2019 marks only the second year that companies have had to report their revenues under IFRS 15. Some issuers may still be unfamiliar with it and now have to face the challenge of complying with it in the current market conditions. IFRS 15 is extremely detailed with plenty of aspects that issuers need to take into account. In this article, we will walk you through the essential points to consider when dealing with existing and new customer contracts in light of Covid-19.
Does a customer contract exist?
In assessing new contracts, companies must still evaluate if the agreement creates enforceable rights and obligations under the law (IFRS 15.10). This means that the contract exists only if the criteria set out in step one of the five-step model for revenue recognition are fulfilled. Here’s a quick refresher:
- The contract is approved and the parties are committed to their obligations.
- Right to goods or services and payment terms can be identified.
- The contract has commercial substance.
- Collection of consideration is probable.
In the case that facts and circumstances significantly change, e.g. due to a coronavirus outbreak, companies need to reassess if the above criteria are still being met for existing contracts (IFRS 15.13). For example, many customers might now struggle to pay the agreed upon consideration amount. The entity must, therefore, reassess the probability of collecting cash flows related to the sale. If the collection of consideration becomes unlikely, then the contract existence criteria are no longer satisfied.
Revenue over time: are the criteria still met?
If your company operates in sectors like construction or engineering, then it is likely that revenues are recognized over time as per IFRS 15.35(c), i.e. the company’s performance does not create an asset with an alternative use and the company has an enforceable right to payment for performance completed to date. Consequently, the entity needs to reassess if the right to payment is still enforceable under the current conditions. If not, then the company must recognize revenue at a point in time, unless any other over-time criteria from paragraph 35 of IFRS 15 are met.
To face the Covid-19 crisis, companies and their customers could start to amend their contracts. A contract modification occurs if there is a change in scope or price, or both (IFRS 15.18).
In this respect, a common issue is determining when to account for the modification. In short, modifications must be accounted for when they are approved, and they create or change enforceable rights and obligations for the parties involved in the contract. This may require use of judgement, especially since amendments might become frequent due to the circumstances.
Depending on the extent of the modification, the company must apply the requirements of paragraphs 20 and 21 of IFRS 15.
What to consider next
The widespread impact of coronavirus could bring into question the ability of companies and customers to stick to the stated terms of their contracts. Therefore, timing and amount of revenue recognition may be significantly affected, up to the point that revenue should not be recognized at all.
The Covid-19 pandemic does not only affect contract existence, modification or revenue recognition. Many more revenue related aspects require consideration. In my next article, we will examine how the uncertainty of the current situation impacts revenue estimates and the recoverability of revenue cycle assets.