What Are Enforceable Contracts With Customers? – FAQ | IFRS

What are enforceable contracts with customers?

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.

The assessment of whether a contract exists for the purposes of applying IFRS 15 focuses on the enforceability of rights and obligations rather than the form of the contract (oral, implied, or written).

The assessment focuses on whether enforceable rights and obligations have been established, based on the relevant laws and regulations. This may require significant judgment in some jurisdictions or for some arrangements. What are enforceable contracts with customers?

In cases of significant uncertainty about enforceability, a written contract and legal interpretation by qualified counsel may be required to support a conclusion that the parties to the contract have approved and are committed to perform under the contract. What are enforceable contracts with customers?

However, although the contract has to create enforceable rights and obligations, not all of the promises in the contract to deliver a good or service to the customer need to be legally enforceable to be considered performance obligations (see the following case).

Implied performance obligation – Pre- and post-sale incentivesIFRS 15 Vehicle sales by Original Equipment Manufacturers

Car Manufacturer N has an historical practice of offering free maintenance services – e.g., oil changes and tire rotation – for two years to the end customers of dealers who purchase its vehicles. Although not explicitly stated in the contract with its dealers, Car Manufacturer N has a customary business practice of offering the two-year maintenance incentive; therefore, the maintenance is treated as a separate performance obligation in the sale of the vehicle to the dealer. Revenue from the sale of the vehicle is recognized when control of the vehicle is transferred to the dealer. Revenue from the maintenance services is recognized as the maintenance services are provided to the retail customer.

However, if Car Manufacturer N does not have a customary business practice of offering free maintenance, and instead announces the maintenance program as a limited-period sales incentive after control of the vehicle has transferred to the dealer, then the free maintenance is not a separate performance obligation in the sale of the vehicle to the dealer. In this case, Car Manufacturer N recognizes the full amount of revenue when control of the vehicle is transferred to the dealer. If Car Manufacturer N subsequently creates an obligation by announcing that it will provide incentives, Car Manufacturer N will accrue as an expense its expected cost of providing maintenance services on the vehicles in the distribution channel – i.e., controlled by dealers – when the program is announced. [IFRS 15 IE 64 – IE 65] What are enforceable contracts with customers?

Determining whether a sales incentive to end customers was offered pre- or post-sale to the dealer will be challenging for some entities, especially for implied sales incentives where the entity has a customary business practice of offering incentives. The entity will need to assess whether the dealer and customer have an expectation that the entity will provide a free service.

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