Contract Review under IFRS 15: Assessing Performance Obligations

Posted In | Finance | Accounting Software

The introduction of International Financial Reporting Standard (IFRS) 15, 'Revenue from Contracts with Customers', marked a significant change in the revenue recognition landscape. A critical aspect of this standard lies in identifying and assessing performance obligations in a contract. This article aims to provide a detailed insight into how to review contracts and assess performance obligations under IFRS 15.

 

 

Understanding Performance Obligations

A performance obligation under IFRS 15 is a promise in a contract to transfer a distinct good or service (or a series of distinct goods or services that are substantially the same and have the same pattern of transfer) to the customer. Each distinct good or service is accounted for separately. Therefore, identifying performance obligations accurately is essential to correctly recognize revenue.

 

Reviewing Contracts

The process of identifying performance obligations starts with a careful review of the contract with the customer. The contract can be in writing, verbal, or implied by an entity's customary business practices, but it must create enforceable rights and obligations.

Contracts should be analyzed to identify all the promises to transfer goods or services. It's important to note that these promises can be explicit or implicit based on customary business practices, published policies, or specific statements.

 

Assessing Performance Obligations

Once the promises in the contract are identified, the next step is to determine whether each promise represents a distinct performance obligation. IFRS 15 outlines two criteria that need to be met for a good or service to be considered distinct:

 

1. The customer can benefit from the good or service on its own or together with other resources readily available to them.
    
2. The good or service is separately identifiable from other promises in the contract.

 

In other words, if a good or service is not distinct within the context of the contract, it should be bundled with other goods or services until a bundle of goods or services that is distinct is identified.

 

For example, if a company sells a product and also promises to provide maintenance services for a year, the product and the maintenance service would generally be considered separate performance obligations if the customer can benefit from the product without the maintenance services.

 

Series Provision

There is also a 'series provision' in IFRS 15 that allows (or sometimes requires) an entity to account for a series of distinct goods or services as a single performance obligation if certain criteria are met. For instance, a monthly cleaning service contract could be viewed as a series of distinct services that are substantially the same and are transferred to the customer in the same pattern over time.

 

The assessment of performance obligations is a crucial step in the revenue recognition process under IFRS 15. It requires a careful review of contracts and a clear understanding of what constitutes a distinct good or service. It's crucial for companies to thoroughly understand these concepts to ensure they are compliant with the standard and that their revenue is accurately reported. This, in turn, leads to more transparency and consistency, which enhances the reliability of financial statements for stakeholders.