IFRS 15, REVENUE FROM CONTRACTS WITH CUSTOMERS
In May 2014, the IASB issued IFRS 15, Revenue from Contracts with Customers which supersedes IAS 18, Revenue. It applies to all businesses reporting under IFRS for periods beginning on or after 1 January 2018. This article considers the application of IFRS 15, Revenue from Contracts with Customers and the impact it will have on accounting for prompt payment discounts; it is most relevant to students studying F3/FFA. Students studying FA1 and FA2 will also see prompt payment discounts but the underlying detail of IFRS 15 will be less relevant.
This new standard considers there to be a five step approach when recognising revenue:
- Step 1: Identify the contract with the customer
- Step 2: Identify the performance obligations in the contract
- Step 3: Determine the transaction price
- Step 4: Allocate the transaction price to the performance obligations in the contract
- Step 5: Recognise revenue when (or as) the entity satisfies a performance obligation
ACCOUNTING FOR DISCOUNTS
Prompt payment discounts (also known as settlement or cash discounts) are offered to credit customers to encourage prompt payment of their account. It is not guaranteed that customers will take advantage of prompt payment discounts at the point of sale as it is dependent upon whether or not credit customer pays within the settlement window.
Historically, and in accordance with IAS 18 Revenue, income from a credit sale in which a settlement discount has been offered has been recognised in full at the point of sale. Accounting for the settlement discount only takes place if the customer pays within the required settlement period (thus accepting the discount).The discount allowed would be recorded as an expense in the seller’s statement of profit or loss and revenue would remain at the full amount.
A Ltd sold goods with a list price of $1,500 on credit to a customer. A Ltd has a 30 day payment period and has offered the customer a 5% prompt payment discount if payment is made within 14 days.
In accordance with IAS 18 Revenue, the initial sale would have been recorded as debit Receivables $1,500 credit Revenue $1,500. If the customer pays within the 14 day settlement period the accounting entry would be Debit Cash $1,425 Debit Discounts Allowed $75 Credit Receivables $1,500. If the customer pays outwith the 14 day period, A Ltd would record the receipt as Debit Cash $1,500 Credit Receivables $1,500.
IMPACT OF IFRS 15 ON ACCOUNTING FOR PROMPT PAYMENT DISCOUNTS
The five step approach to recognising revenue as outlined above will change the way in which prompt payment discounts are accounted for. In order to recognise revenue, an entity must determine the amount of consideration it expects to be entitled to in accordance with the criteria of IFRS 15.
Per IFRS 15, the third step of the five step approach requires an entity to 'Determine the transaction price', which is the amount to which an entity expects to be entitled in exchange for the transfer of goods and services. When making this determination, an entity will consider past customary business practices. [IFRS 15:47]
When prompt payments discounts are offered, it means that the expected consideration is variable (variable consideration) as the amount the entity will actually receive is dependent upon the customer choice as to whether it will take advantage of the discount.
Where a contract contains elements of variable consideration, the entity should estimate the amount of variable consideration to which it will be entitled under the contract. [IFRS 15:50]
The standard deals with the uncertainty relating to variable consideration by limiting the amount of variable consideration that can be recognised. Specifically, variable consideration is only included in the transaction price if, and to the extent that, it is highly probable that its inclusion will not result in a significant revenue reversal in the future when the uncertainty has been subsequently resolved. [IFRS 15:56]
When an entity enters into a sale with a customer and a prompt payment discount has been offered, the amount of revenue to be recognised initially will need to be estimated taking into account the probability of the discount being accepted. When the entity expects that the customer will accept the discount, revenue should be recorded net of the discount.
J Ltd sold goods with a list Price of $2,000 on credit to a customer. J Ltd has a 30 day payment period and has offered the customer a 3% prompt payment discount if payment is made within 15 days. Based on past experience the customer is expected to take up the 3% discount.
The initial sale will be recorded as Debit Receivables $1,940 Credit Revenue $1,940. If the customer pays within the 14 day settlement period the accounting entry would be Debit Cash $1,940 Credit Receivables $1,940. If the customer does not pay within the 14 day period, when payment is made A Ltd would record this as Debit Cash $2,000 Credit Receivables $1,940 Credit Revenue $60.
As the above example highlights, the introduction of IFRS 15 will have a significant impact on the reported revenue. Offering prompt payment discounts will result in lower revenue being recognised (when the discount is accepted). This will have an impact on entities’ gross profit margins. However, the net impact on profit as a whole will be the same as, by recording revenue net of the prompt payment discount, there is no longer a requirement to record a discount allowed expense in the statement of profit or loss. Prompt payment discounts are examined in FA1, FA2 and F3/FFA and so an appreciation of this impact is important.
Written by a member of the FA1, FA2 and F3/FFA examining team