revenue and expenses

FRS 102 provides no illustrative examples on the determination of contract revenue and expenses. Preparers could refer to the Illustrative Examples in IAS 11 (superseded) for further guidance. The following example is based on an illustrative example from IAS 11 (superseded).

This does not mean that contract activity is necessarily based on the total costs that have been incurred by the entity. Contract costs that relate to future activity, such as for inventories or prepayments, should be deferred and recognised as an asset if it is probable that the costs will be recovered. [FRS 102.23.23].

FRS 102 requires that where it is not probable that costs will be recovered, these costs should be expensed immediately. [FRS 102.23.24]. FRS 102 again does not provide any examples of situations in which this may occur, however IAS 11 (superseded) provided further guidance in this area. There may be deficiencies in the contract, which means that it is not fully enforceable. Other problems may be caused by the operation of law, such as the outcome of pending litigation or legislation or the expropriation of property. The customer or the contractor may be unable for some reason to complete the contract.

3.9.8 Inability to estimate the outcome of a contract reliably

When the outcome of a construction contract cannot be estimated reliably, an entity will first have to determine whether it has incurred costs that it is probable will be recovered under the contract. It can then recognise revenue to the extent of these costs. Contract costs should be recognised as an expense in the period in which they are incurred, [FRS 102.23.25], unless, of course, they relate to future contract activity, such as materials purchased for future use on the contract as explained above.

It is often difficult to estimate the outcome of a contract reliably during its early stages. This means that it is not possible to recognise contract profit. However, the entity may be satisfied that at least some of the contract costs it has incurred will be recovered and it will be able to recognise revenue to this extent.

3.9.9 Loss making contracts and uncollectible revenue

As soon as the entity considers that it is probable that the contract costs will exceed contract revenue it must immediately recognise the expected loss as an expense, with a corresponding provision for an onerous contract. [FRS 102.23.26].

Where the collectability of an amount already recognised as contract revenue is no longer probable, the entity shall recognise the uncollectible amount as an expense rather than as an adjustment of the amount of contract revenue. [FRS 102.23.27].

3.9.10 Examples of construction contract revenue recognition under the principles of Section 23

The Appendix to Section 23 provides two examples in relation to the construction of real estate to help determine when the percentage of completion method should be used.

An entity that undertakes the construction of real estate, directly or through subcontractors, and enters into an agreement with one or more buyers before construction is complete, shall account for the agreement using the percentage of completion method, only if: [FRS 102.23A.14]

• the buyer is able to specify the major structural elements of the design of the real estate before construction begins and/or specify major structural changes once construction is in progress (whether it exercises that ability or not); or
• the buyer acquires and supplies constriction materials and the entity provides only construction services.

If the entity is required to provide services together with construction materials in order to perform its contractual obligation to deliver real estate to the buyer, the agreement shall be accounted for as the sale of goods. In this case, the buyer does not obtain control or the significant risks and rewards of ownership of the work in progress in its current state as construction progresses. Rather the transfer occurs only on delivery of the completed real estate to the buyer. [FRS 102.23A.15].

4.2.1 Accounting for a software licence

If the arrangement is for a simple provision of a licence for a single software product, then the guidance for accounting for licences, as discussed at 3.8.1 above, should be applied.

4.2.2 Accounting for software arrangements with multiple elements

Software arrangements may provide licences for many products or services such as additional software products, upgrades/enhancements, rights to exchange or return software or post-contract customer support (PCS).

As noted at 3.3 above, in certain circumstances it is necessary to apply the recognition criteria to the separately identifiable components of a single transaction in order to reflect the substance of the transaction. [FRS 102.23.8]. However, as discussed at 3.5 above, when services are performed by an indeterminate number of acts over a specified period of time, an entity shall recognise revenue on a straight-line basis over that period, unless another method better reflects the stage of completion. [FRS 102.23.15].

It is likely that many software contracts will fall somewhere between these two extremes and so entities must use their judgement in order to select the most appropriate methodology, taking into consideration all relevant facts and circumstances.

4.2.3 Accounting for arrangements which require significant production, modification or customisation of software

Where companies are running well-established computer installations with systems and configurations that they do not wish to change, off-the-shelf software packages are generally not suitable for their purposes. For this reason, some software companies will enter into a customer contract whereby they agree to customise a generalised software product to meet the customer's specific requirements. A simple form of customisation is to modify the system's output reports so that they integrate with the customer's existing management reporting system. However, customisation will often entail more involved obligations, e.g. having to translate the software so that it is able to run on the customer's specific hardware configuration, data conversion, system integration, installation and testing.

The question that arises, therefore, is what is the appropriate basis on which a software company recognises revenue when it enters into a contract that involves significant obligations? Section 23 includes guidance on accounting for construction contracts and it is our view that this guidance, including the percentage of completion method, may also be applied to other contracts with separately identifiable components. [FRS 102.23.18]. The percentage of completion method is discussed at 3.6 and 3.9.6 above.

Consequently, where an entity is able to make reliable estimates as to the extent of progress towards completion of a contract, the related revenues and the related costs, and where the outcome of the contract can be assessed with reasonable certainty, the percentage of completion method of profit recognition should be applied.

4.3.1 Recording revenue for multiple service elements (‘bundled offers’)

Section 23 states that when necessary to reflect the substance of the transaction, revenue shall be recognised for the separately identifiable components of a single transaction and refers specifically to situations where the selling price of a product includes an identifiable amount for subsequent servicing, in which case that amount is deferred and recognised as revenue over the period during which the service is performed. [FRS 102.23A.19]. This is directly relevant to some aspects of multiple deliverable arrangements offerings, where customers are offered a ‘bundle’ of assets and services.

When a consumer enters into a mobile phone contract with a provider, the contract may be a package that includes a handset and various combinations of talktime, text messages and data allowances (internet access). The bundle may also include fixed line products, such as voice, video and broadband services.

Consumers may pay for their bundle of assets and services in a number of different ways: a payment for the handset (which may be discounted); connection charges related to activation of the handset; monthly fixed or usage-based payments; and prepayments by credit card or voucher. None of these payments may relate directly to the cost of the services being provided by the operator, and operators also may offer loyalty programs that entail the provision of future services at substantially reduced prices.

As there is no specific guidance within FRS 102 (nor the superseded IFRSs) on the subject of multiple deliverable arrangements beyond the brief references as noted above, companies will need to apply judgement in applying the requirements of Section 23 relevant to the facts and circumstances of each transaction.

4.3.2 ‘Gross versus net’ issues

The difficulty of deciding whether to record revenue gross or net is pervasive in the telecommunications sector. The problem occurs because of the difficulty in deciding whether the parties involved in any particular agreement are acting as principal or agent. Section 23 sets out that in an agency relationship, the amounts collected on behalf of the principal are not revenue and instead, revenue is the amount of commission. [FRS 102.23.4].

The principal versus agent assessment is further discussed at 3.2.2 above but does not necessarily help decide the matter in many telecoms scenarios. A frequent arrangement is where there is data content provided by third parties that is subject to a separate provider agreement.

Content, such as music, navigation and other downloads such as ‘apps’ can either be included in the monthly price plan, or purchased separately on an ad hoc basis. Operators can either develop the content in-house, or use third party providers to offer a range of items to their subscribers, with charges based either on duration (news, traffic updates etc.) or on quantity (number of ringtones, games etc.).

The issue is whether the operator should report the content revenue based on the gross amount billed to the subscriber because it has earned revenue from the sale of the services, or the net amount retained (that is, the amount billed to the subscriber less the amount paid to a supplier) because it has only earned a commission or fee. Is the substance of the transaction with the supplier one of buying and on-selling goods or selling goods on consignment (i.e. an agency relationship)? The two most important considerations for most of these arrangements are:

• whether the operator has the primary responsibility for providing the services to the customer or for fulfilling the order, for example by being responsible for the acceptability of the services ordered or purchased by the customer; and
• whether it has latitude in establishing prices, either directly or indirectly, for example by providing additional goods or services.

Inventory risk is unlikely to be relevant for a service provision and credit risk may be only a weak indicator as the amounts are individually small and may be paid to access the download.

Therefore, if the content is an own-brand product or service, then the revenue receivable from subscribers should be recorded as revenue by the operator, and the amounts payable to the third party content providers should be recorded as costs.

By contrast, if the content is a non-branded product/service that is merely using the mobile operator's network as a medium to access its subscriber base, then the amounts receivable from subscribers should not be recorded as revenue. The operator's revenue will comprise only the commissions receivable from the content providers for the use of the operator's network.

4.3.3 Accounting for roll-over minutes

Where an operator offers a subscriber a finite number of call minutes for a fixed amount per period with the option of rolling over any unused minutes, the question arises as to how the operator should account for the unused minutes that the subscriber holds. The operator is not obliged to reimburse the subscriber for unused minutes, but is obliged (normally subject to a ceiling) to provide the accumulated unused call minutes to the subscriber until the end of the contract, after which they expire.

In such cases, revenue is recognised at the time the minutes are used. Any minutes unused at the end of each month should be recognised as deferred revenue.

However, in some instances, the operator has relevant and reliable evidence that shows that a portion of those unused minutes will not be used before the expiration of the validity period. In that case, the operator could consider an alternative revenue recognition policy that would take account of the probability of unused minutes at the end of the validity period in the computation of the revenue per minute used by the subscriber. This would result in allocating a higher amount of revenue per minute used.

When the validity period expires, any remaining balance of unused minutes would be recognised as revenue immediately, since the obligation of the operator to provide the contractual call minutes is extinguished.

4.3.4 Accounting for the sale of prepaid calling cards

Prepaid cards are normally sold by an operator either through its own sales outlet or through distributors. The credit sold with the cards may have an expiry date that varies from one operator to another, although, in certain limited jurisdictions (not the UK), there is no expiry date. For example, prepaid cards may be sold with an initial credit of £10 covering 60 minutes of communication and the credit has a validity period of 90 days from the date of activation. If not used within this period, the credit is lost.

When the cards are sold through distributors, the distributor is usually obliged to sell the cards to the customers at the face value of the card. On sale of the card, the distributor pays the operator the face value less a commission. The distributor has a right to return unsold cards to the operator. Once the distributor has sold the cards, it has no further obligation to the operator.

In our view, when an operator sells calling cards directly, revenue is recognised at the time the minutes are used. Any minutes unused at the end of each month should be recognised as deferred revenue. However, if the operator has relevant and reliable evidence that shows that a portion of those unused minutes will not be used before the expiration of the validity period then it could consider an alternative revenue recognition policy. This would take account of the probability of unused minutes at the end of the validity period in the computation of the revenue per minute recognised as the minutes are used by the customer.

When an operator sells calling cards through a distributor, the revenue is required to be recognised based on the substance of the arrangement with the distributor.

It is usually the case that the distributor is in substance acting as an agent for the operator. The revenue associated with the sale of the calling card is recognised when the subscriber uses the minutes. The difference between the card's usage value, which is charged to the subscriber, and the amount paid to the operator is the distributor's commission.

In our view, unless the distributor is also an operator or the calling card could be used on any operator's network (which is rare), it would be difficult to conclude that the distributor is the principal in the arrangement with the subscriber, because the distributor would not have the capacity to act as the principal under the terms of the service provided by the calling card to the subscriber (see 3.2.2 and 4.3.2 above).