IFRS 15 Practical alternative for similar goods or services

Case – Applying the practical alternative

Company B enters into a contract with Customer C to transfer two units of Product P for 2,000 (1,000 per unit, which is the stand-alone selling price) with an option to purchase up to two more units of P at 500 per unit (i.e. 50% discount). B concludes that each unit of P is distinct and satisfied at a point in time.

B concludes that the option for up to two additional units of P is a material right because the discount is incremental to discounts provided to other customers in this class of customers and does not exist independently from the current contract. B also concludes that the stand-alone selling price for the two additional units of P is 1,000.

The options allow C to acquire additional units of P, which are the same as the goods purchased in the original contract, and the purchases would be made in accordance with the original terms of the contract; therefore, B uses the alternative approach to allocate the transaction price to the options.

B expects that there is a high likelihood of the customer exercising each option because of the significant discount provided. As such, B does not expect breakage and includes all of the options in the expected number of goods that it expects to provide. Therefore, B allocates the expected transaction price to the units expected to be transferred.

Expected transaction price

Therefore, in effect 1,500 of the total consideration in the original contract of 2,000 is allocated to the purchase of the original two units and the remaining 500 is allocated to the two options.

IFRS 15 does not provide detailed guidance on how to determine the amount of expected goods or services to be provided. The following are acceptable approaches to determining this amount.

• Contract-by-contract basis: Under this approach, an entity considers each option that provides thecustomer with a material right to be a ‘good or service that is expected to be provided’ unless it expects the customer’s right to expire unexercised. For example, if an entity includes a renewal option with a contract price of 100 and a 60 percent probability of being exercised, then the entity includes 100 in the hypothetical transaction price rather than 60. This is because 100 is the ‘corresponding expected consideration’ for the additional good or service. The entity would then allocate the hypothetical transaction price (which includes 100) to all of the expected goods or services, including the renewal option on a relative stand-alone selling price basis.
• Portfolio approach: Under this approach, an entity estimates the number of goods or services expected to be provided based on historical data for a portfolio of similar transactions. For example, an entity enters into 100 similar annual contracts with two optional renewal periods around the same time. The entity estimates the number of expected renewals for the portfolio to estimate the transaction price and allocate consideration to the initial and renewal contracts.

Under both approaches, if the actual number of options exercised is different from what the entity expected, then the entity updates the transaction price and revenue recognised accordingly. We believe that it is acceptable to adjust the number of expected goods or services during the period(s) for which a material right exists, on either a cumulative catch-up or prospective basis, as long as the entity establishes a policy for the approach that it uses and applies it consistently.