Revenue recognition for a smart-meter installation contract
GridSense Ltd, a manufacturer, signs a contract with a municipality on 1 March 20X5 to supply 500 smart meters, install them, and provide remote monitoring for two years. The total contract price is R4,200,000, payable 30% on signing, 40% on delivery, and 30% after installation. GridSense routinely sells the meters separately for R3,600,000, installation for R500,000, and monitoring for R450,000 per year. The meters are delivered on 1 June 20X5; installation is completed on 15 July 20X5; monitoring starts on 16 July 20X5. The contract includes a penalty of R200,000 if installation is late. At inception, GridSense assesses a 25% chance of delay. It has reliable data from similar contracts but no prior experience with this municipality. The financial year-end is 31 December 20X5.
1. Identify the performance obligations in the contract and allocate the transaction price. Explain how the potential penalty affects the allocation.
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Step 1 - Identify promises. GridSense promises (a) 500 smart meters, (b) installation, and (c) two years of remote monitoring. The meters are capable of being distinct, installation does not significantly modify them, and monitoring is separately identifiable. Treat these as three performance obligations.
Step 2 - Transaction price. The fixed price is R4,200,000. The late-installation penalty is variable consideration. Expected value = 25% × R200,000 = R50,000. Under IFRS 15, variable consideration is included only to the extent that it is highly probable there will not be a significant reversal. A 25% chance of a R200,000 penalty makes a significant reversal possible, so the constraint should be applied and the variable consideration included at nil. A defensible alternative is to include R50,000 if the entity concludes the constraint is met; the key is to explain the judgement. Assume the constrained transaction price is R4,200,000.
Step 3 - Allocate using relative stand-alone selling prices (SSP). Total SSP = R3,600,000 + R500,000 + (2 × R450,000) = R5,000,000.
| Obligation | SSP | Allocation (R4.2m × SSP/5m) |
|---|---|---|
| Meters | 3,600,000 | 3,024,000 |
| Installation | 500,000 | 420,000 |
| Monitoring | 900,000 | 756,000 |
| Total | 5,000,000 | 4,200,000 |
Monitoring is R378,000 per year. The discount of R800,000 is allocated proportionately because the contract does not evidence that the discount relates only to specific obligations.
2. Determine the amount of revenue GridSense should recognise for the year ended 31 December 20X5, and the contract liability at that date. State when each performance obligation is satisfied.
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Meters. Control transfers at delivery on 1 June 20X5, so recognise R3,024,000 on that date.
Installation. This is a distinct service. The customer obtains the benefit of the installed meters when installation is complete on 15 July 20X5, so recognise R420,000 then. If GridSense concluded the customer controls the work in progress, it would recognise over time using an input method; the short duration makes completion accounting a reasonable simplification, but the basis must be documented.
Monitoring. This is a stand-ready obligation satisfied over two years. Recognise straight-line from 16 July 20X5. In 20X5: R378,000 × 5.5/12 = R173,250.
Total 20X5 revenue = R3,024,000 + R420,000 + R173,250 = R3,617,250.
Contract liability. Cash received in 20X5 is R4,200,000 (30% + 40% + 30%). Liability = R4,200,000 − R3,617,250 = R582,750. This equals the unrecognised monitoring revenue (R756,000 − R173,250). If variable consideration had been included, the allocation and liability would change by the same proportion.
3. Explain how the revenue profile would change if installation were not a distinct performance obligation. Why does this judgement matter?
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If installation is not distinct, it is combined with the meters into one performance obligation because the customer cannot benefit from the meters without installation and the installation significantly integrates them into the municipality's network. The combined SSP is R3,600,000 + R500,000 = R4,100,000. Relative allocation is unchanged in total for the combined item: R4,100,000/R5,000,000 × R4,200,000 = R3,444,000.
The timing changes: the combined R3,444,000 is recognised when the combined obligation is satisfied, which is completion of installation on 15 July 20X5, rather than R3,024,000 at delivery on 1 June and R420,000 on 15 July. Revenue of R420,000 therefore shifts from 15 July to the same date but is no longer separately identified; more importantly, no revenue is recognised at delivery. The 20X5 total remains R3,617,250 because both dates fall in 20X5, but the interim profile and the contract liability at 1 June differ.
This matters because the judgement affects the timing of revenue and the associated margin, and because installation delays could defer a much larger amount of revenue. The auditor should challenge the distinctness assessment, inspect the contract and technical specifications, and consider whether the municipality could benefit from the meters without installation.