Revenue from Contracts

Table of Contents

IFRS 15 is a step forward in the simplification of financial reporting for global businesses.

Revenue recognition is the accounting principle that governs when revenue should be recorded. Revenues are recognized when they have been realized. IFRS 15 is based on a core principle requiring a company to recognize revenue in a way that reflects the pattern in which goods or services are transferred to customers.

IFRS 15 – Revenue from Contracts with Customers provides a comprehensive framework that has changed the way companies account for revenue and introduces a 5-step model for recognizing revenue from contracts with customers.

IFRS 15 replaced the following standards

IAS 18 Revenue,
IAS 11 Construction Contracts.

Scope

IFRS 15 applies to all contracts with customers except for:

leases within the scope of IFRS 16 Leases;
financial instruments within the scope of IFRS 9 Financial Instruments, IFRS 10 Consolidated Financial Statements, IFRS 11 Joint Arrangements, IAS 27 Separate Financial Statements, and IAS 28 Investments in Associates and Joint Ventures;
insurance contracts within the scope of IFRS 4 Insurance Contracts;

Impact

IFRS 15 impact on entities may be as below:

Revenue recognition may be accelerated or deferred,
Sales and contracting content may be reconsidered,
Change in accounting processes & controls,
Updating in IT and other control systems.

IFRS 18 Presentation and Disclosure in Financial Statements | ATIF

Recognition & Measurement

Five Step Model Framework

The core principle of IFRS 15 is that an entity will recognize revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services.

This core principle is delivered in a five-step model framework:

STEP 1: Identify the contract(s) with the customer

A contract with a customer will be within the scope of IFRS 15 if all the following conditions are met:

the contract has been approved by the parties to the contract;
each party’s rights in relation to the goods or services to be transferred can be identified;
the payment terms for the goods or services to be transferred can be identified;
the contract has commercial substance; and
It is probable that the consideration to which the entity is entitled to in exchange for the goods or services will be collected.

If a contract with a customer does not yet meet all of the above criteria, the entity will continue to re-assess the contract going forward to determine whether it subsequently meets the above criteria. From that point, the entity will apply IFRS 15 to the contract.

STEP 2: Identify the performance obligations in the contract

The next step is to identify the specific performance obligations distinct/bundle of goods or services – which have been promised to the customer in the contract.
At contract inception, an entity should assess the goods or services promised in a contract with a customer and should identify as a performance obligation each promise to transfer to the customer either:

a good or service (or a bundle of goods or services) that is distinct;
a series of distinct goods or services that are substantially the same and that have the same pattern of transfer to the customer.

STEP 3: Determine the transaction price

Step three requires the entity to determine the transaction price, which is the amount of consideration that an entity expects to be entitled to, before taking credit risk into account. The transaction price should include the impact of discounts, rebates, contingencies, incentives, and, for contracts over one year, the time value of money.

STEP 4: Allocate the transaction price to the performance obligations

For a contract that has more than one performance obligation, an entity should allocate the transaction price to each performance obligation in an amount that depicts the amount of consideration to which the entity expects to be entitled in exchange for satisfying each performance obligation.

STEP 5: Recognize revenue when (or as) each performance obligation is satisfied:

Revenue is recognized upon the satisfaction of performance obligations, which occurs when control of the good or service transfers to the customer. This can occur either at a point in time or over time. A performance obligation is satisfied over time, only if any of the following criteria are met:

the customer receives and consumes the benefits of the entity’s performance as the entity performs.
the entity’s performance creates or enhances an asset (work in process) that the customer controls as the asset is created or enhanced.
the entity’s performance does not create an asset with an alternative use to the entity, and the customer does not have control over the asset created, but the entity has an enforceable right to payment for performance completed to date.

The point at which control passes will vary from contract to contract however the following should be considered to determine the point at which control passes:

transfer of legal title
physical transfer
passing of significant risks and rewards
acceptance by the customer

Bottom Line

Applying IFRS 15 – Revenue from Contracts with Customers could result in material changes to revenue recognition policies, as revenue currently recognized over the contract’s life may instead be recognized on completion of identified performance obligations.

ABOUT THE AUTHOR

Humayun Atif | CMA, CPA, CA (FIN), MS-IT, Oracle Certified, CA Articles from Big4

Atif is passionate about Business, Tech, and the written word. He is the author of the book ‘IFRS Made Easy’. He is a tax and IFRS coach and the founder of accountingblogger.com

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Revenue from Contracts – IFRS 15 | Atif