The IFRS Interpretations Committee tentatively decided not to add this matter to its standard-setting agenda at its meeting in November 2017. The Committee will reconsider the following tentative agenda decision, including the reasons for not adding the matter to the standard-setting agenda, at a future meeting. The Committee encourages interested parties to submit their responses using the link below.
Tentative Agenda Decision
The Committee received a request about revenue recognition in a contract for the sale of land and a building to be constructed on the land. The land represents all of the area on which the building will be constructed. Specifically, the request asked (a) about the identification of performance obligations in the contract and (b) for each performance obligation identified, whether the real estate developer (entity) recognises revenue over time or at a point in time.
In the fact pattern described in the request, the contract includes the following features:
- the entity and the customer enter into a non-cancellable contract for the sale of a building yet to be constructed by the entity that will comprise residential units.
- at contract inception, the entity irrevocably transfers to the customer legal title to the land on which the entity will construct the building. The contract specifies a price for the land, which the customer pays on signing the contract.
- the entity and the customer agree upon the structural design and specification of the building before the contract is signed. As the building is being constructed:
- if the customer requests changes to the structural design or specification, the entity prices the proposed changes based on a methodology specified in the contract; the customer then decides whether to proceed with the changes. The entity can reject the customer’s request for changes only for a limited number of reasons, such as when the change would breach planning permission.
- the entity can request changes to the structural design or specification only if not doing so would lead to an unreasonable increase in costs or delay to construction. The customer must approve those changes.
- the customer is required to make milestone payments throughout the construction period. However, these payments do not necessarily correspond to the amount of work completed to date.
Identifying performance obligations in the contract
Applying paragraphs 22–30 of IFRS 15, an entity identifies as a performance obligation each promise to transfer to the customer a good or service (or a bundle of goods or services) that is distinct, or a series of distinct goods or services that are substantially the same and that have the same pattern of transfer to the customer.
Paragraph 27 of IFRS 15 specifies that a good or service promised to a customer is distinct if (a) the customer can benefit from the good or service on its own or together with other resources readily available to the customer (ie the good or service is capable of being distinct); and (b) the entity’s promise to transfer the good or service is separately identifiable from other promises in the contract (ie the promise to transfer the good or service is distinct within the context of the contract). The assessment of the criteria in paragraph 27 requires judgement.
Paragraph BC100 explains that an entity assesses the criterion in paragraph 27(a) based on the characteristics of the goods or services themselves. Accordingly, an entity disregards any contractual limitations that might preclude the customer from obtaining readily available resources from a source other than the entity.
Paragraph 29 explains that the objective underlying the criterion in paragraph 27(b) is to determine whether the nature of the promise, within the context of the contract, is to transfer each of the promised goods or services individually or, instead, to transfer a combined item to which those goods or services are inputs. Paragraph 29 also specifies some factors that indicate that two or more promises to transfer goods or services are not separately identifiable.
The Board explained in paragraphs BC105, BC116J and BC116K that the notion of ‘separately identifiable’ in paragraph 27(b) is influenced by the notion of separable risks (ie whether the risk an entity assumes to fulfil its obligation to transfer one of those promised goods or services to the customer is a risk that is inseparable from the risk relating to the transfer of the other promised goods or services). The evaluation of whether an entity’s promise is separately identifiable considers the relationship between the various goods or services within the contract in the context of the process of fulfilling the contract. Therefore, an entity considers the level of integration, interrelation or interdependence among the promises to transfer goods or services. Rather than considering whether one item, by its nature, depends on the other (ie whether two items have a functional relationship), an entity evaluates whether there is a transformative relationship between the two items in the process of fulfilling the contract.
Application of paragraph 27 to the fact pattern in the request
The identification of performance obligations in a contract requires an entity to assess the particular facts and circumstances of the contract. The Committee observed that that assessment may involve judgement and the outcome depends on those particular facts and circumstances.
In the fact pattern described in the request, the land and the building are each capable of being distinct and thus the Committee observed that the criterion in paragraph 27(a) is met. The customer could benefit from the land on its own or together with other resources readily available to it. For example, the customer could hire another developer to construct a building on the land. Similarly, the customer could benefit from the construction of the building on its own or together with other resources readily available to it. For example, the customer could obtain the construction services from the entity or another developer without any transfer of land.
When assessing the criterion in paragraph 27(b) and its underlying objective explained in paragraph 29—ie determining whether the nature of the promise, within the context of the contract, is to transfer the land and the building individually or, instead, to transfer a combined item to which the land and building are inputs, the Committee observed that the entity considers the following:
- is there a transformative relationship between the transfer of the land and the construction of the building? In other words, would the entity’s performance in constructing the building be any different had the customer already purchased the land from another party and vice versa? There is a functional relationship between the land and the building—the building cannot exist without the land; its foundations will be built into the land. However, this does not necessarily mean that the risks to which the entity is exposed in transferring the land to the customer are inseparable from the risks of constructing the building.
- would the entity be able to fulfil its promise to transfer the land even if the customer purchased the construction services from another developer, and would it be able to fulfil its promise to construct the building even if the customer had purchased the land from another party?
The Committee observed that the promise to transfer the land would be separately identifiable from the promise to construct the building on that land if the entity concluded that (a) its performance in constructing the building would be the same regardless of whether the customer had purchased the land from it or another party; and (b) it would be able to fulfil its promise to construct the building even if the customer had purchased the land from another party, and would be able to fulfil its promise to transfer the land even if the customer purchased the construction services from another developer.
In the fact pattern described in the request, the Committee observed that this would be the case and, thus, concluded that there are two performance obligations in the contract—ie a promise to transfer the land to the customer and a promise to construct the building on that land.
Application of paragraph 35 to the fact pattern in the request
The entity applies the criteria in paragraph 35 of IFRS 15 to determine whether, for each performance obligation, to recognise revenue over time. If none of the criteria in paragraph 35 are met, the entity recognises revenue at a point in time.
Application of paragraph 35 to the promise to transfer land
In the fact pattern described in the request, the entity’s performance delivers the land to the customer. The land is not consumed immediately and, thus, the criterion in paragraph 35(a) is not met. Nor does the entity’s performance create or enhance the land, and, thus, the criteria in paragraphs 35(b) and 35(c) are not met.
Consequently, the Committee observed that the entity recognises revenue for the transfer of the land to the customer at a point in time applying paragraph 38 of IFRS 15.
Application of paragraph 35 to the promise to construct the building
The Committee discussed the application of paragraph 35 to a promise to construct a real estate unit in [September 2017]. The following observations made by the Committee in its [tentative] agenda decision ‘Revenue recognition in a real estate contract (IFRS 15)’ are also applicable to the promise to construct the building in the fact pattern described in the request:
- in a contract for the sale of a building that the entity constructs, the Committee observed that paragraph 35(a) is not applicable because the entity’s performance creates an asset, ie the building, that is not consumed immediately.
- paragraph BC129 of IFRS 15 explains that the Board included the criterion in paragraph 35(b) to ‘address situations in which an entity’s performance creates or enhances an asset that a customer clearly controls as the asset is created or enhanced’. Accordingly, the Committee observed that, in applying paragraph 35(b), an entity assesses whether there is evidence that the customer clearly controls the asset that is being created or enhanced (for example, the part-constructed building) as it is created or enhanced. An entity considers all relevant factors in making this assessment—no one factor is determinative.
- in applying paragraph 35(b), it is important to apply the requirements for control to the asset that the entity’s performance creates or enhances. In a contract for the sale of a building that the entity constructs, the asset created is the building itself. It is not, for example, the right to obtain the building in the future.
[The paragraph above will be updated depending on the outcome of the Committee’s consideration of comment letters received on the IFRS 15 tentative agenda decision published in September 2017.]
In the fact pattern described in the request discussed in November 2017, the Committee observed that the criterion in paragraph 35(a) is not met. This is because the customer does not simultaneously receive and consume the benefits provided by the entity’s construction of the building as the building is being constructed—the entity’s performance creates an asset, the part-constructed building, that is not consumed immediately.
In assessing the criterion in paragraph 35(b), the entity assesses whether, as the building is being constructed, the customer has the ability to direct the use of, and obtain substantially all of the remaining benefits from the part-constructed building.
The Committee concluded that, in the fact pattern described in the request, the customer controls the part-constructed building as it is being constructed because the customer has the following:
- the ability to direct the use of the building as it is being constructed. The customer has this ability through its control of the land, and by being able to change the structural design and specification of the building as it is being constructed. The contract also enables the customer to prevent the entity or others from directing the use of the building.
- the ability to obtain substantially all of the remaining economic benefits from the building. The entity cannot redirect the building for another use or to another entity. Accordingly, on signing the contract, the customer has the ability to obtain substantially all of the remaining benefits from the building.
Accordingly, the criterion in paragraph 35(b) is met. The Committee noted the Board’s observation in paragraph BC129 of IFRS 15 that ‘in the case of a construction contract in which the entity is building on the customer’s land, the customer generally controls any work in progress arising from the entity’s performance’.
The Committee concluded that the principles and requirements in IFRS 15 provide an adequate basis for an entity to recognise revenue in the fact pattern described in the request. Consequently, the Committee [decided] not to add this matter to its standard-setting agenda.
The Tentative Agenda Decision is open for comment until 29 January 2018.
