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IFRS 15 — Right to payment for performance completed to date

Date recorded:

Initial consideration — Agenda Paper 2B

Background

This is a new issue.

The IC received a request to clarify whether revenue from the sale of pre-completion residential units in a multi-unit condominium should be recognised over time or at a point in time. Specifically, the submitter asks whether the entity (developer) has a right to payment for work done to date in terms of IFRS 15.35(c) in the fact pattern below.

Fact pattern

The pertinent facts are as follows:

  1. The entity and the customer enter into a contract for the sale of a real estate unit in a residential multi-unit development before the entity constructs the unit.
  2. Once the contract is signed, the entity is obliged to deliver the completed unit as specified in the contract—it cannot change or substitute the unit agreed to in the contract. The entity retains legal title to the unit (and any land attributed to it) until construction is complete.
  3. The customer pays 10% of the purchase price for the unit at contract inception, and pays the remainder when construction is complete.
  4. The customer is able to cancel the contract at any time before construction is complete. If the customer cancels the contract:
    1. the entity has a legal right to obtain the original purchase price for the unit plus costs arising from cancellation. The entity is required to make reasonable efforts to resell the unit to a third party. If there is any shortfall between the resale price and the original purchase price (plus any sale and marketing costs), the customer has a legal obligation to pay the difference to the entity.
    2. the customer does not have any rights to sell, use or develop the unit, nor is it entitled to any excess of resale proceeds over the original purchase price.
  5. Court rulings have confirmed the legal right of the entity and the legal obligation of the customer described in (d)(i) above.

In this case, the entity is entitled to 100% of the original purchase price at all times throughout the duration of the contract, although  some or all of the original purchase price would be obtained from a party other than the original customer in the event of a contract cancellation. The question is whether such an entitlement to the full purchase price represents a right of the entity to payment for work done to date.

Staff analysis

The assessment of whether the entity has an enforceable right to payment for performance completed to date is only one scion of consideration in the more fundamental question of whether control of the residential unit passes to the customer as the unit is being constructed. The Staff observe that in the fact pattern submitted, in the event of a cancellation, the customer does not obtain legal title to the unit, nor does it have any rights to sell, use or develop the unit. The customer does not novate the original contract to the new purchaser, nor does it use the entity as an agent to sell the unit on its behalf. Instead, the entity acts as principal in reselling the unit and has the right to decide when and how to sell it, and what price to accept for the resale. Furthermore, the customer is not entitled to any increase in price of the unit. These facts indicate that the customer does not control the unit upon cancellation, because the customer cannot direct the use of the unit, nor can it obtain substantially all of the remaining benefits from the unit.

As regards the entity’s entitlement to the full original purchase price, the Staff believe that it is important to make two distinctions:

  1. Is the entity recovering the purchase price from the original customer under the original contract or from a third party under a new contract? and
  2. Whether the payment from the original customer is for work done to date or for compensation for loss of profit.

Upon contract cancellation, the entity controls the real estate unit and is legally obliged to make reasonable efforts to resell the unit to a third party. In doing so, the entity recovers some or all of the original purchase price from a third party under a new contract. In the Staff’s view, the payment made by the third party should be considered a payment for the entity’s performance in a new contract with the third party, and should not be considered to be a payment for its performance under the original contract. Upon cancellation, in the context of the original contract, the only right the entity has against the customer is to obtain from the latter any shortfall between the resale price and the original purchase price. The Staff believe that this is a right to compensation for loss of profit (i.e. the profit that the entity would have made had the contract not been cancelled), and not a right to payment for performance completed to date, because the latter is effectively covered by the resale price under a new contract with a third party.

Staff recommendation

The Staff recommend that the IC not add this issue to its agenda on grounds that the requirements in IFRS 15 provide an adequate basis for an entity to determine whether revenue should be recognised over time or at a point in time for the fact pattern described in the submission.

Discussion

The IC agreed with the Staff’s technical analysis and agreed not to add this issue to its agenda.
 
Apart from drafting suggestions to include more of the Staff’s analysis in the tentative agenda decision, there was not much substantive discussion.

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