Revenue is recognized when or as performance obligations are satisfied by transferring control of a promised good or service to a customer.

Control either transfers over time or at a point in time. Management needs to determine, at contract inception, whether control of a good or service transfers to a customer over time or at a point in time. If the performance obligation is not satisfied over time, it is satisfied at a point in time.

What does control mean in the context of transferring goods and services? The idea of relinquishing authority over a product or service aligns with the definition of an asset. While control may seem relevant only in the context of transferring a tangible item, it applies to services as well, even if they are immediately consumed. When a customer gains control over a product or service, it means they have the power to direct its use and enjoy most of its benefits. Although a customer might have future rights to control and reap the benefits of an asset, they must have actually obtained those rights for control to shift. Directing the use of an asset entails the ability to utilize it, permit another entity to use it, or prevent others from using it. The benefits of an asset refer to the potential monetary gains or savings achievable through various means, such as using it for production, selling or exchanging it, or leveraging it as collateral. Evaluating the transfer of control should primarily consider the customer’s perspective to avoid recognizing revenue for activities that haven’t truly transferred control. Management should also assess whether there’s an option or obligation to buy back an asset when determining if control has been transferred.

Performance obligations satisfied over time

Arrangements where the performance obligations are satisfied over time are not limited to service arrangements. Complex assets or certain customized goods constructed for a customer, such as building specialized machinery, could also transfer over time, depending on the terms of the arrangement.

Revenue is recognized over time if any of the following three criteria are met:

1. the customer simultaneously receives and consumes the benefits provided by the entity’s performance as the entity performs;
2. the entity’s performance creates or enhances an asset that the customer controls as the asset is created or enhanced; or
3. the entity’s performance does not create an asset with an alternative use to the entity, and the entity has an enforceable right to payment for performance completed to date.

Refer to the following agenda decisions:

• revenue recognition in a real estate contract;
• revenue recognition in a real estate contract that includes the transfer of land; and
• right to payment for performance completed to date.

The customer receives and consumes benefits as the entity performs

This criterion could also apply to arrangements that are not typically viewed as services, such as contracts to deliver electricity or other commodities. For example, an entity that provides a continuous supply of natural gas upon demand might conclude that the natural gas is simultaneously received and consumed by the customer. This assessment could require judgment.

The customer receives and consumes the benefits as the entity performs if another entity would not need to substantially reperform the work completed to date to satisfy the remaining obligations. The fact that another entity would not have to re-perform the work already performed indicates that the customer receives and consumes the benefits throughout the arrangement.

In determining whether another entity would not need to substantially re-perform the work, contractual or practical limitations that prevent an entity from transferring the remaining obligations to another entity are not considered. The objective is to determine whether control transfers over time, using a hypothetical assessment of whether another entity would have to re-perform work completed to date. Limitations that would prevent an entity from practically transferring a contract to another entity are therefore disregarded.

Simultaneously receiving and consuming benefits Entity C, operating as a freight railway entity, engages in a contract with a shipper to transport goods from location A to location B for a fee of C1,000. The shipper bears an unconditional obligation to remit payment for the service upon the goods’ arrival at location B. Question When should entity C recognise revenue from this contract? Answer Entity C would acknowledge revenue as it carries out the transportation of the goods since the obligation to perform is fulfilled during this period. At the end of each reporting period, Entity C would assess the extent of transportation services provided and recognize revenue accordingly, proportionate to the services rendered. The shipper benefits from the goods being transported from location A to B, as it eliminates the need for another entity to transport them to their current position if Entity C fails to complete the entire distance. Although there may be practical constraints on another entity taking over the shipping responsibility midway through the contract, these limitations are disregarded in the evaluation.

The entity’s performance creates or enhances an asset that the customer controls

This criterion applies in situations where the customer controls the work in progress as the entity manufactures goods or provides services. The asset being created can be tangible or intangible. Management should apply the principle of control to determine whether the customer obtains control of an asset as it is created, which could require judgment. The control principle should be applied to the asset that the entity’s performance creates or enhances. For example, if the entity is constructing an asset, management should assess whether the customer controls that asset as it is constructed. The agenda decision, ‘Revenue recognition in a real estate contract’, highlighted that the customer’s ability to sell or pledge a right to obtain the asset in the future is not evidence of control of the asset itself. The criterion was intended to address situations in which the customer controls the asset being created or enhanced.

Revenue recognition in a real estate contract In a March 2018 decision, the IFRS Interpretations Committee (IFRS IC) addressed the application of IFRS 15 in a contract involving the sale of a unit within a residential multi-unit complex. The IFRS IC highlighted several requirements from IFRS 15: If the entity’s performance results in the creation of real estate that is not immediately consumed, paragraph 35(a) does not apply. If there’s no evidence indicating that the customer can direct the use of the unit being constructed, the customer does not control the partially constructed unit as per paragraph 35(b). When applying paragraph 35(b), the entity evaluates whether there’s clear evidence that the customer controls the asset being created or enhanced as it progresses. In a real estate contract, the entity assesses whether the customer controls the real estate itself, not just the right to obtain it in the future. The right to sell or pledge the future right to obtain real estate doesn’t demonstrate control over the real estate itself. The entity considers various factors in this assessment, with no single factor being decisive. If the entity cannot change or substitute the specified real estate unit, and the customer could enforce its rights to the unit if the entity diverted it for another use, the contractual restriction is significant, and the real estate unit lacks an alternative use. The entity examines relevant legal precedents to determine if it’s entitled to compensation for work completed if the customer cancels the contract. If legal precedent indicates only a termination penalty, the criteria in paragraph 35(c) for recognizing revenue over time are not met. In the specific case considered by the IFRS IC, it observed that the entity did not control the real estate unit during construction because it lacked clear authority to direct its use. Additionally, legal precedent indicated that the entity had an enforceable right to payment for work completed if the customer canceled the contract.

The asset has no alternative use and the entity has the right to payment

This last criterion was developed to assist entities in their assessment of control in situations where applying the first two criteria for recognizing revenue over time is challenging.

Entities that create assets with no alternative use, that have a right to payment for performance to date, recognize revenue as the assets are produced, rather than at a point in time (for example, on delivery). Example 14 of the revenue standard illustrates this concept.

1. No alternative use

An asset has an alternative use if an entity can redirect that asset for another use or to another customer. An asset does not have an alternative use if the entity is unable, because of contractual restrictions or practical limitations, to redirect the asset for another use or to another customer. Contractual restrictions and practical limitations could exist in a broad range of contracts. Judgment is needed in many situations to determine whether an asset has an alternative use. Example 15 of the revenue standard illustrates this concept.

What restrictions result in an asset having no alternative use? Contractual limitations on an entity’s capacity to redirect an asset are prevalent in certain industries. Such restrictions arise when the customer holds the power to enforce its right to a particular product if the entity attempts to allocate that product for another use, like selling it to a different customer. One form of restriction involves obligating the entity to deliver certain specified units to a specific customer (e.g., the initial ten units produced). This kind of restriction suggests that the asset lacks alternative utility, regardless of whether the product is typically part of standard inventory or highly customized. This is because the customer can inhibit the entity from repurposing it. Practical constraints can also signal the absence of an alternative use for an asset. If significant rework (at substantial cost) is needed to make the asset suitable for another customer or purpose, it’s likely devoid of alternative utility. For instance, a highly specialised component tailored for a specific client is unlikely to be resold without substantial modifications. A practical constraint would also be present if the entity could only sell the asset to another customer at a significant loss. Assessing whether practical limitations exist in an arrangement may entail significant judgement.

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Asset with an alternative use A manufacturer engages in a contract to produce an automobile for a driver, who specifies options like color, trim, and electronics. The driver provides a non-refundable deposit to reserve the automobile but does not exercise control over the work in progress. At any point, the manufacturer retains the option to redirect the automobile to another customer and initiate production on a different automobile for the same driver with identical specifications. Question How should the manufacturer recognise revenue from this contract? Answer The manufacturer should recognize revenue when control of the automobile is transferred to the driver, marking a point in time. In this scenario, the criteria for a performance obligation fulfilled over time are not met. Throughout the manufacturing process, the driver lacks control over the asset. While the driver specifies certain features of the automobile, these specifications don’t impose practical or contractual limitations on the manufacturer’s ability to transfer the car to another customer. The manufacturer can redirect the automobile to another customer at minimal or no additional expense, indicating an alternative use for the car. Now, let’s consider the same circumstances, but with the driver holding an enforceable right to the first automobile produced by the manufacturer. Although the manufacturer could practically redirect the automobile to another customer, contractual obligations prevent it from doing so. Consequently, the asset lacks an alternative use for the manufacturer in this case. Under these conditions, the arrangement would satisfy the criteria for a performance obligation fulfilled over time, provided that the manufacturer is entitled to payment for the work conducted as the automobile is being built.

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Highly specialised asset without an alternative use A cruise shipbuilder contracts to construct a cruise ship for a cruise line, tailored to the cruise line’s requirements. While the shipbuilder could redirect the ship to another customer, doing so would entail substantial costs for reconfiguration. Additional details include: The cruise line does not physically acquire the ship during its construction. The contract encompasses a single performance obligation, as the goods and services to be furnished are not individually distinct. In the event of contract cancellation by the cruise line, the cruise shipbuilder is entitled to reimbursement for costs incurred plus an agreed profit margin. Question How should the cruise shipbuilder recognise revenue from this contract? Answer The cruise shipbuilder should recognize revenue gradually throughout the shipbuilding process. The vessel is crafted according to the precise specifications of the cruise line and would necessitate substantial alterations to serve another customer effectively. Selling the ship to another customer would incur significant expenses, rendering it devoid of an alternative use. Additionally, the cruise shipbuilder holds the right to payment for work completed thus far. These conditions satisfy the criteria for a performance obligation fulfilled over time.

Management should assess at contract inception whether the asset that an entity will ultimately transfer to the customer has an alternative use. This assessment is only updated if there is a contract modification that substantively changes the terms of the arrangement. 2. Right to payment for performance to date

This criterion is met if an entity is entitled to payment for performance completed to date, at all times during the contract term, if the customer terminates the contract for reasons other than the entity’s nonperformance. Examples 16 and 17 of the revenue standard illustrate this concept. The assessment of whether a right to payment exists might not be straightforward and depends on the contract terms and relevant laws and regulations. Management will generally have to assess the right to payment on a contract-by-contract basis. Therefore, variances in contract terms could result in recognizing revenue at a point in time for some contracts and overtime for others, even when the products promised in the contracts are similar.

An entity’s right to payment for performance completed to date does not have to be a present unconditional right; that is, the contract does not have to contain explicit contractual terms that entitle the entity to invoice at any point throughout the contract period. Many arrangements include terms that stipulate that progress or milestone payments are required only at specified intervals, or only upon completion of the contract. Regardless of the stated payment terms or payment schedule, management needs to determine whether the entity would have an enforceable right to demand payment if the customer canceled the contract for reasons other than a breach of contract or non-performance.

A right to payment would also exist if the contract (or other laws) entitles the entity to continue fulfilling the contract and demand payment from the customer under the terms of the contract if the customer attempts to terminate the contract.

In assessing whether a right to payment is enforceable, management should consider relevant laws or regulations in addition to the contract terms. An entity’s enforceable right to payment for performance completed to date will generally be evidenced by the contractual terms agreed to by the parties. However, legislation or legal precedent in the relevant jurisdiction might supplement or override the contractual terms. An entity asserting that it has an enforceable right to payment despite the lack of a contractual right should have sufficient legal evidence to support this conclusion. The fact that the entity would have a basis for making a claim against the counterparty in a court of law is not sufficient to support that there is an enforceable right to payment. If the contractual terms do not provide for a right to payment, management is not required to do an exhaustive search for legal evidence that might support an enforceable right to payment; however, it would be inappropriate for an entity to ignore evidence that provides for such a right. Similarly, if the contractual terms do provide for a right to payment, it would be inappropriate to ignore evidence that indicates such rights have no binding legal effect. This concept was discussed in the agenda decision, ‘Right to payment for performance completed to date’. Even if an entity has a customary business practice of not enforcing right-to-payment clauses in its contracts, this generally does not mean there is no longer an enforceable right to payment. Such a business practice would only impact the assessment if it renders the right unenforceable in a particular legal environment.

Can an entity conclude it has an enforceable right to payment for performance if the contract includes an acceptance provision? The impact of an acceptance provision on the assessment of an entity’s enforceable right to payment hinges on its nature. If the provision primarily serves to affirm that the entity has fulfilled its obligations under the contract, we anticipate it would not affect the determination of whether the entity possesses an enforceable right to payment. Conversely, if the acceptance provision primarily concerns subjective specifications and empowers the customer to withhold payment for reasons unrelated to breach or non-performance, the existence of an enforceable right to payment would likely be compromised.

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Right to payment for performance completed to date In March 2018, the IFRS Interpretations Committee (IFRS IC) released an agenda decision addressing the presence of an enforceable right to payment in a contract involving the sale of a unit within a residential multi-unit complex (real estate unit). The IFRS IC examined a scenario where the entity possessed a contractual entitlement to receive payment for the discrepancy between the resale value of the unit, if any, and the original purchase price (plus associated selling costs) if the initial customer opted not to purchase the real estate. The IFRS IC emphasized that the assessment of an entity’s enforceable right to payment focuses solely on the payments specified in the existing contract. In the scenario described, the payment was not invariably tied to the progress of the asset thus far (i.e., the selling price of the partially constructed real estate). Consequently, the IFRS IC noted that this amount did not adequately compensate the entity for the work completed to date.

The amount of the payment that the entity can enforce does not need to be a fixed amount, but it should at least compensate the entity for performance to date at any point during the contract. The amount should reflect the selling price of the goods or services provided to date. For example, an entity would have an enforceable right to payment if it is entitled to receive an amount that covers its cost plus a reasonable profit margin for work completed. An entity that is entitled only to recover costs incurred does not have a right to payment for the work to date if the selling price of the finished goods or completed services includes a profit margin.

Right to payment Entity D enters into a contract with entity E to deliver the next piece of specialised equipment produced. The contract price is C1 million, which includes a profit margin of 30%. Entity E can terminate the contract at any time. Entity E makes a non-refundable deposit at contract inception to cover the cost of materials that entity D will procure to produce the specialised equipment. The contract precludes entity D from redirecting the equipment to another customer. Entity E does not control the equipment as it is produced Question How should entity D recognise revenue for this contract? Answer Entity D should recognize revenue when control of the equipment shifts to Entity E, marking a point in time. The specialized equipment lacks an alternative use for Entity D because the contract imposes significant terms preventing it from reallocating the equipment to another customer. However, Entity D is only entitled to reimbursement for incurred costs, excluding a reasonable profit margin. The condition for a performance obligation satisfied over time is not fulfilled as Entity D lacks the entitlement to payment for the work completed thus far. This is because the contract price encompasses a profit, yet Entity D can solely recoup costs if Entity E terminates the contract.

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No right to payment for standard components Entity F engages in a contract to fabricate a large, tailor-made piece of equipment for a manufacturer. Due to the specific customer requirements, Entity F cannot repurpose the equipment for other clients or alter its design and functionality without significant rework. Entity F procures or produces various standardized components utilized in the equipment’s construction. In the event of early contract termination by the manufacturer, Entity F is entitled to reimbursement for incurred costs plus a reasonable margin. However, Entity F is not entitled to payment for the standardized components until they are integrated into the customized equipment intended for delivery to the customer. This is because Entity F has the flexibility to utilize these components in alternative projects prior to their integration into the custom equipment. Question Does entity F have an enforceable right to payment for performance completed to date? Answer Entity F possesses a valid entitlement to reimbursement for work accomplished thus far because it will be remunerated for incurred expenses plus a reasonable profit margin once the standard components are integrated into the customized equipment. Throughout the contract duration, an entity maintains a right to payment for work completed. Entity F’s performance under the contract commences when it initiates the integration of the standard components into the customized equipment. With an enforceable right to payment and no alternative utility for the equipment, Entity F should recognize revenue gradually as it constructs the equipment. Prior to integration into the customized equipment, Entity F would classify standard components as inventory.

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Can a right to payment for performance completed to date exist when the contract is priced at cost or at a loss, and thus the right to payment does not include a profit margin? Certainly. The criterion for determining whether an entity has a claim to payment for its performance revolves around whether it has a right to compensation at a value approximating the selling price of the goods or services provided thus far. Although the selling price for a contract typically comprises estimated costs along with a profit margin, this margin may not be included if the contract is priced at cost or at a loss. For instance, an entity might be willing to accept a loss on a sale if it anticipates securing profits from future orders from the same customer, even if those orders are not contractually guaranteed. In our view, the assessment of the right to payment should concentrate on whether the entity is entitled to a proportionate share of the selling price (reflecting performance to date), rather than solely considering whether this amount matches the costs incurred plus a profit margin.

Compensation for a reasonable profit margin need not equal the profit margin expected if the contract was fulfilled as promised, but an entity should be entitled to compensation for either of the following amounts:

1. A proportion of the expected profit margin in the contract that reasonably reflects the extent of the entity’s performance under the contract before termination by the customer (or another party); or
2. A reasonable return on the entity’s cost of capital for similar contracts (or the entity’s typical operating margin for similar contracts) if the contract-specific margin is higher than the return that the entity usually generates from similar contracts.

A specified payment schedule does not necessarily indicate that the entity has a right to payment for performance. This could be the case in situations where milestone payments are not based on performance. Management should assess whether the payments at least compensate the entity for performance to date. The payments should also be non-refundable in the event of a contract cancellation (for reasons other than non-performance).

Customer deposits and other upfront payments should also be assessed to determine if they compensate the entity for performance completed to date. A significant non-refundable upfront payment could meet the requirement if the entity has the right to retain that payment if the customer terminates the contract. The payment should at least compensate the entity for work performed to date throughout the contract. The requirement would also be met even if a portion of the customer deposit is refundable, as long as the amount retained by the entity provides compensation for work performed to date throughout the contract.

Measures of progress

Once management determines that a performance obligation is satisfied over time, it should measure its progress towards complete satisfaction of that performance obligation, to determine the timing of revenue recognition. The purpose of measuring progress towards satisfaction of a performance obligation is to recognize revenue in a pattern that reflects the transfer of control of the promised good or service to the customer.

Partially satisfied performance obligations Entities sometimes commence activities on a specific anticipated contract before finalising the contract with the customer or meeting the contract criteria. At the date the contract criteria are met, an entity should recognise revenue for any promised goods or services that have already been transferred (that is, revenue should be recognised on a cumulative catchup basis). Activity A manufacturer engages in a long-term contract with a customer to produce highly customized goods. The customer issues purchase orders every 60 days on a rolling calendar basis, with each order being non-cancellable. The manufacturer holds a contractual entitlement to payment for all work in progress once an order is received. To meet the anticipated demand based on a non-binding forecast from the customer, the manufacturer pre-assembles some goods. Upon receiving a purchase order, the manufacturer typically has both completed and partially completed goods on hand. The manufacturer has determined that each customized good constitutes a performance obligation fulfilled over time, as they lack an alternative use, and the manufacturer has a guaranteed right to payment upon order receipt. On January 1, 20X6, the manufacturer receives a purchase order for 100 goods. At that point, the manufacturer has 30 completed goods and 20 partially completed goods, determined to be 50% complete using a cost-to-cost input method for measuring progress. The transaction price is C200 per unit, and the contract entails no additional promised goods or services. Question How should the manufacturer account for its progress completed to date when it receives the purchase order from the customer? Answer The contract criteria are fulfilled upon the receipt of the purchase order by the manufacturer. On this date, revenue should be recognized for any promised goods or services that have already been delivered. The manufacturer should recognize revenue amounting to C8,000 for performance satisfied to date, calculated as ((30 completed units × C200) + (20 partially completed units × C100)), as the performance obligation is met over time during the assembly of the goods.

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Indicators to be considered to determine when revenue recognition should begin and the pattern of revenue recognition for a performance obligation satisfied over time Question What indicators are considered to determine when revenue recognition should begin and the pattern of revenue recognition for a performance obligation satisfied over time? Answer When measuring progress, the main objective is to accurately represent how an entity is performing in terms of transferring control of promised goods or services to the customer. Initially, the entity must identify the specific performance obligations outlined in the contract. The nature of these obligations plays a crucial role in determining both the time frame or activities over which they are satisfied, and the method used to measure progress. If it seems that multiple measures of progress would best represent progress under the contract, management might need to consider whether multiple performance obligations should be identified. Standard offers guidance on determining whether a performance obligation is satisfied over time, rather than prescribing the specific measure of progress to use. However, since paragraph 35 addresses the transfer of control, factors influencing control transfer over time could be relevant to assessing the measure of progress. In this evaluation, the entity considers the specific guidance on progress measurement provided in paragraphs 36–45 of IFRS 15, along with the factors used to conclude that control transfers over time in paragraph 35, and the indicators of when control transfers in paragraph 38. Revenue recognition begins only once the entity has started to fulfill its promise. For example, revenue isn’t recognized for producing inventory not controlled by the customer or for carrying out other activities before starting to satisfy the performance obligation. Costs incurred in connection with these activities might relate to future performance and should therefore be evaluated for recognition as an asset under the relevant standards or as a fulfillment cost under IFRS 15. The entity might recognize an asset (such as inventory or fulfillment costs) before beginning to transfer control of goods or services to the customer. Management must consider how the subsequent transfer of such assets is incorporated into the measure of progress once performance begins. In some cases, a revenue ‘catch-up’ might be appropriate if the asset is transferred to the customer immediately when the contract is signed or at another point during the performance period. Alternatively, revenue might be recognized on a systematic basis over the period of performance, depending on the circumstances. Determining the nature of the promise and the appropriate measure of progress requires judgment. For example, if an entity contracts to construct a large factory and delivers a significant component (such as equipment) separately, management should consider whether the equipment constitutes a separate performance obligation or integrates with construction services. The timing of when the entity starts to transfer goods or services and the method used to measure progress once the transfer has begun are also critical considerations. Should an entity recognise a ‘catch-up’ of revenue for activities undertaken before it begins to transfer goods or services? The chosen method of measuring progress may lead to a ‘catch-up’ of revenue, particularly when the entity commences transferring goods or services related to activities conducted before this initiation. This adjustment might be appropriate, for instance, if control of the equipment transfers to the customer at a specific moment in time. Management needs to carefully assess whether control of the equipment, which is exclusively usable in the factory under construction, has indeed been transferred. If the equipment is not distinct and is manufactured by a third party, the guidance regarding ‘uninstalled material’ might be applicable. However, it’s important to note that this guidance is relevant only when the equipment is manufactured by a third party and not by the entity itself.

Management can employ various methods for measuring progress but should select the method that best depicts the transfer of control of goods or services, and apply that method consistently to similar performance obligations and in similar circumstances. At the end of each reporting period, an entity should remeasure its progress towards complete satisfaction of a performance obligation.

Measuring progress when multiple items form a single performance obligation Within a single performance obligation, there may exist a collection of goods or services that lack distinctiveness. The guidance stipulates that entities must employ a unified method for measuring progress for each performance obligation satisfied over time. Identifying a suitable method to gauge progress, particularly when the individual goods or services within the performance obligation will be transferred over varying periods, can pose challenges. To determine the appropriate measure of progress, an entity should assess the nature of its overarching commitment for the performance obligation. In this evaluation, the rationale for consolidating individual goods or services into a single performance obligation should be considered. For contracts encompassing multiple payment streams like upfront payments, contingent performance bonuses, and reimbursement of expenses, entities should apply a singular measure of progress to each performance obligation fulfilled over time for revenue recognition. This entails incorporating all payment streams into the total transaction price and recognizing them based on the designated measure of progress, irrespective of payment timing. For instance, an upfront payment should not be amortized uniformly over time if an alternate measure (such as incurred costs, labor hours, or units produced) is utilized to measure progress for the associated performance obligation.

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Measuring progress of acquired contracts after the acquisition In the scenario of acquiring a business, entities may obtain an in-process contract with a customer featuring performance obligations satisfied over time. Any balances linked to the acquired contract (such as contract assets or liabilities) are recorded in line with the pertinent business combinations guidance and typically at fair value (refer to chapter 29, paragraph 120). Subsequently, the entity must ascertain the measure of progress to recognize revenue for the acquired contract during the post-acquisition period. This measure of progress should be grounded in the acquirer’s estimation of the remaining performance after the acquisition. For instance, if the ‘cost-to-cost’ method is employed, the acquirer should gauge progress based on the anticipated costs to fulfill the contract as of the acquisition date, rather than the estimated costs from contract inception. Essentially, the acquired contract is treated as a new performance obligation that is considered 0% complete as of the acquisition date.

Methods for measuring progress include:

• Output methods, that recognize revenue based on direct measurements of the value transferred to the customer.
• Input methods, that recognize revenue based on the entity’s efforts to satisfy the performance obligation.

Circumstances affecting the measurement of progress often change for performance obligations satisfied over time. Management should update its measurement of progress and the revenue recognized to date as a change in estimate, when circumstances change, to accurately depict the entity’s performance completed to date. Such changes to an entity’s measurement of progress should be accounted for as a change in estimate by IAS 8.

The selection of a method is not an accounting policy choice. Management should select the method of measuring progress that best depicts the transfer of goods or services to the customer.

Output methods

Output methods measure progress towards satisfying a performance obligation based on results achieved and value transferred relative to the remaining goods or services promised under the contract. Examples of output measures include surveys of work performed, units produced, units delivered, and contract milestones. The measure selected should depict the entity’s performance to date and should not exclude a material amount of goods or services for which control has transferred to the customer. Measuring progress based on units produced or units delivered, for example, might be a reasonable proxy for measuring the satisfaction of performance obligations in some, but not all, circumstances. These measures should not be used if they do not take into account work in progress for which control has been transferred to the customer.

Can control of a good or service transfer at discrete points in time when a performance obligation is satisfied over time? Typically, no. While IFRS 15 mentions milestones achieved, units produced, and units delivered as potential examples of output methods, management should exercise caution when opting for these methods, as they may not accurately depict the entity’s progress in fulfilling its performance obligations. It’s crucial for management to evaluate whether the chosen measure of progress is aligned with actual performance and whether the entity has transferred significant goods or services that are not adequately captured in the output measure. An appropriate measure of progress should not result in the entity accumulating a substantial asset (such as work in process), as this would indicate that the measure does not effectively reflect the entity’s performance.

Output methods directly measure performance and can be the most faithful representation of progress. It might be difficult to obtain directly observable information about the output of performance without incurring undue costs, in which case the use of an input method might be necessary.

A method based on units delivered could provide a reasonable proxy for the entity’s performance if the value of any work in progress and the value of any units produced, but not yet transferred to the customer, is immaterial to both the contract and the financial statements as a whole at the end of the reporting period.

Output method of measuring progress Entity G engages in laying railroad track and strikes a deal with a customer to substitute a segment of track for a set fee of C100,000. All work in progress belongs to the customer. By the year’s end, Entity G has replaced 75 units of track out of a total of 100 units scheduled for replacement. The effort required for Entity G remains uniform across each of the 100 units. Entity G concludes that the performance obligation is fulfilled over time, given that the customer exercises control over the work in progress asset being developed. Question How should entity G recognise revenue? Answer An output method, utilizing the number of track units replaced to gauge Entity G’s progress under the contract, seems to be the most reflective of the services rendered, given the consistent effort exerted across each track unit replaced. Moreover, this method accurately portrays the entity’s performance, as it encompasses all work in progress for which control has shifted to the customer. With progress towards completion at 75% (75 units out of 100 units), Entity G would accordingly recognize revenue amounting to 75% of the total contract price, equating to C75,000.

Management can elect a practical expedient to recognize revenue based on amounts invoiced to the customer in certain circumstances, but only if the amount invoiced represents the value transferred to the customer. Evaluating whether an entity’s right to consideration corresponds directly with the value transferred to the customer will require judgment. Management should not presume that a negotiated payment schedule or a fixed price per unit automatically implies that the invoiced amounts represent the value transferred to the customer. The market price or stand-alone selling prices of the goods or services could be evidence of the value to the customer. However, other evidence could also be used to demonstrate that the amount invoiced corresponds directly with the value transferred to the customer.

Other considerations on ‘right to invoice’ practical expedient Variable pricing under IFRS 15 encompasses scenarios beyond a straightforward ‘fixed amount for each hour of service’. This flexibility allows for application of the practical expedient to contracts featuring pricing variations over the contract term. However, entities must furnish adequate evidence demonstrating that the variable pricing reflects the ‘value to the customer’ throughout the contract duration. For instance, consider a contract supplying electricity to a customer over three years at increasing rates. The entity may justify the escalating rates if they mirror the forward market price of electricity at contract inception, thus reflecting value to the customer. On the contrary, contemplate a contract for monthly payroll processing services, with a payment structure stipulating lower monthly payments initially and higher payments later due to the customer’s short-term cash flow constraints. In this case, the escalating rates fail to align with the ‘value to the customer’. In scenarios involving escalating fees, such as a four-year non-cancellable service contract with annual 10% pricing increases, management’s eligibility to utilize the ‘right to invoice’ practical expedient hinges on whether the escalating fees directly correspond with the value of the entity’s performance to the customer. If the scheduled price hikes do not align directly with the increase in value to the customer, management cannot elect the practical expedient and must determine another suitable measure of progress. For instance, employing a time-based measure of progress, such as straight-line recognition, might be appropriate, resulting in recognition of the total transaction price uniformly over the four-year period. Upfront payment and back-end rebate Other payment streams within a contract may influence an entity’s eligibility to opt for the practical expedient. For instance, the inclusion of an upfront payment or a back-end rebate might suggest that the invoiced amounts do not accurately portray the value to the customer for the entity’s completed performance to date. Management should analyze the nature of these payments and their magnitude relative to the total arrangement. Entities choosing the ‘right to invoice’ practical expedient may also opt to omit certain disclosures regarding the remaining performance obligations in the contract.

Input methods

Input methods measure progress towards satisfying a performance obligation indirectly, based on resources consumed or efforts expended relative to total resources expected to be consumed or total efforts expected to be expended. Examples of input methods include costs incurred, labor hours expended, machine hours used, the time elapsed, and quantities of materials.

Accounting for learning curve costs The learning curve represents the phenomenon of efficiency improvement over time as an entity engages in a task or produces a product. In contracts featuring a single performance obligation fulfilled over time, the entity may opt for a method of measuring progress, such as the cost-to-cost method, which leads to recognizing more revenue and expenses in the initial phases of the contract. For instance, in a scenario where an entity is tasked with processing transactions for a customer over a five-year duration, it may acknowledge more revenue and expense for the transactions handled early on compared to those processed later, owing to higher costs incurred in the initial periods due to the impact of the learning curve.

An entity using an input method should include only those inputs that depict the entity’s performance towards satisfying a performance obligation. Management should exclude from its measure of progress any costs incurred that do not result in the transfer of control of a good or service to a customer or when a cost incurred is not proportionate to the entity’s progress in satisfying the performance obligation. For example, mobilization or set-up costs, while necessary for an entity to be able to perform under a contract, might not transfer any goods or services to the customer. Management should consider whether such costs should be capitalized as a fulfillment cost.

Input methods An input method commonly used to measure progress involves assessing costs incurred relative to total estimated costs to determine the extent of completion. Known as the ‘cost-to-cost’ method, it encompasses various costs that signify progress under the contract, including direct labor, direct materials, subcontractor costs, allocations of costs directly related to contract activities indicating the transfer of control to the customer, costs explicitly chargeable to the customer per the contract, and other costs incurred solely due to the contract. While some costs like direct labor and materials are easily identifiable, determining the inclusion of other expenses such as insurance and depreciation can be more challenging. Management must ensure that cost allocations include only those costs contributing to the transfer of control of the good or service to the customer. Costs unrelated to the contract or not aiding in fulfilling a performance obligation should be excluded from the progress measurement. Examples of costs not reflecting progress in fulfilling a performance obligation include general and administrative costs unrelated to the contract unless contractually chargeable to the customer, selling and marketing expenses, research and development costs not specific to the contract, and depreciation of idle plant and equipment. These costs are typical operating expenses rather than expenses aimed at advancing a contract towards completion. Similarly, costs like wasted materials or abnormal labor expenses, unless planned or budgeted during contract negotiations, should be disregarded from the progress measurement. These items denote inefficiencies in the entity’s performance rather than progress in transferring control of a good or service. Activity The contractor’s contract with the government to construct an aircraft carrier for a fixed price of C4 billion constitutes a single performance obligation satisfied over time. Total estimated contract costs amount to C3.6 billion, excluding costs related to wasted labor and materials. In the first year, costs incurred reach C740 million, which includes C20 million attributed to wasted labor and materials. Given that the government retains control over the aircraft carrier’s creation, the contractor deems the performance obligation to be satisfied over time. Additionally, the contractor determines that utilizing an input method, specifically measuring costs incurred relative to the total expected costs, serves as an appropriate gauge of progress towards fulfilling the performance obligation Question How much revenue and cost should the contractor recognise as of the end of year one? Answer The contractor would recognise revenue of C800 million, based on a calculation of costs incurred relative to the total expected costs. The contractor would recognise revenue as follows (figures in millions): Total transaction price                                                C4,000 Progress towards completion 20%                                          (C720 / C3,600) Revenue recognised                                                                   C800 Cost recognised                                                                           C740 Gross profit                                                                    C60 Wasted labour and materials of C20 million should be excluded from the calculation of progress, because the costs do not represent progress towards completion of the aircraft carrier.

Uninstalled materials

Uninstalled materials are materials acquired by a contractor that will be used to satisfy its performance obligations in a contract for which the cost incurred does not depict transfer to the customer. The cost of uninstalled materials should be excluded from measuring progress toward satisfying a performance obligation if the entity is only providing a procurement service. A faithful depiction of an entity’s performance might be to recognize revenue equal to the cost of the uninstalled materials if all the following conditions are met:

1. the good is not distinct.
2. the customer is expected to obtain control of the good significantly before receiving services related to the good.
3. the cost of the transferred good is significant relative to the total expected costs to completely satisfy the performance obligation; and
4. the entity procures the good from a third party and is not significantly involved in designing and manufacturing the good (but the entity is acting as a principal by the standard).

Uninstalled materials The contractor engages in a contract with entity H to erect a power plant, specifying the procurement and installation of a specific turbine, with a contract price of C200 million. Estimated total construction costs are C160 million, with C50 million allocated to the turbine. After procuring and gaining control of the turbine, the contractor delivers it to the construction site, where entity H maintains control over any work in process. Determined as a single performance obligation, the contract is deemed satisfied over time as the power plant is erected, with the contractor identified as the principal party in the agreement. Question How much revenue should the contractor recognise upon delivery of the turbine? Answer Upon delivery of the turbine, the contractor recognizes both revenue and costs amounting to C50 million. Retaining the risks associated with turbine installation within the construction project, the contractor concludes that entity H, controlling work in process, has obtained control of the turbine, especially considering its substantial cost relative to the overall expected contract costs. Since the contractor was not engaged in designing and manufacturing the turbine, including its costs in the measure of progress would overstate the extent of its performance. Consequently, the turbine is classified as an uninstalled material, prompting the contractor to recognize revenue equivalent to the turbine’s cost only.

Time-based methods

Time-based methods to measure progress might be appropriate in situations when a performance obligation is satisfied evenly over some time or the entity has a stand-ready obligation to perform over some time. Judgement will be needed to determine the appropriate method to measure progress towards satisfaction of a stand-ready obligation. It is not appropriate to default to straight-line attribution. However, straight-line recognition over the contract period will be reasonable in many cases. Example 18 of the revenue standard illustrates this concept.

A promise to stand ready versus a promise to deliver specific goods or services and related measurements Differentiating between a commitment to be on standby and a commitment to furnish specific goods or services necessitates exercising judgment. For instance, committing to offer one or more designated upgrades to a software license does not constitute a stand-ready obligation. Conversely, a contract to supply unspecified upgrades on an as-and-when-available basis is generally considered a stand-ready obligation. This distinction arises because the customer uniformly benefits throughout the contract duration from the assurance that any updates or upgrades developed by the entity during that period will be accessible. The suitability of a time-based method varies depending on the circumstances and may best depict the entity’s performance in certain scenarios. For instance, a commitment to deliver a fixed quantity of a good or service, where the quantity of remaining goods or services diminishes with customer usage, typically represents a pledge to furnish the underlying good or service rather than a commitment to stand ready. Conversely, a contract containing a commitment to deliver an unlimited quantity of a good or service might entail a stand-ready obligation, warranting the use of a time-based measure of progress.

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Stand-ready obligation Entity H has a contractual agreement with a client to furnish a software license and unrestricted usage of its call center for a duration of one year. After analysis, Entity H discerns that the software license and support services constitute distinct performance obligations. Typically, customers avail themselves of the call center services throughout the entire contractual term. Regarding revenue recognition for the limitless support services, Entity H identifies its commitment to the customer as a stand-ready obligation, entailing the provision of unrestricted access to its call center. Subsequently, Entity H selects a method of measuring progress that accurately portrays its fulfillment of this obligation. Assuming the adoption of a time-based measure, Entity H would distribute the revenue for the support services uniformly over the one-year service period.

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Obligation to provide a specified quantity of services Question Entity H enters into a contract with a customer to provide a software licence and 100 hours of call centre support for a one-year period. Entity H determines that the software licence and support services are separate performance obligations. Entity H monitors customer usage of support hours to determine when the hours have been utilised. Customers are charged an additional fee for call centre usage beyond 100 hours. Customers frequently use more than 100 hours of support. How should entity H recognise revenue for the 100 hours of support services? Answer Entity H would determine that its commitment to the customer entails delivering 100 hours of call center support. Subsequently, Entity H would assess that an output method, specifically measuring hours of service rendered, most accurately represents its endeavors in fulfilling the performance obligation. Under this approach, revenue recognition would be contingent upon the customer’s utilization of the support services.

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Is it always acceptable to use a time-based measure of progress (that is, straight-line recognition) for a performance obligation that is a series of distinct goods or services? No, opting for a time-based measure of progress by default for a series is not suitable. Nevertheless, in numerous scenarios, recognizing revenue on a straight-line basis throughout the contract duration would be reasonable. Management should opt for the method that most accurately portrays the entity’s advancement in transferring control of the goods or services.

Inability to estimate progress

An entity might not be able to reasonably determine the outcome of a performance obligation or its progress towards satisfaction of that obligation. In that case it is appropriate to recognise revenue over time as the work is performed, but only to the extent of costs incurred (that is, with no profit recognised), as long as the entity expects to at least recover its costs.

Management should discontinue recognising revenue to the extent of costs incurred once it has better information and can estimate a reasonable measure of performance. A cumulative catch-up adjustment should be recognised in the period of the change in estimate, to recognise revenue related to prior performance that had not been recognised due to the inability to measure progress.

Performance obligations satisfied at a point in time

A performance obligation is satisfied at a point in time if none of the criteria for satisfying a performance obligation over time are met. The guidance on control should be considered, to determine when the performance obligation is satisfied by transferring control of the good or service to the customer. In addition, there are five indicators that a customer has obtained control of an asset:

• The entity has a present right to payment.
• The customer has legal title.
• The customer has physical possession.
• The customer has the significant risks and rewards of ownership.
• The customer has accepted the asset.

This is a list of indicators, not criteria. Not all of the indicators need to be met for management to conclude that control has transferred and revenue could be recognised. Management needs to use judgement to determine whether the factors collectively indicate that the customer has obtained control. This assessment should be focused primarily on the customer’s perspective.

Entity has a present right to payment

A customer’s present obligation to pay for an asset could indicate that the entity has transferred the ability to direct the use of, and obtain substantially all of the remaining benefits from, the asset.

Customer has legal title

A party that has legal title is typically the party that can direct the use of and receive the benefits from an asset. The benefits of holding legal title include the ability to sell an asset, exchange it for another good or service, or use it to secure or settle debt, which indicates that the holder has control.

An entity that has not transferred legal title, however, might have transferred control in certain situations. An entity could retain legal title as a protective right, such as to secure payment. Legal title retained solely for payment protection does not indicate that the customer has not obtained control. All indicators of transfer of control should be considered in these situations.

Legal title retained as a protective right Entity J determines that its performance obligation in the contract with Entity K is satisfied at a specific moment when control transfers. This conclusion is reached considering that Entity K possesses the capability to utilize the equipment and relocate it to different work sites upon delivery. Additionally, the standard payment and credit terms are applicable. Question When should entity J recognise revenue for the sale of the equipment? Answer Revenue recognition for Entity J should occur upon the delivery of the equipment to Entity K since control has effectively transferred. This is evidenced by Entity K’s capacity to direct the usage of the equipment and derive benefits from it. Despite Entity J retaining legal title until payment is received, this aspect does not alter the fundamental nature of the transaction.

Customer has physical possession

Physical possession of an asset typically gives the holder the ability to direct the use of and obtain benefits from that asset, and is therefore an indicator of which party controls the asset. However, physical possession does not, on its own, determine which party has control. Management needs to carefully consider the facts of each arrangement to determine whether physical possession coincides with the transfer of control.

Sale of goods with resale restrictions A publisher ships copies of a new book to a retailer. The publisher has a present right to payment for the books, but its terms of sale restrict the retailer’s right to resell the book for several weeks to ensure a consistent release date across all retailers. Question Can the publisher recognise revenue upon delivery of the books to the retailer? Answer Whether revenue recognition occurs immediately or upon the lapse of resale restrictions depends on the publisher’s assessment of the retailer’s control over the books. In most cases, the publisher may determine that the retailer lacks control until the resale restrictions are lifted, delaying revenue recognition until that point. However, the publisher should carefully evaluate all pertinent factors to ascertain when control transfers to the retailer. For instance, if the retailer can still distribute the books to other distributors despite consumer resale restrictions, the publisher may conclude that control has transferred to the retailer, warranting revenue recognition.

Customer has significant risks and rewards of ownership

An entity that has transferred the risks and rewards of ownership of an asset has typically transferred control to a customer. Management should exclude any risks that give rise to a separate performance obligation when evaluating the risks and rewards of ownership. Retained risks could result in separate performance obligations in some fact patterns. This would require management to allocate some of the transaction price to the additional obligation.

Can control of a good transfer prior to delivery to the customer’s location if an entity has a customary practice of replacing or crediting the customer for lost or damaged goods in transit? The determination of when the customer gains control of the goods depends on various factors that need to be considered by management. While the entity’s practice of replacing lost or damaged goods during transit is relevant, it alone does not determine the transfer of control. If the entity decides that control transfers at the shipping point in this scenario, it should also evaluate whether there are any additional performance obligations or guarantees associated with the goods during transit.

Customer has accepted the asset

A customer acceptance clause provides protection to a customer by allowing it either to cancel a contract or to force a seller to take corrective action if goods or services do not meet the requirements in the contract.

Customer acceptance that is only a formality does not affect the assessment of whether control has transferred. An acceptance clause that is contingent upon the goods meeting certain objective specifications could be a formality if the entity has performed tests to ensure that those specifications are met before the good is shipped. Management should consider whether the entity routinely manufactures and ships products of a similar nature, and the entity’s history of customer acceptance upon receipt of products. The acceptance clause might not be a formality if the product being shipped is unique, as there is no history to rely upon.

An acceptance clause that relates primarily to subjective specifications is unlikely to be a formality, because the entity cannot ensure that the specifications are met prior to shipment. Management might not be able to conclude that control has transferred to the customer until the customer accepts the goods in such cases. A customer also does not control products received for a trial period if it is not committed to pay any consideration until it has accepted the products. This accounting differs from a right of return, which is considered in determining the transaction price. Customer acceptance, as with all indicators of transfer of control, should be viewed from the customer’s perspective. Management should consider not only whether it believes that the acceptance is a formality, but also whether the customer views the acceptance as a formality.

Do payment terms linked to product acceptance impact the timing of control transfer? Question The payment terms for a contract to sell a product to a customer specify that the final 10% of the fee is not due until the customer accepts the product. Control of the product transfers at a point in time, and there are no other performance obligations in the contract. Do these payment terms indicate that control of the product does not transfer until customer acceptance? Answer The determination of when control transfers to the customer depends on various factors beyond just the payment terms. Management must evaluate the substance of the acceptance provision, considering whether it pertains to objective or subjective specifications, and take into account other indicators of control transfer. The total transaction price should be recognized at the point when control of the product transfers to the customer. Therefore, it would not be appropriate to recognize 90% of the transaction price before acceptance and the remaining 10% upon acceptance.