IFRS 15, Revenue from Contracts with Customers
This article considers the application of IFRS 15, Revenue from Contracts with Customers in accounting for prompt payment (early settlement) discounts; it is most relevant to students studying FA. Students studying FA1 and FA2 will also see prompt payment discounts but the underlying detail of IFRS 15 will be less relevant.
IFRS 15 considers there to be a five-step approach when recognising revenue:
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 the credit customer pays within the settlement window.
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 payment 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]
IFRS 15 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.
EXAMPLE 1
J Co sold goods with a list price of $2,000 on credit to a customer. J Co has a 30-day payment period and has offered the customer a 3% prompt payment discount if payment is made within 14 days. Based on past experience, the customer is expected to pay within 14 days and therefore will be entitled to the 3% discount.
What accounting would be required to deal with this transaction in the following scenarios:
Answer
The initial sale will be recorded at the discounted amount of $1,940 ($2,000 x 97%) because that is the amount that J Co expects to receive from the customer:
| Dr Receivables | $1,940 | |||
| Cr Revenue | $1,940 |
If the customer pays within the 14-day settlement period, the accounting entry would be:
| Dr Cash | $1,940 | |||
| Cr Receivables | $1,940 |
If the customer pays after the 14-day period, J Co would instead record this as:
| Dr Cash | $2,000 | |||
| Cr Receivables | $1,940 | |||
| Cr Revenue | $60 |
If, based on past experience, J Co did not expect the customer to make the payment within 14 days, then the full $2,000 would have been recorded as revenue in the first instance. If the payment was made within the 14-day period after all, this would require an adjustment to reduce revenue by $60.
EXAMPLE 2
J Co sold goods to another customer with a list price of $8,000. Similar payment terms were offered to that of the customer in Example 1. Based on past experience, this customer is expected to pay after 14 days and therefore will not be entitled to the 3% prompt payment discount.
What accounting would be required to deal with this transaction in the following scenarios:
Answer
The initial sale will be recorded at the full list price because that is the amount that J Co expects to receive from the customer:
| Dr Receivables | $8,000 | |||
| Cr Revenue | $8,000 |
If, as expected, the customer pays after the 14-day period, J Co would record this as:
| Dr Cash | $8,000 | |||
| Cr Receivables | $8,000 |
If, however, the customer unexpectedly pays within the 14-day settlement period then part of the initial revenue recognised must be reversed and the accounting entry would instead be:
| Dr Cash | $7,760 | |||
| Dr Revenue | $240 | |||
| Cr Receivables | $8,000 |
An element of judgement is required over whether an entity is likely to take advantage of the prompt payment discount and, therefore, how much revenue should initially be recognised. This will have an impact on entities’ gross profit margins and there should be appropriate evidence to support judgements made.
Written by a member of the FA1, FA2 and FA examining team