If you prepare financial statements under IFRS, you’ll want to be current on IFRS 15 which outlines a five-step model for revenue recognition. This accounting rule explains when to record revenue, how much to record, and what conditions need to be present for revenue to be earned. An important change in this new rule relates to the idea that revenue is recognized when control of a good is transferred. Because of this rule, your clients may recognize revenue over time or at a specific point in time based on when requirements are met.
What Is the Five-Step Model?
Revenue must be booked following these steps:
- First, you have to identify contracts. These contracts are agreements between your client and its customers. They say what work is going to happen and when it’s going to happen.
- The second step is to identify the performance obligation, a key element of a contract. The performance obligation is the promise in a contract that your client will transfer a good or service to its customers.
- Next, you have to determine the transaction price. This is usually outlined in the contract, but it might not always be a straightforward dollar amount. The transaction price is the value of what your client is going to receive in return for the good or service.
- Fourth, you allocate the transaction price based on the performance obligations. If your client’s contract has more than one performance obligation, you should allocate the price across all obligations and assign a dollar amount to each obligation based on what your client expects to receive after satisfying each piece. If your client is supposed to landscape 100 acres, each acre could be assigned 1% of the total revenue to be earned.
- The fifth and final step is to recognize revenue when your client earns it. Record revenue when your client satisfies the performance obligation. This occurs when the work is done and the good or service is in control of the customer.
What Defines Control?
The biggest change under IFRS 15 relates to control. Revenue is only recognized when your client’s customers control the good or service under the performance obligation. Companies that sell bundled contracts with both product and service elements are highly affected by this new rule. For instance, say your client sells a software package that includes installation and future upgrades. Under old rules, these services could be recorded all at one time. Under the new rules, the installation service satisfies a performance obligation and triggers the recognition of revenue, but the future software upgrades haven’t been received by your client’s customers. Because your client hasn’t satisfied this obligation, you can’t recognize all the revenue at the same time.
Other Impacts of IFRS 15
Another major impact of IFRS 15 is the timing of when your client reports profits. Even though your client’s general business remains unchanged, the time it’s allowed to book revenue is delayed until it satisfies the contracted obligations. The timing of revenue recognition can cause contracts to have income recorded in multiple accounting periods. This leads to differences in tax treatment for different parts of the same contract.
For fiscal years starting in January 2018, IFRS 15 is officially a revenue reporting requirement. Help your client understand the five-step process of recording revenue, and make sure it relinquishes control of the good of service before you report the income.