Revenue recognition – how to account for free gifts and loyalty programmes

IFRS 15 includes specific requirements related to “customer options for additional goods or services” – for example free gifts, discount vouchers, etc – and requires a distinction to be made as to whether this option confers a “material right”. We will look at what is a “material right” and how do you make this assessment.

Performance obligations

A promise deemed to be free or deemed to be a marketing tool is probably a PO. One of the steps of IFRS 15 is the identification of performance obligations in the contract to enable the recognition of revenue. Performance obligations (POs) are promises to a customer that arise every time they enter a contract to supply a good or service. Not all POs need to be explicitly stated in the contract. Contracts may provide customers with the option to acquire additional goods or services either for free or at a discount through loyalty point programmes, customer award credits, sales incentives, contract renewal options, etc. Where the buyer has a valid expectation of an ‘extra’ or ‘free’ good or service being provided this is an additional PO and needs to be considered in the application of IFRS 15.

Material right

Retailers transfer goods directly to their customers on or close to the date the goods are paid for, so many retailers believe that the implementation of IFRS 15 will be straightforward. However, where incentives are offered, like free goods, coupons or loyalty points to keep customers returning this future offer is referred to as a material right under IFRS 15.

If the option provides a right the customer would not have received had they not entered into this contract, (e.g., a right incremental to the rights provided to other customers in the same region or market), the customer is in effect paying in advance for future goods and services. If such an option provides the customer with a “material right”, then the option should be accounted for as a separate performance obligation.

Entities may argue that the cost of the free goods is a marketing expenses. However, if a free good is promised to a customer, then it should be treated as a separate PO.

Accounting requirements

Once the determination has been made that a material right exists and it is a separate PO, a portion of the total transaction price must be allocated to this right. If the stand-alone selling price of the material right is not directly observable, it must be estimated. In determining this value, entities should factor into their estimate:

  • any discounts that could be obtained without exercising the option
  • the likelihood the option will be exercised.

How much is allocated to each item (or PO), will depend on how the transaction price is allocated.

Loyalty points are in substance the same as a coupon or free good. Some of the consideration received in exchange for the goods sold at the time when the points are earned should be deferred until the points are exchanged for goods or services in the future. The loyalty point is providing a right to a good or service to the customer, and therefore is a distinct PO.

Example – Free gift: If a customer buys a football and receives a voucher for a free cap if they buy another football in the following month, part of the consideration for the initial football would need to be allocated to the free cap.

What to consider?

In the process to determine when and how much revenue should be recognised, consideration should be given to all the promises being offered to the customer, those POs must be identified, including those which are implicit.

Example – Customer Loyalty Programme: A customer loyalty programme rewards a customer with one loyalty point for every R10 of purchases. Each point is redeemable for a R1 discount on any future purchases. During a reporting period, customers purchase products for R100,000 and earn 10,000 points that are redeemable for future purchases. The consideration is fixed and the stand-alone selling price of the purchased products is R100,000. The entity expects 9,500 points to be redeemed. The entity estimates a stand-alone selling price of 95 cents per point (totalling R9,500) on the basis of the likelihood of redemption. It was concluded that the promise to provide points to the customer is a PO. The entity allocates the transaction price (R100,000) to the product and the points on a relative stand-alone selling price basis as follows: 

  • Product = R91,324 [R100,000 × (R100,000 selling price ÷ R109,500)] 
  • Points = R8,676 [R100,000 × (R9,500 selling price ÷ R109,500)]

End of Year 1: 

  • 4,500 points have been redeemed and the expectation is still that 9,500 points will be redeemed in total. 
  • The entity recognizes revenue for the loyalty points of R4,110 [(4,500 points ÷ 9,500 points) × R8,676] and recognizes a contract liability of R4,566 (R8,676 less R4,110) for the unredeemed points at the end of the first reporting period.

End of Year 2: 

  • 8,500 points have been redeemed cumulatively. The entity updates its estimate of the points that will be redeemed and now expects that 9,700 points will be redeemed. 
  • The entity recognizes revenue for the loyalty points of R3,493 {[(8,500 total points redeemed ÷ 9,700 total points expected to be redeemed) × R8,676 initial allocation] less R4,110 recognized in the first reporting period}. 
  • The contract liability balance is R1,073 (R8,676 initial allocation less R7,603 [R4110 + R3493] of cumulative revenue recognized).

VAT on Non-Executive Director Fees

What is the Binding General Ruling (BGR) about?

As no control or supervision is exercised by a company over the manner in which a non-executive director (NED) performs his or her duties or the NED’s hours of work NEDs are not regarded as common law employees.

The fees earned for services rendered as a NED do not constitute “remuneration” and should therefore not be subject to the mandatory deduction of employees’ tax (PAYE) by the company concerned. It was clarified that NEDs are carrying on an “enterprise” in respect of services rendered as a NED and should therefore register for VAT where the fees exceed the VAT registration threshold.

Who does the BGR apply to?

The Ruling applies to any person appointed as an NED under the Companies Act 71 of 2008. It does not matter what type of company the NED serves – whether it be a public, private, state owned or non-profit company. This also applies to the extent that the member is a NED, serving in the various committees of a company. This includes, for example, Board committees, Risk and Audit committees, Remuneration committees and Social and Ethics committees.

What about executive directors?

Executive directors are normally regarded as employees of the company which they serve. The BGR only deals with individuals that are appointed as NEDs to serve on the board of a company as contemplated in the Companies Act. As such, NEDs are regarded as independent contractors (sole proprietors) that provide services to the company concerned in their personal capacity and are therefore treated differently to employees of the company.

Should all NEDs register for VAT?

Only those NEDs that earn NED fees and other income from taxable supplies that have, in total, exceeded the compulsory VAT registration threshold of R1 million in any consecutive period of 12 months (or will exceed that amount in terms of a written contractual arrangement). NEDs that earn fees below the compulsory VAT registration threshold can choose to register voluntarily if the minimum threshold of R50 000 has been exceeded and all the other requirements for voluntary registration have been met.

How to determine total fees and income from taxable supplies?

  • The value of all taxable supplies of goods or services made in the course or furtherance of the enterprises conducted by the NED as a sole proprietor must be added together.
  • For example, if, in addition to your NED fees for serving on the board of a company, you also supply forensic accounting services to other clients in the normal course of conducting an enterprise as a sole proprietor, then you need to add the total value of NED fees and the total value of service charges from the forensic accounting business together. The resultant total value of income from taxable supplies in a 12 month consecutive period must then be compared to the R1 million compulsory VAT registration threshold to see if you have to register.
  • Any salary (or any other type of remuneration) earned in the capacity as an employee is not taken into account when determining the VAT registration liability. The reason is that NED fees or other charges for goods or services supplied constitute consideration received for the taxable supply of goods or services, whereas remuneration earned for services supplied to your employer is not.
  • The value of other benefits (for example company car) received by the NED forms part of the calculation of the consideration charged in respect of the NED services. The NED is therefore required to account for VAT based on the open market value of the benefit as well as any other component of consideration which is used to calculate the total of the NED fees.

What about income tax?

The fact that the payments to an NED are not subject to PAYE, does not mean they are not subject to normal tax. The normal tax liability arising from the income earned must be settled via the provisional tax system during the year of assessment.

Effective Date

The levying and accounting for VAT on NED fees earned was already effective from 1 June 2017.

Those NEDs that became liable to register before 1 June 2017, but have not done so, will be required to register and start accounting for VAT from 1 June 2017 on NED fees earned from this date, unless the NED chooses an earlier date of registration.