IFRS 15 Create or enhance an asset is the second phase for IFRS 15 Revenue recognition. This is part of a primary and fundamental subject in the recognition of revenue. There are two ways of recognising revenue, revenue recognition over time and revenue recognition at a point in time. Revenue recognition over time is often referred to as the ‘Percentage of completion‘ method under the (superseded) IAS 11 Construction contracts. IFRS 15 Create or enhance an asset
The general principle is the revenue is recognised at a point in time (and as such it is the most common type of sales transaction at least in volume, just think of: a retailer sells a candy bar for cash in the shopping mall). As a result there are three criterion (see below ability, direct the use and obtain benefits from) that have to be met to qualify as revenue recognised over time.
Revenue recognition IFRS 15 Create or enhance an asset
Under IFRS 15, an entity only recognises revenue when it satisfies an identified performance obligation by transferring a promised good or service to a customer. A good or service is considered to be transferred when the customer obtains control.
Obtain control IFRS 15 Create or enhance an asset
IFRS 15 states that “control of an asset refers to the ability to direct the use and obtain substantially all of the remaining benefits from the asset”. [IFRS 15 33] IFRS 15 Create or enhance an asset
The IASB explained the key terms in the definition of control in the Basis for Conclusions, as follows: [IFRS 15 BC 118] Satisfaction of performance obligations
- Ability — a customer must have the present right to direct the use of, and obtain substantially all of the remaining benefits from, an asset for an entity to recognise revenue. For example, in a contract that requires a manufacturer to produce an asset for a customer, it might be clear that the customer will ultimately have the right to direct the use of, and obtain substantially all of the remaining benefits from, the asset. However, the entity should not recognise revenue until the customer has actually obtained that right (which, depending on the contract, may occur during production or afterwards). IFRS 15 Create or enhance an asset
- Direct the use of — a customer’s ability to direct the use of an asset refers to the customer’s right to deploy or to allow another entity to deploy that asset in its activities or to restrict another entity from deploying that asset. IFRS 15 Create or enhance an asset
- Obtain the benefits from — the customer must have the ability to obtain substantially all of the remaining benefits from an asset for the customer to obtain control of it. Conceptually, the benefits from a good or service are potential cash flows (either an increase in cash inflows or a decrease in cash outflows). IFRS 15 33 indicates that a customer can obtain the benefits directly or indirectly in many ways, such as: using the asset to produce goods or services (including public services); using the asset to enhance the value of other assets; using the asset to settle a liability or reduce an expense; selling or exchanging the asset; pledging the asset to secure a loan; or holding the asset. IFRS 15 Create or enhance an asset
Under IFRS 15, the transfer of control to the customer represents the transfer of the rights with regard to the good or service. The customer’s ability to receive the benefit from the good or service is represented by its right to substantially all of the cash inflows, or the reduction of the cash outflows, generated by the goods or services. Upon transfer of control, the customer has sole possession of the right to use the good or service for the remainder of its economic life or to consume the good or service in its own operations.
Performance obligation satisfied over time/ Performance obligation satisfied at a point in time
Frequently, entities transfer the promised goods or services to the customer over time. While the determination of whether goods or services are transferred over time is straightforward in some contracts (e.g., many service contracts), it is more difficult in other contracts. Satisfaction of performance obligations
IFRS 15 35 states that an entity transfers control of a good or service over time if one of the following criteria is met:
- As the entity performs, the customer simultaneously receives and consumes the benefits provided by the entity’s performance.
- The entity’s performance creates or enhances an asset (e.g., work in progress) that the customer controls as the asset is created or enhanced. IFRS 15 Create or enhance an asset
- 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.
The following decision tree illustrates how to evaluate whether control transfers over time/at a point in time:
The second question (see below explanation) is: Does the entity’s performance create or enhance an asset that the customer controls as the asset is created or enhanced?
Reference – IFRS 15 BC129
Document your decisions in your financial close file to facilitate internal review and approval and external audits.
Customer controls the asset as it is created or enhanced
The second criterion to determine whether control of a good or service is transferred over time requires entities to evaluate whether the customer controls the asset as it is being created or enhanced. This criterion addresses situations in which the customer controls any work in progress arising from the entity’s performance. The example used by IASB is the example in which the entity has entered into a construction contract to build on the customer’s land, stating that any work in progress arising from the entity’s performance is generally controlled by the customer. [IFRS 15 BC129]
See also: The IFRS Foundation