IFRS 15 & Contract Modifications

Contract modifications are considered to be changes in the scope or price (or both) of a contract and may be accounted for in a number of different ways, depending on the nature of the change.

Once approved, a determination must be made as to whether the contract modification should be accounted for as a separate contract.

Separate Contract

In order for the modification to be accounted for as a separate contract, the following two conditions must both exist:

  1. The scope of the contract increases because of the addition of promised goods or services that are distinct;
  2. The price of the contract increases by an amount of consideration that reflects the entity’s stand-alone selling price of the additional goods or services.

If both conditions are met, the modification is treated as a separate contract, and the five-step model will be applied separately to this contract. The accounting for the existing contract will remain unchanged.

Not a Separate Contract

If the above conditions are not met and:

  1. The remaining goods or services are distinct from the goods or services of the initial contract, then entities will be required to treat the modification as if it were the creation of a new contract. Effectively, the original contract is terminated. The new contract will include both the remaining goods or services of the original contract and the additional goods or services promised in the modification. The accounting for such a modification is fully prospective.
  2. The remaining goods or services are not distinct from the goods or services of the initial contract, the modification will be considered part of the remaining performance obligations in the contract and an adjustment must be made to the cumulative amount of revenue to reflect the effect the modification. The accounting impact for such a modification is retrospective.

Example 1 – Distinct

On January 1, 20X1, ABC Ltd entered into a contract with DEF Ltd to sell 200 Tablet Computers Type X for $350 each. The agreement states that ABC Ltd will send 40 tablet computers Type X at the end of each month up to May 31, 20X1. Revenue of $14,000 (40 * $350) per month is recognized on delivery. On April 4, 20X1, after delivery of the first 120 tablet computers, the contract is modified as follows:

  • ABC Ltd will additionally sell DEF Ltd 100 Tablet Computers Type Y for $250 each. Tablet Computers Type Y are normally sold at $400 per unit.

This contract modification should not be treated as a separate contract. Although there are additional, distinct goods being promised by ABC Ltd, the price of those additional goods is significantly lower compared to their standalone selling price.

The original contract is considered to be terminated, but the $42,000 (120 * $350) of revenue already recognized will not be adjusted.

The remaining performance obligations from the original contract and the additional obligations from the modification will create a new contract with a total value of $53,000.

Effectively ABC Ltd has granted a discount of $15.000. This amount should be allocated to both Tablet Computers Type X & Tablet Computers Type Y pro rata based on their stand-alone selling prices.

Type Units to be delivered Price per Unit Total
X 80 $350 $28.000
Y 100 $250 $25.000
Total     $53.000
Type Units SP Total Discount Total Revenue Revenue per unit
X 80 $350 $28.000 ($6.178) $21.822 $273
Y 100 $400 $40.000 ($8.822) $31.178 $312
Total     $68.000 ($15.000) $53.000  

As such, ABC Ltd will recognize $273 per Tablet Type X and $312 per Tablet Type Y.

Example 2 – Not Distinct

QRS Ltd has entered into a contract with a customer to build a new 12-floor building for a fee of $32 million. Total costs are expected to be $20 million. At the end of year 1, QRS Ltd determined that it has satisfied 40% of its performance obligation (based on costs incurred).

On that date the customer requested for an extra floor to be erected for an additional fee of $6 million. QRS Ltd estimated that it would incur additional costs of $4 million as a result of the changes. The extra floor is not considered to be a distinct performance obligation.

The modification will be accounted as follows:

Costs Incurred$8.000.000$8.000.000
Total Costs$20.000.000$24.000.000
% Completed (based on costs incurred)40%33%
Revenue Recognized$12.800.000$12.667.000