To apply IFRS 15, automotive parts suppliers (APSs) will need to change the way they evaluate long-term supply contracts. APSs need to use significant judgement when they identify separate performance obligations (i.e., units of account), which may be different from those identified under IAS 18.
APSs commonly enter into long-term arrangements with Original Equipment Manufacturers (OEMs) to provide specific parts, such as seat belts or steering wheels. An arrangement typically includes the construction for the tooling, which is required to be used when manufacturing the parts to meet the OEM’s specifications. In many cases, the APS will construct and transfer the legal title for the tooling to the OEM after construction, even though they will retain physical possession of it in order to produce the parts.
Currently, some APSs account for tooling as a revenue element because they have concluded it is a deliverable in the arrangement. Those APSs will likely be able to reach the same conclusion under IFRS 15, because the Boards concluded that these goods and services are goods or services for which the customer pays and to which the entity allocates consideration (i.e., identifies as separate performance obligations) for revenue recognition purposes.
Other APSs may have concluded that tooling is not a revenue element under IAS 18 because it does not represent a deliverable in the arrangement. In order to reach the same conclusion under IFRS 15, APSs will need to conclude that the tooling does not transfer a good or service to the customer, similar to administrative tasks performed by a service provider to set up a contract. It is not clear whether this interpretation will be permitted under the standard. As contract terms can vary, careful consideration of the APS’s terms with its customers will be necessary in order to make this determination.
Under IFRS 15, if the tooling is determined to be a revenue element, the entity must first evaluate whether the tooling is distinct (i.e., both capable of being distinct and distinct within the context of the contract) and, therefore, a separate performance obligation. In making this evaluation, an APS will have to consider whether the tooling is separately identifiable from the production of the specified parts (e.g., is the tooling highly dependent on, or highly interrelated with, the production of the specified parts?). APSs will have to apply significant judgement in making these determinations. Long-term supply contracts
An entity recognises revenue when it transfers control of the promised good or service to the customer, which can occur over time or at a point in time. If the tooling is distinct, an APS would account for the tooling separately from the production of the other specialised parts. Revenue would be recognised for the tooling either over time or at a point in time, depending on how control of the tooling transfers to the OEM. If the tooling is not distinct, the APS would combine the tooling with the production. Revenue would be recognised as control of the specialised parts is transferred to the OEM. This evaluation will require judgement and careful consideration of the facts and circumstances.
Under their supply agreements, an APS may provide OEMs with a customised part (e.g., a car seat) that is designed and constructed specifically to fit within a particular make and model of vehicle. In these types of arrangements, APSs will have to carefully consider whether each individual part is a separate performance obligation or whether all the parts supplied in the contract (or some combination of them) are considered a single performance obligation.
After the performance obligations are identified, APSs will also need to evaluate whether the performance obligations meet the criteria for recognising revenue over time (rather than at a point in time, such as when delivery occurs). Long-term supply contracts
The Boards concluded that, when an entity is creating something that is highly customised for a particular customer, which may be the case in an APS contract, it is less likely that the entity could use that asset for any other purpose. When determining whether an asset has alternative use, IFRS 15 states that an entity needs to consider the effects of contractual restrictions and practical limitations on the entity’s ability to readily direct that asset for another use (i.e., sell it to a different customer). A contractual restriction needs to be substantive (i.e., the customer could enforce its rights to the promised asset if the entity directed the asset for another use). A practical limitation only exists if an entity would incur significant economic losses to direct the asset for another use. An APS may need to consider these concepts in the context of selling customised parts to an after-market supplier. The evaluation of whether an asset has alternative use will require significant judgement. Long-term supply contracts
APSs will also have to evaluate whether they have an enforceable right to payment for performance completed to date, considering the terms of the contract and any applicable laws or regulations. IFRS 15 states that the right to payment for performance completed to date need not be for a fixed amount. However, at any time during the contract term, an entity must be entitled to an amount that at least compensates it for performance completed to date. This applies even if the customer can terminate the contract for reasons other than the entity’s failure to perform as promised.
The APS may need to change the timing of the recognition of the revenue from the customised parts under IFRS 15. If the APS’s performance does not create an asset with alternative use to the APS and the APS has an enforceable right to payment for performance completed to date, the APS is required to recognise revenue associated with the supply of customised parts over time (i.e., as production occurs), rather than at a point in time (i.e., when production is complete or when delivery takes place). This change in the timing of revenue recognition for the customised parts could be significant. Long-term supply contracts