Revenue recognition remains one of the most judgemental areas in financial reporting. Although IFRS 15 Revenue from Contracts with Customers has been effective for several years, practical application continues to require careful analysis of contract terms, commercial substance and supporting documentation.
This update summarises key application points under IFRS 15, with a focus on common scenarios encountered in practice, including bundled arrangements, variable consideration, customer incentives, warranties, rights of return, contract modifications and contract costs.
IFRS 15 is a Principles-Based Standard
IFRS 15 requires entities to recognise revenue in a manner that depicts the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled.
The standard is not a checklist-based exercise. In many cases, the correct accounting outcome depends on the precise facts and circumstances. Contract terms, legal enforceability, customer behaviour, historical experience and commercial substance should all be considered before concluding on the accounting treatment.
A useful discipline is to first identify which part of the IFRS 15 model is being triggered before attempting to answer the accounting question.
The Five-Step Model
The core IFRS 15 framework comprises five steps:
- Identify the contract with the customer.
- Identify the performance obligations in the contract.
- Determine the transaction price.
- Allocate the transaction price to the performance obligations.
- Recognise revenue when, or as, each performance obligation is satisfied.
Each step addresses a different accounting question. For example, issues involving enforceability belong mainly to Step 1, bundled goods and services to Step 2, discounts and bonuses to Step 3, stand-alone selling prices to Step 4, and timing of revenue recognition to Step 5.
Step 1: Identifying the Contract
A contract exists only when the IFRS 15 criteria are satisfied. In particular, the arrangement must be enforceable, the parties must be committed to perform, rights and payment terms must be identifiable, the contract must have commercial substance, and collection must be probable.
In practice, management’s description of an arrangement is not always sufficient. The signed contract, purchase order, delivery records, acceptance evidence and legal enforceability should be reviewed.
Where goods are delivered before a formal contract is signed, it does not automatically mean that no contract exists. The analysis should consider whether the customer had already approved the arrangement, accepted the goods, and become legally committed before the reporting date. Legal advice may be required where enforceability is unclear.
Step 2: Identifying Performance Obligations
A key judgement under IFRS 15 is whether promised goods or services are distinct. A good or service is generally distinct if the customer can benefit from it on its own, or together with other readily available resources, and the promise to transfer it is separately identifiable from other promises in the contract.
This assessment is especially important for bundled arrangements. For example:
| Arrangement | Likely IFRS 15 Consideration |
|---|---|
| Handset sold together with a mobile voice/data plan | The handset and service plan are generally separate performance obligations if each can be used or purchased separately. |
| Broadband plan with free modem and router | The modem, router and broadband service may be separate performance obligations if they are distinct goods or services. |
| Standard software with installation, upgrades and support | The components may be separate if installation is routine and upgrades/support are separately available. |
| Customised software with installation | May be a single performance obligation if the software and installation are highly integrated. |
| Product with separately purchasable extended warranty | The extended warranty is generally a separate performance obligation. |
Items described as “free” are not necessarily free for accounting purposes. IFRS 15 requires the total transaction price to be allocated to all distinct performance obligations, including free or discounted items, based on relative stand-alone selling prices.
Step 3: Determining the Transaction Price
The transaction price is the amount of consideration the entity expects to be entitled to in exchange for transferring goods or services.
This may require adjustment for:
- variable consideration;
- discounts;
- rebates;
- rights of return;
- performance bonuses;
- milestone payments;
- non-cash consideration;
- significant financing components; and
- consideration payable to customers.
Variable Consideration
Variable consideration should be estimated using either the expected value method or the most likely amount method, depending on which better predicts the amount of consideration.
However, IFRS 15 includes a constraint: variable consideration is included in the transaction price only to the extent that it is highly probable that a significant reversal of cumulative revenue will not occur when the uncertainty is resolved.
Examples include:
| Scenario | Key Consideration |
|---|---|
| Bonus payable only if a client’s equity placement is successful | Recognise only if it is highly probable that no significant reversal will occur. If success is uncertain and outside the entity’s control, the bonus may be constrained to nil. |
| Milestone payment subject to regulatory approval | Usually constrained until approval is obtained, unless there is strong evidence that reversal risk is remote. |
| Revenue based on future occupancy or sales levels | Historical data, market conditions and customer-specific facts should be assessed before including the amount in revenue. |
Consideration Payable to a Customer
Payments, credits or incentives given to customers require careful assessment. As a general rule, consideration payable to a customer reduces the transaction price unless the payment is for a distinct good or service received from the customer and the fair value of that good or service can be reasonably measured.
Examples include:
| Scenario | Likely Treatment |
|---|---|
| Supplier pays retailer for shelf space or shelf changes | Usually reduces the transaction price unless a distinct service at fair value is received. |
| Credit granted to customers due to service outage | Reduces the transaction price. |
| Credit granted to new customers as a sign-up incentive | Reduces the transaction price. |
| Cashback offered to end customers through an online platform | Reduces the transaction price. |
| Commission paid to an online platform for marketplace services | May be recognised as an expense if the platform provides a distinct service. |
| Advertising service purchased from a customer on normal commercial terms | May be treated as a separate purchase of services if the service is distinct and priced at fair value. |
This distinction is important because it affects whether an amount is presented as an expense or as a reduction of revenue.
Step 4: Allocation of the Transaction Price
Where a contract contains more than one performance obligation, the transaction price is allocated based on the relative stand-alone selling prices of each distinct good or service.
Observable stand-alone selling prices should be used where available. If the stand-alone selling price is not directly observable, it must be estimated. Common estimation methods include:
- adjusted market assessment approach;
- expected cost plus margin approach; and
- residual approach.
The residual approach is limited. It should be used only where the stand-alone selling price is highly variable or uncertain. Where comparable market data exists, the adjusted market assessment approach is generally more appropriate.
For bundled contracts, this means revenue recognised for an upfront item may differ from the cash received upfront. For example, in a handset and service plan bundle, the handset revenue may need to be based on its stand-alone selling price, with part of the overall contract consideration allocated to the handset even if the upfront payment is heavily discounted.
Step 5: Recognising Revenue
Revenue is recognised when control of the good or service transfers to the customer.
Control refers to the customer’s ability to direct the use of, and obtain substantially all remaining benefits from, the asset.
Revenue Recognised Over Time
Revenue is recognised over time if any one of the following criteria is met:
- The customer simultaneously receives and consumes the benefits as the entity performs.
- The entity creates or enhances an asset controlled by the customer.
- The entity creates an asset with no alternative use and has an enforceable right to payment for performance completed to date.
Examples include recurring services, construction on a customer-controlled site, and specialised assets built to customer specifications where the supplier has enforceable payment rights.
Revenue Recognised at a Point in Time
If revenue is not recognised over time, it is recognised at the point in time when control transfers. Indicators of control transfer include:
- physical possession;
- legal title;
- risks and rewards of ownership;
- customer acceptance; and
- present obligation to pay.
Payment timing alone does not determine revenue recognition. Deposits and advance payments are generally contract liabilities until the entity satisfies the related performance obligation.
Rights of Return and Consignment Arrangements
Rights of return create variable consideration. Entities should estimate expected returns based on historical experience, customer behaviour and other available evidence. Revenue should be recognised only for the amount not expected to be returned, subject to the constraint on variable consideration.
Where goods are delivered to a retailer or intermediary, it is also necessary to consider whether the arrangement is a sale or a consignment arrangement. If the intermediary does not obtain control of the goods, revenue may not be recognised until control transfers to the end customer.
Contract review is critical in such cases. The legal terms may reveal rights of return, repurchase rights, consignment features or other conditions that affect revenue recognition.
Warranties
Warranties should be analysed to determine whether they are assurance-type or service-type warranties.
An assurance-type warranty confirms that the product complies with agreed specifications. It is generally accounted for as a provision and not as a separate performance obligation.
A service-type warranty provides an additional service to the customer. If the customer can purchase the warranty separately, or if the warranty provides coverage beyond assurance that the product complies with specifications, it is generally a separate performance obligation. A portion of the transaction price should then be allocated to the warranty and recognised over the warranty period.
Contract Modifications
Contract modifications occur when the parties change the scope, price or both. IFRS 15 requires the modification to be assessed based on whether the additional goods or services are distinct and whether the additional consideration reflects their stand-alone selling price.
A modification may be accounted for as:
- a separate contract;
- termination of the existing contract and creation of a new contract; or
- part of the existing contract with a cumulative catch-up adjustment.
For example, if a software customer adds more users during the contract term, the accounting depends on whether the additional user rights are distinct and whether the additional price reflects the stand-alone selling price of those added rights.
Contract Costs
IFRS 15 also contains guidance on costs of obtaining and fulfilling contracts.
Sales commissions may be capitalised if they are incremental costs of obtaining a contract and are expected to be recovered. If the benefit period is more than one year, the asset is generally amortised over the expected period of benefit. If the amortisation period is one year or less, the practical expedient may allow immediate expensing.
Ongoing payroll costs are different. Salaries of employees who provide services or support are generally expensed as incurred unless they meet the criteria for capitalisation as fulfilment costs. The key distinction is whether the cost is incremental to obtaining the contract and whether it is recoverable.
Practical Documentation Points
When assessing IFRS 15 issues, audit teams and preparers should ensure that the following are obtained and documented:
- signed contracts and amendments;
- purchase orders and acceptance evidence;
- payment terms and billing schedules;
- evidence of legal enforceability;
- stand-alone selling price support;
- basis for variable consideration estimates;
- historical return, rebate or cancellation data;
- warranty terms;
- basis for principal-versus-agent conclusions;
- assessment of whether payments to customers are contra-revenue or expenses; and
- accounting papers supporting key judgements.
Key Takeaways
The practical application of IFRS 15 requires more than identifying when cash is received or invoices are issued. The focus should be on the contractual promises, the consideration expected, the allocation of that consideration, and the timing of control transfer.
In summary:
- Start with the five-step model.
- Identify the specific IFRS 15 issue before concluding.
- Read the contract and supporting legal documents.
- Do not assume that “free” or discounted items have no accounting value.
- Apply the variable consideration constraint carefully.
- Assess whether payments to customers reduce revenue.
- Allocate revenue based on stand-alone selling prices.
- Recognise revenue based on control transfer, not billing or cash collection.
- Document all key judgements clearly.
A well-supported IFRS 15 conclusion should be fact-specific, contract-based and consistent with the economic substance of the arrangement.