Accounting for customer options
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Customer options are common in revenue arrangements. A customer may receive an option to purchase additional goods or services, renew a contract, obtain additional products at a discount, or receive other benefits in the future.
The accounting becomes particularly important when the customer actually exercises the option.
The key question is:
How should an entity account for the exercise of a customer option under IFRS 15?
The answer depends first on whether the option provided the customer with a material right.
1. Start with the material-right assessment
IFRS 15 requires an entity to assess whether an option to acquire additional goods or services gives the customer a right that they would not receive without entering into the original contract.
An option is a material right when, for example, it provides the customer with a discount that is incremental to the range of discounts normally offered to that class of customer in that geographical area or market.
If the option provides a material right, the option is treated as a separate performance obligation.
If it does not provide a material right, it is generally treated as a marketing offer rather than a performance obligation.
This distinction is fundamental because it determines what happens both when the original contract is entered into and when the option is subsequently exercised.
2. What happens when the option is a material right?
Suppose an entity sells a product to a customer and, as part of that transaction, gives the customer an option to purchase another product in the future at a significant discount.
If that discount represents a material right, the entity cannot simply recognise all of the original transaction price as revenue for the first product.
Instead, part of the transaction price is allocated to the option.
At inception
The entity:
identifies the option as a separate performance obligation;
estimates the stand-alone selling price of the option;
allocates part of the transaction price to the option; and
records the allocated amount as a contract liability.
The amount allocated to the option is not revenue at this point because the entity has not yet satisfied the performance obligation associated with the option.
IFRS 15.B42 requires the stand-alone selling price of the option to reflect, among other things, the discount the customer would receive on exercise, adjusted for discounts generally available to customers and the likelihood that the customer will exercise the option.
3. What happens when the customer exercises the option?
This is the central issue.
When the customer exercises an option that was a material right, the entity has to account for the goods or services that the customer is now entitled to receive.
The amount that was previously allocated to the option is already sitting in the contract liability.
When the underlying goods or services are transferred to the customer, the entity therefore recognises:
the amount previously allocated to the option + the additional consideration paid by the customer
as revenue, subject to the normal IFRS 15 recognition requirements.
In other words, the amount deferred when the option was originally granted does not disappear when the option is exercised. It is released from the contract liability and recognised as revenue when the underlying goods or services are transferred.
4. Two approaches discussed by the TRG
The accounting for the exercise of a material-right option was discussed by the IFRS 15 Transition Resource Group (TRG).
Two approaches were identified.
View A — update the transaction price
Under View A, when the customer exercises the option, the entity updates the transaction price to include the additional consideration arising from the exercise.
The consideration previously allocated to the option remains part of the economics of the transaction.
The entity then allocates the relevant consideration to the underlying goods or services and recognises revenue when or as those goods or services are transferred.
View B — account for the exercise as a contract modification
Under View B, the exercise of the option is treated as a contract modification.
Because the additional goods or services are being provided at a price below their stand-alone selling price—the feature that caused the original option to be a material right—the modification generally does not qualify as a separate contract under IFRS 15.20.
Instead, the entity applies the contract-modification guidance and accounts for the additional goods or services prospectively as appropriate.
The TRG discussion identified both approaches as acceptable, with entities applying their chosen approach consistently.
Importantly, these approaches are most easily understood as different ways of operationalising the same underlying economics: the customer has exercised a right that was already accounted for as part of the original arrangement.
5. A simple example
Consider the following example.
A retailer sells Product X for CU1,000.
As part of the transaction, the customer receives a voucher giving them 40% off their next purchase.
The retailer normally offers customers a 10% discount. Therefore, the incremental benefit provided by the voucher is 30%.
Assume that the option is assessed to provide a material right and that the customer has an 80% probability of exercising it.
The estimated stand-alone selling price of the option is:
CU1,000 × (40% − 10%) × 80% = CU240
The stand-alone selling price of Product X is CU1,000, so the total estimated stand-alone selling prices are:
Item | Stand-alone selling price |
Product X | CU1,000 |
Option | CU240 |
Total | CU1,240 |
The CU1,000 transaction price is therefore allocated on a relative stand-alone selling price basis.
Allocation to Product X
CU1,000 × 1,000 / 1,240 = CU806.45
Allocation to the option
CU1,000 × 240 / 1,240 = CU193.55
The accounting at the initial sale is therefore:
Account | Debit | Credit |
Cash | CU1,000.00 | |
Revenue — Product X | CU806.45 | |
Contract liability — option | CU193.55 |
The CU193.55 is deferred because the material right has not yet been exercised or otherwise satisfied.
6. The customer exercises the option
The customer subsequently purchases Product Y.
The normal selling price of Product Y is CU1,000, but the customer receives the 40% discount and pays CU600.
At this point, the entity has:
CU193.55 previously allocated to the option; and
CU600 of additional consideration received from the customer.
Therefore, under the continuation approach illustrated in the TRG discussion, the revenue associated with Product Y is:
CU193.55 + CU600 = CU793.55
The accounting entry when Product Y is transferred is:
Account | Debit | Credit |
Cash | CU600.00 | |
Contract liability — option | CU193.55 | |
Revenue — Product Y | CU793.55 |
The total revenue recognised over the two transactions is therefore:
CU806.45 + CU793.55 = CU1,600
This equals the total consideration ultimately received:
CU1,000 + CU600 = CU1,600.
7. What if the option is not a material right?
Not every customer option is a material right.
For example, suppose a retailer tells a customer:
"You can purchase another product next month at its normal stand-alone selling price."
The fact that the customer received this offer only because they entered into the original contract does not, by itself, make the option a material right.
If the customer could obtain the same pricing without entering into the original contract, there is generally no incremental benefit.
In that situation:
the option is not a separate performance obligation;
no portion of the original transaction price is allocated to the option; and
no contract liability is recognised for the option.
When the customer subsequently exercises the option, the entity accounts for the additional purchase under the normal IFRS 15 requirements.
In substance, the additional purchase is treated as a new transaction unless it forms part of an existing arrangement that requires application of the contract-modification guidance.
8. Do not include future exercise consideration in the original transaction price
A common mistake is to reason as follows:
The customer is likely to exercise the option, so the entity should include the expected future purchase price in the transaction price from day one.
That is not the correct approach.
Consideration that would arise only if the customer exercises the option is not included in the transaction price simply because the entity expects exercise.
The entity does not yet have an enforceable right to that future consideration.
Therefore, the transaction price at inception does not include consideration that is contingent solely on the customer's future exercise of the option.
This is an important distinction between:
variable consideration arising from existing contractual rights; and
future consideration that arises only if a customer exercises an option.
9. What if the customer never exercises the option?
An option can also expire.
If the option was a material right, the entity will have recognised a contract liability for the portion of consideration allocated to that right.
If the customer does not exercise the option, the entity needs to consider the breakage requirements in IFRS 15.B44–B47.
Where the entity expects to be entitled to breakage, expected breakage is recognised as revenue in proportion to the pattern of rights exercised.
If the entity does not expect to be entitled to breakage, the amount is generally recognised when the likelihood of the customer exercising the remaining rights becomes remote.
Thus, the accounting does not simply involve leaving the contract liability indefinitely.
10. Renewal options are a special case
Renewal options can also give rise to material rights.
For example, a customer may enter into a one-year contract with an option to renew for another year at a price that is below the price normally available to comparable customers.
If the renewal option provides a material right, the entity may allocate consideration to that option.
IFRS 15.B43 provides a practical alternative for certain renewal options: rather than estimating the stand-alone selling price of the renewal option directly, an entity may allocate the transaction price by reference to the goods or services expected to be provided and the corresponding expected consideration.
When the customer renews, the amount previously deferred for the renewal right is then recognised in accordance with the applicable revenue recognition requirements.
11. The key accounting distinction
The entire analysis can be summarised in one table:
Material right | Not a material right | |
Separate performance obligation? | Yes | No |
Allocate original transaction price to option? | Yes | No |
Contract liability at inception? | Yes | No |
Future exercise consideration included at inception? | No | No |
Accounting on exercise | Recognise deferred amount plus relevant additional consideration as the underlying goods/services are transferred | Account for additional purchase under normal IFRS 15 requirements |
If option expires | Apply breakage guidance | No deferred option balance exists |
12. Why the material-right assessment matters so much
The material-right assessment is the starting point for the entire accounting model.
An entity should carefully consider:
the discount available through the option;
discounts normally offered to the relevant class of customers;
the geographical area or market;
the probability that the customer will exercise the option;
whether the customer receives a benefit that they would not otherwise receive; and
whether multiple rights accumulate, such as in loyalty programmes.
The objective is not simply to determine whether the option has a numerical discount. The question is whether the customer receives a material incremental right as a result of entering into the contract.
13. The practical answer
So, how should an entity account for the exercise of a customer option?
The answer can be stated quite simply:
First determine whether the option provided a material right. If it did, the option is a performance obligation and part of the original transaction price is deferred as a contract liability. When the customer exercises the option, the entity recognises the amount allocated to the option together with the relevant additional consideration as revenue when or as the underlying goods or services are transferred. If the option did not provide a material right, no amount is allocated to the option at inception and the additional purchase is accounted for under the normal IFRS 15 requirements when exercised.
The critical accounting principle is therefore that exercise of a material-right option is not simply a completely new transaction. The entity must take into account the amount that was already allocated to the option when the original contract was accounted for.
Conclusion
Customer options illustrate an important feature of IFRS 15: revenue recognition depends not merely on the cash received but on the rights and obligations created by the contract.
The analysis has three essential stages:
At inception → determine whether the option is a material right.
If it is → allocate part of the transaction price to the option and recognise a contract liability.
On exercise → recognise the deferred amount, together with the relevant additional consideration, as the underlying goods or services are transferred.
If the option is not a material right, there is no initial deferral and the subsequent purchase is accounted for under the normal IFRS 15 model.
For most practical situations, therefore, the most important question is not "What happens when the customer exercises the option?" but rather:
What did the customer receive when the original contract was signed, and did the option constitute a material right?
Once that question has been answered, the accounting for exercise follows much more naturally.
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