The five revenue recognition steps of IFRS 15 – and how to apply them.
IFRS 15 became mandatory for accounting periods beginning on or after 1 January 2018. As entities and groups using the international accounting framework leave the old regime behind, let’s look at the more prescriptive new standard.
Changes, which include replacing the concept of transfer of ‘risks and rewards’ with ‘control’ and the introduction of ‘performance obligations’ alongside extensive disclosures, are likely to put more pressure on accountants and auditors to closely evaluate client contracts and challenge directors' judgements.
Here, we summarise the following five steps of revenue recognition and illustrative practical application for the most common scenarios:
New contracts may arise when terms of existing contracts are modified. Contract modifications:
The following are examples of circumstances which do not give rise to a performance obligation:
Identifying performance obligations may result in unbundling contracts into performance obligations, or combining contracts into a performance obligation, to recognise revenue correctly.
Unbundling a contract may apply when incentives are offered at the time of sale, such as free servicing or enhanced warranties. In this case servicing and warranties are performance obligations that are distinct and revenue relating to them needs to be recognised separately from the goods or services promised on the contract to which they relate.
Circumstances which could result in contracts being combined:
Variable amounts of consideration:
Adjustments for the effects of the time value of money (a ‘financing component’):
Allocation of transaction price may include allocation of discounts, which are applied:
Variable consideration is applied to a specific performance obligation if:
Contract modifications may require reassessment how consideration is allocated to performance obligations.
Recognition over time applies when:
The vendor’s performance creates an asset, when:
How to recognise revenue over time:
Capitalisation of costs associated with a sale contract (for example bidding costs, sales commission)