Contract modifications and variable consideration are discussed on this page.
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 modifications and variable consideration
A contract modification arises when the parties approve a change in the scope and/or the price of a contract (eg a change order). In IFRS 15 this exercise is part of step 1 Identify the contract. The accounting for a contract modification depends on whether the modification is deemed to be a separate contract or not. Contract modifications and variable consideration
Modification is a separate contract
An entity accounts for a modification as a separate contract, if both: Contract modifications and variable consideration
- the scope changes due to the addition of ‘distinct’ goods or services (see below)
- the price change reflects the goods’ or services’ stand-alone selling prices under the circumstances of the modified contract.
In this case, only future revenue is impacted as the entity will continue to account for the pre-modification contract as before.
Accounting for a contract modification
The accounting for a contract modification that is not a separate contract depends on whether the remaining goods and services to be delivered under the modified contract are ‘distinct’ from those already transferred to the customer at the modification date:
Remaining goods or services are distinct
if the remaining goods or services are distinct, then the modification is treated as a termination of the original contract and the creation of a new contract. The transaction price to be allocated to the remaining separate performance obligations is the (modified) total consideration promised by the customer less the amount already recognised as revenue. No adjustments are made to the amount of revenue recognised for separate performance obligations satisfied on or before the modification date. If a change to an amount of variable consideration arises subsequently and relates to performance prior to the modification the entity applies the guidance on variable consideration Contract modifications and variable consideration
Remaining goods or services are not distinct
if the remaining goods or services are not distinct and are part of a single performance obligation that is partially satisfied as of the modification date, the entity adjusts both the transaction price and the measure of progress toward completion of the performance obligation. Revenue recognised to date is adjusted for the contract modification on a ‘cumulative catch-up’ basis Contract modifications and variable consideration
Combination of distinct and not distinct
the remaining goods or services are a combination of these scenarios the entity accounts for the effects of the modification on unsatisfied or partially satisfied obligations consistently with the guidance above. No adjustments are made to the amount of revenue recognised for separate performance obligations satisfied on or before the modification date.
If the parties approve a change in scope but the price change has not yet been determined, the entity applies the relevant guidance to the modified contract using an estimate of the change in transaction price arising from the modification. The guidance on variable consideration applies in such cases: Contract modifications and variable consideration
The amount of consideration received under a contract might vary due to discounts, rebates, refunds, credits, price concessions, incentives, performance bonuses, penalties and similar items. IFRS 15’s guidance on variable consideration also applies if:
- the amount of consideration received under a contract is contingent on the occurrence or non-occurrence of a future event (eg a fixed-price contract would be variable if the contract included a return right) Contract modifications and variable consideration
- the facts and circumstances at contract inception indicate that the entity intends to offer a price concession.
Estimate the transaction price
To estimate the transaction price in a contract that includes variable consideration, an entity determines either:
- the expected value (the sum of probability-weighted amounts) or Contract modifications and variable consideration
- the most likely amount of consideration to be received, Contract modifications and variable consideration
whichever better predicts the amount of consideration to which the entity will be entitled. Contract modifications and variable consideration
The expected value might be the appropriate amount in situations where an entity has a large number of similar contracts. The most likely amount might be appropriate in situations where a contract has only two possible outcomes (for example, a bonus for early delivery that either would be fully received or not at all).
An entity should use the same method to estimate the transaction price throughout the life of a contract.
Refund of consideration
An entity that expects to refund a portion of the consideration to the customer would recognise a liability for the amount of consideration it reasonably expects to refund. The entity would update the refund liability each reporting period based on current facts and circumstances.
See also: The IFRS Foundation