Understanding IFRS15: Episode 4 - Step 3 Determining the Transaction Price

Understanding IFRS15: Episode 4 – Step 3 Determining the Transaction Price



welcome to episode 4 of the IFRS 15 made easy series so far we have learned how to identify a contract with the customer and its performance obligations within the new IFRS 15 revenue recognition standard we are from Conklin and partners Chartered Accountants of Singapore and the member of GHI and tasks and in this video we will be going through step 3 of the revenue recognition model determining the transaction price first let's define what is the transaction price a transaction price is the amount of consideration to which an entity expects to be entitled in exchange for transferring the promised goods or services to the customer however this excludes the amounts that you may have collected on behalf of third parties for example sales tax the new IFRS 15 standard states that in determining the transaction price accountants should include variable consideration the existence of a significant financing component non-cash consideration and the consideration payable to the customer if the consideration promised in a contract includes a variable amount an entity shall estimate the amount of consideration to which the entity will be entitled in exchange for transferring the promised goods or services examples of variable consideration include discounts rebates refunds credits price concessions incentives performance bonuses and penalties therefore in this new standard the transaction price may include both fixed and variable amounts as well as other considerations there may be times when your transaction price could be a range of possibilities depending on outcomes or effects of the contracts IFRS 15 states that an entity shall estimate and amount of variable consideration by number one establishing the expected value which is the sum of probability weighted amounts in a range of possible amounts or number two establishing the most likely amount which is the single most likely amount in a range of possibilities usually when there are two possible consideration amounts lastly variable consideration should not be included in the transaction price if these factors that increase the likelihood of revenue reversal are present let us look at an example of variable consideration entity a entered into a contract with customer B in terms of the contract entity a will build a shopping complex for customer B the contract price was agreed between the two parties at 1 million dollars a performance bonus of $500,000 is payable should construction be completed by the agreed date the bonus will decrease by 10 percent per week for every week past the agreed date as an accountant you will have to determine which is the most likely date of completion by entity a with past experiences of similar contracts you may estimate that there is a 60% probability that the contracts will be completed by the agreed date a 30% probability that it will be one week late and a 10% probability that it will be two weeks late calculate the estimated variable consideration to be received by entity a based on a probability razored method and the most likely outcome using the probability weighted method the total estimated revenue would be 1 million four hundred and seventy five thousand dollars in the case of the most likely outcome the estimated revenue would be 1.5 million dollars since there are more than two possible outcomes the probability weighted method should seem more appropriate when determining the transaction price one should consider whether the promised amount of consideration provides the entity or the customer with a significant benefit of financing the transfer of goods or services to the customer for example if a contract states that the goods are to be delivered today but the customer is only required to make payment in two years that creates a significant financing component to the agreement the significant financing component may exist regardless of whether the promise of financing is explicitly or implicitly stated in the contract an entity shall assess whether a contract contains a financing components and whether that financing component is significant to the contracts by determining both of the following a the difference if any between the amount of promise consideration and the cash shelling price of the promised goods or services and B the combined effect of both of the following firstly the expected length of time between when the entity transfers the promised goods or services to the customer and when the customer pays for those goods or services and number to the prevailing interest rates in the relevant market however IFRS 15 states that no adjustment is required if the time between the transfer and payment is 1 year or less let's look at an example on the 1st of August 2013 entity a enters into a contract with customer bean in terms of the contract entity a would deliver a product to customer being on 1st August 2013 the full contract price of about 1.4 million dollars is payable by customer B on 31st of July 2017 four years later the read the regular cash selling price of the product is $900,000 the costs incurred by entity a to manufacture the product amounts to five hundred and ninety thousand dollars entity a makes use of the perpetual inventory system prepare the general journal entries to account for this economic event in the accounting records of entity a for the year ending on 31st December 2013 in accordance with IFRS the general journal entry for entity a would look like this where the interest rate of 12% is derived from the difference between the full contract price of 1.4 million dollars and the regular cash selling price of the product and nine hundred thousand dollars the effective interest rate method was used to determine the transaction price for contracts in which a customer promises consideration in a form other than cash an entity shall measure the non-cash consideration at fair value if an entity cannot reasonably estimate the fair value of the non-cash consideration the entity shall measure the consideration indirectly by reference to the standalone selling price of the goods or services promised to the customer in exchange for the consideration if a customer contributes goods or services for example materials equipment or labor to facilitate an entity's fulfillment of the contract the entity shall assess whether it obtains control of those contributed goods or services if so the entity shall account for the contributed goods or services as non-cash consideration received from the customer let's look at an example an entity enters into a contract with the customer to provide a weekly service for one year the contract is signed on 1st of January 2013 and work begins immediately the entity concludes that the service is a single performance obligation this is because the entity is providing a series of distinct services that are substantially the same and have the same pattern of transfer in exchange for the service the customer promises 100 shares of its common stock per week of service the terms in the contract require that the shares must be paid upon successful completion of each week of service yeah to determine the transaction price and the amount of revenue to be recognized the entity measures the fair value of 100 shares that are received upon completion of each weekly service consideration payable to a customer includes cash amounts that and anticipates or expects to pay to the customer this includes credit coupons or vouchers an entity shall account for consideration payable as a reduction of the transaction price and therefore of revenue unless the payment to the customer is in exchange for a distinct goods or service if consideration payable to a customer is a payment for a distinct goods or service then an entity shall account for that purchase 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 shall account for the excess as a reduction of the transaction price if consideration payable to a customer is accounted for as a reduction to the transaction price an entity shall recognize the reduction of revenue when number 1 the entity recognizes revenue for the transfer of the related goods or services to the customer and number 2 the NCT pays or promises to pay the consideration let's look at an example an entity that manufactures consumer goods enters into a one-year contract to sell goods to a customer the customer commits to buy at least fifteen million dollars of products during the year the contract also requires the entity to make a non-refundable payment of 1.5 million dollars to the customer at the inception of the contract the 1.5 million dollar payment will compensate the customer for the changes it needs to make to its shelving to accommodate the entity's products the entity concludes that the payment in the customer is not in exchange for a distinct goods or service that transfers to the entity consequently the entity concludes that the consideration payable is accounted for as a reduction in the transaction price when the entity recognizes revenue or the transfer of goods as the entity transfers goods to the customer the entity reduces the transaction price for each goods by 10 percent therefore in the first month in which the entity transfers goods to the customer the entity recognizes revenue of 1.8 million dollars for more in-depth examples stay tuned for future episodes of our series

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