Learning Outcomes
After reading this article, you will be able to explain when revenue from contracts with customers should be recognised under IFRS 15. You will understand the five-step revenue recognition model, describe what constitutes a contract and a separate performance obligation, and correctly apply transaction price determination and allocation in ACCA FR exam style questions.
ACCA Financial Reporting (FR) Syllabus
For ACCA Financial Reporting (FR), you are required to understand and apply IFRS 15 for the recognition of revenue. Focus your revision on the following syllabus areas, which are covered in this article:
- The identification and criteria for contracts with customers under IFRS 15
- The identification of performance obligations within a contract
- The determination and allocation of the transaction price to performance obligations
- The point at which revenue is recognised—either over time or at a point in time
- Applying the five-step model to different transaction types
Test Your Knowledge
Attempt these questions before reading this article. If you find some difficult or cannot remember the answers, remember to look more closely at that area during your revision.
- List the five sequential steps of the IFRS 15 revenue recognition model.
- True or false? A contract must always be in writing to be within the scope of IFRS 15.
- What are the minimum criteria a contract must meet to be accounted for under IFRS 15?
- In what circumstances is revenue recognised over time rather than at a point in time?
Introduction
Revenue is a critical figure in most financial statements and is tightly controlled by accounting standards. IFRS 15—Revenue from Contracts with Customers—sets out a clear, principles-based five-step model for recognising revenue from contracts with customers. The correct application of this model is frequently tested in the ACCA FR exam, focusing on contract identification, performance obligations, and recognition timing.
Key Term: contract
An agreement between two or more parties that creates enforceable rights and obligations, which can be written, oral, or established by customary business practices.
THE IFRS 15 FIVE-STEP REVENUE RECOGNITION MODEL
IFRS 15 requires revenue to be recognised in accordance with the following strict sequence of steps:
- Identify the contract(s) with a customer
- Identify the separate performance obligations in the contract
- Determine the transaction price
- Allocate the transaction price to the performance obligations in the contract
- Recognise revenue when (or as) each performance obligation is satisfied
Each step must be satisfied before proceeding to the next.
Step 1: Identify the Contract
A contract with a customer exists under IFRS 15 only if all the following criteria are met:
- The parties have approved the contract and intend to perform their obligations
- Each party’s rights and payment terms can be identified
- The contract has commercial substance (i.e., it will affect the entity’s future cash flows)
- It is probable that the entity will collect the consideration to which it is entitled
A contract can be written, oral, or arise from customary business practices. If the contract does not meet all the above, no revenue should be recognised under IFRS 15.
Step 2: Identify Performance Obligations
Performance obligations are distinct goods or services, or bundles of goods or services, promised in a contract.
A good or service is considered distinct if both:
- The customer can benefit from it on its own (or together with other resources readily available)
- It is separately identifiable from other promises in the contract
Separate all distinct goods and services as individual performance obligations for revenue allocation.
Key Term: performance obligation
A promise in a contract to transfer a distinct good or service, or a bundle, to the customer.
Step 3: Determine the Transaction Price
The transaction price is the amount of consideration an entity expects to be entitled to in exchange for transferring goods or services. This excludes amounts collected for third parties, such as sales taxes.
Adjustments to the transaction price may be required for:
- Variable consideration (bonuses, rebates, penalties)
- Significant financing components (payment in advance or in arrears)
- Non-cash items and amounts payable to the customer
Key Term: transaction price
The amount of consideration an entity expects to receive in exchange for goods or services transferred.
Step 4: Allocate the Transaction Price to Performance Obligations
Where a contract contains more than one performance obligation, allocate the transaction price to each based on the stand-alone selling price of each obligation at contract inception.
If observable prices are not available, estimate using appropriate methods such as adjusted market assessments or expected cost plus margin.
Discounts are usually allocated proportionately unless evidence shows the discount applies only to certain performance obligations.
Step 5: Recognise Revenue When (or as) Performance Obligation is Satisfied
Revenue is recognised when (or as) the entity transfers control of a good or service to the customer.
Key Term: control
The ability to direct the use of, and obtain substantially all remaining benefits from, the asset.
A performance obligation is satisfied:
- At a point in time (e.g., when goods are delivered and legal title passes)
- Over time if at least one of the following is met:
- The customer simultaneously receives and consumes the benefits
- The entity is creating or enhancing an asset the customer controls as it is created
- The entity's performance does not create an asset with alternative use and the entity has an enforceable right to payment for performance to date
Worked Example 1.1
Warren Ltd sells machinery for $60,000, with $10,000 payable upfront and the balance after one year. Market interest rate is 6%. When and how much revenue is recognised?
Answer:
Revenue is recognised when control passes, measured at present value of consideration. The deferred $50,000 is discounted at 6% for one year: $50,000 × 1/1.06 = $47,170. Total revenue at recognition date is $10,000 + $47,170 = $57,170. The difference of $2,830 is recognised as interest income over the year.
Worked Example 1.2
Gemini Co enters into a contract to supply equipment and three years of maintenance for $25,000. The observable stand-alone price for the equipment is $20,000 and for maintenance is $9,000. How should the $25,000 be allocated?
Answer:
Total stand-alone price = $29,000. Allocate: Equipment: $25,000 × (20,000 / 29,000) = $17,241. Maintenance: $25,000 × (9,000 / 29,000) = $7,759. Revenue for equipment is recognised when delivered; maintenance is recognised over three years.
Worked Example 1.3
A construction company builds offices for $800,000. At year-end, 50% of work (certified by a surveyor) is complete, with costs incurred of $380,000 and estimated costs to finish of $320,000. How much revenue and profit can be recognised at year-end?
Answer:
Percentage completion = 50%. Revenue to date = $800,000 × 50% = $400,000. Cost of sales to date = $380,000. Profit recognised = $400,000 – $380,000 = $20,000.
Exam Warning
A frequent mistake is recognising all revenue at the time a contract is signed, or when cash is received, rather than when control passes or performance occurs. Ensure timing is based on transfer of control, not payment date or contract signature.
SPECIAL ISSUES IN REVENUE CONTRACTS
Contract Modifications
When contracts are modified, assess whether the modification represents a new contract or the continuation of the existing contract based on whether additional goods/services are distinct.
Principal vs Agent
If the company controls the good or service before transfer, it is the principal and recognises revenue on a gross basis. If the entity facilitates the provision without control, it acts as an agent and recognises revenue only for commission or fee.
Significant Financing Component
Where contract payment terms provide the customer or entity with a material financing benefit, the consideration must be discounted to present value. The unwinding of the discount is recorded as interest income or expense.
Revision Tip
When calculating progress for revenue over time, always use the measure specified in the contract—either an input method (e.g., costs incurred to date/total expected costs) or output method (e.g., surveys of work certified).
Summary
IFRS 15 requires revenue to be recognised only after passing through a systematic five-step model: identify the contract, performance obligations, transaction price, allocation, and recognition when (or as) performance obligations are satisfied. Accurate contract analysis and allocation are critical for correct revenue recognition.
Key Point Checklist
This article has covered the following key knowledge points:
- State and apply the five-step revenue recognition model under IFRS 15
- Identify the necessary criteria for accounting for contracts with customers
- Define and recognise separate performance obligations in a contract
- Calculate and allocate the transaction price
- Distinguish when revenue should be recognised over time or at a point in time
- Understand the impact of significant financing components, contract modifications, and principal vs agent considerations
Key Terms and Concepts
- contract
- performance obligation
- transaction price
- control