IFRS 15 – Revenue from contracts with customers www.pwc.com IFRS 15 – Revenue from contracts with customers June 2014 NOTE: This presentation is a summary of IFRS 15 and does not discuss all matters that might need to be considered to implement this standard. Please see www.pwc.inform.com for further details including the standard itself.

IFRS 15 - Project objective Effective for annual periods beginning on or after 1 January 2017 One Model A single, joint revenue standard to be applied across all industries and capital markets Clear principles Robust framework Comparability across industries Enhanced disclosures Simplified guidance   IFRS 15 – Revenue from contracts with customers, is the culmination of a long running joint project between the IASB and the FASB to create a single revenue standard. It applies to all contracts with customers except those that are financial instruments, leases or insurance contracts. It is effective for annual periods beginning on or after 1 January 2017, but entities that use IFRS are allowed to early-adopt the guidance. There is a choice of transition methods – full retrospective application or a practical expedient that permits prospective application, however requires additional disclosures. Under the old guidance revenue recognition was measured and presented inconsistently. The current revenue guidance in IFRS was limited and not sufficient for very complex transactions. There was a significant amount of industry specific literature in US GAAP that could result in different answers for similar transactions and, at times, outcomes that did not represent the economic substance of the transaction. The guidance replaces all existing IFRS (and US GAAP) revenue recognition literature. The objective of the revenue project is to clarify the principles for recognising revenue and to develop a common revenue standard for IFRSs and US GAAP that would: (a) remove inconsistencies and weaknesses in previous revenue requirements; (b) provide a more robust framework for addressing revenue issues; (c) improve comparability of revenue recognition practices across entities, industries, jurisdictions and capital markets; (d) provide more useful information to users of financial statements through improved disclosure requirements; and (e) simplify the preparation of financial statements by reducing the number of requirements to which an entity must refer. (IFRS 15, IN5).

Awareness is essential! A change in mindset Reassessment of contracts will be time consuming Greatest impact for those that use industry based models Transaction price allocated on a relative selling price basis Change to model for variable consideration Full retrospective application may require running dual systems and gathering of historic data More extensive disclosure requirements Potential impact on compensation arrangements Awareness is essential! IFRS 15 could significantly change how many entities recognise revenue, especially those that currently apply industry-specific guidance. The standard will also result in a significant increase in the volume of disclosures related to revenue. All entities will likely have to consider changes to information technology systems, processes, and internal controls as a result of the increased disclosure requirements, among other aspects of the model. Management will need to perform a comprehensive review of existing contracts, business models, company practices, accounting policies, information technology systems, and internal processes and controls to assess the extent of changes needed as a result of IFRS 15. This may be the case even if the entity’s revenue recognition model has not significantly changed.

Focus on risk and rewards IFRS 15 – Revenue recognition model IAS 18 /11 IFRS 15 Separate models for: Construction contracts Goods Services Single model for performance obligations: Satisfied over time Satisfied at a point in time Focus on risk and rewards Focus on control Limited guidance on: Multiple element arrangements Variable consideration Licences More guidance: Separating elements, allocating the transaction price, variable consideration, licences, options, repurchase arrangements and so on…. So what’s changed? IFRS 15 will replace IAS 18 and IAS 11 which currently provide separate revenue recognition models for goods and services and for construction contracts. IFRS 15 is based on a single model that distinguishes between promises to a customer that are satisfied at a point in time and those that are satisfied over time. IFRS 15 does not distinguish between sales of goods, services or construction contracts. It defines transactions based on performance obligations satisfied over time versus point in time. Revenue is recognised when control of a good or service transfers to a customer. The notion of control replaces the notion of risks and rewards in the existing guidance. The focus on IAS 18 and 11 is on risk and rewards with control (that is, managerial control) as an aspect of risk and rewards. IFRS 15 focuses on control although risk and rewards is still an indicator of control. One of the more significant changes is that IFRS 15 provides a lot more guidance than the existing standards. For example, it has more detail on multiple element arrangements and variable consideration and provides specific guidance on the accounting for licences, customer options and repurchase arrangements. This is likely to affect existing practice, especially in complex arrangements where existing guidance is limited. IAS 18 provides very limited guidance and the new standard provides significant guidance on key practice issues. This was one of the key objectives of the project from an IFRS perspective. 4

Scope Revenue is income from ‘ordinary activities’. Scope exclusions Leases, insurance, financial instruments, certain guarantee contracts and certain nonmonetary exchanges Contracts with elements in multiple standards Evaluate under other standards first Revenue is income from ‘ordinary activities’. A contract has rights and obligations between two or more parties. A customer receives a good or service. The proposed standard applies to all contracts with customers. The customer is defined as ‘a party that has contracted with an entity to obtain goods or services that are an output of the entity’s ordinary activities in exchange for consideration.’ Defining the customer is a new concept. The definition of the customer might not significantly change the nature of transactions previously considered in scope of revenue guidance, but transactions with partners in collaborative arrangements may need to be considered further. Management will need to evaluate arrangements with collaborators and partners carefully to identify whether such arrangements or portions thereof are in the scope of IFRS 15. A transaction that might be outside the scope is one with a collaborator or partner that shares risk in developing a product and that is not for the sale of goods or services that are an output of the entity's ordinary activities, and therefore not a contract with a customer. Example - a biotechnology entity that has an agreement with a pharmaceutical entity to share risks in the development of a specific drug candidate likely will not be in the scope of the standard if the parties share the risk in developing the drug. If, however, the substance of the arrangement is that the biotechnology entity is selling its compound to the pharmaceutical entity and/or providing research and development services, it will likely be in scope. The proposed standard provides a number of scope exceptions. They are very similar in practice to those in today’s guidance. No industries are scoped out of the standard, only transactions. Leases – Lease transactions are out of the scope of the revenue standard. However, intangibles have been scoped out of the leasing standard and are captured in the revenue standard. Financial instruments – Financial institutions will need to look to IAS 39 / IFRS 9 to determine whether transactions are financial instruments or services under the revenue standard. Insurance – Insurance contracts are within the scope of IFRS 4. Guarantee contracts in the scope of other standards are outside the scope of IFRS 15. Product guarantees, however, are in scope. Non-monetary transactions – IFRS 15 excludes non-monetary exchanges between entities in the same line of business to facilitate sales to customers or potential customers. For example, IFRS 15 would not apply to a contract between two oil companies that agree to an exchange of oil to fulfil demand from their customers in different specified locations on a timely basis. For contract with elements in multiple standards, entities should apply separation and measurement guidance in other standards. If not, entities should apply revenue guidance on separation and allocation of the transaction price. EXAMPLE - A contract that includes a lease as well as a service element would be bifurcated based on the guidance in the leasing project. Thereafter, the lease element will be accounted for in accordance with the lease standard and the non-lease (service element) would be accounted for under the revenue standard. 5

Revenue – the five step approach Core principle Revenue recognised to depict transfer of goods or services Step 1 - Identify the contract with the customer Step 2 - Identify the performance obligations in the contract Step 3 - Determine the transaction price The core principle of IFRS 15 is that an entity recognises revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. The five steps might appear simple, but significant judgement will be needed to apply the underlying principles, and most entities should expect some level of change from current practice. A change of mindset about revenue recognition might be needed to migrate from an evaluation of risk and rewards under existing guidance to an evaluation of transfer of control under the new standard. To apply the guidance, an entity shall: (a) identify the contract with a customer; (b) identify the performance obligations in the contract; (c) determine the transaction price; (d) allocate the transaction price to the performance obligations; and (e) recognise revenue when the entity satisfies each performance obligation. Each of the above steps will be discussed in more detail. This presentation also discusses a number of other topics including licences, contract costs, disclosures and transitions. For more information on these topics and other matters addressed by the standard, see additional materials on Inform. NOTE: This presentation is a summary of IFRS 15 and does not discuss all matters that might need to be considered to implement this standard. Step 4 - Allocate the transaction price Step 5 - Recognise revenue when (or as) a performance obligation is satisfied

Step 1 – Identify the contract Agreement between two or more parties that creates enforceable rights and obligations No contract unless customer committed, criteria include: it is probable that the entity will collect the consideration to which it will be entitled Combine two or more contracts with the same customer when: negotiated as a package with a single commercial objective; amount of consideration to be paid in one contract depends on the price or performance of the other contract; or goods or services promised in the contracts are a single performance obligation (see step 2) The first step is to identify the contract. The definition of a contract emphasises that a contract exists when an agreement between two or more parties creates enforceable obligations between those parties. The concept of enforceable might vary based on governing laws, regulations or practice. Such an agreement does not need to be in writing to be a contract - agreed terms can be written, oral, or evidenced otherwise. The Boards have specified the attributes of a contract that must be present before an entity would apply the proposed revenue requirements. Those attributes are mainly derived from existing requirements: the parties to the contract have approved the contract (in writing, orally or in accordance with other customary business practices) and are committed to perform their respective obligations; the entity can identify each party’s rights regarding the goods or services to be transferred; the entity can identify the payment terms for the goods or services to be transferred; the contract has commercial substance (ie the risk, timing or amount of the entity’s future cash flows is expected to change as a result of the contract); and it is probable that the entity will collect the consideration to which it will be entitled in exchange for the goods or services that will be transferred to the customer. (IFRS 15, paragraph 9) One of the criteria to determine whether a contract exists is about the customer’s ability to pay. IFRS 5, paragraph 9(e) includes the following criterion: it is probable that the entity will collect the consideration to which it will be entitled in exchange for the goods or services that will be transferred to the customer. In evaluating whether collectability of an amount of consideration is probable, an entity shall consider only the customer’s ability and intention to pay that amount of consideration when it is due. The amount of consideration to which the entity will be entitled may be less than the price stated in the contract if the consideration is variable because the entity may offer the customer a price concession (see paragraph 52). This means that there is no contract if there is significant doubt about whether the customer will pay the amount to which the entity is entitled. This is part of step 1. Once a contract exists and revenue is recognised, any subsequent impairment of receivables as result of the customer default is recognised in accordance with the guidance for financial asset impairment. This ‘threshold’ is not different from the probability threshold included in IAS 18 and IAS 11 above. Under current guidance, the evaluation of whether it is probable that economic benefits will flow creates limited issues in practice. That said, the evaluation is now part of step 1 and thus could lead to a different outcome from current practice. This is an example of where management needs to apply a ‘change in mindset’ and the criterion should be considered carefully. Note for US GAAP preparers: IFRS and US GAAP are not converged on this point. The threshold under US GAAP is also set at probable which is generally considered to be higher than the same threshold under IFRS. That is ‘probable’ under US GAAP is generally the equivalent of ‘highly probable’ under IFRS. Both thresholds however are consistent with existing practice under IFRS and US GAAP respectively. Contract combination guidance is likely to be similar to today but may have an impact on more complex arrangements. Entities may want to consider the need to educate sales staff to understand the implications of pricing negotiations of multiple contracts and contract negotiations. EXAMPLE – An entity signs two separate contracts – one for the operation of a manufacturing facility and the other for the maintenance. The contracts are separate but are entered into a same time and performance bonus on operations contract is linked to the performance of maintenance services. It is likely that these two contracts would be combined.

Contract modifications Modification accounted for when it creates or changes enforceable rights and obligations Accounting depends on whether distinct goods or services added Distinct goods/services added at price that reflects stand-alone selling price New separate contract: Prospective accounting only Remaining goods or services distinct from existing contract, but not at stand-alone selling price Treated as new contract: Prospective accounting but ‘carry forward’ existing position (e.g. contract liabilities) Goods / services not distinct from existing contract Continuation of contract: Cumulative catch up If combination of above Apply the ‘principles’ above A contract modification is approved when the modification creates or changes the enforceable rights and obligations of the parties to the contract. Management will need to determine if a modification, such as a claim or unpriced change order, is approved either in writing, orally, or implied by customary business practice such that it creates enforceable rights and obligations before recognising the related revenue. This assessment might also be difficult for contract claims, as no specific guidance has been provided for the accounting for contract claims. Management will have to evaluate contract claims similar to other contract modifications and apply judgement to determine when a claim is approved. A contract modification is treated as a separate contract if it results in the addition of a separate performance obligation and the price reflects the stand-alone selling price of that performance obligation. Otherwise, a modification is accounted for as an adjustment to the original contract, either prospectively or through a cumulative catch-up adjustment. An entity will account for a modification prospectively if the goods or services in the modification are distinct from those transferred before the modification. An entity will account for a modification through a cumulative catch-up adjustment if the goods or services in the modification are not distinct and are part of a single performance obligation that is only partially satisfied when the contract is modified. A contract modification that only affects the transaction price will be treated like any other contract modification. The change in price will be either accounted for prospectively or on a cumulative catch-up basis, depending on whether the remaining performance obligations are distinct. Management will need to apply judgement in evaluating whether goods or services in the modification are distinct to determine whether a contract modification should be accounted for prospectively or as a cumulative catch-up adjustment. This may be particularly challenging in situations where there are multiple performance obligations in a contract.

Unit of account IFRS 15 is applied to each individual ‘contract’ specific guidance on contract combination ‘step 2’ covers separation of contract into different promises Portfolio approach allowed as practical expedient only if the entity reasonably expects that the effects of applying the model to portfolio versus individual contracts would not differ materially Judgment required to select size and composition of portfolio The model in IFRS 15 is applied to each individual contract. There is a specific guidance on when contracts can be combined as well as specific guidance on how to identify separate performance obligations. When the IASB and FASB were developing the guidance, some entities with a large number of contracts expressed concern about the practical challenges of applying the model on a contract-by-contract basis. This was a particular concern of the telecommunications industry. In response IFRS 15 paragraph 4 acknowledges that entities might use a ‘portfolio approach’ if the entity reasonably expects that application of the revenue recognition model to the portfolio would not differ materially from the application of the revenue recognition model to the individual contracts or performance obligations in that portfolio. It is important to note that in order to achieve this objective, management will need to apply judgment in selecting the size and composition of the portfolio. In the basis of conclusions (paragraph BC69) the boards note ‘that they did not intend for an entity to quantitatively evaluate each outcome and, instead, the entity should be able to take a reasonable approach to determine the portfolios that would be appropriate for its types of contracts.’ [EXAMPLE – A health club enters into contracts with customer to allow access to their health clubs. A non-refundable upfront fee is paid. Some customers will not renew the contract after one month while others will renew for several years. The upfront fee is amortised to revenue over the average life of all customers as management reasonably expect that this approach would result in a revenue recognition profile similar to if each customer contract were accounted for individually – that is the upfront fee was amortised into revenue over the exact period each customer is retained.’ Also, see IFRS 15, illustrative example 22]

Step 2 – Identify the performance obligations Performance obligations are promises to transfer goods or services to a customer that are: explicit, implicit, or arise from customary business practices Identifying performance obligations is critical to measurement and timing of recognition A performance obligation is a promise in a contract with a customer to transfer to the customer either: (a) a good or service (or a bundle of goods or services) that is distinct; or (b) a series of distinct goods or services that are substantially the same and that have the same pattern of transfer to the customer. A performance obligation is the key building block in applying the standard. The transaction price is allocated to each separate performance obligation (step 4) and the recognition criteria are applied individually to each separate performance obligation (step 5). Examples of promised good or services include: Goods produced for sale or purchased for resale Standing ready to provide goods and services Construction services Granting licences Granting options to purchase additional goods and services Performance obligations do not include activities that an entity undertakes to fulfil a contract unless it results in the transfer of a good or service to a customer. For example, administration costs to set up a contract would not be a performance obligation. An entity accounts for each promised good or service as a separate performance obligation if the good or service is distinct. The boards have provided some detailed criteria to determine whether or not the goods or services are distinct. This is covered on the next slide.

Separate performance obligations Separate performance obligation if: Distinct good or service: customer benefits from good/service on its own or with other resources; and not dependent on/interrelated with other items in the contract E.g., consumer goods E.g., a building, not the individual ‘bricks’ Series of goods/services that are substantially the same, if consistent pattern of transfer to customer over time E.g., a daily cleaning service A good or service might be distinct and thus a separate performance obligation (POs) if two criteria are met: the customer can benefit from the good or service either on its own or together with other resources that are readily available, and the good or service is separable from other promises – that is, it is not dependent on or interrelated with other items in the contract.   This would include, for example, most consumer goods, machines that require simple installation, or a mobile phone that can be used with any network. A performance obligation also might be a group of integrated goods or services. Some goods or services could be seen as distinct, but are interrelated or interdependent with other goods or services in the contract. EXAMPLE – Let’s take a contract is to build a house. The customer could benefit from each individual brick, but in the context of the contract each individual brick is interrelated with all of the other bricks. The house is thus accounted for as a single performance obligation. IFRS 15 includes indicators to help decide whether the goods and services in the contract are interdependent or interrelated. This guidance will not only apply to traditional construction contracts but will also be relevant for goods requiring complex installation or customised software solutions. A series of distinct POs might also be accounted for as a single promise if certain criteria are met. IFRS 15 also states that a series of distinct goods or services is a single performance obligation if the promise is transferred over time and the pattern of transfer is consistent. EXAMPLE – A daily cleaning service might be accounted for as one single performance obligation even though each day or even each hour of the service is distinct. This is because the weekly cleaning service are a series of services that are substantially the same and have the same pattern of transfer to the customer (time-based measure of progress). Accounting for this as a single promise simplifies the rest of the model and does not change the pattern of recognition. What does all this mean for current practice? Current IFRSs say very little about arrangements with multiple elements. IAS 18 requires that a single transaction is separated into components to reflect the substance. IFRS 15 does not change this principle. However, it does provide significantly more guidance than on how to separate a contract into its components and clarifies that the separation is evaluated from the perspective of the customer. The key message is that it’s necessary to look carefully at multiple element arrangements and identify each performance obligation before applying the rest of the model.

Step 3 – Estimating the transaction price Probability weighted or best estimate More specific guidance covering: time value of money constraint on variable consideration non-cash consideration consideration payable to customers: reduction to transaction price unless for a distinct good or service. The transaction price is the amount of consideration to which an entity expects to be entitled in exchange for transferring goods or services. IFRS 15 includes specific guidance dealing with a number of complexities including the effects of variable consideration, whether there is a significant financing component, non-cash consideration and so on. The transaction price is estimated using a best estimate or weighted average approach, whichever best reflects the amount to which the entity expects to be entitled. Non-cash consideration is measured at fair value. If an entity cannot reasonably estimate the fair value of the non-cash consideration, the entity shall measure the consideration indirectly by reference to the stand-alone selling price of the goods or services in exchange for the consideration. (IFRS 15, paragraph 66-67) Consideration paid (or expected to be paid) to a customer (or to a customer’s customer) will reduce the transaction price unless such consideration is a payment for a distinct good or service from the customer. This includes both cash amounts and credit or other items (for example, a coupon or voucher) that can be applied against amounts owed to the entity. An entity will recognise the reduction of revenue when the later of the following occurs: (a) the entity recognises revenue for the transfer of the related goods or services to the customer; and (b) the entity pays or promises to pay the consideration (even if the payment is conditional on a future event). That promise might be implied by the entity’s customary business practices. (IFRS 15, paragraph 72) More guidance on time value of money and variable consideration to follow.

Time value of money Adjust consideration, if there is a significant financing component: optional if period between payment and performance less than year captures advanced payments Consider: difference between consideration and the cash selling price, and Then combined effect of both: time between transfer of goods/services and customer payment the prevailing interest rates in the relevant market Specific examples of when there is no significant financing component e.g. transfer at customers’ discretion (customer loyalty programmes) Some contracts provide the customer or the entity with a significant financing benefit (explicitly or implicitly). This is because performance by an entity and payment by its customer might occur at significantly different times. An entity should adjust the transaction price for the time value of money if the contract includes a significant financing component. There is a practical expedient which allows entities to ignore time value of money if the time between transfer of goods or services and payment is less than one year. The transaction price should be adjusted for the effects of time value of money when the contract contains a significant financing component. Examples are provided to illustrate when an arrangement includes a significant financing component. Management should consider the following factors: (a) the difference, if any, between the amount of promised consideration and the cash selling price of the promised goods or services; and (b) the combined effect of both of the following: (i) the expected length of time between when the entity transfers the promised goods or services to the customer and when the customer pays for those goods or services; and (ii) the prevailing interest rates in the relevant market. (IFRS 15, paragraph 61) There are also specific examples of when there is no a significant financing component as follows: (a) the customer paid for the goods or services in advance and the timing of the transfer of those goods or services is at the discretion of the customer. (b) a substantial amount of the consideration promised by the customer is variable and the amount or timing of that consideration varies on the basis of the occurrence or non-occurrence of a future event that is not substantially within the control of the customer or the entity (for example, if the consideration is a sales-based royalty). (c) the difference between the promised consideration and the cash selling price of the good or service (as described in paragraph 61) arises for reasons other than the provision of finance to either the customer or the entity, and the difference between those amounts is proportional to the reason for the difference. For example, the payment terms might provide the entity or the customer with protection from the other party failing to adequately complete some or all of its obligations under the contract. (IFRS 15, paragraph 62)

Variable consideration Included in the transaction price only if it is highly probable that there will not be a significant revenue reversal Uncertainty over long period of time Limited experience with similar contracts Susceptible to factors outside control Broad range of outcomes Key effects Must recognise ‘minimum amount’ that is highly probable of not reversing Reassessed at the end of each reporting period The amount that an entity expects to be entitled to can vary for a number of different reasons –discounts, refunds, price concessions and penalties. It can also vary if the amount is contingent on a future event. For example, consideration is variable when the customer has a right to return the goods, there are performance bonuses, or when the consideration is based on a customer’s future sales – this is normally described as a royalty.   Variable consideration does not capture uncertainty about whether the customer will pay. See discussion under slide 7. The transaction price is estimated using a best estimate or weighted average approach, whichever best reflects the amount to which the entity expects to be entitled. However, variable consideration is included in the transaction price only if it is highly probable that there will not be a significant revenue reversal. This principle intended to increase the usefulness of information provided– that is, the IASB does not believe it is useful to recognise revenue that might be reversed in the future. IFRS 15 includes a number of indicators to assess whether it is highly probable that there will not be a significant revenue reversal. These include whether the variability is subject to factors outside the entity’s influence, how long until the variability will be resolved, whether the entity has experience with similar types of contracts and whether there is a broad range of possible outcomes. The ‘minimum’ amount that is not subject to significant reversal is recognised and updated at each period. EXAMPLE - An entity sells machinery for CU 100 today plus a bonus of up to 5% based on the machine meeting future efficiency targets. There is evidence at inception that it is highly probable that the bonus will not be less than 3%. Thus, revenue of 103 is recognised as the ‘minimum’. Part way through the contract, it becomes clear that the whole bonus will be received. The remaining bonus of 2% is recorded once it is highly probable that there will not be a significant revenue reversal. What does this mean in practice? It means that some entities that previously deferred revenue recognition until all contingencies were resolved might need to make an estimate and record revenue earlier. Others might find that the ‘highly probable’ threshold is not met, so revenue might be recognised later than under current practice.

Sales and usage-based royalties exception For licences of intellectual property with a sales or usage based royalty, revenue recognised only when sales/usage occurs ‘highly probable’ constraint does not apply not meant to be applied by analogy The challenges? What is a licence? What is a sales based or usage based royalty? What is intellectual property? There is an exception to the principle that the transaction price only includes variable consideration for which it is highly probable that there will be no significant reversal. IFRS 15 states that for licences of intellectual property with a sales or usage based royalty, revenue is recognised only when sales or usage occurs. The ‘highly probable’ constraint does not apply to these transactions.   This exception is not meant to be applied by analogy –it shall only be applied to sales or usage based royalties arising from the sale of a license. However, it will be necessary to determine what is intellectual property, whether a transaction is a licence or a sale of intellectual property, and what is a sale or usage based royalty. These terms are not defined in the standard. EXAMPLE – If a pharmaceutical entity licences IP to a drug manufacturer. The licence is a right to use and thus, control transfers at a point in time (see future discussion). The consideration to which the pharmaceutical entity is entitled is 5% of the sales of the drug manufacturer over the next five years. This consideration is variable and a sales-based royalty. Revenue is only recognised as the sales by the drug manufacturer occur, even if the pharmaceutical entity is able to estimate the amount and it is highly probable that it will not be subject to significant reversal. The rationale for this exception is that applying the general principle might require an entity to report, throughout the life of the contract, significant adjustments to any revenue recognised even though those changes in circumstances are not related to the entity’s performance. Many thought that this would not provide relevant information to users.

Step 4 – Allocating the transaction price Allocate transaction price to separate performance obligations based on relative standalone selling price: Actual or estimated Residual ‘approach’ if selling price is highly variable or uncertain (change from current practice) Initial allocation and changes to variable consideration might be allocated to a single performance obligation if: Contingent payment relates only to satisfaction of that performance obligation, and Allocation is consistent with the amount the entity expects to be entitled to for that performance obligation Entities that sell multiple goods or services in a single arrangement must allocate the consideration to each of those goods or services. This allocation is based on the price an entity would charge a customer on a stand-alone basis for each good or service. Management should first consider observable data to estimate the stand-alone selling price. An entity will need to estimate the stand-alone selling price if such data does not exist. Some entities will need to determine the stand-alone selling price of goods or services that have not previously required this assessment. If management estimates the selling price because a stand-alone selling price is not available, they should maximise the use of observable inputs. Possible estimation methods include (but are not limited to): Expected cost plus reasonable margin; Assessment of market prices for similar goods or services; and Residual approach, in certain circumstances. A residual approach may be used to calculate the stand-alone selling price when the selling price is highly variable or uncertain for one or more goods or services, regardless of whether that good or service is delivered at the beginning or at the end of the contract. A selling price is highly variable when an entity sells the same good or service to different customers (at or near the same time) for a broad range of prices. A selling price is uncertain when an entity has not yet established a price for a good or service or the good or service has not been sold previously. The residual approach required by IFRS 15 might be different than the residual applied under IFRS today. Applying today’s residual method generally results in the entire discount in an arrangement being allocated to the delivered item. The residual approach in IFRS 15 is used to estimate the stand-alone selling price of the separate good or service, not to determine the amount of consideration allocated to a specific performance obligation. This approach requires that any discounts related to specific performance obligations first be allocated to those performance obligations prior to using the residual approach to determine the stand-alone selling price of the remaining item(s). This could result in a change for some contracts especially when there are more than two performance obligations. Changes to the transaction price, including changes in the estimate of variable consideration, might only affect one performance obligation. Such changes would be allocated to that performance obligation rather than all performance obligations in the arrangement if the following criteria are met: The contingent payment terms relate to a specific performance obligation or outcome from satisfying that performance obligation; and Allocating the contingent amount of consideration entirely to the separate performance obligation is consistent with the amount of consideration that the entity expects to be entitled for that performance obligation. There is additional guidance proposed on when discounts should be allocated.

Step 5 – Recognition of revenue Key question: Point in time or over time Guidance applies to each separate performance obligation First, evaluate if performance obligation satisfied ‘over time’ recognise revenue based on the pattern of transfer to the customer If not point in time recognise revenue when control transfers IFRS 15 has replaced the separate models for goods, services and construction contracts with a single model that distinguishes between performance obligations satisfied at a point in time and those that are satisfied over time. The recognition framework is applied to each performance obligation separately - that is, each distinct good or service. The recognition model requires that management consider whether a performance obligation is satisfied over time.

When does control transfer over time? Customer receive benefits as performed/ another would not need to re-perform e.g. cleaning service, shipping Over time Point in time Yes No Create/enhance an asset customer controls e.g. house on customer land Yes No A performance obligation is satisfied over time if one of three criteria is met. Revenue is recognised over time if the customer simultaneously receives and consumes all of the benefits provided as the entity performs. This criterion generally captures traditional service arrangements, for example, a daily cleaning service or a security service, where the customer receives the benefit of a clean or secure office as the service is being performed. Revenue is also recognised over time if performance creates or enhances an asset that the customer controls. This criterion is likely to capture many construction contract arrangements, for example, building a house on customer’s land where the customer controls the work in progress throughout the arrangement. Finally, revenue is recognised over time when performance does not create an asset with an alternative use and the entity has an enforceable right to payment for performance completed to date. This criterion is more complicated and requires consideration of both whether an asset has an alternative use and the nature of any rights to payment. When does an entity’s work ‘not create an asset with alternative use’? The most common example is a typical service where there is no asset created, for example, legal services. It also applies when an asset is created but has no alternative use to the supplier, for example, the construction of a highly customised asset that could not be sold to another customer. The standard is specific that an asset does not have alternative use if it cannot be redirected to another customer either legally or practically. This might happen for example, in connection with a specialised asset that can only be used by a specific customer or an asset where the contract prevents the entity selling to another customer. It is also necessary that the entity has the right to payment for work completed to date if the customer cancels the contract. This does not need to be in the form of an upfront payment or progress payments. It could be in other forms, for example, a cancellation penalty. Judgment will be required when the right to payment relies on a cancellation provision or milestone payments. The key consideration is whether the payment reflects the work performed to date including a reasonable profit margin. IFRS 15 is explicit that recovery of cost incurred to date is not a right to payment. If a performance obligation is satisfied over time, revenue is recognised by measuring the progress towards satisfaction of the performance obligation. This might be determined based on output or input methods, whatever best reflects transfer to the customer. Specific guidance is given on selecting an appropriate method. Does not create asset w/alternative use AND Right to payment for work to date e.g. an ‘audit’ report Yes No

Indicators of control transfer – point in time If not over time, then point in time…. Recognise revenue when control transfers Indicators that customer has obtained control of a good or service: Right to payment for asset Customer has accepted the asset Legal title to asset If the performance obligation is not satisfied over time, revenue is recognised when control is transferred to the customer. The standard includes indicators of when control has transferred: The entity has a present right to payment for the asset The customer has legal title to the asset unless legal title is retained solely as protection against the customer’s failure to pay The customer physically possesses the asset. The customer is exposed to the significant risks and rewards of ownership of the asset The customer has accepted the asset No one indicator is definitive and all indicators should be considered when determining the point of transfer. The standard also contains specific implementation guidance on repurchase options, consignment, and bill-and-hold arrangements. The timing of revenue recognition could change for some entities compared to current guidance, which is more focused on the transfer of risks and rewards than the transfer of control. The transfer of risks and rewards is an indicator of whether control has transferred under the new standard, but additional indicators will also need to be considered. Physical possession of asset Customer has significant risk and rewards

Licences intellectual property – two types Right to use Right to use IP as it exists at a point in time Revenue recognised at a point in time Right to access Right to access to IP as it exists through out the licence period Revenue recognised over time Right to access if following criteria met: Licensor performs activities that significantly affect the IP Rights expose customer to effects of those activities Activities are not a separate good / service A licence is the right to use an entity's intellectual property including, among others: software and technology; media and entertainment rights; franchises; patents; trademarks; and copyrights. Given the diversity in the types of licences granted, there is not a ‘one size fits all’ approach to accounting for licences. Entities that license their IP to customers will need to determine whether the licence transfers to the customer over time or at a point in time. IFRS 15 distinguishes between two types of licences: right to use and a right of access. A licence that is transferred over time allows a customer access to the entity’s IP as it exists during the licence period. Licences that are transferred at a point in time allow the customer the right to use the entity’s IP as it exists when the licence is granted. The customer must be able to direct the use of and obtain substantially all of the remaining benefits from the licensed IP to recognise revenue when the licence is granted. IFRS 15 paragraph B58 provides criteria to determine whether a licence is a right of access: the contract requires, or the customer reasonably expects, that the entity will undertake activities that significantly affect the intellectual property to which the customer has rights (see paragraph B59); the rights granted by the licence directly expose the customer to any positive or negative effects of the entity’s activities identified in paragraph B58(a); and those activities do not result in the transfer of a good or a service to the customer as those activities occur. If these criteria are not met, then the licence is a right to use. It is important to remember that this guidance in only applicable to licences that are distinct performance obligations. Licences, for example, that form a component of a tangible good or those that a customer can benefit from only in conjunction with a related service are not likely separate performance obligations. In such cases, the implementation guidance on licences is not applicable and the entity should apply the normal model for determining whether the performance obligation transfers over time or at a point in time. There are a number of examples in IFRS 15 and significant judgment is required in this area. The fact that licences come in a variety of forms and are common in a number of industries makes it challenging to apply a single, principles-based model. Also, it is important to remember that even licences for which the consideration is a sales- or usage-based royalty will be subject to the exception for variable consideration which permits revenue to be recognised only when the sales or usage occur. See slide 15. Judgment required

Contract costs Incremental costs of obtaining a contract required to be capitalised if expected to be recovered (e.g. sales commissions) May be expensed if expected contract period less than 1 year Contract fulfilment costs Look to other guidance first (inventory, PPE) If out of scope of other standards, required to be capitalised if: Relate directly to a contract and Relate to future performance and Expected to be recovered Amortise capitalised costs as control transfers Impairment reversals required An entity recognises an asset for the incremental costs to obtain a contract that management expects to recover. Incremental costs of obtaining a contract are costs the entity would not have incurred if the contract had not been obtained (for example, sales commission). As a practical expedient, an entity is permitted to recognise the incremental cost of obtaining a contract as an expense when incurred if the amortisation period would be less than one year, as a practical expedient. This is a requirement and not an accounting policy choice. This may be different from current practice where many entities expense contract acquisition costs as incurred, allowing for diversity in practice. An entity recognises an asset for costs to fulfil a contract when specific criteria are met. Management will first need to evaluate whether the costs incurred to fulfil a contract are in the scope of other standards (for example, inventory, fixed assets, intangibles). Costs that are in the scope of other standards should be either expensed or capitalised as required by the relevant guidance. If fulfilment costs are not in the scope of another standard, an entity recognises an asset only if the costs relate directly to a contract, will generate or enhance a resource that the entity will use to satisfy future performance obligations, and are expected to be recovered. An asset recognised for the costs to obtain or costs to fulfil a contract should be amortised on a systematic basis as the goods or services to which the assets relate are transferred to the customer. An entity recognises an impairment loss to the extent that the carrying amounts of an asset recognised exceeds (a) the amount of consideration the entity expects to receive for the goods or services less (b) the remaining costs that relate directly to providing those goods or services. Entities that currently expense all contract fulfilment costs as incurred might be affected by the proposed guidance since costs are required to be capitalised when the criteria are met. Fulfilment costs that are likely to be in the scope of this guidance include, among others, set-up costs for service providers and costs incurred in the design phase of construction projects. 21

Disclosure Both qualitative and quantitative information including; Disaggregated information Contract balances and a description of significant changes Amount of revenue related to remaining performance obligations and an explanation of when revenue is expected to be recognised Significant judgments and changes in judgments Extensive disclosures are required to provide greater insight into both revenue that has been recognised, and revenue that is expected to be recognised in the future from existing contracts. Quantitative and qualitative information will be provided about the significant judgments and changes in those judgments that management made to determine revenue that is recorded. The following are some of the key disclosures required by IFRS 15: Disaggregation of revenue – Disclose disaggregated revenue information in categories that depict how the nature, amount, timing, and uncertainty of revenue and cash flows are affected by economic factors and describe relationship with disaggregated revenue to revenue for reportable segments. Contract balances - Disclose opening and closing balances of contract assets (such as unbilled receivables) and liabilities (such as deferred revenue) and provide a qualitative description of significant changes in these amounts. Costs to obtain or fulfil contracts - Disclose the closing balances of capitalised costs to obtain and fulfil a contract and the amount of amortisation in the period. Disclose the method used to determine amortisation for each reporting period. Remaining performance obligations – The aggregate amount of the transaction price allocated to the performance obligations that are unsatisfied (or partially unsatisfied) and an explanation of when the entity expects to recognise as revenue for such amounts, except when the performance obligation is part of a contract that has an original expected duration of one year or less or the entity recognises revenue when they receive the right to consideration because such right corresponds directly to the performance completed to date. Other qualitative disclosures – Disclose significant judgements and changes in judgements that affect the amount and timing of revenue from contracts with customers. Disclose how management determines the minimum amount of revenue not subject to the variable consideration constraint. Describe the practical expedients, including those for transition, used in an entity's revenue accounting policies. Interim disclosures – IAS 34 will be amended to specifically require specific disclosures about the disaggregation of revenue. Otherwise, the principles of IAS 34 will apply such that only significant changes will need to be disclosed. Implications - The implications are as follows: Disclosure requirements are more extensive than today Entities will need to assess how systems can be leveraged to capture disclosure information More disclosures

Cumulative effect at 1 Jan 2016 Transition Effective date = 1 Jan 2017 2016 2017 Reliefs NEW IFRS 15 NEW IFRS 15 For completed contracts: No adjustment for interims Hindsight allowed for variable consideration Option 1 – Full retrospective (Apply IAS 8) Cumulative effect at 1 Jan 2016 No reliefs Option 2– Prospective OLD GAAP NEW IFRS 15 IFRS 15 permits an entity to apply the final standard either (1) retrospectively with some reliefs or (2) use the following practical expedient to simplify transition Apply the revenue standard to all existing contracts as of the effective date and to contracts entered into subsequently. Recognise the cumulative effect of applying the new standard to existing contracts in the opening balance of retained earnings on the effective date. In the year the standard is initially adopted, disclose the amount by which each financial statement line item is affected in the current year as a result of the entity applying IFRS 15 and an explanation of the significant changes between the reported results under IFRS 15 and previous guidance.   An entity that uses this practical expedient must disclose this fact in its financial statements. The availability of this new simplified transition method should significantly reduce transition issues for preparers that choose this option. The requirement to disclose how all of the financial statement line items in the current year have been affected as a result of applying IFRS 15 will allow for comparability in the year of adoption and provides trend information, a key concern of investors. The longer than normal period of time from finalisation of the standard to the effective date is provided because of the pervasiveness of the standard and the importance of reporting revenue. It is intended to ensure there is sufficient time for entities that want to use full retrospective application as well as for those that use the simplified transition method, given the concerns of preparers about the amount of effort adopting the standard might require. Full retrospective application provides more holistic trend information that some entities might prefer to provide to investors, so it was important to provide sufficient time for these preparers to transition. Disclose OLD GAAP Cumulative effect at 1 Jan 2017 It depends.

What else haven’t we covered? Customer options Warranties Breakage Non-cash consideration Consideration payable to the customer Returns Repurchase options Principal or agent It is important to remember that one of the more significant changes is that IFRS 15 provides a lot more guidance than the existing standards. This presentation has only provided a high level overview into the requirements of IFRS 15. The standard, implementation guidance, illustrative examples and basis for conclusions is available on Inform. More guidance on the implications on industries is also available. Significantly more implementation guidance than existing IFRS!

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