Navigating IFRS 15

Identifying distinct services

IFRS 15 requires technology companies to identify each contract’s distinct services. This can be a complex process as these contracts often include a number of different components.

Determining the transaction price

This is the amount to be received by the company in exchange for their services. The contract may not explicitly state the transaction price if there are multiple elements such as:

• upfront fees ;
• milestone payments ;
• variable payments ; or
• discounts.

Technology companies should use reasonable and supportable estimates where the transaction price is not defined. Any significant changes or modifications to the transaction price should be reassessed and updated accordingly throughout the contract period.

Allocating revenue

As technology contracts often include multiple elements, it is important that the fair value of services is correctly allocated to the appropriate revenue lines.

Recognising revenue

Once a customer obtains control of the services, the company can begin to recognise the revenue. Control is deemed to be passed if the customer can obtain benefits from the services.

For example, perpetual licences should be recognised upfront once the customer has control. However, for a licence with a specific term, the revenue should be spread over the length of the contract.

Additional complexities tend to arise as the contract value increases. Sophisticated enterprise software introduces complexities in revenue recognition because, despite granting customers access to the software, deriving significant benefits from the installation often requires a lengthy implementation phase.

Billing such licences immediately would be advantageous for revenue (at least initially). However, this may be perceived as unfair from the customers’ perspective because they would be charged for a licence which cannot be fully utilised due to an ongoing implementation process. An immediate recognition policy could therefore damage customer relationships and create hurdles during the service renewal phase. The resulting knock-on effect might lead to lower retention rates in the future, which would be detrimental to the company’s valuation.

Modifying contracts

Companies must account for contract changes in accordance with IFRS 15. Typical examples in businesses we have worked with are changes in:

• the number of seats for a licence ;
• subscription price ; and
• cost which are not proportional to extensions in the service (e.g. changing a licence term from 4 to 5 years without adjusting the price).

Considering variable payments

Companies should appropriately estimate and allocate the variable consideration (such as discounts, rebates, or performance bonuses) based on expected outcomes.

Implementing internal controls

It is critical that there are robust procedures in place to ensure that revenue is being recognised correctly. Common pitfalls for technology companies are:

• not capturing changes to customer contracts ; and
• incorrectly recognising implementation revenue for both time and materials (T&M) and fixed price engagements.

Apportioning discounts

Where companies have applied a discount to a bundle package which includes multiple revenue lines (e.g. support and licence fees), companies should allocate these discounts proportionally to the performance obligations in a contract.