Recognising revenue when assets are transferred for services
An entity enters into an agreement with a customer involving the outsourcing of information technology (IT) functions. As part of the agreement, the customer transfers ownership of its existing IT equipment to the entity. Initially, the entity must use the equipment to provide the service required by the outsourcing agreement. The entity is responsible for maintaining the equipment and for replacing it when it decides to do so. The useful life of the equipment is estimated to be three years. The outsourcing agreement requires service to be provided for ten years for a fixed price that is lower than the price the entity would have charged if the IT equipment had not been transferred.
These facts indicate that the IT equipment is an asset of the entity, which will recognise the equipment and measure its cost on initial recognition at its fair value, together with a liability to provide the service. Because the price charged for the service is lower than the price the entity would charge without the transfer of the IT equipment, this service is a separately identifiable service included in the agreement. The facts also indicate that it is the only service to be provided in exchange for the transfer of the IT equipment. Therefore, the entity should recognise revenue arising from the exchange transaction when the service is performed, i.e. over the ten-year term of the outsourcing agreement.
Alternatively, assume that after the first three years, the price the entity charges under the outsourcing agreement increases to reflect the fact that it will then be replacing the equipment the customer transferred. In this case, the reduced price for the services provided under the outsourcing agreement reflects the useful life of the transferred equipment. For this reason, the entity should recognise revenue from the exchange transaction over the first three years of the agreement.