IFRS 15 / ASC 606 Case: Customer contract over time
Sell 12 months ‘Active IoT Remote Monitoring’ service with upfront full invoice
SAP introduced enhancements to SAP Business ByDesign to allow customers to comply with accounting standard IFRS15/ASC606 revenue recognitions requirements. A series of case documents introduces the key requirements of IFRS15 /ASC606 along with steps to be taken by the client to implement the functionality.
This case document focuses on:
- standardized service example with time series performance obligation
- extending an existing contract by a customer contract
Revenue Accounting Contract with multiple sales document assignments
- introduction of contract assets / contract liabilities
Business Scenario – Example
This case description is a variation of the first basic case document and extends the contract.
Media Productions Limited had ordered 2 new printing machines including setup and machine installation service.
Prior to any delivery, Media Productions, Ltd contacts the sales representative of Printing Solutions Corp to add a remote monitoring service. The remote IOT (Internet of Things) monitoring service is offered for 1000 USD/month with a full invoice for 12 months upfront.
The IOT machine sensor and communication infrastructure allows the transmittal of data to Printing Solutions Corp at a high frequency for:
- remote calibration
- ink usage optimization
- automatic ink replenishment (separate service)
- firmware updates
- regular maintenance planning for consumable parts and fluids
- alerts or warnings indicating machine inconsistencies or irregular behavior
- remote analysis and remote support of local service crew
Media Productions Limited wants to validate the IOT service for 12 month. The sales representative agrees on a special 10% discount per printing machine for the monitoring service.
For the request to add the IoT Services, what requirements of IIFRS 15/ASC 606 does Printing Solutions Corp need to consider when adding the new item to a Sales Document?
- Do the two ‘12 month remote IoT services’ belong to a new contract or existing contract with the customer?
Printing Solutions Corp assessment: it must be assigned to the existing revenue accounting contract.
- Do the 2 services form a new performance obligation or must it be assigned to an existing performance obligation?
Printing Solutions Corp assessment: the remote maintenance per machine form a separate performance obligation.
- When is revenue to be realized?
Printing Solutions Corp assessment: It is decided to realize the revenue equally over the period of performance – 1/12 per month.
Adding the customer contract to existing revenue contract
Before the new service is added the status of the revenue accounting contract and the associated sales order are depicted below.
The Sales Order with 2 printing machine and 2 setup services:
And the logical view of the revenue accounting contract:
The sales representative creates in the system a new customer contract and enters 2 lines for the respective remote monitoring service with start and end dates matching the planned delivery and setup of the machines. The invoicing rules are setup to upfront billing with full amount.
While creating the customer contract, the defaulted new revenue accounting contract is replaced by the existing one for Media Productions, Ltd. The existing revenue accounting contract can be found in the list of values – in this case, the relevant revenue accounting contract 583. By default, the new entries in the customer contract lead to new performance obligations 30 and 40. This meets the assessments Printing Solution Corp made concerning the revenue accounting contract. The standalone selling prices for the added remote services are derived by the price list determination.
The added customer contract (together with the sales order at the same RAC):
The derived SSP for the added items is shown below:
The following simplifications have been made to keep this and upcoming time series examples understandable and more easy to follow.
- the start and end period in this example showcase are simplified views of time spans
- the list price being a monthly price is a simplified view
- the service quantity matching the number of periods is a simplified view.
When should revenue be realized?
The realization method over time is handled by the accrual method assigned to the sales order item.
The following illustration shows the simplified settings for the assigned sales document items in the revenue accounting contract.
Logical view on revenue accounting contract with combined sales order and customer contract
Now the revenue accounting contract spans across 2 sales documents:
|Sales order||#27||Machines and Setup Service|
|Customer contract||#30||Remote IoT Monitoring Service|
The SSP derivation is triggered for the new items. For the existing items the already derived SSP price remains fixed based on initial derivation. The overall revenue allocation basis and the overall contract transaction value has changed to reflect the added POBs 30 and 40.
The picture below depicts the logical status of the revenue accounting contract:
Simplified posting example
- Step 1 / period 4: full delivery of machines, setup and installation completed, IoT monitoring activated
- Step 2 / period 4: Full upfront invoice 12 months ‘IoT remote monitoring’
- Step 3 / period 4: Revenue recognition
- Step 4 / period 5: Invoice 2 printing machines and setup and installation service
- Step 5 / period 5: Revenue recognition
- Step 6 / period 6: Revenue recognition
- Step 7 / period 15: Revenue recognition – final accrual
Step 1 / period 4: full delivery of machines, setup and installation completed, IoT monitoring activated
The 2 printing machines are delivered and the setup and installation has been completed. The ‘IoT monitoring service’ has been activated on both machines. The resulting simplified postings are shown below:
Step 2 / period 4: Full upfront invoice 12 months ‘IoT remote monitoring’
The activation of the IoT monitoring service triggered an automatic upfront invoice for upcoming the 12 periods.
Step 3 / period 4: Revenue recognition
The progress per performance obligation is measures by the underlying assigned sales document item accrual methods. The 2 machines and the setup and installation are to be realized ‘At delivery’. Therefore, the progress is shown as 100%. The IoT monitoring are to be recognized per ‘straight-line even periods’. Therefore, their progress is shown as 1/12 = 8,33 %.
Revenue recognition leads to following simplified journal entry.
As a simplification it is assumed that the cost for providing the IoT monitoring service are 10,- USD by month.
Formula / Calculations
The overall revenue accounting contract in period 4 has to show a contract asset of 3000,- USD. A short explanation on the formula and calculation on a cumulated revenue accounting contract level:
- Invoiced Amount= 21.600,- USD
- Billable Amount = Progress % x Transaction Price = 181.800,- USD
- Contract Receivable = max (Invoiced, Billable) = 181.800,- USD
- Earned Revenue = Progress % x Allocated Amount = 184.800,- USD
- If Earned Revenue > max(Invoiced, Billable) than Contract Asset = Earned Revenue – max(Invoiced, Billable) else Contract Liability = max(Invoiced, Billable) – Earned Revenue => here Contract Asset = 184.800,- USD – 181.800,- USD = 3000, USD
Background: The calculation of the Contract Asset or Contract Liability can be made at either the Sales Document of the Sales Document Item Level. The same formula and calculation is used at either level. SAP has chosen to calculate this at the Sales Document Item Level to provide the lowest level of granularity to the calculation and result. The summation of the results at the Item Level will determine if the calculation results in a net Contract Asset or Contract Liability. The below illustration shows the journal entry filtered by “Contract Asset”. The difference between the Debit of 30.545,45 and Credit of 27.545,45 = 3.000,00 USD will be shown on the revenue accounting contact level.
Illustration: Filtered Journal Entry Lines ‘Contract Assets’:
Step 4 / period 5: Invoice 2 printing machines and setup and installation service
In period 5, the 2 printing machines and the setup and installation service are fully invoiced. Please note that for the 100% discounted setup and installation service deferred revenue 40.000,- USD and deferred discount 40.000,- USD are posted.
Step 5 / period 5: Revenue recognition
After execution of the Revenue Recognition Run in Period 5, the Revenue Accounting Contract has changed from having Contract Assets to having Contract Liabilities. The Posted Contact Assets of prior periods are reversed and Contract Liabilities are posted at the Line Item Level. The results are shown below.
The invoiced amount = 201.600,00 USD is greater than the earned net value = 186.327,26 USD. The same formula as above is used resulting in a net Contract Liability of 15.272,74 USD. The progress of the IoT monitoring services has also now increased to 2/12 months = 16,67%.
Step 6 / period 6: Revenue recognition
During period 6 to 14 only the time series based performance obligations are affected.
They realize revenue and reduce the contract liability.
The progress has increased. The contract liability reduced. The reduction of the contract liability is reflected on the 2 sales document items with a change in progress.
The same pattern is now repeated for period 7 to 14.
Step 7 / period 15: Revenue recognition – final
With period 15 the time series for the ‘IoT monitoring service’ is completed. The basis for revenue recognition on period 15 shows all performance obligations 100% completed and no contract liabilities or contract assets.
The finally created simplified journal entry by revenue recognition reverses the remaining contract liabilities on sales document level and realizes revenue, discounts and costs for the ‘IoT monitoring service’.
Profit and loss statement