• Stephan Lego-Deiber, Partner |

In my last blog, we discussed how the coronavirus outbreak impacts contract modifications and the existence of a customer contract. As promised, in this article we will take a closer look at how to deal with revenue estimates and revenue related assets in light of the current pandemic.

Variable consideration

The first thing that comes to mind when thinking of revenue estimates is certainly the variable consideration. If a customer contract includes a variable consideration, then the company must estimate the amount of consideration to which it will be entitled. This amount is included only if it’s highly probable that a significant reversal will not occur (“the constraint” – IFRS 15.56).

There are numerous situations that could give rise to variable consideration (even if the contract did not previously include one!) or impact the constrained amount: Companies may not receive the normal volume of discounts or rebates due to a decrease in their purchase volumes, or extra incentives might be given to customers during this difficult time. Also, companies might not manage to satisfy their obligations, which results in penalties and reduces the transaction price (pay attention for any force majeure clause), or leads to refunds for purchased subscriptions that customers were unable to use.

These are just a few of the many scenario that could unfold. However, the recipe for success remains the same: The estimate of variable consideration must reflect the latest circumstances and expectations (IFRS 15.59).

Stand-alone selling price

In step four of the five-step model for revenue recognition, entities must reserve the transaction price for the performance obligations in the contract, estimating a stand-alone selling price for each promised good or service. Market prices or expected costs might significantly change in light of COVID-19, so again, the use of up-to-date estimates to calculate the transaction price for new contracts is essential in order to comply with IFRS 15 requirements. And be careful, this only applies to new contracts, since after the contract’s inception any changes in transaction price are allocated to the performance obligations on the same basis as at contract inception. (IFRS 15.88).

Input method for revenue recognition over time

In case your company is using the input method to measure progress in completing the performance obligation, then it must assess at year end the inputs used to calculate the percentage of the expected total costs. The coronavirus pandemic could significantly change the timeline or the expected cost to satisfy the performance obligation. Therefore, companies need to ensure that the measure of progress reflects the latest expectations.

Last but not least: recoverability of revenue cycle assets

Now let’s take a quick look at the balance sheet side of the revenue cycle and how this might be impacted. Here are a few things to keep in mind:

  • Current conditions may decrease the estimated selling prices or extend the time period to sale, affecting the inventory’s net realizable value.
  • Contract assets and receivable are both in the scope of IFRS 9 for impairment purposes. In case you missed it, check out the article about COVID-19’s impact on ECL.
  • Contract costs are subject to the specific impairment requirements of IFRS 15.101 and amortization requirements of IFRS 15.99. A company’s approach to the impairment and amortization of those costs is often driven by, among other factors, the expectation that customers will renew their contracts or enter into future ones. Therefore, this expectation must now be revised, and might result in impairment or accelerated amortization (over a shorter period).

Time to stretch your limits

Everybody is aware of how difficult it can be to model different scenarios and assign probabilities in order to come up with accurate estimates in the current conditions. However, this doesn’t exempt companies from making their best efforts to measure them as accurately as possible!

In periods like this, it’s essential to provide clear and transparent disclosures about estimates and judgements made, no matter how difficult, so as to allow users to understand the key assumptions that underlie the financial statements.

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This article has been written by Ersilia Erbaio.