How to Deal with Revenue Recognition Under IFRS 15

IFRS 15 is the new accounting standard for revenue recognition that came into effect on 1 January 2018. It replaces the previous standards and interpretations, such as IAS 18 and IAS 11, and introduces a single, principles-based five-step model for recognizing revenue from contracts with customers. In this article, we will explain how to apply IFRS 15 in your business.

What is revenue recognition?

Revenue recognition is the process of recording the amount of income that an entity has earned from providing goods or services to its customers. Revenue recognition is important because it affects the financial performance and position of an entity, as well as its taxation and cash flows.

What are the five steps of revenue recognition?

Under IFRS 15, an entity should recognize revenue by applying the following five steps:

– Identify the contract with a customer
– Identify the performance obligations in the contract
– Determine the transaction price
– Allocate the transaction price to the performance obligations
– Recognize revenue when (or as) the entity satisfies a performance obligation

Let’s look at each step in more detail.

Step 1: Identify the contract with a customer

A contract is an agreement between two or more parties that creates enforceable rights and obligations. A contract with a customer exists when:

– The parties have approved the contract and are committed to perform their respective obligations
– The entity can identify each party’s rights and obligations regarding the goods or services to be transferred
– The entity can determine the payment terms for the goods or services to be transferred
– The contract has commercial substance (i.e., it will affect the cash flows or risks of the parties)
– It is probable that the entity will collect the consideration to which it will be entitled

If a contract does not meet these criteria, the entity should not recognize revenue until the criteria are met or until the contract is terminated.

Step 2: Identify the performance obligations in the contract

A performance obligation is a promise to transfer a distinct good or service (or a series of distinct goods or services) to a customer. A good or service is distinct if:

– The customer can benefit from it on its own or together with other resources that are readily available
– The entity’s promise to transfer it is separately identifiable from other promises in the contract

The entity should account for each distinct good or service as a separate performance obligation. However, some goods or services may not be distinct and may need to be combined with other goods or services and treated as a single performance obligation.

Step 3: Determine the transaction price

The transaction price is the amount of consideration that an entity expects to receive in exchange for transferring goods or services to a customer. The transaction price may include fixed or variable amounts, such as discounts, rebates, incentives, penalties, etc. The entity should estimate the transaction price by considering all relevant factors and using either an expected value or a most likely amount approach.

The transaction price may also be affected by financing components, non-cash consideration, consideration payable to a customer, or significant changes in circumstances. The entity should adjust the transaction price accordingly if any of these factors are present.

Step 4: Allocate the transaction price to the performance obligations

The entity should allocate the transaction price to each performance obligation on a relative stand-alone selling price basis. This means that the entity should estimate how much it would charge for each good or service if it sold it separately to a similar customer in similar circumstances.

The entity may use various methods to estimate the stand-alone selling prices, such as market prices, cost-plus margins, adjusted market assessments, residual values, etc. However, if there is observable evidence of a stand-alone selling price for a good or service, the entity should use that evidence.

Step 5: Recognize revenue when (or as) the entity satisfies a performance obligation

The entity should recognize revenue when (or as) it transfers control of a good or service to a customer. Control is the ability to direct the use of and obtain substantially all of the remaining benefits from an asset. Control also means that the customer can prevent others from directing the use of and obtaining benefits from an asset.

The entity should assess whether it transfers control of a good or service over time or at a point in time. If control transfers over time, then revenue should be recognized over time using an appropriate method (such as output-based or input-based methods). If control transfers at a point in time, then revenue should be recognized at that point.

The entity should consider various indicators to determine whether control transfers over time or at a point in time, such as:

– Whether the customer has a present obligation to pay for the asset
– Whether the customer has legal title to the asset
– Whether the customer has physical possession of the asset
– Whether the customer has significant risks and rewards of ownership of the asset
– Whether the customer has accepted the asset

Conclusion

IFRS 15 is a comprehensive and complex standard that requires careful analysis and judgment to apply correctly. It affects many industries and transactions, and may have significant impacts on the timing and amount of revenue recognition, as well as on the disclosures and internal controls of an entity. Entities should therefore understand the requirements and implications of IFRS 15 and communicate them clearly to their stakeholders.

Sources:

(1) IFRS 15 — Revenue from Contracts with Customers – IAS Plus. https://www.iasplus.com/en/standards/ifrs/ifrs15.
(2) IFRS 15 – revenue recognition steps | ACCA Global. https://www.accaglobal.com/gb/en/technical-activities/technical-resources-search/2018/october/IFRS15-revenue-recognition-steps.html.
(3) Revenue from Contracts with Customers IFRS 15. https://www.ifrs.org/content/dam/ifrs/publications/pdf-standards/english/2021/issued/part-a/ifrs-15-revenue-from-contracts-with-customers.pdf.