Friday 19 April 2019
Distinct or not distinct under IFRS 15?
Question: How to determine whether the performance obligation is distinct?
I work for a software company. We develop software and sell it to our clients. Clients can buy the installation services from us. Also, we provide 1-year of support services after the purchase.
I am very confused when it comes to determining the performance obligations under IFRS 15. They should be distinct, but what is distinct in this case?
Answer:
Distinct or not distinct – yes, many people get confused about these concepts.
Yet it is absolutely crucial to get it right, because further steps in the revenue recognition process depend on the correct splitting of the contract into separate distinct performance obligations.
What is distinct?
IFRS 15.27 says that a good or a service is distinct if both of the following are met:
The good or service is capable of being distinct.
It means that the customer can benefit from it either on its own or together with other available resources.
The good or service is distinct within the context of the contract.
It means that the good or a service is separately identifiable from other promises in the contract.
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Here, you have two steps, or two levels to assess whether your goods or services are distinct:
You need to assess the good or service at its individual level.
Is the good or service capable of being distinct?
Basically, in the first step, you are assessing the minimum characteristics for a good or service to be distinct and thus accounted for separately.
Only if you said yes in the first step, you assess whether this good or a service is distinct in the context of the contract.
Here you are assessing what is interrelationship of the goods and services in the contract.
Just as an example: imagine you agreed to build a house for your customer and within the construction, you deliver everything: walls, roof, electricity installations etc.
Each of these things meets the first criterion – it is capable of being distinct, because the customer can benefit from it on its own or with other available resources.
For example: a roof.
A customer cannot benefit from the roof on its own, but if the house is ready just without the roof, then yes, customer can buy the roof elsewhere and benefit from it.
But, despite these items are capable of being distinct, they are NOT distinct in the context of the contract, because the contractor promised to deliver a combined output – a house.
Now let’s break it down a bit.
#1: Is the good or service capable of being distinct?
As written above, this is met in the case when the customer can benefit from the good or service either on its own, or with readily available resources.
What are these resources?
They can either be sold separately by the entity or by another entity, or the customer has already obtained them from the entity from other transactions or events.
Let’s take a look to the goods or services in the software contact:
An entity sells software, installation services and 1-year support. Are these services capable of being distinct?
Can the customer install the software himself? Does the installation significantly modify software? Can the customer use the software also without 1-year support?
It seems yes. Software seems to be capable of being distinct in this case.
Installation services seem capable of being distinct, too, because the question said that the customer could buy the installation from the software vendor. It implies that it was not obligatory.
And even if it was obligatory, then still the customer can benefit from the installation services with readily available resources – software.
The same applies to 1-year support.
In this case we can conclude that yes, the first criterion is met and the software, installation service and 1-year support are capable of being distinct.
But we are not done yet.
#2: Is the good or service distinct within the context of the contract?
Here we need to assess whether the goods or services are separately identifiable in the contract.
Or, in other words, whether the nature of the promise in the contract is to transfer each of those goods or services individually or a combined item.
IFRS 15 lists a few situations when two or more goods or services are NOT separately identifiable and thus not distinct:
You provide a significant service of integrating the goods or services with other goods or services in the contract into a bundle and you are in fact delivering combined output.
As mentioned the example of similar situation – when you build a house.
One or more of the goods or services significantly modifies or customizes the other goods or services in the contract.
As an example, you sell software, but before it is functional and customer can use it, you need to customize it to the customer’s environment.
The goods or services are highly depended or highly interrelated and the entity or a supplier cannot fulfill the contract by transferring each of them independently.
With regard to today’s question, let’s take a look whether the software, installation and 1-year support are separately identifiable.
The customers can buy the installation elsewhere or install the software themselves and it means that installation is separately identifiable.
It simply does not integrate the software to the combined output and it is not highly interrelated, because also other entities can provide installation.
Even if the installation is obligatory per contract, the outcome would still be the same.
The same applies for 1-year support services. Supplier can still transfer the software and customer can use it without the subsequent services.
You should always look to the substance of the contract.
Therefore, software, installation and 1-year support are each distinct goods or services in this case and you need to account for them separately.
Well, you will have to apply your judgment and make lots of considerations in some cases.
I work for a software company. We develop software and sell it to our clients. Clients can buy the installation services from us. Also, we provide 1-year of support services after the purchase.
I am very confused when it comes to determining the performance obligations under IFRS 15. They should be distinct, but what is distinct in this case?
Answer:
Distinct or not distinct – yes, many people get confused about these concepts.
Yet it is absolutely crucial to get it right, because further steps in the revenue recognition process depend on the correct splitting of the contract into separate distinct performance obligations.
What is distinct?
IFRS 15.27 says that a good or a service is distinct if both of the following are met:
The good or service is capable of being distinct.
It means that the customer can benefit from it either on its own or together with other available resources.
The good or service is distinct within the context of the contract.
It means that the good or a service is separately identifiable from other promises in the contract.
Special For You! Have you already checked out the IFRS Kit ? It’s a full IFRS learning package with more than 40 hours of private video tutorials, more than 140 IFRS case studies solved in Excel, more than 180 pages of handouts and many bonuses included. If you take action today and subscribe to the IFRS Kit, you’ll get it at discount! Click here to check it out!
Here, you have two steps, or two levels to assess whether your goods or services are distinct:
You need to assess the good or service at its individual level.
Is the good or service capable of being distinct?
Basically, in the first step, you are assessing the minimum characteristics for a good or service to be distinct and thus accounted for separately.
Only if you said yes in the first step, you assess whether this good or a service is distinct in the context of the contract.
Here you are assessing what is interrelationship of the goods and services in the contract.
Just as an example: imagine you agreed to build a house for your customer and within the construction, you deliver everything: walls, roof, electricity installations etc.
Each of these things meets the first criterion – it is capable of being distinct, because the customer can benefit from it on its own or with other available resources.
For example: a roof.
A customer cannot benefit from the roof on its own, but if the house is ready just without the roof, then yes, customer can buy the roof elsewhere and benefit from it.
But, despite these items are capable of being distinct, they are NOT distinct in the context of the contract, because the contractor promised to deliver a combined output – a house.
Now let’s break it down a bit.
#1: Is the good or service capable of being distinct?
As written above, this is met in the case when the customer can benefit from the good or service either on its own, or with readily available resources.
What are these resources?
They can either be sold separately by the entity or by another entity, or the customer has already obtained them from the entity from other transactions or events.
Let’s take a look to the goods or services in the software contact:
An entity sells software, installation services and 1-year support. Are these services capable of being distinct?
Can the customer install the software himself? Does the installation significantly modify software? Can the customer use the software also without 1-year support?
It seems yes. Software seems to be capable of being distinct in this case.
Installation services seem capable of being distinct, too, because the question said that the customer could buy the installation from the software vendor. It implies that it was not obligatory.
And even if it was obligatory, then still the customer can benefit from the installation services with readily available resources – software.
The same applies to 1-year support.
In this case we can conclude that yes, the first criterion is met and the software, installation service and 1-year support are capable of being distinct.
But we are not done yet.
#2: Is the good or service distinct within the context of the contract?
Here we need to assess whether the goods or services are separately identifiable in the contract.
Or, in other words, whether the nature of the promise in the contract is to transfer each of those goods or services individually or a combined item.
IFRS 15 lists a few situations when two or more goods or services are NOT separately identifiable and thus not distinct:
You provide a significant service of integrating the goods or services with other goods or services in the contract into a bundle and you are in fact delivering combined output.
As mentioned the example of similar situation – when you build a house.
One or more of the goods or services significantly modifies or customizes the other goods or services in the contract.
As an example, you sell software, but before it is functional and customer can use it, you need to customize it to the customer’s environment.
The goods or services are highly depended or highly interrelated and the entity or a supplier cannot fulfill the contract by transferring each of them independently.
With regard to today’s question, let’s take a look whether the software, installation and 1-year support are separately identifiable.
The customers can buy the installation elsewhere or install the software themselves and it means that installation is separately identifiable.
It simply does not integrate the software to the combined output and it is not highly interrelated, because also other entities can provide installation.
Even if the installation is obligatory per contract, the outcome would still be the same.
The same applies for 1-year support services. Supplier can still transfer the software and customer can use it without the subsequent services.
You should always look to the substance of the contract.
Therefore, software, installation and 1-year support are each distinct goods or services in this case and you need to account for them separately.
Well, you will have to apply your judgment and make lots of considerations in some cases.
Wednesday 7 March 2018
Price elasticity of demand (PED or Ed) is a measure used in economics to show the responsiveness, or elasticity, of the quantity demanded of a good or service to a change in its price. More precisely, it gives the percentage change in quantity demanded in response to a one percent change in price (ceteris paribus, i.e. holding constant all the other determinants of demand, such as income).
Price elasticities are almost always negative, although analysts tend to ignore the sign even though this can lead to ambiguity. Only goods which do not conform to the law of demand, such as Veblen and Giffen goods, have a positive PED. In general, the demand for a good is said to be inelastic (or relatively inelastic) when the PED is less than one (in absolute value): that is, changes in price have a relatively small effect on the quantity of the good demanded. The demand for a good is said to be elastic (or relatively elastic) when its PED is greater than one (in absolute value): that is, changes in price have a relatively large effect on the quantity of a good demanded.
Revenue is maximized when price is set so that the PED is exactly one. The PED of a good can also be used to predict the incidence (or "burden") of a tax on that good. Various research methods are used to determine price elasticity, including test markets, analysis of historical sales data and conjoint analysis.
Definition
It is a measure of responsiveness of the quantity of a raw good or service demanded to changes in its price. The formula for the coefficient of price elasticity of demand for a good is:
The overriding factor in determining PED is the willingness and ability of consumers after a price change to postpone immediate consumption decisions concerning the good and to search for substitutes ("wait and look"). A number of factors can thus affect the elasticity of demand for a good:
Availability of substitute goods: the more and closer the substitutes available, the higher the elasticity is likely to be, as people can easily switch from one good to another if an even minor price change is made; There is a strong substitution effect. If no close substitutes are available, the substitution effect will be small and the demand inelastic.
Breadth of definition of a good: the broader the definition of a good (or service), the lower the elasticity. For example, Company X's fish and chips would tend to have a relatively high elasticity of demand if a significant number of substitutes are available, whereas food in general would have an extremely low elasticity of demand because no substitutes exist.
Percentage of income: the higher the percentage of the consumer's income that the product's price represents, the higher the elasticity tends to be, as people will pay more attention when purchasing the good because of its cost;The income effect is substantial.[30] When the goods represent only a negligible portion of the budget the income effect will be insignificant and demand inelastic,
Necessity: the more necessary a good is, the lower the elasticity, as people will attempt to buy it no matter the price, such as the case of insulin for those that need it.
Duration: for most goods, the longer a price change holds, the higher the elasticity is likely to be, as more and more consumers find they have the time and inclination to search for substitutes. When fuel prices increase suddenly, for instance, consumers may still fill up their empty tanks in the short run, but when prices remain high over several years, more consumers will reduce their demand for fuel by switching to carpooling or public transportation, investing in vehicles with greater fuel economy or taking other measures. This does not hold for consumer durables such as the cars themselves, however; eventually, it may become necessary for consumers to replace their present cars, so one would expect demand to be less elastic.
Brand loyalty: an attachment to a certain brand—either out of tradition or because of proprietary barriers—can override sensitivity to price changes, resulting in more inelastic demand.
Who pays: where the purchaser does not directly pay for the good they consume, such as with corporate expense accounts, demand is likely to be more inelastic.
Tuesday 15 August 2017
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