Practical guide to IFRS

Transportation and Logistics industry supplement November 2010

Revenue recognition full speed ahead
Transportation and Logistics industry supplement
Overview
The Transportation and Logistics sector includes entities associated with four primary modes of transportation:
shipping, railways, airlines, and trucking and logistics. Customers generally pay a fee for the movement of cargo or
passengers between two or more specified points. Customer incentives are primarily in the form of volume discounts,
or for airlines, customer loyalty programmes where awards are earned based on mileage flown and can be redeemed
for a variety of products or services.
The accounting for common items in the transportation industry may be significantly affected by the proposed revenue
recognition standard. This paper, examples, and related assessments are based on the Exposure Draft, 'Revenue
from contracts with customers', issued on 24 June 2010. The proposed standard is subject to change until a final
standard is issued. The examples reflect the potential effects of the proposed standard, pending further interpretation
and assessment based on the final standard. For a more comprehensive description of the model, refer to PwC's
Practical guide Revenue recognition: Full speed ahead or visit www.iasb.org.
Transportation revenue and costs
Transportation or freight services are generally provided over a period of time ranging from a day to several months.
The proposed standard includes a control transfer model for recognising revenue that will require careful
consideration to determine when an entity can recognise revenue.
Proposed standard Current US GAAP Current IFRS
Transportation revenue
Revenue is recognised upon
satisfaction of performance
obligations, which occurs when
control of the good or service
transfers to the customer. Control
can transfer at a point in time or
continuously over the service period.
Factors to consider in assessing
control transfer include, but are not
limited to:
The customer has an
unconditional obligation to pay.
The customer has legal title.
The customer has physical
possession.
The customer specifies the
design or function of the good or
service.
This list is not intended to be a
checklist or all-inclusive. No one
factor is determinative on a stand-
alone basis.
There are two predominant methods
for recognising revenue and costs for
freight services:
(1) recognise both revenue and
direct costs when the shipment is
completed; and
(2) allocate revenue between
reporting periods based on
relative transit time in each
period, with costs recognised as
incurred (the proportionate
performance method).
Revenue is recognised for service
transactions, such as freight
services, based on the stage of
completion of the transaction. Costs
are recognised as incurred.
Impact:
Management will need to determine whether the service being performed is
transporting the goods in which case the entity might conclude the service
is provided (and control transferred) continuously or the service is to
transport goods to a specific destination and thus control transfers and
revenue is recognised upon delivery.
Freight costs are expensed as incurred unless they can be capitalised under
another standard or they relate directly to a contract, generate or enhance
resources of the entity that the entity will use to satisfy performance
obligations in the future, and are expected to be recovered. This might allow,
Proposed standard Current US GAAP Current IFRS
Transportation costs
All costs of obtaining a contract,
costs relating to satisfied
performance obligations, and costs
related to inefficiencies (that is,
abnormal costs of materials, labour,
or other costs to fulfil) are expensed
as incurred.
Other direct costs incurred in fulfilling
a contract are expensed as incurred
unless they are within the scope of
other standards (for example,
inventory, intangibles, fixed assets)
or if other specified criteria are met.
Costs that are in the scope of other
standards are accounted for in
accordance with those standards. An
asset is recognised for costs outside
the scope of other standards when
the costs relate directly to a contract,
relate to future performance, and are
probable of recovery under a
contract. These costs are then
amortised as control of the goods or
services to which the asset relates is
transferred to the customer.
in certain situations, direct costs of a contract to be capitalised until delivery,
if revenue is recognised upon delivery.
Costs to obtain a contract (for example, selling costs) as well as abnormal
amounts of wasted contract fulfilment costs are expensed as incurred.
Example 1
Facts: A freight railway entity enters into a contract with a customer to ship goods from point A to point B for C1,000.
The customer has an unconditional obligation to pay for the service when the service has been performed, which is
when the goods reach point B. The transportation services are provided specifically for the customer. When should
the entity recognise revenue from this contract?
Discussion: The performance obligation may not be satisfied until the goods reach point B. The indicators of control
transfer are difficult to apply to certain service transactions and further clarification of the guidance may be needed to
make the assessment of when control transfers. The expenses incurred need to be evaluated to determine if they are
eligible for capitalisation until the performance obligation is satisfied.
The proposed standard focuses on recognition of revenue when control transfers to the customer rather than on the
entity's activities. Judgement will be required to determine when control transfers for service transactions typical in the
transportation and logistics industry.
Customer loyalty programmes frequent flyer programmes
Transportation and logistics entities, such as airlines, often grant award credits (often called 'points' or 'miles') as part
of sales transactions, including award credits that can be redeemed for goods and services not supplied by the entity.
The most common customer loyalty programmes in the industry are the frequent flyer programmes offered by airlines.
Proposed standard Current US GAAP Current IFRS
Customer loyalty programmes
frequent flyer programmes
Performance obligations
Credits issued under customer
loyalty programmes are separate
performance obligations if they
provide the customer with a material
right that the customer would not
receive without entering into the
transportation contract. The
transaction price is allocated
between the initial flight and the
award credits based on the actual or
estimated stand-alone selling price of
each obligation. Revenue relating to
the award credits is deferred until the
obligation is satisfied (when the
award credits are redeemed or
expire).
Measurement (breakage)
The stand-alone selling price for a
customer's option to acquire
additional goods or services (loyalty
awards) is not usually directly
observable and must typically be
estimated. That estimate should
reflect the discount the customer
would obtain when exercising the
option, adjusted for discounts readily
available without the option and the
likelihood that the option will be
forfeited (breakage).
Principal versus agent
The airline recognises revenue in the
amount of consideration received
(gross) when the airline redeems the
award credit for goods or services
that it provides. The airline
recognises revenue in the amount of
any fee or commission received (net)
when the airline arranges for another
party to provide those goods or
services.
There is divergence in practice in the
accounting for loyalty programmes.
Two models commonly followed are
the incremental cost model and the
multiple-element model.
Most entities use the incremental
cost model and recognise revenue
relating to the flight when the flight
occurs. The cost of fulfilling award
credits is treated as an expense and
accrued.
Other entities use the multiple-
element model and allocate revenue
to the award credits based on
relative fair value. Revenue
allocated to the award credits is
deferred and recognised when the
award credits are redeemed or
expire.
The fair value of the award credits is
not reduced for expected forfeitures
(breakage).
An entity determines whether it is
acting as a principal or an agent in
the arrangement based on certain
criteria.
Customer loyalty programmes are
accounted for as multiple-element
arrangements. Revenue allocated to
the award credits is deferred and
recognised when the award credits
are redeemed or expire.
The fair value of the award credits is
adjusted for discounts available to
other buyers absent entering into the
initial purchase transaction and for
expected forfeitures (breakage).
An entity determines whether it is
acting as a principal or an agent in
the arrangement. An entity may be
acting as an agent if it issues award
credits that are transferred to and
redeemed by other entities. Revenue
is recognised net of payments made
to others to redeem award credits if
the entity is acting as an agent.
Impact:
Award credits issued under customer
loyalty programmes will likely be
accounted for as separate
performance obligations and the
incremental cost model will no longer
be acceptable.
Adjustments for expected forfeitures
(breakage) will affect the timing of
revenue recognition. The stand-alone
Impact:
The proposed standard is consistent
with the current IFRS guidance; the
effect will therefore be limited.
Proposed standard Current US GAAP Current IFRS
selling price of award credits will be
reduced to reflect the award credits
not expected to be redeemed. The
accounting for breakage will result in
earlier revenue recognition for
entities that use the multiple-element
model today. An entity will need to
determine whether it is acting as a
principal or an agent when delivering
the underlying goods or services
upon redemption of award credits.
An entity might be acting as an agent
if it issues award credits that are
transferred to and redeemed by other
entities. The entity will recognise
revenue from the award credits net of
payments made to other parties in
these situations.
These changes will align the
accounting for customer loyalty
programmes under US GAAP with
IFRS.
Example 2
Facts: Airline A has a frequent flyer customer loyalty programme rewarding customers with one award credit for each
mile flown. A customer purchases a ticket for C500 (the stand-alone selling price) and earns 2,500 award credits
based on mileage flown. Award credits are redeemable at a rate of 25,000 award credits for one free travel award,
which has an average value of C500 (C0.02 per credit). The award credits may only be redeemed for flights with
Airline A. How is the consideration allocated between the award credits and the ticket (ignoring the time value of
money and breakage)?
Discussion: The transaction price of C500 is allocated between the ticket and award credits based on the relative
stand-alone selling prices of C500 for the ticket and C50 for the award credits as follows:
Ticket: C455 (C500 x C500/C550)
Award credits: C 45 (C500 x C 50/C550)
Revenue of C455 is recognised when the flight occurs. Revenue of C45 is recognised upon the earlier of the
redemption of the travel award or expiration of the award credits.
Example 3
Facts: Assume the same facts as in Example 2 above, except that the airline expects redemption of 80% of award
credits earned (that is, 20% breakage) based on the airline's history. The airline estimates a stand-alone selling price
for the credits of C0.016 (C0.02 x 80%) based on the likelihood of redemption. How is the consideration allocated
between the award credits and the ticket (ignoring the time value of money)?
Discussion: The transaction price of C500 is allocated between the ticket and award credits based on the relative
stand-alone selling prices of C500 for the ticket and C40 for the award credits as follows:
Ticket: C463 (C500 x C500/C540)
Award credits: C 37 (C500 x C 40/C540)
Revenue of C463 is recognised when the flight occurs. Revenue of C37 is recognised upon the earlier of the
redemption of the travel award or expiration of the award credits.
Example 4
Facts: Assume the same facts as in Example 3 above, except that the award credits can be redeemed for services
not provided by the airline. The airline pays other participating entities the value of the award credits less a 10%
commission when the award credits are redeemed for products or services not provided by the airline. How much
revenue is recognised upon the redemption of the award credits assuming all credits are redeemed by other entities
(ignoring the time value of money)?
Discussion: Revenue of C3.70 (10% of C37) is recognised upon the redemption of the award credits for products not
provided by the airline. The entry when the award credits are redeemed is as follows:
Dr. Contract Liability C37
Cr. Revenue C 3.70
Cr. Cash C33.30
Onerous performance obligations
The proposed standard requires that each performance obligation be assessed to determine whether a loss will be
incurred relating to that obligation.
Proposed standard Current US GAAP Current IFRS
Onerous performance obligations
Management will need to assess
whether performance obligations are
onerous. A performance obligation is
onerous when the present value of
the direct costs to satisfy a
performance obligation exceeds the
consideration allocated to it. The
excess is recognised as a contract
loss, with a corresponding liability
that is remeasured at each reporting
period.
Anticipated losses on executory
contracts (onerous contracts)
generally should not be recognised.
Contracts in which the unavoidable
costs of meeting the obligations
under the contract exceed the
economic benefits expected to be
received under such contract are
onerous, thus an onerous provision
is recognised.
Impact:
More provisions for onerous obligations are likely to be recognised under the
proposed standard than currently recognised under both US GAAP and
IFRS. Broader application will create more onerous provisions under US
GAAP, and the need to perform the onerous loss assessment at the
performance obligation level rather than the contract level will create more
onerous provisions under both IFRS and US GAAP.
The proposed standard may cause a significant change for entities, such as
airlines, where excess capacity is sold at deeply discounted prices. Deeply
discounted tickets may be onerous performance obligations at the time sold
and require accrual of the expected loss. This would be the case if the selling
price of a discounted ticket did not exceed total allocated costs of the flight,
even though the ticket may be sufficient to cover the related incremental
costs and contributes to the overall profitability of the flight.
Change fees
Change fees are common in the airline industry. The predominant industry practice under US GAAP and IFRS is to
account for change fees as a separate transaction independent of the original ticket sale and recognise revenue when
the change occurs. Change fees are viewed as a separate transaction because the fees are charged subsequent to
the initial sale, passengers are not required to pay the fee at the time of the original sale, and passengers who pay the
fee receive an additional benefit. An alternative view is that the change is not a separate transaction but the result of
the customer paying the lowest cost to obtain the new travel reservation (that is, paying the change fee instead of the
price of a new ticket). Under this view, the change fee is deferred and recognised when the travel occurs.
The proposed standard will require management to consider whether the change fee is a separate contract or one
that should be combined with the original sales transaction. Contracts that are priced interdependently will need to be
combined, while contracts priced independently are accounted for separately. It may be challenging to conclude that
change fees are independently priced, as the change fee is generally agreed at the time of the original ticket sale.
Variable consideration
Determining the transaction price is simple when the contract price is fixed and paid at the time services are provided.
Determining the transaction price may be more complex if the consideration contains an element of variable or
contingent consideration. Common issues for the transportation and logistics industry include the accounting for
volume discounts, performance bonuses, and time value of money. Many transportation and logistics entities offer
discounts for shipping a specified cumulative volume or shipping to or from specific locations. Discounts based on
volume or other factors are variable consideration under the proposed standard. Management will need to determine
the probability-weighted estimate of consideration to be received and adjust the transaction price. The same
accounting treatment applies to performance bonuses.
Proposed standard Current US GAAP Current IFRS
Volume discounts
Volume discounts are generally
receivable by the customer when
specified cumulative levels of
revenue are earned during a defined
period.
If an entity receives consideration
from a customer and expects to
refund some or all of that
consideration, the entity recognises a
refund liability. That liability is
measured at the probability-weighted
amount of consideration that the
entity expects to refund to the
customer. Revenue is measured
using a probability-weighted
approach when payments can be
reasonably estimated. The amounts
can be reasonably estimated when
the seller has experience with such
volume rebates and the experience
is relevant to the contract. Otherwise,
revenue is limited to the amount of
consideration that management can
reasonably estimate.
Volume discounts are recognised as
a reduction of revenue as the
customer earns the rebate. The
reduction is limited to the estimated
amounts potentially due to the
customer. If the discount cannot be
reliably estimated, revenue is
reduced by the maximum potential
rebate.
Volume discount payments are
systematically accrued based on
discounts expected to be taken. The
discount is then recognised as a
reduction of revenue based on the
best estimate of the amounts
potentially due to the customer. If the
discount cannot be reliably
estimated, revenue is reduced by the
maximum potential rebate.
Impact:
Revenue is measured based on the probability-weighted average estimated
consideration to be received after adjusting for expected discounts. The
probability-weighted approach in the proposed standard may change the
timing of revenue recognition compared to the best estimate approach used
today.
Time value of money
In determining the transaction price,
an entity shall adjust the amount of
promised consideration to reflect the
time value of money if the contract
includes a material financing
component (whether explicitly or
implicitly).
Management uses a discount rate
that reflects a separate financing
transaction between the entity and its
The discounting of revenues is
required only in limited situations, for
example, receivables with payment
terms greater than one year.
When discounting is required, the
interest component is calculated
based on the stated rate of interest in
the instrument or a market rate of
interest if the stated rate is
considered unreasonable.
Discounting of revenues to present
value is required in instances where
the effect of discounting is material. In
such instances, an imputed interest
rate is used to determine the amount
of revenue to be recognised
immediately, as well as the separate
interest income component to be
recorded over time.
Proposed standard Current US GAAP Current IFRS
customer, and factors in credit risk. Impact:
We do not expect a significant change to current practice for most
transportation and logistics entities (excluding airlines) in connection with the
time value of money, because payment terms often do not vary significantly
from the timing of contract performance.
Contracts with payment terms that vary significantly from the timing of
contract performance, such as prepayments for flights and customer loyalty
programmes, might be affected (see Example 6).
Example 5
Facts: A railway entity enters into a contract to ship goods from point A to point B for C1,000. The customer earns a
discount of C100 per load if the customer ships at least 10,000 loads annually. How should the railway entity record
revenue from this contract?
Discussion: Based on past experience, the railway entity believes there is a 70% probability that the customer will
ship 10,000 loads and earn the discount of C 100 per load. The railway entity will record revenue of C930 per load
based on the probability-weighted amount of consideration it expects to receive [(0.70 x C900) + (0.30 x C1,000)].
Example 6
Facts: An airline sells a non-refundable ticket to a customer with payment due at the time of booking, which is one
year before the reserved flight. The ticket price is C500. How should the airline record revenue from this contract?
Discussion: The airline will record a contract liability of C500 when the customer pays. The airline determines that a
5% discount rate is appropriate based on the one-year term and its credit characteristics. The airline recognises
interest expense of C25 (C500 x 0.05) during the year before the flight with a corresponding increase to the contract
liability. The airline records revenue of C525 when the reserved flight is taken. This accounting treatment is a
significant change from current practice.
Multiple-element arrangements
Many transportation entities provide multiple services to their customers as part of a single contract. Determining
when to separately account for performance obligations under the proposed standard is a key determination and will
require a significant amount of judgement.
Proposed standard Current US GAAP Current IFRS
Multiple-element arrangements
The proposed standard states that a
single contract may have numerous
performance obligations. When these
performance obligations are distinct
they should be accounted for
separately.
A good or service is distinct and
should be accounted for separately if
the entity, or another entity, sells an
identical or similar good or service
separately. Performance obligations
could be distinct if not sold
separately if the good or service has
a distinct profit margin and a distinct
function.
For performance obligations that
require separate accounting, contract
revenue is allocated to each
performance obligation based on
relative actual or estimated stand-
alone selling prices.
Current guidance requires
deliverables in contracts to be
accounted for separately if each
deliverable has stand-alone value
and there is objective and reliable
evidence of fair value of the
undelivered element. When fair value
does not exist for delivered elements,
the residual method of allocation is
permitted.
The lack of objective and reliable
evidence of fair value of the
undelivered element often limits the
separation of deliverables in a
multiple-element arrangement.
New multiple element guidance
(required to be adopted for calendar
year end companies effective
January 1, 2011) requires
deliverables in contracts to be
accounted for separately if each
deliverable has stand-alone value. At
the inception of the arrangement,
consideration is allocated to all
deliverables based on the relative
selling price. The residual method is
no longer permitted.
The revenue recognition criteria are
applied to each separately
identifiable component of a single
transaction to reflect the transaction's
substance.
Fair value is used to allocate the
transaction price to the separate
elements of a contract. The price that
is regularly charged when an item is
sold separately is the best evidence
of the item's fair value. A cost-plus-
reasonable-margin approach to
estimating fair value is also
acceptable. The use of the relative
fair value method, residual method,
and, under rare circumstances, the
reverse residual method, is
acceptable to allocate arrangement
consideration.
Entities might separate elements in a
single contract even if the elements
are not sold separately.
Impact:
Management will need to determine
whether transportation or logistics
contracts include more than one
performance obligation. The
separation criteria in the proposed
standard are less restrictive than
current guidance. This might result in
more performance obligations being
accounted for separately, thereby
changing the timing of revenue
recognition. For example, entities
that provide a complete solution
including completion and filing of
necessary transportation paperwork
(for example, customs forms) should
consider whether the individual
services are distinct performance
obligations.
The residual method of allocation is
not permitted under the proposed
standard.
Impact:
The proposed separation and
allocation methodology is similar to
current guidance, although more
performance obligations might be
identified. The residual and reverse
residual methods of allocation will no
longer be acceptable.
Example 7
Facts: A trucking entity enters into a contract with a customer for maintenance services and emergency roadside
assistance. The services are not typically sold on a stand-alone basis. Assume the performance obligations are each
distinct and will be delivered at different times. How should the trucking entity allocate revenue to the performance
obligations?
Discussion: The entity will need to consider observable prices of services, when available, in estimating the stand-
alone selling price of each of the services. Stand-alone selling prices of the maintenance services and the emergency
roadside assistance will be estimated because they are not sold separately by the entity. The entity might use a cost-
plus-reasonable-margin approach or any other reasonable and reliable method to estimate stand-alone selling price
as long as that method is consistent with stand-alone selling prices that maximise observable inputs. The
arrangement consideration is allocated to each performance obligation on a relative basis. Revenue is recognised as
the performance obligations are satisfied.