Last update 06/12/2019
IFRS 15 Software contract modifications – It is common in the software industry to change the scope or price of the contract. For example, a vendor may license software and provide post-contract customer support (PCS) to a customer in an initial transaction and then license additional software to the same customer at a later time. In general, any change to an existing contract is a modification per the guidance when the parties to the contract approve the modification either in writing, orally, or based on the parties’ customary business practices. A new contract entered into with an existing customer could also be viewed as the modification of an existing contract, depending on the circumstances.
In determining whether a contract has been modified, among other factors, company might consider whether: IFRS 15 Software contract modifications
- the terms and conditions of the new contract were negotiated separately from the original contract, and
- the additional goods or services were subject to a competitive bid process, and IFRS 15 Software contract modifications
- any discount to the stand alone selling price of the additional goods or services is attributable to the original contract.
Modifications are accounted for as either a separate contract or as part of the existing contract (either prospectively or through a cumulative catch-up adjustment). This assessment is driven by whether: IFRS 15 Software contract modifications
- the modification adds distinct goods and services and IFRS 15 Software contract modifications
- the distinct goods and services are priced at their stand alone selling prices.
Modification accounted for as a separate contract
A modification is accounted for as a separate contract if the additional goods or services are distinct and the contract price increases by an amount that reflects the stand alone selling price of the additional goods or services. The guidance provides some flexibility to adjust the stand alone selling price to reflect contract-specific circumstances. For example, a company might provide a discount to a recurring customer that it would not provide to a new customer because it does not incur the same selling-related costs.
Modification accounted for prospectively
The modification is accounted for as if it were a termination of the original contract and the creation of a new contract if the additional goods or services are distinct, but the price of the added goods or services does not reflect stand alone selling price. Any unrecognised revenue from the original contract and the additional consideration from the modification is combined and allocated to all of the remaining performance obligations under the original contract and modification. IFRS 15 Software contract modifications
Modification accounted for through a cumulative catch-up adjustment
If the added goods or services are not distinct and are part of a single performance obligation that is only partially satisfied when the contract is modified, the modification is accounted for through a cumulative catch-up adjustment.
CASE – Contract modifications
Facts: Cloud Co. enters into a three-year service contract with Customer for $450,000 ($150,000 per year). The stand alone selling price for one year of service at inception of the contract is $150,000 per year. Cloud Co. concludes the contract is a series of distinct services.
At the end of the second year, the parties agree to modify the contract as follows:
- The fee for the third year is reduced to $120,000
- Customer agrees to extend the contract for another three years for $300,000 ($100,000 per year)
The stand alone selling price for one year of service at the time of modification is $120,000, taking into account the contract-specific circumstances.
How should Cloud Co. account for the modification?
Analysis: The modification would be accounted for as part of the existing contract on a prospective basis (as if the original arrangement was terminated and a new contract created) because the additional services to be provided are distinct, but the price of the contract did not increase by an amount of consideration that reflects the stand alone selling price of the additional services.
Cloud Co. should reallocate the remaining consideration of $120,000 and the new consideration of $300,000 to all of the services to be provided (obligations remaining from the original contract and the new obligations). Cloud Co. will recognize a total of $420,000 ($120,000 + $300,000) over the remaining four-year service period (one year remaining under the original contract plus three additional years), or $105,000 per year.
See also: The IFRS Foundation