Updated: Jun 12
For entities follow International Financial Reporting Standards (IFRSs), they should adopt IFRS 15 Revenue from contracts with customers for periods beginning or after 1 January 2018. No matter you are preparing for professional accountancy exam, working as an accountant, or a senior management in a company, you need to understand what it is and what’re the impacts on financial statements.
Before IFRS 15 is in place, IAS 18 Revenue and IAS 11 Construction Contracts governed the accounting treatment on revenue. So, why do we need to change from IAS 18 / IAS 11 to IFRS 15? What are the scopes of IFRS 15?
What is the purpose of IFRS 15?
Revenue is an important element for users of financial statements while it is used to assess a company’s financial performance and being analysed against inventory or receivables.
However, the requirements from IAS 18 and IAS 11 under IFRS (which are covered by International Accounting Standards Board (IASB)) are very different from ASC 605 under FASB (Financial Accounting Standards Board, is responsible for U.S. Generally Accepted Accounting Principles (GAAP)).
IFRS in revenue recognition requirements was lack of sufficient detail but U.S. GAAP requirements were considered to be overly prescriptive and conflicting in certain areas, as stated by them.
In order to improve the financial reporting of revenue and comparability of the top line in financial statements globally, the public demand to converge recognition of revenue to these two big standards setters are huge.
To respond the challenges, two boards developed converged requirements for the recognition of revenue in both IFRS and U.S. GAAP.
It is the background explaining why do we have IFRS 15 Revenue for Contracts with Customers.
What is the meaning of IFRS 15?
The core principle of IFRS 15 is for companies to recognize revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the companies expect to be entitled in exchange for those goods or services.
In its publication on adoption of IFRS 15, Deloitte points out the standard is a complex standard, introducing far more prescriptive requirements than were previously included in the IFRSs that it replaces, (IAS 18 Revenue, IAS 11 Construction Contracts). However, it requires the application of significant judgement in some areas.
Specifically, IAS 18 and IAS 11 provided separate revenue recognition models for goods, services and construction contracts. But IFRS 15, there is only a single model on identification of performance obligations –
Satisfied at a point in time;
Satisfied over time.
Hence, some contract manufacturing revenue may be recognized over time and some construction contracts revenue may be recognized at a point in time. In revenue recognition, IFRS 15 focuses on control, instead of focusing on risk and rewards under IAS 18 and IAS 11.
A 5-step approach is adopted in revenue recognition under IFRS 15, which describes the identification of performance obligations as well.
How is revenue recognised under IFRS 15?
As stated, IFRS 15 core principle is an entity should recognize revenue to depict transfer of goods or services. The standard adopts a five-step model. The five steps are –
Identify the contract(s) with a customer
Identify the performance obligations in the contract
Determine the transaction price
Allocate the transaction price to performance obligations
Recognize revenue when (or as) performance obligations are satisfied
To comply with IFRS 15, every company must follow the five-step model. I won’t go into details but will brief you as below.
Step 1: Identify the contract(s) with a customer
A contract does not have to be written in order for it to meet the criteria for revenue recognition; however, it does need to create enforceable rights and obligations.
Step 2: Identify the performance obligations in the contract
Distinct goods and services should be accounted for as separate deliverables (a.k.a “unbundling”). These distinct goods and services are referred to as ‘performance obligations’, which are promises in a contract with customers to transfer goods or services.
Step 3: Determine the transaction price
Transaction price is the amount of consideration (e.g. cash payment) to which an entity expects to be entitled in exchange for transferring promised goods or services to a customer, excluding those amounts collected on behalf of third parties (e.g. some sales taxes).
Step 4: Allocate the transaction price to performance obligations
For a contract that has more than one performance obligation, an entity is required to allocate transaction price to each performance obligation that depict the consideration to which the entity expects to be entitled in exchange for transferring each of the performance obligations to the customer.
Step 5: Recognise revenue when performance obligations are satisfied
There are two key concepts under Step 5. First, revenue is recognised when the entity satisfies a performance obligation by transferring a promised good or service to the customer. Second, an asset is transferred when the customer obtains control of that asset.
This five-step model should be adopted by every business. As pointed out by Richard Martin who is head of corporate reporting in ACCA, some business such as retail and property investment should have no significant different from current standards (i.e. IAS 18 /11).
However, the impact to industry where bundled contracts of “product + service” such as telecom, software development or real estate development, is significant.
Other key areas of guidance in IFRS 15
In addition to the five-step model, IFRS 15 provides specific guidance relating to licenses and costs relating to a contract.
A licence establishes a customer’s rights to the intellectual property (IP) of an entity. Examples of IP include licences of:
Film, music and other forms of media;
Patents, trademarks and copyrights.
First of all, you have to determine whether the license is distinct from others or not. The revenue recognition rule is different between two conditions. Only if the licence is distinct, you can adopt the licence guidance rule.
The rule is divided into two recognition methodologies, point-in-time recognition and over-time recognition. If the software will be used in its current form, the company can recognize licence revenue under point-in-time recognition rule. Otherwise, the software entity has to adopt over-time recognition.
Another area highlighted is how to account for costs relating to a contract, that is, distinguishing between –
Incremental costs of obtaining a contract; and
Costs of fulfilling a contract.
Incremental costs to obtain a contract that would have been incurred irrespective of whether the contract was obtained are recognised as an expense when incurred, unless those costs are explicitly chargeable to the customer irrespective of whether the contract is obtained, e.g. a sales commission.
Under IFRS 15, the incremental costs of obtaining a contract with a customer are recognised as an asset if the entity expects to recover those costs.
IAS 2 Inventories, IAS 16 Property, Plant and Equipment or IAS 38 Intangible Assets cover the accounting treatment on costs incurred in fulfilling a contract with a customer. IFRS 15 only applies for costs incurred to fulfil a contract if those costs are not within the scope of those standards.
Costs of fulfilling a contract are recognised as an asset only if all of the following criteria are met, the costs:
Relate directly to a contract, or to an anticipated contract that can be specifically identified;
Generate or enhance resources to be used to satisfy performance obligations in future; and
Are expected to be recovered.
ACCA SBR Specimen Paper
If you plan to join ACCA exam, my advice on studying this topic is to review the association’s published exam papers.
ACCA published two Specimen papers on SBR exam. One question in SBR Specimen Paper 2 is about IFRS 15 which can help you to understand what are the requirements expected in exam.
Question 4a requires an understanding of IFRS 15 and apply it into the cases. Two cases are provided which are gift cards and royalty used.
Cash proceeds generated from selling gift cards with specific expiry date cannot be recognised as revenue until the cards are redeemed by customers. Under the principle of performance obligation has been satisfied, revenue can be recognized only if the control over an asset has transferred to customer.
Revenue from a usage-based royalty should be recognised as the usage occurs.
Based on the information provided in this question, an explicit contract specifying payment terms and conditions were clearly stated and the possibility of default is low. Therefore, the criteria of revenue recognition are met.
In this article, I briefly introduced what was the change of accounting standards in revenue recognition while many of you may have questions and concerns.
To study accounting standards for ACCA exam, you are suggested to understand principle first, for example, how to recognize, what is the accounting treatment if not recognize, and disclosure requirements.
Then, you should check with listed company’s report and read what is done in the real world. In addition, ACCA published an article about IFRS 15 which are ‘Revenue revisited’. It is very helpful to you to understand all the key concepts and principles needed for exam.
Next, you read through ACCA SBR Specimen and past exam paper on any questions relevant to the topic.
Last but not the least, reviewing what you did against the suggested answers so that you know what you should improve.
I hope the information in this article could help you in preparing SBR exam. Just let me know if you have any questions by sending mail to email@example.com
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