IFRS 15 Revenue from Contracts with Customers (contents page is here) introduced a single and comprehensive framework which sets out how much revenue is to be recognised, and when. The core principle is that a vendor should recognise revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the vendor expects to be entitled in exchange for those goods or services. See a summary of IFRS 15 here.
Contract costs are initially recognised as an asset and expensed on a systematic basis that is consistent with the transfer to the customer of the good or service to which those costs relate. Contract costs comprise both incremental costs of obtaining a contract and costs to fulfil a contract. Contract costs from Contracts with Customers
Incremental costs of obtaining a contract Contract costs from Contracts with Customers
Incremental costs incurred in obtaining a contract are those that would not have been incurred had that individual contract not been obtained. This is restrictive and includes only costs such as a sales commission that is paid only if the contract is obtained, unless the costs can be explicitly recharged to a customer.
As a practical expedient, incremental costs of obtaining a contract can be recognised as an immediate expense rather than capitalised if the period over which they would otherwise be expensed (or amortised) is one year or less.
All other ongoing costs of running the business, including costs that are incurred with the intention of obtaining a contract with a customer, are not incremental and will be expensed unless they fall within the scope of another accounting standard (such as IAS 16 Property, Plant and Equipment) and are required to be accounted for as an asset.
Costs to fulfil a contract Contract costs from Contracts with Customers
In contrast with the incremental costs of obtaining a contract, which fall wholly within its scope, the requirements of IFRS 15 apply only to costs to fulfil a contract which do not fall within the scope of another IFRS (for example, IAS 2 Inventories, IAS 16 Property, Plant and Equipment and IAS 38 Intangible Assets). For those costs which do fall within the scope of IFRS 15, the threshold for identifying costs to fulfil a contract is lower than the ‘incremental’ threshold for costs in obtaining a contract. However, there are still restrictions and all of the following criteria need to be met:
- The fulfilment costs relate directly to a contract or to an anticipated contract that can specifically be identified;
- The costs generate or enhance resources of the vendor that will be used to satisfy performance obligations in future; and
- The costs are expected to be recovered.
Examples Contract costs from Contracts with Customers
A sales employee is paid a commission for each contract obtained with a customer. CU 100 is paid for a new customer contract. CU 60 is paid each time that same customer renews the contract. Assume the CU 60 renewal commission is not considered commensurate with the CU 100 commission paid on the initial contract.
The CU 100 paid for the new customer contract must be capitalised at contract inception.
The CU 60 for each renewal must be capitalised upon renewal because it is considered an incremental cost that would not have been incurred if the renewal contract was not obtained.
For the CU 100 capitalised when the new customer contract is obtained, alternative amortisation approaches include:
If the renewal contract was not a specifically anticipated future contract and the renewal commission is considered commensurate with the initial commission, an entity would amortise the CU100 paid for the new customer contract over the original contract term and then amortise each capitalised renewal amount over the respective renewal period.
Scenario 2 (looking at subsequent commission)
An employee receives an initial sales commission based on the contract price when a contract is obtained. This commission is considered incremental, so it is capitalised under IFRS 15. Subsequently, the customer modifies the contract to purchase additional goods, and the modification does not result in the company accounting for the modification as a separate contract. The employee is paid an additional commission based on the increase in the contract price arising from the modification.
Even though the contract modification is not accounted for as a separate contract, the increase in the contract price results in additional commission that is incremental to obtaining the modified contract. Therefore, the additional commission paid is an incremental cost of obtaining a contract and should be capitalised and amortised (along with any unamortised amount relating to the initial commission) on a systematic basis that is consistent with the transfer to the customer of the remaining goods or services to be provided over the remaining contractual period.