• Accounting Alert July 2020

Impairment is not the only accounting consequence of COVID-19 – revenue recognition, share-based payments and termination benefits also require consideration

Since early 2020, the news cycle, both globally and at home, has been dominated by the COVID-19 pandemic. In an attempt to limit the spread of COVID-19, governments have placed considerable restrictions on the activities of individuals and businesses.  For the majority of businesses this has resulted in substantial operational and financial impacts.  Many of those businesses that report under International Financial Reporting Standards will also find that COVID-19 has substantial financial reporting impacts, particularly for entities with 30 June 2020 reporting dates.

In this article, we look at COVID-19 impacts on an entity’s revenue recognition and the accounting for share-based payments and termination benefits.


Revenue recognition – Refunds

Pre-COVID-19, many businesses may not have offered refunds to customers who changed their minds about a purchase, or may have offered such refunds, but only occasionally had to provide them. 

COVID-19 is expected to result in an increase in the rate of customer returns, and therefore greater refund liabilities being recognised at 30 June 2020 due to the constraint on the amount of revenue that can be recognised under IFRS 15 Revenue from Contracts with Customers (“IFRS 15”) when a contract includes variable consideration.


Retail Co sells fast fashion items targeted at the young adult market. Due to social distancing restrictions, it was forced to shut its stores in shopping centres and online sales increased as a result. It has always had a 30-day return policy for customers who changed their mind about a purchase and historically return rates have been 10%. Since March 2020, return rates have increased to 25% due to many online customers purchasing multiple sizes as they have been unable to try on the garments in store prior to purchase.

The table below illustrates how the revised return rate will impact the amount of sales and refund liability recognised on $500,000 sales in June 2020:

  Revenue recognised
Refund liability recognised
10% return rate $450,000 $50,000
25% return rate $375,000 $125,000
Difference $75,000 less revenue $75,000 more refund liability

As noted above, IFRS 15 constrains the amount of revenue that can be recognised when the contract includes variable consideration. If there is significant uncertainty surrounding whether the entity will have to refund a portion of consideration in future, some entities may have to account for a significant portion (if not all) consideration received or receivable as a contract liability, rather than revenue.

Entities therefore cannot simply rely on historical estimates when estimating refund liabilities at 30 June 2020. These will need to be reassessed based on updated return rates during the COVID-19 pandemic period.


Revenue recognition – Volume rebates

While COVID-19 is likely to result in lower revenues being recognised because of revenue being constrained due to an expected higher level of returns, the opposite may occur for volume rebates.

Lower levels of volume rebates where entities previously assumed maximum rebate thresholds may result in less revenue being constrained, and higher revenue for 30 June 2020


ABC Limited, which has a 30 June 2020 year-end, manufactures widgets and has the following pricing structure for Customer A which applies to sales made between 1 September 2019 and 31 August 2020:

Price (per widget) Annual sales volume (widgets)
$12 0 - 900,000
$10 900,001 – 1,200,000
$9 1,200,001 – 1,500,000
$7 1,500,001 and above

Note: Cash is received based on the selling price for each volume category, and the volume rebate is given to the client via a lump-sum reimbursement on 31 August 2020.

Based on past sales experience, ABC Limited expects Customer A to purchase 1.6 million widgets during this contract period, i.e. the average selling price per widget will be $7. However, due to COVID-19, sales have slowed and by 30 June 2020:

  • ABC had only sold 700,000 widgets to Customer A, and
  • ABC anticipates that in total, only 1 million widgets would be sold by 31 August 2020.

Based on original estimated volumes, at 30 June 2020, revenue would be recognised for the 700,000 widgets sold as follows:

Dr         Cash (700,000 X $12)                                         $8,400,000
Cr         Revenue (700,000 X $7)                                                           $4,900,000
Cr         Contract liability (volume rebates)                                             $3,500,000

However, with the total anticipated volume for the contract period being 1 million widgets, the revenue ‘constraint’ has been resolved, and the correct journal entry is:

Dr         Cash (700,000 X $12)                                         $8,400,000
Cr         Revenue (700,000 X $10)                                                         $7,000,000
Cr         Contract liability (volume rebates)                                             $1,400,000

This results in $2.1 million additional revenue being recognised at 30 June 2020.


Revenue recognition - Penalties

Particularly in industries such as construction, if contracts do not contain force majeure clauses, social distancing rules and other restrictions may result in success-based fees such as bonuses being less likely to be achieved than under normal circumstances, and may instead result in entities incurring penalties due to completion deadlines not being met. This could result in lower revenue being recognised due to the IFRS 15 requirements to constrain the amount of revenue recognised where a contract includes variable consideration.


On 1 January 2020, Construction Co enters into a contract with a customer to build a house for $1 million. Construction Co recognises revenue on this contract over time. At 30 June 2020 (year-end), Construction Co’s progress towards completion is 50%.

Construction Co has built many houses in the past, and based on its experience, on commencement of the contract it estimates that it will complete the contract on time (i.e. the estimated transaction price is $1 million). However, due to COVID-19 restrictions, at 30 June 2020 it estimates the following probabilities for the completion date, which results in an estimated transaction price of $860,000.

Estimated completion Probability Transaction price Estimated transaction price
On time 20% $1,000,000 $200,000
One month late 30% $900,000 $270,000
Two months late 40% $800,000 $320,000
Three months late 10% $700,000 $70,000

If Construction Co recognises revenue based on its initial estimate of the transaction price on 1 January 2020, it would recognise revenue of $500,000 for the year ended 30 June 2020 (i.e. 50% of $1 million). However, using appropriate, updated estimates, Construction Co would instead only recognise $430,000 revenue (i.e. 50% of $860,000). This could have a significant impact on the amount of revenue, and ultimately profit, recognised during the 30 June 2020 financial year.


Fulfilment costs under IFRS 15

Entities that deliver promised goods or services at a point in time in the future may incur costs to fulfil the contract that are not capitalised under other financial reporting standards (for example, IAS 2 Inventories, IAS 16 Property, Plant and Equipment, and IAS 38 Intangible Assets). IFRS 15 permits these costs to be capitalised under certain circumstances, and amortised on a systematic basis, consistent with the transfer of goods or services to customers. In addition, this fulfilment cost asset is also written down if it is impaired.

An entity shall update the amortisation to reflect a significant change in the entity’s expected timing of transfer to the customer of the goods or services to which the asset relates. Such a change shall be accounted for as a change in accounting estimate in accordance with IAS 8 Accounting policies, changes in accounting estimates and errors.
IFRS 15, paragraph 100

As noted in paragraph 100 of IFRS 15, above, COVID-19 may require amortisation of the fulfilment cost asset at a faster rate than initially anticipated. This is accounted for as a change in an accounting estimate and expensed prospectively over the remaining life of the asset.


Share-based payments

COVID-19 may result in changes to share-based payment arrangements, particularly whether employees will meet service conditions and other vesting conditions due to business disruptions during the pandemic period. IFRS 2 Share-based Payment includes examples and guidance to assist with the appropriate accounting treatment in most instances. However, where employees have been stood down temporarily during the pandemic period, considerable judgement may be required to determine the appropriate accounting treatment.


Termination benefits

COVID-19 may result in many entities retrenching employees, particularly when government wage subsidies end. Termination benefits will need to be determined and entities need to ensure that any provisions (liabilities) for termination benefits are recognised in the correct accounting period.

An entity shall recognise a liability and expense for termination benefits at the earlier of the following dates:

(a) when the entity can no longer withdraw the offer of those benefits; and

(b) when the entity recognises costs for a restructuring that is within the scope of IAS 37 Provisions, Contingent Liabilities and Contingent Assets and involves the payment of termination benefits.

IAS 19 Employee Benefits, paragraph 165

An entity is typically unable to withdraw an offer once it has been communicated to the affected employees in sufficient detail. 


More information

Our IFRB 2020 03 provides a useful summary of possible impacts you should consider when preparing June 2020 financial statements. The following Accounting Alert articles also provide information about the accounting implications of COVID-19: