Brief facts of enquiry:

The Accounting Standards Board (the Board) received following enquiries related to the accounting of customer contribution received by a utility company (the Company), under IFRS 15 Revenue from contracts with customers.

A.What shall be the timing of revenue recognition for customer contributions for construction of infrastructure (i.e. a pipeline required for the supply of gas by the Company).

B.What shall be the timing of revenue recognition under following specific arrangements of customer contributions for infrastructure assets required for the supply of gas:

a)Arrangement for laying of a service line for a domestic consumer (customer).

b)Arrangement with the industrial consumer (customer) for laying of pipeline and transport of gas under the OGRA Gas (Third Party Access Rules), 2018.

c)Arrangement with the housing society for construction of network infrastructure in the housing society.

C.How would the transitional requirements of IFRS 15 apply to contracts for customer contribution for construction of infrastructure that have been previously accounted for under IFRIC 18 Transfers of Assets from Customers.

Opinion:

The Board based on the specific enquired fact pattern discussed the requirements of IFRS 15 on following matters:

Enquiry (A): Revenue recognition from customer contribution for construction of infrastructure

The Board noted that the infrastructure development/construction is an essential and fundamental function for the fulfillment of the Company’s objectives i.e. supply of gas to customers whether domestic, commercial or industrial.

For scoping of enquired fact pattern under IFRS, the Board noted that contributions i.e. unconditional transfers of cash or asset in a voluntary non-reciprocal transfer, are scoped out of IFRS 15. Whereas exchange transactions (i.e. a reciprocal transaction in which two parties exchange items of commensurate value) are within the scope of IFRS 15.

In the enquired fact pattern, customer funds the infrastructure cost (cost of pipeline and necessary equipment) as part of an arrangement to obtain a connection to the Company’s network for the gas supply. The term ‘customer’ is defined in IFRS 15 as a party that has contracted with an entity to obtain goods or services that are an output of the entity’s ordinary activities in exchange for consideration. Accordingly, the Board noted that the arrangement between the Company and its customers would be within the scope of IFRS 15.

Application of IFRS 15

At contract inception, for each performance obligation, an entity applies the criteria in paragraph 35 of IFRS 15 to determine whether it recognizes revenue over time. If criteria of paragraph 35 are not met, then entity recognizes revenue at point in time in accordance with provisions of paragraph 32. Before applying paragraph 35, an entity applies paragraphs 22–30 in identifying as a performance obligation, each promise to transfer to the customer a good or service that is distinct.

The entity assesses whether each of such goods or services is distinct in accordance with paragraph 27 of IFRS 15. The assessment under the criteria in paragraph 27 involves judgement. Under paragraph 27, a good or service promised to a customer is distinct if:

a)the customer can benefit from the good or service on its own or together with other resources readily available to the customer (i.e. the good or service is capable of being distinct); and

b)the entity’s promise to transfer the good or service is separately identifiable from other promises in the contract (i.e. the promise to transfer the good or service is distinct within the context of the contract).

In assessing whether an entity’s promises to transfer goods or services to the customer are separately identifiable, the objective is to determine whether the nature of the promise, within the context of the contract, is to transfer each of those goods or services individually or, instead, to transfer a combined item or items to which the promised goods or services are input.

The Board while analyzing the enquired matter noted that the information shared by the enquirer (relating to customer’s funding of infrastructure development) contains following main features:

•Customer submits an application for ‘Gas Connection’ to the Company.

•Pursuant to a separate correspondence of the Company (issued under customer’s application for gas connection) the customer is requested to fund the necessary infrastructure (e.g. pipeline). This correspondence specifies that a proposal letter for individual connection would be issued after the supply main has been laid and commissioned. The terms also specify that the Company will retain full authority to give connection from the laid infrastructure to any other customer also at its sole discretion. Further, it also specifies that for gas supply a separate agreement would be signed between the Company and the customer.

•In context of the customer funding for infrastructure, a ‘Gas Purchase Agreement’ between the Company and customer is entered into, further to the above correspondence. This agreement mainly spells out the Company’s obligation to construct the infrastructure with customer funded amount and the Company’s right to own and operate this infrastructure.

•Subsequent to the above agreement a separate ‘Contract for Supply of Gas’ is entered into between the Company and customer.

The Board based on the fact pattern mentioned in the enquiry and documentary information shared by the Company, noted that:

a)In accordance with paragraph 27 of IFRS 15, the Company’s gas connection to the customer and laying of infrastructure through customer funding would be separate performance obligations if these are distinct, i.e.:

•if a customer can obtain economic benefits from the pipeline on its own or with other available resources; and

•the Company’s promise to transfer the good or service is separable from other promises under the contract(s) with customer.

b)The underlying ‘promise’ with a customer is to provide a gas connection, which in certain cases is provided subsequent to the laying of infrastructure. Construction of the infrastructure is a necessary activity for ensuring supply of gas.

c)The arrangement between the Company and the customer involves different activities at different timelines. However, primary objective of all these arrangements and activities remains the same, i.e., to provide/obtain gas supply. This clearly exhibits that the distinct good or service from the customer’s perspective would be obtaining gas supply through laid pipeline and gas connection.

d)The Company under the arrangement is responsible to provide combined output i.e. required to integrate the pipeline and customer’s gas connection in order to fulfill the principal objective/envisaged activity i.e. supply of gas. In entirety, the Company has promised the customer for gas supply through a gas connection. It provides a significant service of integrating the connection to the network and on-going supply. The Company is responsible to provide combined output i.e. connection to the network and ongoing supply of gas.

e)Importantly, in the enquired scenario supply of gas to a customer is highly dependent on the construction of a pipeline and the gas connection. There is two-way dependency, the Company cannot provide ongoing service (i.e. gas supply) without the connection to the network and the customer cannot benefit from the connection without the ongoing services.

f)Therefore, a customer funds cost of infrastructure to establish a connection with the Company’s network, as a perquisite to obtain gas supply from it. In such arrangements, the only performance obligation of the Company is to supply gas to the customer. Accordingly, all other promises/activities of the gas Company including constructing a pipeline (through customer funding or own resources) are part of gas supply arrangement

The Board concluded that in the enquired fact pattern:

a)Construction of infrastructure with customer’s funded amount and supply of gas to such customer are not ‘distinct’ performance obligations, under paragraph 27 of IFRS 15.

b)Revenue recognition of the entire arrangement should be ‘over time’, in accordance with paragraph 35 of IFRS 15. The over-time revenue recognition should be based on the estimated period, the Company expects to supply gas to the customer. However, owing to nature of arrangement (i.e. difficulty in estimating the time period over which gas supply would be made to customer), the revenue recognition could be over the useful life of the customer funded pipeline.

Enquiry (B): Consideration of the Company’s special arrangements involving customer contributions for construction of network infrastructure

a)Arrangement for laying of service-line and supply of gas to domestic customers

The Board, based on the information provided in the enquiry, noted that a domestic customer initially applies for a gas connection. However, in certain cases, as part of the gas connection arrangement customer also pays the Company for the cost of laying a service-line. This service-line is required to establish a connection with the Company’s main-line and ultimately obtain gas supply from it.

In this arrangement, similar to Enquiry (A) above, the economic interest of a customer lies in obtaining gas connection and gas supply from the Company. The performance obligation of the Company is to supply gas to the customer and all other promises/activities of the Company including construction of service-line (through customer funding or own resources) are part of ensuring supply of gas.

The Board based on the particular fact pattern of the arrangement for laying of service line and supply of gas to domestic customers concluded that:

a)The arrangement, in context of the identification of performance obligation under IFRS 15, is similar to the above arrangement discussed in detail under Enquiry A (above). Laying of a service-line with customer funded amount and subsequent provision of a connection and gas supply are not ‘distinct’ performance obligations.

b)Revenue recognition for the customer funded amount for construction of a service-line should be ‘over time’, based on the useful life of the related service-line, as explained in paragraph 8 (b) above.

b)Arrangements with the industrial customers for laying of pipeline and transport of gas under the OGRA Gas (Third Party Access Rules) 2018

The Board observed that under OGRA Gas (Third Party Access Rules) 2018 other entities can independently sell gas to customers in Pakistan after having transported it through their own infrastructure or through the infrastructure of the SSGC or SNGPL.

Based on the scenario shared by the enquirer, an industrial customer may be able to obtain economic benefits by funding the infrastructure cost to the Company and subsequently, obtaining gas supply from another third-party gas supplier, if such industrial customer:

•Enters into an arrangement with the Company for funding/construction of a pipeline, only without entering into gas supply contract with the Company;

•Enters into a gas supply contract with another third party gas supplier; and

•btains gas supply from another third party, transported through the Company’s network/infrastructure.

However, conclusion on whether a customer’s ability to obtain supply of gas from a supplier other than the Company under OGRA Gas (Third Party Access Rules) 2018, would make the construction of network as a distinct service under paragraph 27 of IFRS 15, requires an independent assessment of all the pertinent facts and circumstances of that case. The Board (based on the research of Technical Services Department) noted that current practices and scale of operations of third party gas suppliers and arrangements (if any) do not indicate that industrial customers, in general, can readily and conveniently replace the gas supply of the Company with third party gas supplier(s).

The Board based on the above discussion concluded that:

a)In current gas supply market, an industrial customer cannot obtain economic benefits from the infrastructure without obtaining gas supply from the Company. The Board is of the view that the construction of infrastructure and availability of gas supply to the industrial customers, in general, are not ‘distinct’ performance obligations, in accordance with IFRS 15.

b)Revenue recognition for the funds received by customers for infrastructure development should be over time, as discussed in (b) above.

c)Arrangement with housing societies for construction of network infrastructure and supply of gas to household owners

IFRS 15 outlines that promised goods or services in a contract may include granting rights to goods or services to be provided in future that a customer can resell or provide to its customers.

The Board based on the information provided in the enquiry and related information noted that the Company enters into two different types of arrangements with the housing societies:

a)Arrangement I: Under this arrangement, a housing society submits a gas supply application to the Company. The Company pursuant to this application enters into an arrangement with a housing society under which funds are provided by the housing society to the Company for laying of infrastructure.

b)Arrangement II: The Company enters into an arrangement with a housing society under which infrastructure is developed by housing society and transferred to the Company on completion. The Company is engaged by a housing society for supervision of the network being constructed by the housing society.

In both of the arrangements, infrastructure is transferred to the Company upon completion. The Company, after entering into both of the above arrangements, enters into separate contracts with the individual customers for gas connections as per its standard sales procedures.

The Board concluded that in the enquired fact pattern:

a)The only performance obligation of the Company is to provide gas connections and gas supply to customers that have/will have properties in such housing societies. The laying of infrastructure from funds of the housing society or obtaining control of infrastructure developed by housing society are necessary for supplying gas to individual customers. In such arrangements, as discussed in detail under enquiry (A) above, the performance obligations are not ‘distinct’.

b)Revenue recognition against the funds received from customers for infrastructure development should be ‘over time’, in accordance with the principal discussed in (b) above.

Enquiry (C): Application of transitional requirements of IFRS 15 on contracts with customers that were previously accounted for under IFRIC 18

Under this enquiry, the Board’s comments were requested on whether:

•Contracts with the customers for construction of/connection with the network infrastructure, for which the revenue has already been recognised in past under IFRIC 18, meet the definition of ‘completed contracts’ under the transitional provisions of IFRS 15; and

•Revenue already recognised by the Company for such contracts under IFRIC 18, need to be restated on transition to IFRS 15.

The Board noted that in the enquired matter, it is important to understand and assess the appropriateness of the Company’s accounting policy for recognition of revenue from customer contributions for construction of infrastructure assets, under IAS 18, Revenue and IFRIC 18.

IFRS 15 defines a ‘completed contract’ as a contract for which the entity has transferred all of the goods or services identified in accordance with IAS 11 Construction Contracts, IAS 18, Revenue and related Interpretations. For the completed contracts, IFRS 15 provides transition related practical expedients.

The Board noted that under IFRIC 18, if only one service was identified in a contract with a customer, revenue was to be recognised when such service was performed. Conversely, if more than one separately identifiable goods or services were identified, the fair value of the total consideration received (or receivable) for the agreement was to be allocated to each good or service. In such a case, the revenue recognition criteria of IAS 18 were to be applied to each good or service, separately.

Further, for an ongoing service rendered by an entity, the revenue recognition period would have to be determined by the terms of the agreement with the customer. However, if the agreement does not specify a period, revenue recognition would be over a period no longer than the useful life of the transferred asset used to provide the ongoing service.

In context of application of IFRIC 18, a key factor for the determination of separately identifiable services would be that whether construction of a pipeline with customer funding and connection to the network represent ‘stand-alone value’ for that customer. In this regard, based on the explanation provided in IFRIC 18 and the research of the Technical Services Department, the Board noted that two alternative views existed regarding the performance obligation(s) and their fulfilment:

•Pipeline constructed with customer funding has a stand-alone value independent of gas supply; or

•Pipeline constructed with customer funding has no stand-alone value as it is part of gas supply arrangement.

The Board observed that the new revenue standard i.e. IFRS 15 contains comprehensive guidance on identifying separate components, which applies to all revenue-generating transactions. Comparatively, IAS 18 and IFRIC 18 contained very limited discussion and guidance on the determination of whether a transaction contains separately identifiable components. The limited guidance could be a reason for the above alternative views. Management was required to exercise judgement and apply a consistent accounting policy for the determination of identifiable/distinct goods or services while applying IFRIC 18.

The Board concluded that in the context of the enquired matter, arrangements involving customer contributions for network infrastructure for which the revenue has already been completely recognised in prior years under IFRIC 18, meet the definition of ‘completed contracts’ under IFRS 15. The Company can accordingly consider the transitional requirements of IFRS 15 for completed contracts.

(Issued in July, 2020)