SBR – Reporting the Financial Performance

of Entities
IFRS 15 – Revenue Recognition

IFRS 15

IFRS 15 specifies how and when revenue should be recognised in the financial statements. Replacing IAS 18
and IAS 11, the standard provides a five-step model to be applied to all contracts with customers. The steps are
explained below:

STEP 1 – CONTRACT WITH CUSTOMER

There must be a contract with the customer in place before revenue can be recognised. The contract must meet
the following conditions:

 Commitment to Perform - Both parties must be committed to perform their respective elements of the
contract. A written contract is required if it is a common business practice.

 Rights of Parties - Each party’s rights in relation to the goods or services to be transferred should be
identifiable.

 Payment Terms - The payment terms should be identifiable.

 Commercial Substance - The contract must have commercial substance. For example, two entities that
are swapping an identical asset with each other is not actually a revenue-based transaction..

 Probable Flow - There must be probable, but not definite, flow of funds.

STEP 2 – IDENTIFY PERFORMANCE OBLIGATIONS

The next step is to identify separate performance obligations. This is essential because revenue from product is
recognised at a point in time, whereas revenue from services or construction contracts is recognised over time.
A separate performance obligation is something that a customer can benefit from on a stand-alone basis. This
implies that:
  The customer should be able to benefit from the good or services on its own or in conjunction with other
readily available resources; and

 The entity’s promise to transfer the good or service to the customer is separately idenitifable from other
promises in the contract.

STEP 3 – DETERMINE THE TRANSACTION PRICE

The transaction price is the amount to which an entity expects to be entitled in exchange for the transfer of
goods and services. When determining the transaction price, an entity should consider past customary business
practices.

 Fixed and Variable Components - Where a contract contains elements of variable consideration, the
entity should estimate the amount of variable consideration to which it will be entitled under the contract.
Variable consideration can arise, for example, as a result of discounts, rebates, refunds, credits, price
concessions, incentives, performance bonuses, penalties or other similar items. Variable consideration is
also present if an entity’s right to consideration is contingent on the occurrence of a future event. Taking
a prudent approach, variable consideration should not be recognised until the chance or magnitude of
reversal is considered minimal.

 Financing Component - Where consideration is paid in advance or in arrears, the entity will need to
consider whether the contract includes a significant financing arrangement and, if so, adjust for the time
value of money. If the payment is received before the control is passed, an entity should record the
amount received as a loan and charge interest on the loan amount. When the control is passed, the loan
should be removed and transferred to revenue. If the payment is received after the control is passed, an
entity should recognise the present value of future instalments as revenue. The financing income should
be recognised over time.

STEP 4 – ALLOCATE THE TRANSACTION PRICE

Where a contract has multiple performance obligations, an entity will allocate the transaction price to the
performance obligations in the contract by reference to their relative standalone selling prices. If a standalone
selling price is not directly observable, the entity will need to estimate it. IFRS 15 suggests various methods that
might be used, including:

- Adjusted market assessment approach

- Expected cost plus a margin approach

- Residual approach

Any overall discount compared to the aggregate of standalone selling prices is allocated between performance
obligations on a relative standalone selling price basis.

STEP 5 – RECOGNISE REVENUE AFTER SATISFYING PERFORMANCE OBLIGATION

Revenue is recognised as the control is passed, either over time or at a point in time. This is different from the
guidance of previous standard (IAS 18), which was based on transfer of risk.
Control of an asset is defined as the ability to direct the use of and obtain substantially all of the remaining
benefits from the asset. This includes the ability to prevent others from directing the use of and obtaining the
benefits from the asset. The benefits related to the asset are the potential cash flows that may be obtained
directly or indirectly.

An entity recognises revenue over time if one of the following criteria is met:

- The customer simultaneously receives and consumes all of the benefits provided by the entity as the
entity performs;

- The entity’s performance creates or enhances an asset that the customer controls as the asset is
created; or

- 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.

COMBINED OR SEPARATE CONTRACT

If an entity is performing a number of tasks for the same customer, it must determine whether each of the tasks
constitutes a separate contract or all of them should be treated under a combined contract. The two criteria to
consider are:

- Payment Terms - If the payment terms of one contract are not dependent on the performance of other
contracts, each contract is considered separate. However, if the payment of one contract is dependent
on the performance of other contracts, the contracts should be combined together.

- Single Commercial Objective - If the commercial objective of all the contracts is single, they should be
treated as combined contract. For example, if a shipbuilder enters into a contract for building engine and
a contract for building navigation of the same ship, both contracts have a same commercial objective.

CONTRACT MODIFICATIONS

If the nature of that contract changes now partway through the contract, the accounting question is whether this
change constitutes a brand-new separate second contract or a modification to the first contract. Two criteria
must be met in order for the modification to be treated as a brand-new separate:

- The scope of the contract must increase by distinct product or service.

- The price of the contract must increase by an amount which is based on the market rate of that distinct
product or service.