Revenue Recognition under IFRS 15
Safari Tech Ltd, a software company, enters into a contract with a customer on 1 January 2025 to provide a customized software system, including installation, training, and three years of post-contract customer support (PCS). The total contract price is KES 12 million. The standalone selling prices are: software license KES 8 million, installation KES 2 million, training KES 1 million, and PCS KES 3 million (total standalone KES 14 million). The software is highly customized and cannot be used without significant modification. Installation is complex and significantly affects the software's functionality. Training can be provided by other vendors. PCS is provided over three years. The customer pays KES 5 million upfront and the remainder in equal annual installments over three years. The company's year-end is 31 December. The company recognizes revenue based on the progress towards completion for the customization and installation, and straight-line for PCS and training.
1. Identify the performance obligations in the contract and allocate the transaction price to each. Justify your identification with reference to IFRS 15.
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Performance obligations: Under IFRS 15, a performance obligation is a promise to transfer a distinct good or service. A good or service is distinct if the customer can benefit from it on its own or with readily available resources, and the promise is separately identifiable.
- Software license and installation: These are highly interdependent because the software is customized and installation significantly affects functionality. They are not distinct and should be combined into a single performance obligation. The customer cannot benefit from the license without installation, and the installation is not a separate service. Thus, one performance obligation: 'customized software system' (license + installation).
- Training: Training can be provided by other vendors and is not highly integrated with the software. It is distinct. So, separate performance obligation.
- PCS: PCS is a separate service provided over time; the customer can benefit from it separately (e.g., with another software) and it is distinct. So, separate performance obligation.
Thus, three performance obligations: (1) customized software system, (2) training, (3) PCS.
Allocation of transaction price: Total standalone selling prices = 8+2+1+3 = KES 14 million. Transaction price = KES 12 million. Allocate based on relative standalone selling prices:
- Customized software system: (8+2)/14 × 12 = 10/14 × 12 = KES 8.571 million
- Training: 1/14 × 12 = KES 0.857 million
- PCS: 3/14 × 12 = KES 2.571 million
Justification: IFRS 15 requires allocation based on relative standalone selling prices. The discount of KES 2 million is allocated proportionally to all performance obligations unless there is evidence that the discount relates to specific obligations. No such evidence is given, so proportional allocation is appropriate.
2. Determine the amount of revenue to be recognized for the year ended 31 December 2025, assuming the customization and installation are 60% complete, training is delivered in March 2025, and PCS is provided evenly over three years. Show all workings.
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Revenue recognition for 2025:
- Customized software system: Recognized over time based on progress towards completion. 60% complete, so revenue = 60% × 8.571 = KES 5.1426 million.
- Training: Delivered in March 2025, so recognize full amount: KES 0.857 million.
- PCS: Provided evenly over three years. For 2025, one full year of service: revenue = 2.571 / 3 = KES 0.857 million.
Total revenue for 2025 = 5.1426 + 0.857 + 0.857 = KES 6.8566 million (rounded to KES 6.857 million).
Workings:
- Allocation: Software system = (10/14)×12 = 8.5714; Training = (1/14)×12 = 0.8571; PCS = (3/14)×12 = 2.5714.
- Software revenue: 8.5714 × 60% = 5.1428.
- Training: 0.8571 (full).
- PCS: 2.5714 / 3 = 0.8571.
- Total: 5.1428 + 0.8571 + 0.8571 = 6.8570.
Thus, revenue for 2025 is KES 6.857 million. The remaining revenue will be recognized in future periods as the software is completed and PCS is provided.