DipIFR Syllabus B. Elements of financial statements - Revenue Recognition - IFRS 15 - 5 steps - Notes ^{2 / 8}

Ok let’s now get into a bit more detail…

Step 1: Identify the contract(s) with a customer

• The contract must be approved by all involved

• Everyone’s rights can be identified

• It must have commercial substance

• The consideration will probably be paid

Step 2: Identify the separate performance obligations in the contract

This will be goods or services promised to the customer

These goods / services need to be distinct and create a separately identifiable obligation

• Distinct means:

  The customer can benefit from the goods/service on its own AND

  The promise to give the goods/services is separately identifiable (from other promises)

• Separately identifiable means:

  No significant integrating of the goods/service with others promised in the contract 

  The goods/service doesn’t significantly modify another good or service promised in the contract. 

  The goods/service is not highly related/dependent on other goods or services promised in the contract.

Step 3: Determine the transaction price

How much the entity expects, considering past customary business practices

• Variable Consideration
  If the price may vary (eg. possible refunds, rebates, discounts, bonuses, contingent consideration etc) - then estimate the amount expected

• However variable consideration is only included if it’s highly probable there won’t need to be a significant revenue reversal in the future (when the uncertainty has been subsequently resolved)

• However, for royalties from licensing intellectual property - recognise only when the usage occurs

• Amounts collected on behalf of a third-party authority should also not be considered as part of the transaction price. e.g sales tax collected on behalf of the government

Step 4: Allocate the transaction price to the separate performance obligations

If there’s multiple performance obligations, split the transaction price by using their  standalone selling prices. (Estimate if not readily available)

• How to estimate a selling Price

  - Adjusted market assessment approach 
  - Expected cost plus a margin approach 
  - Residual approach (only permissible in limited circumstances).

• If paid in advance, discount down if it’s significant (>12m)

Step 5: Recognise revenue when (or as) the entity satisfies a performance obligation

Revenue is recognised as control is passed, over time or at a point in time.

• What is Control
  It’s the ability to direct the use of and get almost all of the benefits from the asset. 

  This includes the ability to prevent others from directing the use of and obtaining the benefits from the asset.

• Benefits could be:

  - Direct or indirect cash flows that may be obtained directly or indirectly

  - Using the asset to enhance the value of other assets; 

  - Pledging the asset to secure a loan

  - Holding the asset.

• So remember we recognise revenue as asset control is passed (obligations satisfied) to the customer

  This could be over time or at a specific point in time.

• Warranties as also accounted as part of revenue. They are recognised as the liability decreases.

Examples (of factors to consider) of a specific point in time:

1. The entity now has a present right to receive payment for the asset;

2. The customer has legal title to the asset;

3. The entity has transferred physical possession of the asset;

4. The customer has the significant risks and rewards related to the ownership of the asset; and

5. The customer has accepted the asset.

Contract costs - that the entity can get back from the customer

These must be recognised as an asset (unless the subsequent amortisation would be less 12m), but must be directly related to the contract (e.g. ‘success fees’ paid to agents).

Examples would be direct labour, materials, and the allocation of overheads  - this asset is then amortised