Are you familiar with the concept of contract assets under IFRS 15? If not, don`t worry – we`ve got you covered. In this article, we`ll provide you with a clear example of contract assets under IFRS 15, and explain why understanding this concept is important for businesses.
First, let`s define what a contract asset is. Under IFRS 15, a contract asset is an asset that arises from revenue that has been recognized but not yet billed to the customer. This can occur when a business has performed work or provided goods/services to a customer, but has not yet issued an invoice.
Now, let`s look at an example of how contract assets work in practice. Imagine that your business sells software-as-a-service (SaaS) subscriptions to customers. You`ve recently signed a new client, and you`ve agreed to provide them with 12 months of access to your SaaS platform.
Under IFRS 15, you would recognize revenue for the full 12-month subscription upfront, when the contract begins. However, you wouldn`t bill the customer for the entire amount at once – instead, you would issue invoices on a monthly basis.
This means that after the first month of the subscription, you would recognize revenue for 1/12th of the total contract value, but you would only bill the customer for that month`s usage. The remaining 11 months of revenue would be recognized, but not yet billed, leading to the creation of a contract asset on your balance sheet.
As you continue to bill the customer each month, the contract asset would decline until it reaches zero once the full amount of revenue has been billed. At that point, you would have fully realized the revenue from the contract.
So, why is understanding contract assets important for businesses? For one, it can impact your financial reporting. If you don`t properly account for contract assets, it could skew your financial statements and make it difficult for investors or lenders to assess your company`s financial health.
Additionally, properly managing contract assets can help with cash flow management. By recognizing revenue upfront but billing customers on a staggered basis, businesses can maintain a more consistent cash flow over time.
In conclusion, understanding contract assets under IFRS 15 is crucial for businesses that have contracts with customers that span multiple billing periods. By properly accounting for contract assets, businesses can ensure accurate financial reporting and better manage their cash flow.