IFRS 15 – Revenue recognition: A five step process

An entity recognises revenue by applying the following five steps:

1 Identify the contract

2 Identify the separate performance obligations within a contract

3 Determine the transaction price 1000000

4 Allocate the transaction price to the performance obligations in the

contract

5 Recognise revenue when (or as) a performance obligation is satisfied

The five steps will be considered in more detail in this section. However, the
following illustration may help you to gain an understanding of the basic
principles

Example On 1 December 20X1, Wade receives an order from a customer for a

computer as well as 12 months of technical support. Wade delivers the
computer (and transfers its legal title) to the customer on the same day.
The customer paid $420 on 1 December 20X1. The computer normally
sells for $300 and the technical support for $120.

Answer Step 1 – Identify the contract

There is an agreement between Wade and its customer for the provision
of goods (the computer) and services (the technical support).

Step 2 – Identify the separate performance obligations within a contract

There are two performance obligations within the contract:

• The supply of a computer

• The supply of technical support

Step 3 – Determine the transaction price

 The total transaction price is $420.

Step 4 – Allocate the transaction price to the performance obligations in the contract

Based on standalone sales prices, $300 should be allocated to the sale

of the computer and $120 should be allocated to the sale of technical
support.

Step 5 – Recognise revenue when (or as) a performance obligation is satisfied

a Control over the computer has been passed to the customer so the full
goods revenue of $300 should be recognised on 1 December 20X1.

b The technical support is provided over time, so revenue from this should
be recognised over time. In the year ended 31 December 20X1, revenue
of $10 (1/12 × $120) should be recognised from the provision of technical
support.
30/06/2020
Car Sales 900000
Car service 100000
12 months

31/12/2020
Rev 900000 #REF!
31/12/2021
Rev 50000

420 SAP
C 300 At the time
TS 120 Over the 12 months
420

Performace obligation satisfaction - Control Transfer - Risk and reward

 420
Comp 300 300 At the time
Ser 120 120 Over the time
420 420

2001- Rev
Com 300
Ser 10
310

2001- Rev
Com
Ser 110
 Step 1: Identify the contract

A contract is 'an agreement between two or more parties that creates

enforceable rights and obligations' (IFRS 15, Appendix A).

A contract can be agreed in writing, orally, or through other customary business

practices.

An entity can only account for revenue if the contract meets the following criteria:

• 'the parties to the contract have approved the contract and are
committed to perform their respective obligations

• the entity can identify each party’s rights regarding the goods or
services to be transferred

• the entity can identify the payment terms for the goods or services to
be transferred

• the contract has commercial substance, and

• 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' (IFRS 15, para 9).

Illustration 2 Aluna Co has a year end of 31 December 20X1.

On 30 September 20X1, Aluna Co signed a contract with a customer to
provide them with an asset on 31 December 20X1. Control over the
asset passed to the customer on 31 December 20X1. The customer will
pay $1m on 30 June 20X2.

By 31 December 20X1, Aluna Co did not believe that it was probable that
it would collect the consideration that it was entitled to. Therefore, the
contract cannot be accounted for and no revenue should be recognised.

Step 2: Identifying the separate performance obligations within a

contract

Performance obligations are promises to transfer distinct goods or services to a

customer.

Some contracts contain more than one performance obligation. For example:
 • An entity may enter into a contract with a customer to sell a car, which
includes one year’s free servicing and maintenance

• An entity might enter into a contract with a customer to provide 5 lectures,

as well as to provide a textbook on the first day of the course.

The distinct performance obligations within a contract must be identified.

Performance obligations may not be limited to the goods or services that are
explicitly stated in the contract. An entity’s customary business practices,
published policies or specific statements may create an expectation that the
entity will transfer goods or service to the customer.

An entity must decide if the nature of a performance obligation is:

• to provide the specified goods or services itself (i.e. the entity is the
principal), or

• to arrange for another party to provide the goods or service (i.e. the entity
is an agent)

If an entity is an agent, then revenue is recognised based on the fee or

commission to which it is entitled.

Example

Step 3: Determining the transaction price

The transaction price is the 'amount of consideration to which an entity

expects to be entitled in exchange for transferring promised goods or
services to a customer' (IFRS 15, Appendix A).
 Amounts collected on behalf of third parties (such as sales tax) are excluded.

The consideration promised in a contract with a customer may include fixed

amounts, variable amounts, or both.

'When determining the transaction price, an entity shall consider the

effects of all of the following:

• variable consideration

• the existence of a significant financing component in the contract

• non-cash consideration

• consideration payable to a customer' (IFRS 15, para 48).

i) Financing

In determining the transaction price, an entity must consider if the timing of

payments provides the customer or the entity with a significant financing benefit.

If there is a significant financing component, then the consideration receivable

needs to be discounted to present value using the rate at which the customer
would be able to borrow.

The following may indicate the existence of a significant financing component

(IFRS 15, para 61):

• a difference between the amount of promised consideration and the cash

selling price of the promised goods or services
• a significant length of time between the transfer of the promised goods or
services to the customer and the payment date.

ii) Consideration payable to a customer

If consideration is paid to a customer in exchange for a distinct good or service,

then it is essentially a purchase transaction and should be accounted for in the
same way as other purchases from suppliers.
Assuming that the consideration paid to a customer is not in exchange for a
distinct good or service, an entity should account for it as a reduction of the
transaction price.

Step 4: Allocate the transaction price

The total transaction price should be allocated to each performance obligation
in proportion to stand-alone selling prices.

The best evidence of a stand-alone selling price is the observable price of a

good or service when the entity sells that good or service separately in similar
circumstances and to similar customers.

If a stand-alone selling price is not directly observable, then the entity estimates
the stand-alone selling price.

Step 5: Recognise revenue

Revenue is recognised 'when (or as) the entity satisfies a performance

obligation by transferring a promised good or service to a customer'
(IFRS 15, para 31).

For each performance obligation identified, an entity must determine at contract

inception whether it satisfies the performance obligation over time, or satisfies
the performance obligation at a point in time.

Satisfying a performance obligation at a point in time

If a performance obligation is satisfied at a point in time then the entity must

determine the point in time at which a customer obtains control of a promised
asset.
Control of an asset refers to the ability to direct the use of, and obtain
substantially all of the remaining benefits (inflows or savings in outflows) from,
the asset. Control includes the ability to prevent other entities from obtaining
benefits from an asset.

The following are indicators of the transfer of control:

• The entity has a present right to payment for the asset

• The customer has legal title to the asset
• The entity has transferred physical possession of the asset
• The customer has the significant risks and rewards of ownership of the
asset
• The customer has accepted the asset.

Repurchase agreements

A repurchase agreement is where an entity sells an asset but retains a right to

repurchase the asset. This is often not recognised as a sale, but as a secured
 loan against the asset. Indications that this should not be recognised as a sale
may include:

• Sale is below fair value

• Option to repurchase is below the expected fair value
• Entity continues to use the asset
• Entity continues to hold the majority of risks and rewards associated with
ownership of the asset
• Sale is to a bank or financing company

Example Xavier sells its head office, which cost $10 million, to Yorrick, a bank, for
$10 million on 1 January 20X2. Xavier has the option to repurchase the
property on 31 December 20X5, four years later, at $12 million. Xavier
will continue to use the property as normal throughout the period and so
is responsible for its maintenance and insurance. The head office was
valued at transfer on 1 January 20X2 at $18 million and is expected to
rise in value throughout the four-year period.
Giving reasons, show how Xavier should record the above during
the first year following transfer.

Solution • Yorrick faces the risk of falling property prices.

• Xavier continues to insure and maintain the property.
• Xavier will benefit from a rising property price.
• Xavier has the benefit of use of the property.

Xavier should continue to recognise the head office as an asset in the

statement of financial position. This is a secured loan with effective
interest of $2 million ($12 million – $10 million) over the four-year period.

Bill-and-hold arrangements

A bill-and-hold arrangement is a contract under which an entity bills a customer

for a product but the entity retains physical possession of the product until it is
transferred to the customer at a point of time in the future.

For this to be recognised within revenue, the customer must have obtained
control of the product, despite it physically remaining with the entity.

There may be a fee for custodial services, where the entity recognises a fee for
holding the goods on behalf of the customer. This performance obligation
would be satisfied over time, so any revenue would be recognised on this basis.

For a bill-and-hold arrangement to exist:

 • The customer must have requested the arrangement
• The product must be identified as belonging to the customer
• The product must be ready for physical transfer to the customer
• The entity cannot have the ability to use the product or sell it to someone
else.

Substance over form

Determining the substance of a transaction

Common features of transactions whose substance is not readily

apparent are:

• the legal title to an asset may be separated from the principal

benefits and risks associated with the asset (such as is the case
with leases)

• a transaction may be linked with other transactions which means that

the commercial effect of an individual transaction cannot be
understood without an understanding of all of the transactions
involved

• options may be included in a transaction where the terms of the

option make it highly likely that the option will be exercised.

Question

Answer
a) The scenario indicates that control of the head office has not passed
to Seedorf. Clarence has retained use of the office, as well as
responsibility for maintaining and insuring it.
In addition to this, the sale has been made at a value significantly
lower than the market value. The option to repurchase is also
significantly below the market value. Therefore this should not be
treated as a sale.

The head office should not be removed from the financial

statements of Clarence. The $5 million should be treated as a loan,
with 10% interest recorded on it each year. Therefore for the year
ended 31 December 20X1 $500,000 ($5m × 10%) should be
recorded in finance costs.

b) This is a bill-and-hold arrangement. Even though Clarence retains

physical possession of the goods, Edgar retains control. This can be
seen in the fact that Clarence cannot use or sell the goods, and
must ship them immediately upon Edgar's request.

In this arrangement there are potentially three performance

obligations. These will be the provision of the machine and the
spare parts, and the storage of the spare parts.

The performance obligations to provide the machine and the spare

parts appear to be met on 31 December 20X1, so the full $500,000
revenue can be recognised.

If the storage of the parts had been deemed to be significant, and

therefore part of the transaction price, the price related to this
performance obligation would be separately recognised over the
expected period of holding the parts.
 Satisfying a performance obligation over time

'An entity transfers control of a good or service over time and, therefore,
satisfies a performance obligation and recognises revenue over time, if
one of the following criteria is met:

A the customer simultaneously receives and consumes the benefits

provided by the entity’s performance as the entity performs

B the entity’s performance creates or enhances an asset (for example,

work in progress) that the customer controls as the asset is created
or enhanced, or

C the entity’s performance does not create an asset with an alternative

use to the entity and the entity has an enforceable right to payment
for performance completed to date' (IFRS 15, para 35).

In FR, a common application of this is likely to be a building company

constructing an asset for a customer. As long as the building company is not
able to use the asset, and has a right to payment for work to date, revenue
would be recognised over time.

Note For each performance obligation satisfied over time, an entity shall
recognise revenue over time by measuring the progress towards
complete satisfaction of that performance obligation
Dr COS 2000000
CR Revenue 2000000

Dr Revenue 1600000
Cr COS 1600000
Example Rudd Co enters into a contract with a customer to sell equipment on 31
December 20X1. Control of the equipment transfers to the customer on
that date. The price stated in the contract is $1m and is due on 31
December 20X3.
Market rates of interest available to this particular customer are 10%.
Required:

Explain how this transaction should be accounted for in the financial

statements of Rudd Co for the year ended 31 December 20X1.

Revenue = PV of 1000000

FV= PV (1 + r / 100 )^n

1000000 PV (1+ 10 / 100 ) ^2

PV 1000000
(1+ 10 / 100 ) ^2

PV 1000000
1.21

PV 826,446.28 Revenue 31/12/2001

Debtors Ac DR 826,446.28
To Sales 826,446.28

1 January 20X2 b/f 826446 31/12/2002

20X2 Finance income @10% 82644.6
31 December 20X2 Receivable balance 909090.6
20X3 Finance income @10% 90909.06 31/12/2003
31 December 20X3 Receivable balance 1,000,000

31/12/2203
 Trans 31/12/2001
BS 31/12/2001
Payment 31/12/2003
Term 2

2001 Revenue 826,446.28

2002 FI 82644.6
2003 FI 90909.06

Debtors Ac DR 82644.6
To finance income 82644.6

Debtors Ac DR 90909.06
To finance income 90909.06

Cash Ac Dr 1000000
To Debtors 1000000
 1/10/2001 1/10/2002 31/12/2001
Example Golden Gate Co enters into a contract with a major chain of retail stores.
The customer commits to buy at least $20m of products over the next 12
months. The terms of the contract require Golden Gate Co to make a
payment of $1m to compensate the customer for changes that it will need
to make to its retail stores to accommodate the products.
By 31 December 20X1, Golden Gate Co has transferred products with a
sales value of $4m to the customer.

How much revenue should be recognised by Golden Gate Co in the

year ended 31 December 20X1?

Solution The payment made to the customer is not in exchange for a distinct good
or service. Therefore, the $1m paid to the customer is a reduction of the
transaction price.

The total transaction price is being reduced by 5% ($1m/$20m).

Therefore, Golden Gate reduces the transaction price of each good by
5% as it is transferred.

By 31 December 20X1, Golden Gate should have recognised revenue of

$3.8m ($4m × 95%).
31/12/2001 31/12/2002
1 5%
20

4 16
4*5% 0.8
0.2
3.8 15.2

20
1
19
Example Shred Co sells a machine and one year’s free technical support for
$100,000. It usually sells the machine for $95,000 but does not sell
technical support for this machine as a stand-alone product. Other
support services offered by Shred Co attract a mark-up of 50%. It is
expected that the technical support will cost Shred Co $20,000.
Required:
How should the transaction price be allocated between the machine and
the technical support?

Solution selling price of the machine is 95000

Step-1 selling price of the service would be 30000
20000 + 20000*50%
Total 125000

Step-2 Sale price 100000

Discount 25000
Discount % 20%
(125000-100000 ) / 125000*100
Step-3
A selling price of the machine is 76000 95000*80%
B selling price of the service would be 24000 30000*80%
100000

Date
Contact 1/6/2001
BS 31/12/2001
Machine 76000
Services 14000
90000

BS 31/12/2002
Machine 0
Services 10000
10000
 20000 10000 30000

Combine Value 50000 50000

Machine 60000 60000
Tech. 10000 +10000*50% 15000
75000

Dis. 25000
% Dis 33.33

Machine 40002 60000*66.67%

Tech. 10000.5 15000*66.67%

Performance obligation satisfy at the time

Performance obligation satisfy Over the time
 Presentation in the statement of financial position

Step 1 – Calculate overall profit or loss

Contract price x 10
Less: Costs to date x 2
Less: Costs to complete x 6
Overall profit/loss x 2

Step 2 – Determining the progress of a contract

Input methods Cost Incurred / Cost Incurred + Cost to be Incurred

Output methods performance completed to date / performance completed to date + performanc

Note : Where progress cannot be measured

Revenue should be recognised only to the extent of contract costs incurred that will probably be recoverable

Step 3 – Statement of profit or loss (if profitable)

Revenue (Total price × progress %) x 10*25% 2.5

less revenue recognised in previous years x 0
Cost of sales (Total costs × progress %) x (2+6)*25% 2
less cost of sales recognised in previous years x 0
Profit x 0.5

For example, if a contract is worth $10 million and it is 90% satisfied by the end of
year 2, and was 50% satisfied by the end of year 1, then $9 million has been
earned to date, of which $5 million would have been recognised in year 1. This
means that $4 million would be recognised as revenue in year 2.

Step 4 – Statement or financial position

Costs to date (Actual costs, not necessarily cost of sales) x 2

(+ -) Profit/loss to date x 0.5
Less: Amount billed to date x 1.5
Contract asset/liability x 1
Note that these figures are cumulative and not annual

Example 1 On 1 January 20X1, Baker entered into a contract with a customer to

construct a specialised building for consideration of $2m plus a bonus of
$0.4m if the building is completed within 18 months. Estimated costs to
construct the building were $1.5m. If the contract is terminated by the
customer, Baker can demand payment for the costs incurred to date plus
a mark-up of 30%. On 1 January 20X1, as a result of factors outside of its
control, Baker was not sure whether the bonus would be achieved.
At 31 December 20X1 Baker had incurred costs of $1m. They were still
unsure as to whether the bonus target would be met. Baker measures
progress towards completion based on costs incurred.
At 31 December 20X1 Baker had received $1 million from the customer.
Required:
How should this transaction be accounted for in the year ended 31
December 20X1?

Solution Step 1 – Calculate overall profit or loss

0

Contract price 2000

Less: Costs to date 1000
Less: Costs to complete 500 1500-1000
Overall profit/loss 500

Step 2 – Determining the progress of a contract

Input methods Cost Incurred / Cost Incurred + Cost to be Incurred

1000/1500 = 66.67%

Step 3 – Statement of profit or loss (if profitable)

Revenue (Total price × progress %) 2000*2/3 1333

less revenue recognised in previous years x 0
Cost of sales (Total costs × progress %) 1500*2/3 1000
less cost of sales recognised in previous years x
Profit x 333
 Step 4 – Statement or financial position

Costs to date (Actual costs, not necessarily cost of sales) 1000

Profit/loss to date 333
Less: Amount billed to date 1000
Contract asset/liability 333

Example 2 On 1 January 20X1, Castle entered into a contract with a customer to

construct a specialised building for consideration of $10m. Castle is not
able to use the building themselves at any point during the construction.
At 31 December 20X1, Castle had incurred costs of $6m. Costs to
complete are estimated at $6m. Castle measures progress towards
completion based on costs incurred.
At 31 December 20X1 Castle had received $3 million from the customer.
Required:
How should this transaction be accounted for in the year ended 31
December 20X1?

Solution Step 1 – Calculate overall profit or loss

Contract price 10000

Less: Costs to date 6000
Less: Costs to complete 6000
Overall profit/loss 2000 loss

Step 2 – Determining the progress of a contract

Input methods Cost Incurred / Cost Incurred + Cost to be Incurred

6000/12000 = 50%
6000/6000+6000

Step 3 – Statement of profit or loss (if profitable)

Revenue (Total price × progress %) 10000*50% 5000

less revenue recognised in previous years x
Cost of sales (Total costs × progress %) 12000*50% 6000
less cost of sales recognised in previous years x
Loss x 1000
Cost of sales (provision to recognise the full loss) 1000
Loss 2000
 Step 4 – Statement or financial position

1 Costs to date (Actual costs, not necessarily cost of sales) 6000

Profit/loss to date 2000 4000
Less: Amount billed to date 3000
Contract asset/liability 1000

Example 3 On 1 January 20X1 Amir entered into a contract with a customer to

construct a stadium for consideration of $100m. The contract was
expected to take 2 years to complete.

At 31 December 20X1 Amir had incurred costs of $24m. Costs to

complete are estimated at $20m. In addition to these costs, Amir
purchased plant to be used on the contract at a cost of $16m. This plant
was purchased on 1 January 20X1 and will have no residual value at the
end of the 2 year contract. Depreciation on the plant is to be allocated on
a straight line basis across the contract.

Amir measures progress on contracts using an output method, based on

the value of work certified to date.
At 31 December 20X1, the value of the work certified was $45 million,
and the customer had paid $11.4m.

Solution Step 1 – Calculate overall profit or loss

Contract price 100000

Less: Costs to date 24000
Less: Costs to complete 20000
Less : Plant Cost 16000 Cost- SV
Overall profit/loss 40000

Step 2 – Determining the progress of a contract

Output methods Work Certifed / Total contact

45000 / 100000 = 45%

Step 3 – Statement of profit or loss (if profitable)

 Revenue (Total price × progress %) 100000*45% 45000
less revenue recognised in previous years x 0
Cost of sales (Total costs × progress %) 60000* 45% 27000
less cost of sales recognised in previous years x
Profit x 18000

Step 4 – Statement or financial position

1 Contract asset
Costs to date (Actual costs, not necessarily cost of sales) 32000 24000 + 8000 Dep
Profit/loss to date 18000
Less: Amount billed to date 11400
Contract asset/liability 38600

2 Plant 16000
Less : Dep 16000-0 / 2 8000
8000

3 Receivable

Revenue 45000
Less: Cash Received 11400
33600
4 Inventory

Input Cost To date 24000+8000 32000

Ouput Cost of sales 27000
WIP Inventory 5000
 2/8=25%

2/2+6 25%

ompleted to date + performance to be completed

t will probably be recoverable

2 10*90% 9
10*50% 5
2

(2+6)*25%
1000 Cost of Sales Ac DR
1000 To Provision for loss
24000 + 8000 Dep

32000 32000

27000
Margin On sales 100000 SP
10% Margin
10000 Profit

100000 SP
10% Markup
10/100+10 Margin
10/110 Margin
100000/10/110 Profit

Markup On Cost 100000 Cost

10% Markup
10000 Profit

100000 Cost
10% Margin
10/100-10 Markup
10/90. Markup

11,111.11 Profit
C-1

C-3

C-2

C-4
Question

Step-1 Overall Contcat

31/03/2001 31/03/2002

Price 40000 40000

Cost 20400
Architects’ and surveyors’ fees 500
Materials delivered to site 2800
Direct labour costs 3500
Overhead 1400
Depreciation 900 2100
3 / 30*9
 Total cost (For the Year) 9100 22500
Cost to be complted 14800 6600
Depreciation
3/30*21 2100 900 3000/30*9
Total cost 26000 30000
Overall profit 14000 10000

Step-2
Progress. Costs to date 9100 22500
Total costs 26000 30000
35% 75%

31/03/2001 31/03/2002
Step-3

Revenue. 40000*35% 14000 30000

40000*75%
Revenue already recognised 0 14000
COS 26000*35% 9100 22500
30000*75%
Cost already recognised 9100
Profit for the Year 4900 2600

Step-4 31/03/2001
NCA
PPE 3600-900 2700
Contract assets 1200
3900

31/03/2002
NCA
PPE 3600-2100 1500
Contract assets 1000
2500

Step-5 Contract assets 2001 2002

Cost to date 9100 22500

Profit 4900 7500
less: amount billed 12800 29000
1200 1000
Solve the TU-9 from the book
3000/30*9