IFRS 15 SaaS and subscription revenue recognition

1. Is SaaS a service or a software licence?

This is the fork. Get it wrong and every later answer is wrong with it, because the licensing paragraphs push a distinct licence towards a point in time under IFRS 15.B61 while the service answer holds revenue over the term. Auditors see the error most often where a contract is drafted by a software lawyer for a product that is delivered as a service. The document says "licence", "grant", "term of the licence", "non-exclusive right to use the Software". None of that decides anything. What decides it is whether the customer ever holds the code.

The possession test in practice

Three questions settle it on nearly every file.

If all three point to hosted, stop. The arrangement is a service. Where the answers split, look at what the customer paid for. A contract that entitles the customer to on-premise deployment at any time, but which the customer has chosen to consume as a hosted service, still contains a licence, because the entitlement is real and the customer could take it up. A contract that offers on-premise deployment only on renegotiation and at extra cost contains no such entitlement.

Local FAQs

The contract calls it a "subscription licence". Does that change anything? No. IFRS 15.B52 defines a licence by the rights it establishes over intellectual property. A subscription that gives access to a hosted platform establishes no rights the customer can exercise away from that platform.

The customer gets a downloadable desktop agent. Is that a licence? Usually not a separate one. Ask whether the agent has stand-alone functionality. A client that only brokers a connection to the hosted service has none, and the customer can benefit from it only in conjunction with the online service, which is the IFRS 15.B54(b) case.

We host the software in the customer's own cloud tenancy. Which side of the fork? Look at who controls the environment and who can continue to run the software if the contract ends. If the software keeps operating in the customer's tenancy after termination, the customer has taken possession. If access dies with the subscription, it has not.

Potential risks

The first risk is contract drafting driving accounting. The second is inconsistency across a product family, where two products with identical delivery mechanics are accounted for differently because different lawyers wrote the templates. The third is failing to reassess after a product change. A vendor that moves a product from on-premise to hosted has changed its revenue profile permanently, and the transition period will contain contracts on both models. That needs a documented population split, not a policy sentence.

2. Why is the hosted service one performance obligation satisfied over time?

Why it is one obligation, not twelve or thirty-six

A three-year subscription is not three annual services, and it is not thirty-six monthly services accounted for separately. IFRS 15.22(b) allows a series of distinct goods or services that are substantially the same and have the same pattern of transfer to be treated as a single performance obligation, and IFRS 15.23 sets the two conditions: each distinct service in the series would meet IFRS 15.35 to be satisfied over time, and the same method would be used to measure progress for each. A hosted subscription meets both. Daily access is substantially the same service every day and progress is measured by time throughout.

This is not a presentational nicety. The series conclusion is what lets a vendor allocate variable consideration to specific periods under IFRS 15.85 rather than spreading it across the whole term, and it is the basis on which usage overage can be recognised in the period the usage occurs. It also matters for modifications, because a modification to a series is assessed against the remaining distinct services rather than an undifferentiated three-year lump. That interacts with the analysis in the spoke on contract modifications.

Local FAQs

The customer barely uses the platform. Do we still recognise revenue? Yes. The obligation is to stand ready under IFRS 15.24(e). Usage is irrelevant to satisfaction of that obligation unless the consideration itself varies with usage, which is a measurement question, not a timing one.

We suffered a two-day outage. Does that reverse revenue? Only to the extent the contract gives the customer a service credit. That credit is variable consideration under IFRS 15.51 and reduces the transaction price. It does not change the timing model.

Does an annual invoice mean annual recognition? No. Invoicing pattern and delivery pattern are separate. The relationship between them is the subject of unit 12.

Potential risks

The main risk is a start date that runs from contract signature because that is what the billing system knows. Where provisioning takes weeks, revenue starts early and the audit trail is a spreadsheet. Build the go-live date into the revenue system as a required field. The second risk is failing to identify a genuinely non-level service and defaulting to straight line because the system only does straight line.

3. Are implementation, configuration, data migration and training distinct?

Fact pattern A: implementation is distinct

A workforce management vendor sells a hosted platform on a three-year term. The implementation statement of work covers tenant provisioning, loading the customer's existing employee master file through a published import template, configuring approval hierarchies through the standard administration console, and two days of administrator training. The vendor sells the same implementation service separately at a published day rate. Four independent consultancies are certified to perform it, and roughly a third of the vendor's customers use one of them instead. The platform code is not touched. Configuration is stored as customer data, not as a code branch.

Conclusion: distinct. Limb (a) of IFRS 15.27 is met because the service is sold separately by the vendor and by others, so it is capable of being distinct on the IFRS 15.28 reasoning. Limb (b) is met because none of the IFRS 15.29 factors bites. There is no significant integration service producing a combined output, because the output the customer contracted for is the subscription, and implementation is a service that prepares the customer to use it rather than an input into a different combined thing. Nothing is significantly customised. The two promises are not highly interdependent, because the vendor could deliver the subscription to a customer that implemented itself, and could deliver the implementation to a customer buying the subscription from a reseller.

Fact pattern B: implementation is not distinct

The same vendor sells to a large healthcare group. The contract requires the vendor to build seventeen bespoke interfaces into the customer's clinical rostering and payroll systems, to write a rules engine extension that encodes the group's collective agreements, and to deploy that extension into the customer's tenant as a vendor-maintained component of the platform. The extension is not available to other customers. It cannot be maintained by anyone other than the vendor, and it will be re-tested by the vendor at every platform release for the life of the contract. No third party is permitted to perform the work. The customer describes what it has bought internally as "the rostering system", not as "software plus a project".

Conclusion: not distinct. Limb (a) is arguable in isolation but limb (b) fails clearly. IFRS 15.29(a) is met because the vendor is providing a significant service of integrating the build work with the hosted platform into the combined output the customer contracted for. IFRS 15.29(b) is met because the extension significantly customises the platform as the customer receives it. IFRS 15.29(c) is met because the subscription and the build are highly interrelated: the vendor cannot fulfil the subscription promise as specified without the extension, and the extension is worthless without the subscription. One performance obligation, satisfied over time from the point the combined service goes live.

What actually moved the answer

Not the price. Not the effort. Not the duration. Three things moved it:

The single most decisive item is the middle row. Configuration of a standard tenant is data. Customisation of the platform is code. Once the vendor is maintaining code written for one customer, the integration and interdependence factors in IFRS 15.29 are usually met and the argument is over. The wider mechanics of identifying and combining promises are set out in the spoke on identifying performance obligations.

Local FAQs

Does data migration change the answer? On its own, rarely. Loading a customer's own data through a standard tool is preparation, not customisation. Migration that requires the vendor to write transformation logic that then persists in the platform is a different matter.

Is training ever a separate obligation? Yes, commonly. Generic administrator training on a standard product satisfies IFRS 15.27(a) easily and rarely triggers any IFRS 15.29 factor. Training on a bespoke build usually follows the build.

The customer insisted on buying implementation from us as a condition of the deal. Does that make it non-distinct? No. IFRS 15.29 asks whether the promises are separately identifiable within the context of the contract, not whether they were sold together. Bundled purchasing is a pricing fact, and it belongs in the allocation analysis, not the identification analysis.

Potential risks

Two risks dominate. First, a conclusion reached once at the pilot-customer stage and never revisited as the product industrialises. A vendor's first ten deals often need real customisation, and its next thousand do not, yet the accounting policy is frequently written from the first ten. Second, a single conclusion applied to a heterogeneous population. Enterprise contracts and mid-market contracts for the same product routinely land on opposite sides, and a policy that recognises this by segment is easier to defend than one that does not.

4. How are non-refundable upfront fees recognised in a SaaS contract?

The three-step test on any upfront fee

Note that step 3 applies to the deferred fee even where the answer at step 1 was no. That is the trap. A vendor can correctly conclude that its £50,000 activation fee is not a performance obligation, correctly defer it, and then still get the answer wrong by amortising it over twelve months when the customer relationship, supported by a discounted renewal, is expected to last four years.

Local FAQs

The set-up fee is smaller than our costs of setting up. Does that change the answer? No, but it does raise IFRS 15.95. Set-up costs that meet the three criteria in IFRS 15.95 become a fulfilment asset amortised over the same period as the deferred fee.

The customer cancels in month two and forfeits the fee. What happens? The remaining deferred balance is recognised when the vendor has no further obligation to perform, because the contract liability is extinguished by the release from performance rather than by performance. Where forfeiture is expected across a portfolio, consider the breakage guidance in IFRS 15.B46.

Can we present the deferred set-up fee separately from deferred subscription revenue? IFRS 15.109 allows alternative descriptions but requires enough information for users to distinguish receivables from contract assets. Splitting a contract liability by component is presentationally acceptable but adds little.

Potential risks

The largest risk is systems. Billing platforms treat a one-off charge as a one-off revenue event by default, and the revenue sub-ledger inherits the flag. Check the configuration rather than the policy document. A second risk is the amortisation period, which is usually hard-coded to the contract term and therefore silently ignores the IFRS 15.B49 extension for material rights. That extension needs a separate data field for expected customer life, which is the same field the commissions analysis in unit 11 needs.

5. When does a renewal option create a material right?

Deciding whether the discount is incremental

The evidence a vendor needs is its own pricing data, segmented the way B40 segments it: by service, by class of customer, by market. In practice that means a discount distribution table.

A price hold, meaning a renewal at the same price as the initial term with no uplift, is the borderline case that comes up most. It is a material right only if the vendor's normal practice is to raise prices on renewal and the hold is therefore a discount against what the customer would otherwise pay. Where list prices have been flat for years and renewals are routinely at the same price, a price hold is worth nothing.

Local FAQs

Is an auto-renewal at the same price a material right? Not usually, because the customer receives it by doing nothing rather than by having entered into the contract, and because it is not a discount against the vendor's normal renewal price. But see unit 6, because auto-renewal changes the enforceable period question even where it creates no right.

Does a free month at renewal create a material right? A free month is a discount of roughly eight per cent on an annual renewal. Whether that is incremental depends on the vendor's normal practice. Many vendors give a free month to almost everyone, in which case it is not incremental.

How do we release the material right if the customer renews at a different price? The allocated amount is released as the renewal service is provided, regardless of what the renewal is finally priced at. A renegotiated renewal is a new contract or a modification, and the previously allocated amount still relates to the option that was granted.

Potential risks

The dominant risk is a material right identified but never released. Vendors build the deferral correctly, then have no process for the lapse event, and the balance ages in the contract liability. IFRS 15.B40 is explicit that revenue is recognised when the future services are transferred or when the option expires. Build an expiry trigger. A second risk is double counting: allocating value to a material right and then also extending the amortisation of an upfront fee for the same expected renewals, which recognises the same economics twice. Decide which mechanism carries the renewal expectation and apply it once. Allocation mechanics are covered further in the spoke on allocating the transaction price.

6. Contract term or enforceable period: which one drives revenue?

The four patterns

Row three is where the judgement concentrates. What makes a termination fee substantive is whether it is large enough that the customer is compelled economically to continue. A fee equal to the remaining contract value clearly is. A fee equal to one month's charge on a thirty-six month contract clearly is not, and that contract is a one-month contract regardless of what the cover page says. Between the two, the question is whether the fee is a genuine deterrent measured against the value the customer would forgo, and the answer is a matter of degree that has to be documented.

What shortening the period actually changes

Three things move, and none of them is the total revenue over the life of the relationship.

First, the remaining performance obligation disclosure under IFRS 15.120 collapses. A vendor with a nominal three-year book and a one-month enforceable period has almost no remaining performance obligations to disclose, because the transaction price allocated to unsatisfied obligations covers only the enforceable period. Investors reading the backlog figure need to know that, which is why IFRS 15.122 requires qualitative explanation.

Second, the upfront fee amortisation period changes, because the IFRS 15.B49 extension applies to the expected renewal periods where the renewal option carries a material right. Shortening the enforceable period does not shorten the fee amortisation. It usually lengthens it, because the renewal expectation now has to be modelled explicitly rather than being buried in a stated term.

Third, the commission amortisation period changes, for exactly the same reason and through IFRS 15.99. A vendor that shortens its enforceable period from three years to one month and leaves its commission amortisation at three years has created an inconsistency that is hard to defend, because the asset is now being amortised over a period that includes anticipated renewals while the revenue is not.

Local FAQs

Does an annual prepayment make a monthly contract a twelve-month contract? Not by itself. If the customer can cancel and obtain a refund of the unused portion, the enforceable period is still short. If the prepayment is non-refundable and the customer would forfeit it on cancellation, that forfeiture is economically a termination fee and it may make the twelve months enforceable.

Our customers never cancel. Can we use the expected life as the term? No. IFRS 15.11 fixes the period by enforceability. Expected life enters the model through renewal options, material rights and the IFRS 15.99 amortisation period, not through the contract term.

What if the vendor, not the customer, holds the termination right? IFRS 15.11 refers to the parties' present enforceable rights and obligations without distinguishing which party holds them. A unilateral vendor right to walk away also shortens the enforceable period, and it is more common than it looks in usage-based contracts with no minimum.

Potential risks

The most serious risk is a policy conclusion that has never been tested against the contract population. Enterprise sales teams negotiate termination rights deal by deal, and a policy written from the standard template will not describe the estate. Sample the actual signed agreements. A second risk is jurisdictional: the same template signed in different countries can produce different enforceable periods where local law overrides the notice provisions, and a group with one revenue policy and thirty legal environments needs local legal confirmation rather than a group assumption.

7. How is usage-based subscription revenue estimated?

When the exception does apply to a software vendor

It applies where the vendor has granted a distinct licence of its intellectual property and the consideration varies with the customer's sales or usage of that intellectual property. Three real patterns qualify.

An on-premise licence priced per end user, where the customer deploys the software on its own infrastructure and pays a per-seat fee monthly based on actual seats. The licence is distinct, it is the item the royalty relates to, and IFRS 15.B63 applies. Revenue is recognised as the usage occurs, subject to the licence obligation having been satisfied.

An embedded technology licence, where the vendor licenses a component that the customer builds into its own product and pays a royalty per unit shipped. The licence predominates under IFRS 15.B63A even though the vendor also provides support.

A content or data licence delivered through an interface, where the substance is that the customer is licensing the underlying data set rather than buying an availability service. This one requires care, because the same commercial arrangement can be structured either way, and the analysis in the spoke on licensing intellectual property is the right starting point.

What does not qualify is the ordinary SaaS consumption charge: per API call, per gigabyte stored, per transaction processed, per message sent, per compute hour. In each of those the customer is consuming the vendor's service, not exploiting the vendor's intellectual property.

Expected value or most likely amount

IFRS 15.53 offers two methods and requires the entity to use whichever better predicts the consideration to which it will be entitled. The expected value is a probability-weighted sum across a range of outcomes and suits a large number of similar contracts. The most likely amount is the single most likely outcome and suits a contract with essentially two outcomes, such as a bonus that is earned or not earned.

For usage-based subscriptions, expected value is normally right, because the vendor has a portfolio and consumption is continuous rather than binary. But the fault in the previous version of this cluster is worth restating, because it is a real error and not a theoretical one. The expected value estimates the consideration for the units actually transferred. It does not average two different volume outcomes into current revenue. If the vendor expects the customer to consume seventy million calls in the year, the expected value tells the vendor what price per period that implies. It does not tell the vendor to recognise the average of a low case and a high case as if the average had occurred. The full treatment sits in the spoke on variable consideration and the constraint.

Local FAQs

Our platform is delivered as a service but we also grant a licence to a downloadable SDK. Does B63 apply to our usage fees? Only if the licence is the predominant item the royalty relates to, which IFRS 15.B63A tests by asking whether the customer would ascribe significantly more value to the licence. An SDK that exists only to call the hosted service will not predominate.

Can we apply the constraint at portfolio level? The constraint is applied to the estimate, and IFRS 15.53 contemplates using information about a large number of similar contracts. A portfolio-derived constraint applied consistently to contracts with the same characteristics is normal practice. A single blanket percentage applied to unlike contracts is not.

Does an unconstrained amount ever come back? Yes. IFRS 15.59 requires the transaction price to be updated at the end of each reporting period, which releases constrained amounts into revenue as the uncertainty resolves.

Potential risks

The dominant risk is invisible use of IFRS 15.B63. It rarely appears in a policy note. It appears in a system rule that says usage revenue is recognised when billed, and in a memo that never mentions the constraint at all. Ask directly how the usage estimate is made and constrained. If the answer is that no estimate is made, the vendor is applying the royalty exception whether it says so or not. The second risk is an estimate that is never reassessed within the year, which breaches IFRS 15.59 and defers all the truing up to the final quarter.

8. Tiered pricing, minimum commitments, overage and the as-invoiced expedient

When the expedient survives and when it does not

Row six deserves emphasis because it is common and rarely picked up. Volume tiering that resets annually means a transaction in January is priced by reference to how much the customer buys by December. The vendor billing at the January tier rate has invoiced an amount that does not correspond with the value of January's service, because the contractual price of January's service is not yet known. This is variable consideration, estimated and constrained, not an as-invoiced case.

Minimum commitments

A minimum commitment is fixed consideration, not variable. The customer must pay it whether or not it uses the service, so it belongs in the transaction price from inception with no constraint applied. Only the overage above the minimum is variable. Splitting the contract this way is the first step in every usage analysis, and it is frequently skipped because the billing system presents the whole thing as one usage stream.

Where the minimum operates annually but the service is delivered monthly, the fixed element is recognised across the annual period on the same time-elapsed measure as any other subscription, because the minimum is consideration for standing ready across the year. Where the minimum operates monthly, and any monthly shortfall is simply lost, the fixed element belongs to that month. Read the contract, because both structures are drafted with the same vocabulary.

Overage

Overage above a minimum is variable consideration and follows unit 7. Whether it is allocated to the period in which the usage occurs depends on IFRS 15.85. Where the overage rate is fixed and the overage is charged on usage in that period, criterion (a) of IFRS 15.85 is met because the payment relates specifically to the service delivered in the period. Where the overage is computed on cumulative annual volume against an annual minimum, it does not relate specifically to any one period, and the amount is estimated for the year, constrained, and recognised across the year with a cumulative catch-up as the estimate changes. That is the mechanic in unit 10.

Local FAQs

Does using the expedient remove the RPO disclosure? Yes, for the obligations concerned. IFRS 15.121(b) exempts a performance obligation where the entity recognises revenue in accordance with IFRS 15.B16, and IFRS 15.122 then requires the entity to explain qualitatively that it has done so.

Can the expedient apply to part of a contract? Yes. IFRS 15.B16 attaches to the right to consideration for performance completed to date, and a contract with a fixed platform fee and a separate hourly support element can meet the test for the hourly element and fail it for the platform element.

Is a ramp always non-qualifying? A ramp that reflects a genuinely increasing service, for example an increasing number of licensed users going live in tranches, may correspond with value. A ramp that is purely a payment schedule for a constant service does not, and may also raise a significant financing component under IFRS 15.60.

Potential risks

The first risk is that the expedient is treated as an accounting policy rather than as a contract-by-contract conclusion. It is the latter. The second is that its use is not disclosed, which IFRS 15.122 requires explicitly. The third is a significant financing component hiding behind a ramp: where the payment pattern differs materially from the delivery pattern over more than a year, IFRS 15.60 has to be considered before the ramp is smoothed away.

9. Worked example: a three-year SaaS contract with an implementation fee and a discounted renewal

Facts

A vendor signs a hosted workforce platform contract on 1 January 20X5. The term is three years and is non-cancellable. The customer pays a subscription of £360,000 per year, invoiced annually in advance on 1 January, and a non-refundable implementation fee of £120,000 invoiced on signature. The implementation runs from January to March 20X5 and the platform goes live on 1 January 20X5 in a limited form, with full availability from day one for the purposes of this example, so that the timing effects of the allocation rather than the go-live date are visible.

The contract gives the customer an option to renew for a fourth year at £240,000, against a list price of £360,000. The vendor's discount distribution shows that customers of this class in this market are typically given between five and ten per cent off list on renewal. A one-third discount is well outside that range, so the incremental discount is a material right under IFRS 15.B40. Renewal rates for this cohort run at sixty per cent.

The vendor sells the implementation service separately at £150,000 and third-party partners perform it for around a third of customers. Applying the analysis in unit 3, implementation is distinct.

Step 1: performance obligations

Step 2: transaction price

Fixed consideration of £1,080,000 of subscription fees plus the £120,000 implementation fee gives a transaction price of £1,200,000. There is no variable consideration and no significant financing component, because payment is annually in advance for services delivered within the following twelve months.

Step 3: stand-alone selling prices

The subscription stand-alone selling price is the observable list price of £1,080,000 for three years. The implementation stand-alone selling price is the observable separate price of £150,000. The material right is not directly observable, so IFRS 15.B42 applies: the discount obtained on exercise is £360,000 less £240,000, which is £120,000, there is no discount the customer would receive without exercising, and the likelihood of exercise is sixty per cent. The estimated stand-alone selling price of the option is therefore £120,000 multiplied by 0.6, which is £72,000.

Step 4: allocation on relative stand-alone selling prices

The allocation factor is £1,200,000 divided by £1,302,000, which is 0.921659. Applying it: £150,000 times 0.921659 is £138,249; £1,080,000 times 0.921659 is £995,392; £72,000 times 0.921659 is £66,359. The three add to £1,200,000 exactly.

Step 5: recognition profile

The implementation allocation of £138,249 is recognised as the service is delivered across the three months of Q1 20X5, at £46,083 per month. The subscription allocation of £995,392 is recognised across 36 months at £27,650 per month, which is £331,797 in each of 20X5 and 20X6 and £331,798 in 20X7 after rounding. The material right of £66,359 stays in the contract liability until the customer renews or the option lapses at 31 December 20X7.

The closing contract liability at 31 December 20X7 is exactly £66,359, the amount allocated to the material right. That is the arithmetic check on the whole example: once the implementation and the subscription have both been fully satisfied, the only obligation left is the option, and the only consideration left is the amount allocated to it.

Journals

The wrong answer, and what it costs

The common treatment is to recognise the £120,000 implementation fee on signature at its contractual amount, ignore the material right, and straight-line £360,000 of subscription revenue each year. That gives 20X5 revenue of £480,000 against the correct £470,046, and it leaves £66,359 of revenue recognised in the first three years that belongs to year 4. The 20X5 error of £9,954 looks small. On a book of two hundred similar contracts it is £2.0m of revenue in the wrong year, and the year 4 misstatement is £13.3m across the book.

The same contract where implementation is not distinct

Change one fact. The implementation is a bespoke build that significantly customises the platform, only the vendor can perform it, and the subscription cannot be delivered without it. Applying unit 3, IFRS 15.29(a), (b) and (c) are all met and implementation combines with the subscription into a single obligation. Assume the combined service goes live on 1 April 20X5 and runs 36 months to 31 March 20X8.

There are now two obligations: the combined hosted service, with a stand-alone selling price of £1,230,000 being £1,080,000 plus £150,000, and the material right at £72,000. Total stand-alone selling price is unchanged at £1,302,000, so the allocation factor is unchanged at 0.921659. The combined service takes £1,230,000 times 0.921659, which is £1,133,641, and the material right takes £66,359. Recognition of the combined service runs across 36 months from go-live at £31,490 per month.

Same total, and a £186,636 swing in the first year on a single contract. That is the value of the IFRS 15.27 and 29 analysis in unit 3, and it is why "the amounts are small" is not an answer to a distinctness question.

Local FAQs

Why is the implementation revenue £138,249 and not the £120,000 invoiced? Because IFRS 15.74 allocates on relative stand-alone selling prices. The customer received a discount across the bundle, and the discount is shared proportionately across all three obligations rather than being loaded onto the item the contract happened to discount.

Could we use the IFRS 15.B43 practical alternative instead of estimating the option? Yes. The renewal service is similar to the original service and is provided under the terms of the original contract, so the vendor could allocate by reference to the expected services and expected consideration across four years. It produces a different number and is equally acceptable, provided it is applied consistently.

What if the customer renews at a negotiated £300,000 rather than the contractual £240,000? The £66,359 is still released as the year 4 service is provided. The renewal itself is a new contract priced at £300,000 and is accounted for on its own terms.

Potential risks

Rounding is the small risk: allocate to the pound, check the components sum to the transaction price, and put the rounding difference in the largest obligation rather than spreading it. The larger risk is stale stand-alone selling prices. IFRS 15.76 fixes them at contract inception, but the estimate used has to reflect pricing at that date, and a vendor using a two-year-old price file will allocate on prices nobody pays. Refresh the stand-alone selling price analysis at least annually and document the population it was derived from.

10. Worked example: minimum commitment, overage and the true-up

Facts

A vendor provides a hosted transaction processing platform. The contract runs for the calendar year 20X6. The customer commits to a minimum of £600,000 for the year, covering up to 60 million transactions, and pays £0.008 for each transaction above 60 million. The minimum is annual, not monthly: unused volume in one quarter is not lost and does not carry forward, because the whole year is measured against a single 60 million threshold. Invoicing is quarterly in arrears at £150,000 plus any overage crystallised by that date.

At inception the vendor's forecast, built from the consumption history of the customer and of comparable customers, is 78 million transactions for the year. That implies 18 million transactions of overage at £0.008, which is £144,000.

Step 1: split fixed from variable

The £600,000 minimum is fixed consideration. The customer must pay it whether or not it transacts, so no estimation and no constraint apply to it. Only the overage is variable consideration within IFRS 15.50. This split is the step vendors skip, and skipping it leads to constraining the whole contract value, which understates revenue in every early period.

Step 2: estimate the variable element

The vendor has a large number of contracts with similar characteristics, so the expected value method under IFRS 15.53(a) better predicts the consideration. The probability-weighted forecast is 78 million transactions, giving an expected overage of £144,000.

Step 3: apply the constraint

Transaction price at inception is therefore £600,000 plus £96,000, which is £696,000.

Step 4: allocate and choose the recognition pattern

The subscription is a single performance obligation being a series of substantially the same daily services under IFRS 15.22(b). The overage is tested against IFRS 15.85. Criterion (a) fails, because the overage is computed by reference to the cumulative annual volume against a single annual threshold, not by reference to the effort expended in any particular month. A transaction in February is charged at nil while cumulative volume is below the threshold and at £0.008 once it is above, so the payment does not relate specifically to February's service. The overage is therefore not allocated to specific periods. The full £696,000 is recognised across the year by time elapsed, at £58,000 per month.

Step 5: quarterly mechanics

The Q3 reassessment is the interesting one. By 30 September the customer has run 54 million transactions in nine months and the vendor's revised full-year forecast is 82 million, implying 22 million of overage. Reapplying the IFRS 15.56 constraint with three quarters of actual data, the vendor now includes 20 million of overage, which is £160,000, giving a revised transaction price of £760,000. IFRS 15.59 requires the update, and IFRS 15.88 requires it to be recognised as a cumulative catch-up against the measure of progress. Cumulative revenue required at 30 September is £760,000 times nine twelfths, which is £570,000. Cumulative revenue recognised through Q2 was £348,000, so Q3 revenue is £222,000, of which £174,000 is the period charge and £48,000 is the catch-up.

At the year end the uncertainty resolves. Actual volume is 84 million, so overage is 24 million transactions at £0.008, which is £192,000, and the final transaction price is £792,000. Cumulative revenue required is the full £792,000, and £570,000 has been recognised, so Q4 revenue is £222,000. The Q4 invoice is the £150,000 minimum instalment plus the whole £192,000 of overage, which is £342,000.

Journals

The arithmetic checks: revenue of £174,000 plus £174,000 plus £222,000 plus £222,000 is £792,000, and invoicing of £150,000 three times plus £342,000 is also £792,000. The contract asset opens at nil, peaks at £120,000 and closes at nil.

The wrong answer under the royalty exception

A vendor that treats the overage as a usage-based royalty under IFRS 15.B63 recognises revenue as invoiced: £150,000 in each of Q1 to Q3 and £342,000 in Q4. Total revenue for the year is identical at £792,000. The timing is not. Under the royalty treatment, 43 per cent of the year's revenue falls in Q4. Under the correct treatment, 28 per cent does. On a half-year reporting boundary the difference is £48,000 of revenue on a single contract, and it is systematic, not random, because usage-based contracts back-load under an as-invoiced approach every year.

Local FAQs

What if the minimum were monthly rather than annual? Then the overage in each month would relate specifically to that month's service, IFRS 15.85 would be met, and the overage would be allocated to the month in which it arises. Revenue would then track the invoice closely, and the IFRS 15.B16 expedient might also become available.

Do we have to reassess quarterly? IFRS 15.59 requires the update at the end of each reporting period, so at each date the entity reports. A vendor reporting quarterly reassesses quarterly. Monthly management reporting does not create a reporting period for this purpose, but a vendor with monthly close discipline will usually reassess monthly anyway.

Is the catch-up an error correction? No. It is a change in estimate recognised in the period of change, on the basis in IFRS 15.88, which requires changes in the transaction price to be allocated to the performance obligations on the same basis as at inception and recognised as revenue in the period of change.

Potential risks

The first risk is a constraint that never moves. A vendor that includes the same percentage of forecast overage in Q1 and in Q3 has not applied IFRS 15.57(c), because its evidence base has improved materially. The second risk is a contract asset that is never assessed for credit loss. IFRS 15.107 requires a contract asset to be assessed for impairment under IFRS 9, on the same basis as a financial asset in scope of IFRS 9. The third is a system that cannot produce cumulative revenue by contract, which makes the catch-up computation manual and therefore unauditable at volume.

11. Worked example: capitalised sales commission, five-year amortisation and impairment

Facts

A vendor wins a three-year hosted subscription on 1 January 20X5 with a total contract value of £300,000, being £100,000 per year. It pays the account executive a commission of £75,000 on signature. The commission plan pays 5 per cent of annual contract value on renewals, which is £5,000 per renewal year against £25,000 per year on the initial contract. The renewal commission is not commensurate with the initial commission. The vendor's cohort analysis shows an average customer relationship of five years for this segment. Direct costs of delivering the hosted service run at 60 per cent of the related revenue.

Amortisation period

Because the renewal commission is not commensurate, the initial commission relates to the services expected to be provided over the whole expected relationship, which is five years. IFRS 15.99 therefore requires amortisation over five years, at £15,000 per year. The IFRS 15.94 expedient is not available, because the amortisation period exceeds one year.

Journals to 31 December 20X6

Churn rises: the impairment test

On 30 June 20X7 the customer gives formal notice that it will not renew at the end of the initial term on 31 December 20X7. The vendor's cohort renewal rate for the segment has fallen from 80 per cent to 55 per cent over eighteen months. Two consequences follow, and they are separate.

The first is IFRS 15.100, which requires the amortisation to be updated for a significant change in the expected timing of transfer, accounted for as a change in accounting estimate under IAS 8. The second is the IFRS 15.101 impairment test.

No consideration from anticipated renewals can be included, because the customer has told the vendor there will be none. That is exactly the mechanism by which churn feeds through to the income statement: the amortisation period was extended on the strength of expected renewals, and when the renewals disappear the support for the asset disappears with them.

Total charged to profit or loss across the life of the asset is £15,000 plus £15,000 plus £7,500 plus £17,500 plus £20,000, which is £75,000, the full commission. Nothing is lost, only re-timed.

The wrong answer: a three-year policy

A vendor amortising the same commission over the three-year initial term charges £25,000 a year. By 30 June 20X7 the carrying amount is £75,000 less £62,500, which is £12,500, and there is no impairment because £12,500 is below the £20,000 net consideration. The profile looks smoother and requires no impairment memo, which is exactly why it is popular.

The three-year policy understates profit by £10,000 a year while the customer is being retained and overstates it by £20,000 in the year the relationship fails. On a growing subscription book the understatement compounds year after year, which is why a vendor that has been amortising over the contract term will report a large one-off benefit in the year it corrects the period, followed by a permanently higher capitalised balance and a permanently live impairment exposure. Whether that is the right answer is not a policy choice. IFRS 15.99 decides it, and the commission plan supplies the facts.

The mechanics of capitalisation, the boundary with IFRS 15.95 fulfilment costs and the presentation of the resulting asset are worked through in more detail in the spoke on contract costs and sales commissions.

Local FAQs

Do we capitalise commissions paid to sales managers and overlay specialists? Yes, if the payment is contingent on the contract being won. IFRS 15.92 turns on whether the cost would have been incurred had the contract not been obtained, not on who received it.

What about the employer's social security on the commission? It is incremental in the same sense and is normally capitalised with the commission. Bonuses that depend on overall company performance rather than on specific contracts are not incremental.

Where does the amortisation go in the income statement? IFRS 15 does not prescribe a line. Most vendors present it within selling and marketing expenses because that is where the commission itself would sit. Whichever line is used, it should be consistent and disclosed under IFRS 15.127.

Can an impairment be reversed? Yes. IFRS 15.104 requires a reversal in profit or loss when the impairment conditions no longer exist or have improved, capped at the amount that would have been determined net of amortisation had no impairment been recognised.

Potential risks

Three risks recur. The first is a period set once at transition in 2018 and never revisited, while the underlying churn data has moved by twenty points. The second is a single period applied across segments with very different retention, where enterprise customers stay seven years and small business customers stay eighteen months. The third, and the one that causes restatements, is applying the IFRS 15.94 expedient by default on the basis of contract term rather than amortisation period. Test that specifically. It is a five-minute check that has produced material adjustments on several filers.