This is the first of two articles covering key principles from IFRS 15 Revenue from Contracts with Customers.

IFRS 15 sets out a five-step approach to determine when and how to recognise revenue.

The Strategic Business Reporting (SBR) exam regularly tests the topic of revenue. However, candidate performance in this area tends to be poor. Sitting after sitting, candidates waste time writing out the five steps of the revenue recognition model, even though most of these steps are not relevant to the scenario. Candidates clearly know the five steps at a high level, but most lack knowledge of the detail within each of these steps.

Exam requirements in SBR normally test one or two of these steps. To score a high mark, candidates need to:

• identify the relevant principles from IFRS 15 which are applicable to the scenario, and
• apply these principles to the specific information provided in the scenario

This approach will be demonstrated throughout the two articles.

This first article will cover steps 1-3. The second article will cover steps 4 and 5, as well as the accounting implications of contract modifications and contract costs.

Step 1 – Identify the contract

IFRS 15 defines a contract as an agreement between two or more parties which creates enforceable rights and obligations

The following criteria must be met for an entity to account for a contract with a customer:

a) the parties to the contract have approved the contract and are committed to perform their respective obligations

b) the entity can identify each party’s rights regarding the goods or services to be transferred

c) the entity can identify the payment terms for the goods or services to be transferred

d) the contract has commercial substance; and

e) it is probable that the entity will collect the consideration to which it will be entitled in exchange for the goods or services which will be transferred to the customer.

Most of the criteria are designed to confirm the enforceable rights and obligations mentioned in the definition of a contract, which are then used when applying steps 2 – 5 of the revenue recognition model.

The last criterion prevents entities from inflating revenue for arrangements where consideration was never actually expected to be received. In simple terms, if there is no expectation of being paid, then revenue should not be recognised.

If the criteria are not initially satisfied, the entity can continue to assess them. There may, for example, be a change in circumstances which improves the probability of the consideration being collected, at which point the remaining steps of the IFRS 15 revenue recognition model can be applied.

EXAMPLE
Here is an extract from a scenario which appeared in Q4 of SBR specimen exam 2.

We can apply step 1 of IFRS 15 as follows:

Criterion: The entity can identify each party’s rights regarding the goods or services to be transferred

Application: Kiki has the right to receive the royalty fees and Colour has the right to use the characters and imagery in its comic books

Criterion: The entity can identify the payment terms for the goods or services to be transferred

Application: There is a set royalty fee for each issue sold which contains the characters/imagery

Criterion: It is probable that the entity will collect the consideration to which it will be entitled in exchange for the goods or services that will be transferred to the customer

Application: Colour has a strong credit rating and therefore this condition is satisfied

Conclusion: The criteria for accounting for the contract with Colour have been satisfied.

Step 2 – Identify the separate performance obligations

IFRS 15 defines a performance obligation as a promise to transfer to the customer either:

(a) a good or service (or a bundle of goods or services) which is distinct, or

(b) a series of distinct goods or services which are substantially the same and which have the same pattern of transfer to the customer.

Sometimes, it can be relatively straightforward to assess whether goods or services are distinct from one another. For example, if an entity enters a contract to sell a computer to a customer and to provide that customer with a three-year maintenance service, then there are clearly two distinct performance obligations: the sale of the computer; and the provision of a maintenance service. However, many real-life scenarios – and, therefore, exam scenarios – are not so straightforward. In such cases, the principles in IFRS 15 must be applied.

IFRS 15 provides the following guidance to help identify a ‘distinct’ performance obligation:

a) the customer can benefit from the good or service either on its own or together with other resources that are readily available to the customer (ie the good or service is capable of being distinct), and

b) the entity’s promise to transfer the good or service to the customer is separately identifiable from other promises in the contract (ie the promise to transfer the good or service is distinct within the context of the contract)

EXAMPLE
The extract below is taken from Q2 of the published September/December 2025 SBR sample exam.

The requirement asked candidates to discuss whether the up-front fee represents a separate performance obligation and how to account for the $120,000 received.

A comprehensive response to this requirement would include the following:

• Explanation of a separate performance obligation:
  
  
  • A performance obligation is a promise to transfer distinct goods or services to the customer.
     
• Application to the scenario/requirement:
  
  
  • The up-front fee is for the costs of setting up the contract.
  • This is not associated with the transfer of a distinct good or service to the customer.
  • Therefore, it is not a separate performance obligation.
     
• Impact on accounting treatment:
  
  
  • The $120,000 fee would be initially recognised as a contract liability.
  • It will be recognised as revenue over the period in which the goods are delivered.

EXAMPLE

Step 3 – Determine the transaction price

IFRS 15 defines the transaction price as the amount of consideration to which an entity expects to be entitled in exchange for transferring promised goods or services to a customer, excluding amounts collected on behalf of third parties (for example, some sales taxes).

The following factors may need to be considered when determining the transaction price:

a) Variable consideration

b) Constraining estimates of variable consideration

c) The existence of a significant financing component

d) Non-cash consideration

e) Consideration payable to a customer

Variable consideration

This exists when the consideration promised in a contract includes a variable element.

Variable consideration must be estimated. IFRS 15 sets out two acceptable methods; an entity should apply the method that it expects will better predict the amount of consideration to which it will be entitled.

The two estimation methods are as follows:

1) Expected value:

• This is the sum of probability-weighted amounts within a range of possible amounts.
• This may be the most appropriate estimation method when the entity has a large number of contracts with similar characteristics.

2) Most likely amount:

• This is the single most likely amount in a range of possible amounts.
• This may be the most appropriate estimation method if the contract only has two possible outcomes, for example either achieving a bonus or not.

EXAMPLE

Constraining estimates of variable consideration

IFRS 15 states that an entity shall include in the transaction price some or all of an amount of variable consideration only to the extent that it is highly probable that a significant reversal in the amount of cumulative revenue recognised will not occur when the uncertainty associated with the variable consideration is subsequently resolved.

This principle is designed to prevent material amounts of uncertain revenue being recognised in one period and then subsequently reversed in a later period.  It is an application of the prudence concept, and was developed because a lot of high-profile accounting standards have involved the inflation of revenue.

EXAMPLE

Significant financing component

According to IFRS 15, an entity shall adjust the promised amount of consideration for the effects of the time value of money if the timing of payments agreed by the parties to the contract provides the customer or the entity with a significant financing benefit. This may be the case if there is a significant gap between the transfer of the good or service and the payment by the customer.

The discount rate applied when adjusting the consideration is the rate which would be reflected in a separate financing transaction between the entity and the customer. This will depend on the credit worthiness of the customer.

This is an application of substance over form. It removes the effect of the financing from the amount recognised within revenue. The difference between the revenue recognised and the consideration received is instead included in the investing category of the statement of profit or loss as interest expense or interest income (unless providing finance to customers is a specified main business activity for the entity, in accordance with IFRS 18 Presentation and Disclosure in Financial Statements).

EXAMPLE

There is no need to recognise any financing component if, at inception of the contract, the period between transfer of the good or service and the payment by the customer is one year or less.

Non-cash consideration

According to IFRS 15, non-cash consideration should be measured at its fair value. If the fair value cannot be reasonably estimated, it is instead measured indirectly by reference to the stand-alone selling price of the goods or services promised to the customer.

EXAMPLE

Consideration payable to a customer

According to IFRS 15, an entity shall account for consideration payable to a customer as a reduction in the transaction price and, therefore, of revenue unless the payment to the customer is in exchange for a distinct good or service which the customer transfers to the entity.

If the payment is for a distinct good or service, the entity would account for this as a normal purchase from a supplier.

EXAMPLE

See part 2 of this article for steps 4 and 5 of the IFRS 15 five-step approach to revenue recognition.