The new revenue recognition model
4.1 (IFRS 15) FRS 115 Revenue from Contracts with Customers introduces a 5-steps model that is to be applied to all revenue transactions irrespective of the nature of the entity’s business. The new model therefore applies to revenue from the sale of goods, services render, construction contracts, royalties etc.
4.2 The following provides an overview of the new revenue recognition model:
(a) Step 1 Identify contract(s) with customer
(b) Step 2 Identify performance obligations in the contract
(c) Step 3 Determine transaction price
(d) Step 4 Allocate transaction price to separate performance obligations in the contract
(e) Step 5 Recognise revenue when (or as) each performance obligation is satisfied
4.3 (IFRS 15) FRS 115 Revenue from Contracts with Customers establishes a comprehensive framework for determining when to recognise revenue and how much revenue to recognise.
4.4 The core principle is to recognise revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the company expects to be entitled in exchange for those goods or services.
(a) “Promised” – identify what the entity has promised the customer
(b) “Expects” – what the entity expects to be paid in return
Step 1 Identify contract(s) with a customer
5.1 The first step is to identify the contract(s) and to assess at the inception of contract(s).
5.2 (IFRS 15) FRS 115 Revenue from Contracts with Customers states that a contract is an agreement between tow or more parties that creates enforceable rights and obligations. Enforceability of the rights and obligations in a contract is a matter of law. Contracts can be written, oral or implied by an entity’s customary business practices.
5.3 An entity shall account for a contract with a customer only when all of the following 5 contract requirements are met:
(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 that will be transferred to the customer.
5.4 If a contract does not yet meet all the above requirements, the entity must continue to re-assess the contract going forward to determine whether it subsequently meets the required criteria.
5.5 The collectability criterion must be met. The entity must consider only the customer’s ability and intention to pay that amount of consideration when it is due.
5.6 Collectability refers to the customer’s intent and able to pay the promised consideration when due and that it is “probable” the entity will collect the consideration to which it will be entitled.
5.7 Collectability assessment relates to the transaction price, the assessment is therefore applied to the transaction price, not the stated contract price.
5.8 Significant judgement and experience will be required to determine if a partial payment is an implied price concession or an impairment loss (i.e. credit loss).
5.9 Contract modification
(a) The standard provides detailed guidance on how to account for contract modification.
(b) If certain conditions are met, a contract modification will be accounted for as a separate contract with the customer.
(c) If not, it will be accounted for as a modification of the original contract with the customer. Whether to account for prospectively or retrospectively (i.e. whether the change is accounted for going forward or changing the accounting already made) depends on whether the remaining goods or services to be delivered after the modification are distinct from those delivered prior to the modification.
5.10 Summary of Step 1 Identify contract(s) with a customer
(a) (i) Contract defined as an agreement between two or more parties that creates enforceable rights and obligations.
(ii) Applies to each contract that has been agreed upon with a customer and meets specified criteria.
(iii) Contracts must be combined when specified criteria are met.
(iv) Specifies how to account for contract modifications.
(b) Key changes in (IFRS 15) FRS 115
(i) Having oral or implied agreements as contracts may be a change in practice to some entities.
(ii) Unlike the current standard, (IFRS 15) FRS 115 specifies how to account for transactions with customers that do not meet the specified criteria for a contract.
(iii) (IFRS 15) FRS 115 provides more explicit requirements on when to combine contracts and how to account for modifications.
Last review: 31 August 2017