IFRS 15 and IFRS 9 - Accounting Definition - Essay Example

IFRS 15 and IFRS 9 IFRS 15: revenue from contracts with s Accounting definition The standard sets out the requirements for recognition of revenues from contracts with customers. The standard defines a contract as agreement between two or more parties that create enforceable rights and obligations to the parties. The customer is defined as a party that has contracted with another entity to obtain goods and services that are an output of the entity’s ordinary business activities in exchange for a consideration. The revenue refers to income arising from the ordinary activities of the entity. The transaction price is the amount that an entity expects in exchange for transfer of goods or services excluding the collections on behalf of third parties (Christian and Ludenbach 62). The standard will be mandatory in annual reports from 1st January 2017.The objective of the standard is the establish principles that reporting entities should apply to report useful information to the users of the financial statements on the nature, timing, amount and uncertainty of revenues or cash flows arising from contracts with customers (Wilson and Adler 198). The standard deals with all contracts with customers except lease contracts that fall under IAS 17, insurance contracts with the scope of IFRS 4, financial instruments and other contractual rights obligations (IFRS 9/IAS 39, IFRS 10, IFRS 11, IAS 27 and IAS 28) and other non-monetary exchanges. The core principle of IFRS 15 is the five-step model that is used in recognition of revenues from contracts with customers. Step 1- Identification of the contract The first step is the identification of the contract and contract approvals can either be written, oral or implied by the entity’s business actions. Contracts should have been approved, the rights and payment terms regarding the good or services in question should be identifiable, the contact should have a commercial substance and it should be probable that the consideration will be received in regards to the customer’s intention and ability to pay (Christian and Ludenbach 64). The standard allows for combination of multiple contracts if they are entered in to at the same time or same time and with the same customer. The contracts should have been negotiated as package with a single commercial objective, the consideration of such contracts should be independent of each other and the overall goods and services of the contracts should represent a single performance obligation. The contract modifications (scope or price) are accounted for as a contract modification if approved and creates new or changes the existing rights and obligations. Such modified contracts will be accounted for as separate contracts if an only if; the contracts scope will change due to addition or distinct goods and services and the changes in contract prices reflect the stand-alone selling price of a distinct service or good (Christian and Ludenbach 67). The modifications that do not form separate contracts are accounted for as either replacement of initial contract with a new contract (if goods transferred to customer are distinct from those under original contract) or continuation of initial contract (if goods are distinct and performance is partially satisfied at medication date). The contract can also be a mixture if both elements exist. Step 2- Identification of performance obligations The performance obligations are the contractual promise by the entity to transfer distinct goods or service either individually, in bundles or a series over time. Activities not resulting in transfer of goods such as internal administrative or set up activities are not performance obligations and cannot give right to revenues. A good and service may not be separable from other goods or services if the judgment indicates that there is significant integration of the service with other goods or services, if it modifies the other goods or services or if it is highly interrelated with other contract goods or services (Christian and Ludenbach 71). Step 3- determination of the transaction price The transaction price is the consideration and excludes taxes and may be affected by the timing or nature such as financing components, non-cash amounts and amounts payable back to the customer such as refunds and rebates. The transaction price is adjusted to reflect the cash selling price when goods or services are transferred of the timing of payments specifications in the contract provides either the customer or entity with significant benefit of financing the transfer. The significant financing benefit cannot exist when transfer of goods or services is at customer’s discretion, the consideration varies with the amount or timing based on factors beyond the control of the parties or when the difference is a performance protection. The discount should reflect the security provided or credit characteristics of the party receiving the financing (Christian and Ludenbach 73). Variable consideration that includes rebates, credits, concessions, incentives, penalties, and contingent payments or discounts is estimated either using expected value method that is based on probability of weighted amounts of similar contracts or single most likely amount. The variable consideration is recognized when it is probable that no subsequent change in estimate that can lead to revenue reversal (Christian and Ludenbach78). The accounting of consideration payable to customer will include the cash paid and items such as coupons and vouchers. The reduction in transaction price must be accounted except when consideration paid exceeds the fair value of goods and services received in which case a set off against the transaction price is done. No adjustment unless the fair value cannot certainty determined. The non-cash consideration is accounted at fair value or by reference to stand-alone selling price if not capable of being determined directly. Step 4- allocation of transaction price to each performance obligation Transaction price is allocated to the stand-alone selling price as follows. The approaches to estimate the stand-alone selling price when not observable include the adjusted market assessment approach, the expected cost plus a margin approach and residual approach. The restrictive criteria must be met for the residual approach to the used in allocate the transaction price to each performance obligation (Christian and Ludenbach 89). Discount arises when the stand-alone selling price of each performance obligation exceeds the consideration payable. Discounts should be allocated proportionately unless when it related to specific performance obligation after goods and services (bundles) in the performance obligation are sold in stand-alone basis and discount is substantial amount as would be given in the stand-alone basis. The variable consideration is allocated to the obligation if terms of the variable consideration transfer distinct goods or services or relates specifically to satisfying the performance obligation (Christian and Ludenbach 86). Step 5- recognition of revenue over time The transaction price allocated to each performance is recognised either over time or at a point in time. Recognition of revenue over time Recognition over time occurs in many recurring service contracts or in work in progress when an entity enhances an asset controlled by the customer. The entity performance should not create an asset with alternative use to the entity and entity should have enforceable rights to payment for the performance to date. The revenue recognition utilises the outputs methods such as surveys or milestones or the inputs methods such as labour hours and time lapsed (Christian and Ludenbach 167). Recognition of revenue at a point in time The revenue is recognised when entity transfers control over the assets to the customer. Application guidance of IFRS 15 Contract costs Only the ncremental costs that are expected to be recovered are recognised. Costs recognised as expense include administrative costs, wastage, and costs related to past performance obligations. Licensing of intellectual property A licence that is not distinct from other goods and services is accounted as single performance. Licence that is distinct from other goods or services is accounted as single performance and revenue is recognised over time if customer’s rights to intellectual property expose it to effects of activities undertaken by the entity. The revenue is recognised at a point in time when the control is transferred to the customer (Christian and Ludenbach 173). Non-refundable upfront fees Include joining fees and set-up fees. Revenue is recognised when transfer of goods or services occurs or treated as an advance payment in cases where the customer is reasonably expected to extend the contract. Presentation The contract assets and contract liabilities are separated in the statement of financial position. Line items (revenue and impairment) are separated according to IAS 1 in the statement of profit or loss and other comprehensive income. Disclosures Objective is to provide sufficient disclosures so as to understand the nature, uncertainty and timing of revenues and cash flows from contracts. The disclosures include disaggregation of revenue, performance obligations and contract assets or contract liabilities. The significant judgments should be disclosed such as transaction price, performance obligation satisfaction or determining contract costs capitalized. Other disclosures include contract costs capitalized such as method of amortisation, impairments and closing balance by asset types (Christian and Ludenbach 210). International Financial Reporting Standard (IFRS) 9 Accounting definition IFRS 9 provides for a single classification and measurement of financial assets according to the contractual cash flow characteristics of the assets and business model used in managing the financial assets. The standard requires a hybrid contracts to be classified at amortised or fair value. The initial recognition occurs when a entity becomes party to the contractual provisions of the asset or liability while initial measurement is at fair value plus the directly attributable transaction costs. The financial assets can be classified according to amortised cost, fair value through profit or loss while investments in equity can be classified by fair value through other comprehensive income (Wilson and Adler 93). Amortised cost According to the amortised cost approach of classification criteria, the financial assets must be held to collect contractual cash flows. Based on instrument-by-instrument basis, the interest is consideration for the credit risk and time value of money and forex financial assets are assessed in denomination currency (Wilson and Adler 112). Financial assets that do not meet the amortised cost criteria can be classified according to the profit or loss classification criteria. The financial assets are designated at initial recognition if doing so eliminates accounting mismatch. The subsequent is done through fair value and all gains and losses are recognized as either loss or profit (Wilson and Adler 118). The third category of classification is the fair value through other comprehensive income and this is optional and irrevocable. It is only used for equity investment instruments not held for trading. The subsequent measurement is done at fair value and all gains or losses are recognised as comprehensive income. Changes in fair value are not added as profit or losses while dividends are recognised in profit and loss accounts (Wilson and Adler 124). Subsequent classification and measurement of financial liabilities The liabilities are classified as either amortised cost or fair value through profit or loss. The standard also provides for accounting of financial guarantee contracts, commitments for providing a loan below the market interest rates and liabilities that arise when asset transfer does not grant derecognition. All financial liabilities are classified at amortised cost except financial guarantee contracts and commitments to provide a loan at below the market interest rates and amortisation is done through use of effective interest method (Wilson and Adler 89). The second category classification is the fair value through profit and loss and this involves financial liabilities held for trading and derivative financial liabilities. The liabilities are designated at initial recognition if the option there is elimination of recognition inconsistencies or if the group of financials is evaluated at fair value basis according to the risk management and investment strategy of the corporate (Wilson and Adler 132). The financial guarantee contracts and commitments to provide a loan at below market rates of interest are measured at higher of either amounts that is determined in accordance with IAS 37 that provides the basis for accounting of contingencies or amount initially recognised less the cumulative amortisation in accordance with IAS 18 that provides for accounting of revenues (Wilson and Adler 145). The financial liability that result from transfer of financial assets (not resulting in derecognition or where there is a continuing involvement) should recognize the financial liability for the consideration received. The subsequent measurement is done on the basis of net carrying amount of transferred asset and associated liability is measured as either fair value of rights and obligations retained by entity if asset transferred is measured at fair value or amortised cost of rights and obligations retained if transferred asset is measured at amortised cost (Wilson and Adler 49). Embedded derivatives These are hybrid contracts that include non-derivative components that cause contractual cash flows to be modified according to certain variables such as foreign exchange rate, commodity price or interest rate. The non-financial variables that are specific to a party or derivatives that are contractually transferrable independent of the instrument are excluded from embedded derivatives. These contracts are accounted for differently depending on the whether the host contract is a financial liability or financial asset (Wilson and Adler 47). The embedded derivative within financial asset host derivative does not separate the embedded derivative from the host contract and whole contract is accounted as a single instrument. The embedded derivatives within a host contract which is a financial derivative will be accounted for differently subject to meeting a adjacent criteria. The embedded contract is separated from the host derivative and accounted as a derivative at fair value through profit or loss in line with IFRS 9. In this case, the economic characteristics of both the embedded derivative and host contract should be different and entire hybrid contract should not be measured at fair value through profit and loss. The host contract (non-financial asset) will be accounted for appropriately once the embedded derivative is separated (Wilson and Adler 54). Derecognition Financial liabilities are derecognised when obligations are discharged or expire. Substantial modification of terms extinguishes the liability while difference between the carrying amount of extinguished or transferred financial liability to third parties is for consideration is accounted in profit and loss. The transfer of financial asset that qualifies for derecognition, but retains a right to service the asset at a fee should recognise either a servicing asset or servicing liability in a servicing contract. The difference between carrying amount and sum of consideration received, any cumulative gains or loss is also recognised in profit or loss on derecognition (Wilson and Adler 87). In case a entity retains contractual right to receive cash flows of the financial asset, but has assumed an obligation to pay the cash flows to one or more entities, such entity has no obligation to pay the eventual recipients unless it has collected an equivalent amount from the original asset. The entity should derecognise if prohibited from pledging the asset as security except to the eventual recipients. The entity should also derecognise if entity has an obligation to remit the cash flow collections to reciepients with no material delay or when interest earned for short-term reinvestment is transferred to eventual recipients (Wilson and Adler 78). Criteria for hedge accounting There must be an economic relationship between the hedged item and hedging instrument, the credit risk must not dominate changes in value and hedge ratio should be the same in hedge relationship and quantity of the hedged item actually hedged. The eligible hedging instruments are derivatives measured at fair value except written options that are designated as an offset to purchased options. Another instrument is the non-derivatives measured at fair value except that change in fair value due to credit risk. Hedging instruments should be designated in full except a proportion of nominal amount except fair value change during the period of outstanding, the option contracts that separate the intrinsic value and time value, and forward contract that separate the forward element and spot element and designating only the change in the spot element (Wilson and Adler 147). For hedges of a group, the foreign currency is hedged when cash flow variability is not expected to be approximately proportional to overall group cash flows variability. An entity can designate a hedged item if one or more selected contractual cash flows can be hedged, components of nominal amount and separately identifiable and reliably measureable changes are attributable to specific risk can be hedged (Wilson and Adler 154). Eligible hedged items Cash flow hedge It is recognised as other comprehensive income and ineffectiveness is recognised in profit or loss. The lower of cumulative gain or loss on hedging instrument or fair value in hedged item is recognised separately within equity (cash flow hedge reserve). The amount recognised in Cash flow hedge reserve is included in the initial cost of non-financial asset/liability for the forecast transactions that result to non-financial asset/liability. For other forecast transactions, the amount recognised in cash flow hedge reserve is reclassified in profit or loss during the period when cash flows are likely to impact on the profit or loss (Wilson and Adler 162). Fair value hedge The gain or loss is recognised in profit or loss unless hedging instrument is a equity investment that is measured at fair value. The gain or loss on hedged item is recognised in profit or loss unless the hedged item is an equity investment. Hedge of a net investment in a foreign operation The hedge effectiveness is recognised in other comprehensive income (OCI) while ineffectiveness is recognised in profit or loss. The accumulated amounts in equity are reclassified to profit or loss upon disposal of foreign operation (Wilson and Adler 164). Hedging of group entity transactions This is not applicable in consolidated financial statements of the group except for foreign currency risk on intra-group monetary items not eliminated after consolidation or when the transactions between parent and subsidiaries measured at fair value are not to be subjected to elimination adjustments (Wilson and Adler 165). Discontinuation Discontinued if qualifying criteria not met after rebalancing hedging ratio including termination or expiration. Works cited: Christian, Dieter and Ludenbach, Norbert. IFRS Essentials. New York: John Wiley & Sons. 2013. Wilson, Richard and Adler, Ralph. Teaching IFRS. New York: Routledge. 2013. Read More