IFRS 15 for contract costs1 specifies the accounting treatment for costs an entity incurs to obtain and fulfil a contract to provide goods or services to customers as discussed below. An entity only applies these requirements to costs incurred that relate to a contract with a customer that is within the scope of IFRS 15.
When an entity recognises capitalised contract costs under IFRS 15, any such assets must be presented separately from contract assets and contract liabilities in the statement of financial position or disclosed separately in the notes to the financial statements (assuming they are material).
Furthermore, entities must consider the requirements in IAS 1 on classification of current assets when determining whether their contract cost assets are presented as current or non-current.
– Costs to obtain a contract
Before applying the cost requirements in IFRS 15, entities need to consider the scoping provisions of the standard. Specifically, an entity needs to first consider whether the requirements on consideration payable to a customer under IFRS 15 apply to the costs.
For those costs within the scope of the cost requirements in IFRS 15, the incremental costs of obtaining a contract with a customer are recognised as an asset if the entity expects to recover them. An entity can expect to recover contract acquisition costs through direct recovery (i.e., reimbursement under the contract) or indirect recovery (i.e., through the margin inherent in the contract). Incremental costs are those that an entity would not have incurred if the contract had not been obtained.
Costs incurred to obtain a contract that are not incremental costs are required to be expensed as incurred, unless they are explicitly chargeable to the customer (regardless of whether the contract is obtained).
The following decision tree illustrates the requirements in IFRS 152:
Document your decisions in your financial close file to facilitate internal review and approval and external audits.
To determine whether a cost is incremental, an entity should consider whether it would incur the cost if the customer (or the entity) decides, just as the parties are about to sign the contract, that it will not enter into the contract. If the costs would have been incurred even if the contract is not executed, the costs are not incremental to obtaining that contract. The objective of this requirement is not to allocate costs that are associated in some manner with an entity’s marketing and sales activity, but only to identify those costs that an entity would not have incurred if the contract had not been obtained. For example, salaries and benefits of sales employees that are incurred regardless of whether a contract is obtained are not incremental costs. [IFRS 15 91 – 94]
Consider the following example from the FASB TRG agenda paper3:
Example: Fixed employee salaries
An entity pays an employee an annual salary of CU100,000. The employee’s salary is based on the number of prior-year contracts he or she signed, as well as the projected number of contracts the employee will sign for the current year. The employee’s current year salary will not change if the number of contracts the employee actually signs differs from the projected number. However, any difference would affect the employee’s salary in the following year.
FASB TRG members generally agreed that no portion of the employee’s salary should be capitalised because it is not an incremental cost of obtaining a contract. The employee’s salary would have been incurred regardless of the number of contracts the employee has actually signed during the current year.
The standard cites sales commissions as a type of an incremental cost that may require capitalisation under the standard. For example, commissions that are related to sales from contracts signed during the period may represent incremental costs that would require capitalisation. The standard does not explicitly address considerations for different types of commission programmes. Therefore, entities have to exercise judgement to determine whether sales commissions are incremental costs and, if so, the point in time when the costs would be capitalised. However, FASB TRG members generally agreed that an employee’s title or level in the organisation or how directly involved the employee is in obtaining the contract, are not factors in assessing whether a sales commission is incremental. Consider the following example from a FASB TRG paper4:
Example: Commissions paid to different levels of employees
An entity’s salesperson receives a 10% sales commission on each contract that he or she obtains. In addition, the following employees of the entity receive sales commissions on each signed contract negotiated by the salesperson: 5% to the manager and 3% to the regional manager.
In general all of the commissions are incremental because the commissions would not have been incurred if the contract had not been obtained. IFRS 15 does not distinguish between commissions paid to the employee(s) based on the function or the title of the employee(s) that receives a commission. It is the entity that decides which employee(s) are entitled to a commission as a result of obtaining a contract.
In general it is believed that commissions that are paid to a third party in relation to sales from contracts that were signed during the period may also represent incremental costs that would require capitalisation. That is, commissions paid to third parties should be evaluated in the same manner as commissions paid to employees in order to determine whether they are required to be capitalised.
In addition, entities need to carefully evaluate all compensation plans, not just sales commission plans, to determine whether any plans contain incremental costs that need to be capitalised. For example, payments under a compensation ’bonus’ plan may be solely tied to contracts that are obtained. Such costs would be capitalised if they are incremental costs of obtaining a contract, irrespective of the title of the plan.
Example: Commissions paid to a pool of funds
Assume that an entity has a compensation plan for support personnel in its sales department. As a group, the employees are entitled to a pool of funds calculated based on 2% of all new contracts signed during the monthly period. Once the amount of the pool is known, the amount paid to each individual employee is determined based on each employee’s rating.
While the amount paid to each employee is discretionary (based on each employee’s rating), the total amount of the pool is considered an incremental cost to obtain a contract because the entity owes that amount to the employees (as a group) simply because a contract was signed.
TRG members discussed the underlying principle for capitalising costs under the standard and generally agreed that IFRS 15 did not amend the requirements for liabilities (e.g., IAS 37). Therefore, entities would first refer to the applicable liability standards to determine when they are required to accrue for certain costs. Entities would then use the requirements in IFRS 15 to determine whether the related costs need to be capitalised. TRG members acknowledged that certain aspects of the cost requirements require entities to apply significant judgement in analysing the facts and circumstances and determining the appropriate accounting treatment5.
In addition, the IASB staff observed in a TRG agenda paper that incremental costs of obtaining a contract are not limited to initial incremental costs. Commissions recognised subsequent to contract inception (e.g., commissions paid on modifications, commissions subject to contingent events or clawback) because they did not meet the recognition criteria for liabilities at contract inception would still be considered for capitalisation as costs to obtain the contract when the liability is recognised. This would include costs related to contract renewals because, as the TRG agenda paper said, a renewal is a contract and there is nothing in the requirements for costs to obtain a contract that suggests a different treatment for contracts that are renewals of existing contracts. That is, the only difference between the two costs would be the timing of recognition based on when a liability has been incurred6.
Unlike many commissions, some incentive payments, such as bonuses and other compensation that are based on quantitative or qualitative metrics that are not related to contracts obtained (e.g., profitability, earnings per share (EPS), performance evaluations) are unlikely to meet the criteria for capitalisation because they are not incremental costs of obtaining a contract. However, a legal contingency cost may be an incremental cost of obtaining a contract when a lawyer agrees to receive payment only upon the successful completion of a negotiation. Determining which costs must be capitalised under the standard may require judgement and it is possible that some contract acquisition costs are determined to be incremental and others are not. Consider the following example from a FASB TRG agenda paper 7:
Example: Incremental and non-incremental costs for same contract
An entity pays a 5% sales commission to its employees when they obtain contracts with customers. An employee begins negotiating a contract with a prospective customer and the entity incurs CU5,000 in legal and travel costs in the process of trying to obtain the contract. The customer ultimately enters into a CU500,000 contract and, as a result, the employee receives a sales commission of CU25,000.
FASB TRG members generally agreed that the entity should only capitalise the commission paid to the employee of CU25,000. This cost is the only one that is incremental to obtaining the contract. While the entity incurs other costs that are necessary to facilitate a sale (e.g., legal, travel), those costs would have been incurred even if the contract had not been obtained.
The standard provides the following example regarding incremental costs of obtaining a contract Example 36 — Incremental costs of obtaining a contract (IFRS 15 IE189 – IE191).
As a practical expedient, the standard permits an entity to immediately expense contract acquisition costs when the asset that would have resulted from capitalising such costs would have been amortised within one year or less. It is important to note that the amortisation period for incremental costs may not always be the initial contract term.
What’s changed from previous IFRS?
IFRS 15 represents a significant change in practice for entities that previously expensed the costs of obtaining a contract and are required to capitalise them under IFRS 15. Entities need to evaluate all sales commissions paid to employees and capitalise any costs that are incremental, regardless of how directly involved the employee was in the sales process or the level or title of the employee.
In addition, this may be a change for entities that previously capitalised costs to obtain a contract, particularly if the amounts capitalised were not incremental and, therefore, would not be eligible for capitalisation under IFRS 15, unless explicitly chargeable to the customer regardless of whether the contract is obtained.
Costs to fulfil a contract
The standard divides contract fulfilment costs into two categories:
- costs that give rise to an asset; and
- costs that are expensed as incurred.
When determining the appropriate accounting treatment for such costs, IFRS 15 makes it clear that any other applicable standards are considered first. If those other standards preclude capitalisation of a particular cost, then an asset cannot be recognised under IFRS 15. If other standards are not applicable to contract fulfilment costs, IFRS 15 provides the following criteria for capitalisation:
- The costs directly relate to a contract or to a specifically identifiable anticipated contract (e.g., costs relating to services to be provided under renewal of an existing contract or costs of designing an asset to be transferred under a specific contract that has not yet been approved).
- The costs generate or enhance resources of the entity that will be used in satisfying (or in continuing to satisfy) performance obligations in the future.
- The costs are expected to be recovered. [IFRS 15 95]
If all of the criteria are met, an entity is required to capitalise these costs. The following decision tree illustrates these requirements8:
Document your decisions in your financial close file to facilitate internal review and approval and external audits.
When determining whether costs meet the criteria for capitalisation, an entity must consider its specific facts and circumstances. IFRS 15 states that costs can be capitalised even if the revenue contract with the customer is not finalised. However, rather than allowing costs to be related to any potential future contract, the standard requires that the costs be associated with a specifically anticipated contract.
The standard discusses and provides examples of costs that may meet the first criterion for capitalisation (i.e., costs that relate directly to the contract) in IFRS 15 97.
Significant judgement may be required to determine whether costs generate or enhance resources of the entity that will be used in satisfying performance obligations in the future. The standard only results in the capitalisation of costs that meet the definition of an asset and it is precluding an entity from deferring costs merely to normalise profit margins throughout a contract (by allocating revenue and costs evenly over the contract term). [IFRS 15 BC308]
For costs to meet the ‘expected to be recopvered’ criterion, they need to be either explicitly reimbursable under the contract or reflected through the pricing on the contract and recoverable through margin.
If the costs incurred in fulfilling a contract do not give rise to an asset, based on the criteria above, they must be expensed as incurred. The standard provides some common examples of costs that must be expensed as incurred in IFRS 15 98.
If a performance obligation (or a portion pf a performance obligation that is satisfied over time) has been satisfied, fulfilment costs related to that performance obligation (or portion thereof) can no longer be capitalised. This is true even if the associated revenue has not yet been recognised (e.g., the contract consideration is variable and has been fully or partially constrained). Once an entity has begun satisfying a performance obligation that is satisfied over time, it would only capitalise costs that relate to future performance. Accordingly, it may be challenging for an entity to capitalise costs that are related to a performance obligation that an entity has already started to satisfy.
If an entity is unable to determine whether certain costs relate to past or future performance and the costs are not eligible for capitalisation under other IFRSs, the costs are expensed as incurred.
The standard provides an example that illustrates costs that are capitalised under other IFRSs, costs that meet the capitalisation criteria and costs that do not, see Example 37 in IFRS 15 IE192 – IE196.
Amortisation of capitalised contract costs
Any capitalised contract costs are amortised, with the expense recognised on a systematic basis that is consistent with the entity’s transfer of the related goods or services to the customer.
IFRS 15 99 states that capitalised contract costs are amortised on a systematic basis that is consistent with the transfer to the customer of the goods or services to which the asset relates. When the timing of revenue recognition (e.g., at a point in time, over time) aligns with the transfer of the goods or services to the customer, the amortisation of the capitalised contract costs in a reporting period will correspond with the revenue recognition in that reporting period. However, the timing of revenue recognition may not always align with the transfer of the goods and services to the customer (e.g., when variable consideration is constrained at the time the related performance obligation is satisfied). When this occurs, the amortization of the capitalised contract costs will not correspond with the revenue recognition in a reporting
For example, consider an entity that enters into a contract with a customer to provide two performance obligations, a right-to-use licence and a related service for three years, with payment from the customer based on the customer’s usage of the intellectual property (i.e., a usage-based royalty). Revenue in respect of the licence of intellectual property would be recognised at a point in time (see section 8.3.2) and revenue in respect of the related service would be recognised over time. The transaction price allocated to the performance obligation for the licence of intellectual property cannot be recognised at a point in time when control of the licence transfers to the customer due to the royalty recognition constraint (see Sales-based or usage-based royalties on licences of intellectual property 8.5).
Accordingly, any capitalised contract costs that relate to the licence need to be fully amortised upon the transfer of control of that licence (i.e., at a point in time), regardless of when the related revenue will be recognised. Any capitalised contract costs that relate to the services need to be amortised over the period of time consistent with the transfer of control of the service.
It is important to note that certain capitalised contract costs relate to multiple goods or services (e.g., design costs to manufacture multiple distinct goods when design services are not a separate performance obligation) in a single contract, so the amortisation period could be the entire contract term. The amortisation period could also extend beyond a single contract if the capitalised contract costs relate to goods or services being transferred under multiple contracts or to a specifically anticipated contract (e.g., certain contract renewals). In these situations, the capitalised contract costs would be amortised over a period that is consistent with the transfer to the customer of the goods or services to which the asset relates. This can also be thought of as the expected period of benefit of the asset capitalised. The expected period of benefit may be the expected customer relationship period, but that is not always the case. To determine the appropriate amortisation period, an entity needs to evaluate the type of capitalised contract costs, what the costs relate to and the specific facts and circumstances of the arrangement. Furthermore, before including estimated renewals in the period of benefit, an entity should evaluate its history with renewals to conclude that such an estimate is supportable.
An entity updates the amortisation period when there is a significant change in the expected timing of transfer to the customer of the goods or services to which the asset relates (and accounts for such a change as a change in accounting estimate in accordance with IAS 8), as illustrated in the following example:
Example: Amortisation period
Entity A enters into a three-year contract with a new customer for transaction processing services. To fulfil the contract, Entity A incurred setup costs of CU60,000, which it capitalised in accordance with IFRS 15 95-98 and will amortise over the term of the contract.
At the beginning of the third year, the customer renews the contract for an additional two years. Entity A will benefit from the initial set-up costs during the additional two-year period. Therefore, it changes the remaining amortisation period from one year to three years and adjusts the amortisation expense in the period of the change and future periods in accordance with the requirements in IAS 8 for changes in accounting estimates. The disclosure requirements of IAS 8 related to changes in estimates are also applicable.
However, under IFRS 15, if Entity A had been in the position to anticipate the contract renewal at contract inception, Entity A would have amortised the set-up costs over the anticipated term of the contract including the expected renewal (i.e., five years).
Determining the amortisation period for incremental costs of obtaining a contract with a customer can be complicated, especially when contract renewals are expected and the commission rates are not constant throughout the entire life of the contract. When evaluating whether the amortisation period for a sales commission extends beyond the original contract period, an entity would also evaluate whether an additional commission is paid for subsequent renewals. If so, it evaluates whether the renewal commission is considered ‘commensurate’ with the original commission.
In the Basis for Conclusions, the IASB explained that amortising the asset over a longer period than the initial contract would not be appropriate if an entity pays a commission on a contract renewal that is commensurate with the commission paid on the initial contract. In that case, the costs of obtaining the initial contract do not relate to the subsequent contract (IFRS 15 BC309). An entity would also need to evaluate the appropriate amortisation period for any renewal commissions that are required to be capitalised under IFRS 15 in a similar manner.
Impairment of capitalised contract costs
Any asset recorded by the entity is subject to an assessment of impairment. This is because costs that give rise to an asset must continue to be recoverable throughout the contract (or period of benefit, if longer), in order to meet the criteria for capitalisation.
An impairment exists if the carrying amount of any asset(s) exceeds the amount of consideration the entity expects to receive in exchange for providing the associated goods or services, less the remaining costs that relate directly to providing those goods or services. Impairment losses are recognised in profit or loss.
TRG members generally agreed that an impairment test of capitalised contract costs should include future cash flows associated with contract renewal or extension periods, if the period of benefit of the costs under assessment is expected to extend beyond the present contract (Source: TRG Agenda paper no. 4, Impairment testing of capitalised contract costs, dated 18 July 2014). In other words, an entity should consider the total period over which it expects to receive economic benefits relating to the asset, for the purpose of both determining the amortisation period and estimating cash flows to be used in the impairment test. The question was raised because of an inconsistency within IFRS 15. IFRS 15 indicates that costs capitalised under the standard could relate to goods or services to be transferred under ‘a specific anticipated contract’ (e.g., goods or services to be provided under contract renewals and/or extensions) (IFRS 15 99).
The standard also indicates that an impairment loss would be recognised when the carrying amount of the asset exceeds the remaining amount of consideration expected to be received (determined by using principles in IFRS 15 for determining the transaction price) (IFRS 15 101(a) and IFRS 15 102). However, the requirements for measuring the transaction price in IFRS 15 indicate that an entity does not anticipate that the contract will be “cancelled, renewed or modified” when determining the transaction price (IFRS 15 49).
In some instances, excluding renewals or extensions would trigger an immediate impairment of a contract asset because the consideration an entity expects to receive would not include anticipated cash flows from contract extensions or renewal periods. However, the entity would have capitalised contract costs on the basis that they would be recovered over the contract extension or renewal periods. When an entity determines the amount it expects to receive, the requirements for constraining estimates of variable consideration are not considered. That is, if an entity were required to reduce the estimated transaction price because of the constraint on variable consideration, it would use the unconstrained transaction price for the impairment test. While unconstrained, this amount must be reduced to reflect the customer’s credit risk before it is used in the impairment test.
However, before recognising an impairment loss on capitalised contract costs incurred to obtain or fulfil a contract, the entity needs to consider impairment losses recognised in accordance with another standard (e.g., IAS 36 Impairment of Assets). After applying the impairment test to the capitalised contract costs, an entity includes the resulting carrying amounts in the carrying amount of a cash-generating unit for purposes of applying the requirements in IAS 36.
See also: The IFRS Foundation