IFRS 15 Contract Costs: Costs to Obtain and…

IFRS 15 Contract Costs: Costs to Obtain and Fulfil a Contract

By Sai Manikanta Pedamallu (ACCA, CMA US, CSCA US, CGMA, ACMA, Dip IFRS, M.Com, MBA, MA)

Lead Instructor, Global Fin X | www.globalfinx.in/manikanta

Contract costs are the part of IFRS 15 that most accountants underestimate until they are sitting in front of a large IT services company's financials and realising that the sales commission capitalisation policy has a material impact on both the balance sheet and profit.

The standard addresses two categories: costs to obtain a contract and costs to fulfil a contract. The rules for each are different. Both require careful judgment in practice and both carry disclosures that analysts and auditors scrutinise closely.

Before IFRS 15, most Indian companies expensed sales commissions and contract setup costs as incurred. IFRS 15 changed that, at least for a significant subset of these costs. Understanding when to capitalise, how to amortise, and when to test for impairment is what this post covers.

Costs to Obtain a Contract

The Incremental Cost Rule

An entity must recognise an asset for incremental costs of obtaining a contract with a customer if those costs are expected to be recovered.

Incremental costs are costs the entity would not have incurred if the contract had not been obtained. Sales commissions paid only on contract signature are the clearest example. If the salesperson is paid a commission only when the deal closes, that cost is incremental. Without the contract, the cost is zero.

Costs that would have been incurred regardless of whether the contract was obtained are not incremental. Bid preparation costs, tender document costs, proposal writing costs, legal fees for negotiating standard terms: these are incurred whether the contract is won or lost. They are not incremental. They are expensed as incurred.

This distinction matters. A company that wins 30% of tenders spends bid costs on both winning and losing tenders. The costs on losing tenders produce no contract. Capitalising them would create an asset with no recoverable value. The standard correctly excludes them.

Worked Example: Sales Commission at an Indian IT Company

An IT services company signs a three-year managed services contract worth Rs. 18 crore. The sales team earns a commission of Rs. 36 lakh (2% of contract value) on signing, paid only if the contract is executed. There are no other selling costs tied directly to this contract.

The Rs. 36 lakh is incremental: it would not have been incurred without the contract. It is expected to be recovered through the contract revenues. It must be capitalised as a contract cost asset.

Journal entry at contract signing:

Dr Contract cost asset Rs. 36 lakh

Cr Accrued commissions / Cash Rs. 36 lakh

The asset is presented within the statement of financial position. IFRS 15 does not specify exactly where, so entities typically present it within current or non-current assets depending on the amortisation period, or within a specific contract costs line.

The Practical Expedient for Short Contracts

An entity may elect to expense incremental costs of obtaining a contract if the amortisation period would be one year or less. This is a practical expedient, not the default rule. Entities must elect it as an accounting policy.

Most Indian companies with a mix of short and long contracts elect this expedient for short contracts. A one-year maintenance agreement where the commission is paid on signing: expense it directly. A five-year outsourcing contract: capitalise and amortise.

The expedient is applied consistently to all qualifying contracts, not selectively.

Amortisation of Costs to Obtain a Contract

The asset is amortised on a systematic basis that is consistent with the transfer of the goods or services to which the asset relates. This sounds like it mirrors revenue recognition, but it is not exactly the same.

The amortisation period covers the period over which the entity expects to transfer goods or services to the customer in connection with the asset. This may be longer than the initial contract term if the entity expects to renew the contract and the commission covered expected renewals too.

When the amortisation period extends beyond the contract term:

If the sales commission covers both the initial contract and reasonably expected renewals, the amortisation period should reflect both. If a salesperson earns a lower renewal commission (because obtaining a renewal is less costly than a new sale), the initial contract commission is amortised over the initial term only. If the salesperson earns the same full commission on renewals, the economics suggest the initial commission was partly for obtaining the long-term customer relationship, not just the initial contract. Amortisation over the expected customer life is then appropriate.

Worked example: amortisation with renewal consideration

An IT company pays a sales commission of Rs. 60 lakh for a two-year outsourcing contract. Based on historical data, 70% of these contracts renew for a further two years with an additional commission of Rs. 15 lakh on renewal. On the initial commission:

If the Rs. 60 lakh covers only the initial two-year term: amortise over 24 months at Rs. 2.5 lakh per month
If the commission reflects the expected four-year relationship (because the renewal rate is high and the initial commission is significantly higher than the renewal commission, suggesting it priced in relationship development): amortise over 48 months at Rs. 1.25 lakh per month

This judgment call affects the income statement materially for large IT companies with significant contract acquisition costs. Infosys, Wipro, and TCS all disclose their contract cost amortisation policies in their annual reports. The period chosen reflects their assessment of expected customer relationships, not just contract terms.

Change in amortisation period:

If the expected amortisation period changes due to a contract renewal or contract modification, the change in the remaining amortisation period is a change in accounting estimate under IAS 8. Applied prospectively. No restatement.

Costs to Fulfil a Contract

Three Conditions for Capitalisation

Not every cost incurred in fulfilling a contract is capitalised. Costs to fulfil a contract are recognised as an asset only when all three of the following conditions are met:

The costs relate directly to a contract or an anticipated contract that the entity can specifically identify
The costs generate or enhance resources of the entity that will be used to satisfy performance obligations in the future
The costs are expected to be recovered

Costs that are within the scope of another IFRS standard are accounted for under that standard, not under IFRS 15. Costs of manufacturing inventory under IAS 2, costs related to PP&E under IAS 16, and development costs under IAS 38 each follow their own standards. IFRS 15 fills the gap for contract fulfilment costs that no other standard covers.

What qualifies:

Direct labour for pre-contract mobilisation, where the entity has secured the contract and is setting up the delivery infrastructure specifically for it
Direct materials purchased specifically for the contract before performance begins
Allocations of overheads that directly relate to the contract
Setup costs for IT systems built specifically to serve a customer's outsourcing contract, where those systems have no alternative use

What does not qualify:

General administrative costs and overheads that are not directly attributable to a specific contract
Wasted materials, labour, or other costs not reflected in contract pricing
Costs that relate to satisfied performance obligations (already expensed as revenue was recognised)
Selling costs (these fall under costs to obtain, not costs to fulfil)

Worked Example: IT Services Transition and Setup Costs

An Indian IT company wins a five-year BPO (business process outsourcing) contract. Before going live, it must set up dedicated servers, customise software, train staff, and migrate the client's data. These transition activities take three months and cost Rs. 90 lakh. The contract term after go-live is 60 months.

Are the Rs. 90 lakh transition costs capitalisable?

Do they relate directly to the contract? Yes. They are incurred specifically for this client and this contract.
Do they generate or enhance resources used to satisfy future obligations? Yes. The servers, customised software, and trained staff will be used to deliver the outsourcing services over the 60-month term.
Are they expected to be recovered? Yes. The contract pricing includes recovery of setup costs.

All three conditions met. Capitalise Rs. 90 lakh as a contract cost asset.

Amortisation: over the period the entity expects to transfer services, which is the 60-month service period. Monthly amortisation: Rs. 1.5 lakh per month.

The setup months themselves: during the three-month transition, the entity is not yet delivering the outsourcing services (assuming the performance obligation starts at go-live). No revenue is recognised during transition. The Rs. 90 lakh is capitalised and will be amortised once performance begins.

What About the Cost of Transition Labour That Reflects PP&E or IAS 38?

If the setup involves creating software that the entity will own and can use for other clients (general-purpose software), the development costs may fall under IAS 38 rather than IFRS 15. But if the software is client-specific with no alternative use, IAS 38's recognition criteria (particularly the requirement that the asset be capable of being used or sold) may not be met for a client-specific asset. In that case, IFRS 15 is the applicable framework, and the capitalisation depends on the three conditions above.

Impairment of Contract Cost Assets

Contract cost assets (both obtain and fulfil) are subject to impairment. An impairment loss is recognised to the extent the carrying amount of the contract cost asset exceeds:

The remaining consideration the entity expects to receive (transaction price allocated to remaining performance obligations)

Less: costs directly related to satisfying those remaining performance obligations that have not yet been expensed

Before testing contract cost assets for impairment, the entity first applies the impairment requirements of other relevant standards to any assets related to the same contract (inventories under IAS 2, PP&E under IAS 16, recognised intangibles under IAS 38). Only after those are applied does the IFRS 15 impairment test apply to remaining contract cost assets.

Worked example: impairment trigger

The IT company from the earlier example has a contract cost asset of Rs. 75 lakh (Rs. 90 lakh capitalised, Rs. 15 lakh amortised after 10 months). The client announces it will terminate the contract after month 18 (8 months from now) due to a corporate restructuring. The early termination clause entitles the IT company to a fee of Rs. 20 lakh.

Remaining consideration: Rs. 20 lakh (termination fee; future service revenue is no longer expected)

Less: costs to deliver remaining 8 months of service: Rs. 10 lakh

Net: Rs. 10 lakh

The carrying amount of the contract cost asset is Rs. 75 lakh. The recoverable amount under the IFRS 15 impairment test is Rs. 10 lakh. Impairment loss: Rs. 65 lakh.

Reversal of impairment: if conditions that caused the impairment subsequently change, the entity reverses the impairment loss to the extent of the original impairment. The reversal cannot increase the carrying amount above what it would have been had no impairment been recognised. This is identical to the impairment reversal logic under IAS 36.

Presentation and Disclosure

Presentation

IFRS 15 does not specify exactly where contract cost assets appear on the balance sheet. In practice:

Assets with amortisation periods of 12 months or less from the reporting date: current assets
Assets with longer amortisation periods: non-current assets

Some entities present separately labelled line items for contract cost assets. Others include them within prepayments or other receivables. What matters is that they are separately disclosed if material.

Contract cost assets are distinct from contract assets (which arise from performance under the contract before the right to consideration becomes unconditional). Do not confuse the two.

Required Disclosures

IFRS 15 requires the following disclosures for contract costs:

Judgments and methods: description of the judgments made in determining when costs are capitalised, the amortisation method, the amortisation period, and the basis for determining whether the practical expedient for short-duration contracts has been applied.

Carrying amounts: the closing balance of assets recognised from costs to obtain contracts and assets recognised from costs to fulfil contracts, presented separately.

Amortisation: the amount of amortisation recognised in the period for each category of contract cost asset.

Impairment: any impairment losses recognised in the period and any reversals.

These disclosures are straightforward but frequently incomplete in Indian company financials. I see many annual reports that mention "contract costs are capitalised and amortised" without specifying the amortisation period, the basis for determining it, or the closing balance by category. That does not satisfy IFRS 15's disclosure objective.

Common Errors in Practice

Error 1: Expensing All Sales Commissions Regardless of Contract Length

Some companies apply the practical expedient globally, expensing all commissions regardless of contract length. If the entity has significant multi-year contracts, this understates assets and overstates expenses in the contract acquisition year.

Error 2: Capitalising Bid Costs

Costs to prepare a tender or proposal that would have been incurred regardless of the outcome are not incremental. Expensing these is correct. Capitalising them because they are related to the contract that was ultimately won is wrong.

Error 3: Amortising Over the Contract Term Rather Than the Performance Period

For contracts with a long transition period before go-live, the amortisation of contract cost assets should begin when performance begins, not when the costs are incurred. Amortising setup costs over the transition period means the entity is amortising the cost asset before it is generating the benefits it relates to.

Error 4: Forgetting to Test for Impairment When Contracts Are at Risk

When a customer is in financial difficulty or has raised a contract dispute that may result in early termination, contract cost assets linked to that customer need an impairment assessment. Many finance teams test the receivable for credit impairment under IFRS 9 but forget the IFRS 15 contract cost asset sitting on the same balance sheet.

Error 5: Netting Contract Cost Assets Against Contract Liabilities

A contract cost asset (costs to obtain or fulfil) is a different animal from a contract liability (deferred revenue). They cannot be offset. Some entities present contract costs net of related contract liabilities in the notes. That misrepresents both the asset and the liability.

Ind AS 115 vs IFRS 15: Contract Costs

The contract costs requirements in Ind AS 115 are fully converged with IFRS 15. The incremental cost rule, the three conditions for fulfil cost capitalisation, the amortisation framework, the impairment test, and the practical expedient for one-year or less contracts are all identical.

One practical Indian-specific point: the income tax treatment of contract cost assets. Under the Income Tax Act 1961, commissions are typically deductible as incurred. Capitalising them for accounting purposes under Ind AS 115 creates a temporary difference for deferred tax purposes under Ind AS 12. Indian companies with significant contract cost assets carry a deferred tax liability for the timing difference between when the cost is deductible for tax and when it is amortised for accounting. Finance teams need to track this carefully.

What Big 4 Auditors Focus On

Incremental cost classification. Auditors challenge whether costs labelled as incremental would truly have been zero without the contract. Salary costs of a business development team that works on multiple pursuits simultaneously are not incremental to any single contract. Auditors test the basis of the entity's categorisation.

Amortisation period justification. For contracts with anticipated renewals, auditors examine the evidence supporting the assumed renewal rate and expected customer life. If management assumes a five-year customer relationship but historical data shows 60% of contracts lapse after two years, the assumption requires challenge.

Impairment completeness. Auditors link the contract cost asset register to the contract risk register. Any contract flagged as at risk for termination, dispute, or customer financial difficulty triggers an impairment assessment on the related contract cost asset.

Practical expedient consistency. If the entity elects the one-year expedient, auditors verify it is applied to all qualifying contracts, not selectively to contracts where expensing produces a better result.

Dip IFRS Exam Angle

Contract costs appear in Dip IFRS questions, usually as part of a broader IFRS 15 scenario. The most common question formats:

Identify whether a cost is capitalised or expensed: given a list of costs related to a contract, determine which are incremental (capitalise) and which are not (expense). Bid costs vs commissions vs setup costs.

Calculate the amortisation charge: given a capitalised cost and an amortisation period that may extend beyond the contract term, calculate the monthly or annual amortisation charge and the carrying amount at a given date.

Identify an impairment: given a scenario where contract economics deteriorate, calculate whether the contract cost asset is impaired and the impairment loss.

The most common trap: treating all costs related to winning and delivering a contract as capitalisable. Only incremental costs to obtain and qualifying fulfil costs meet the standard's criteria. The difference between a bid cost and a commission is a standard exam distinction.

FAQ

Are renewal commissions capitalised separately from initial commissions?

Yes, if renewal commissions are incremental to obtaining the renewal contract. The renewal commission is a new contract cost asset, amortised over the renewal term. The initial commission asset may have already been fully amortised by the renewal date if it was amortised over the initial term only.

What if the entity provides free setup services as part of the contract?

If setup services are provided as a distinct performance obligation at no additional charge, the costs of providing them are fulfilment costs. If they are not a distinct performance obligation but a necessary activity to enable future services, they are costs that meet the criteria for capitalisation as fulfil costs.

Can contract cost assets be revalued?

No. IFRS 15 does not permit revaluation of contract cost assets. They are carried at cost less amortisation less impairment.

Does the impairment test under IFRS 15 use the IAS 36 methodology?

No. The impairment test for contract cost assets uses a different, simpler framework specific to IFRS 15. The test is not based on recoverable amount (higher of VIU and FVLCD). It is based on whether the carrying amount exceeds the remaining consideration less remaining costs. IAS 36 applies only after the IFRS 15 impairment test, when the contract cost asset is included within a CGU.

Is a deferred commission a financial liability?

No. A commission payable to a salesperson that has been earned but not yet paid is a financial liability (accrued expense). The contract cost asset on the other side is an IFRS 15 asset, not a financial instrument. The two are separate.

How are contract costs treated in interim financial statements?

IAS 34 applies to interim statements. Contract cost assets are carried at their carrying amount less amortisation for the interim period less any impairment. The practical expedient for short-term costs applies equally to interim periods.

What happens to the contract cost asset if the customer terminates the contract early?

Any unamortised balance becomes impaired to the extent it exceeds the recoverable amount under the IFRS 15 impairment test. The impairment is recognised immediately. If the termination fee covers recovery of the remaining asset, no impairment arises.

Enroll with Global Fin X

IFRS 15's contract cost requirements affect the balance sheet and income statement of every company with significant contract acquisition and setup costs. Understanding when to capitalise, how to amortise, and when to impair is essential for both Dip IFRS candidates and working professionals in IT services, outsourcing, pharma, and any business with long-term contracts. Our structured programme covers every aspect of IFRS 15 across this series with in-depth lectures, worked examples, exam-style MCQs, and a purpose-built LMS for working professionals.

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This is Post 13B of the Global Fin X IFRS Series. Previous: IFRS 15 Part 3A: Special Topics. Next: IFRS 15 in Indian IT, Telecom and Real Estate: Real Cases.

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