IFRS 15 Revenue recognition is a primary and fundamental subject in the recognition of revenue. There are two ways of recognising revenue, revenue recognition over time and revenue recognition at a point in time. Revenue recognition over time is often referred to as the ‘Percentage of completion‘ method under the (superseded) IAS 11 Construction contracts.
The general principle is the revenue is recognised at a point in time (and as such it is the most common type of sales transaction at least in volume, just think of: a retailer sells a candy bar for cash in the shopping mall). As a result there are three criterion (see below ability, direct the use and obtain benefits from) that have to be met to qualify as revenue recognised over time. IFRS 15 Revenue recognition
IFRS 15 Revenue recognition
Under IFRS 15, an entity only recognises revenue when it satisfies an identified performance obligation by transferring a promised good or service to a customer. A good or service is considered to be transferred when the customer obtains control.
IFRS 15 states that “control of an asset refers to the ability to direct the use and obtain substantially all of the remaining benefits from the asset”. [IFRS 15 33]
The IASB explained the key terms in the definition of control in the Basis for Conclusions, as follows: [IFRS 15 BC 118] Satisfaction of performance obligations
a customer must have the present right to direct the use of, and obtain substantially all of the remaining benefits from, an asset for an entity to recognise revenue. For example, in a contract that requires a manufacturer to produce an asset for a customer, it might be clear that the customer will ultimately have the right to direct the use of, and obtain substantially all of the remaining benefits from, the asset. However, the entity should not recognise revenue until the customer has actually obtained that right (which, depending on the contract, may occur during production or afterwards).
Direct the use of:
a customer’s ability to direct the use of an asset refers to the customer’s right to deploy or to allow another entity to deploy that asset in its activities or to restrict another entity from deploying that asset. Satisfaction of performance obligations
Obtain the benefits from:
the customer must have the ability to obtain substantially all of the remaining benefits from an asset for the customer to obtain control of it. Conceptually, the benefits from a good or service are potential cash flows (either an increase in cash inflows or a decrease in cash outflows). IFRS 15 33 indicates that a customer can obtain the benefits directly or indirectly in many ways, such as: using the asset to produce goods or services (including public services); using the asset to enhance the value of other assets; using the asset to settle a liability or reduce an expense; selling or exchanging the asset; pledging the asset to secure a loan; or holding the asset.
Under IFRS 15, the transfer of control to the customer represents the transfer of the rights with regard to the good or service. The customer’s ability to receive the benefit from the good or service is represented by its right to substantially all of the cash inflows, or the reduction of the cash outflows, generated by the goods or services. Upon transfer of control, the customer has sole possession of the right to use the good or service for the remainder of its economic life or to consume the good or service in its own operations.
Performance obligation satisfied over time/ Performance obligation satisfied at a point in time
Frequently, entities transfer the promised goods or services to the customer over time. While the determination of whether goods or services are transferred over time is straightforward in some contracts (e.g., many service contracts), it is more difficult in other contracts.
IFRS 15 35 states that an entity transfers control of a good or service over time if one of the following criteria is met:
- As the entity performs, the customer simultaneously receives and consumes the benefits provided by the entity’s performance.
- The entity’s performance creates or enhances an asset (e.g., work in progress) that the customer controls as the asset is created or enhanced. IFRS 15 Revenue recognition
- 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 Revenue recognition
The following decision tree illustrates how to evaluate whether control transfers over time/at a point in time:
The first question (see below explanation) is: Does the customer simultaneously receive and consume the benefits provided by the entity’s performance as the entity performs?
Reference – IFRS 15 B3 – B4
Document your decisions in your financial close file to facilitate internal review and approval and external audits.
Customer simultaneously receives and consumes benefits as the entity performs
In many service contracts the entity’s performance creates an asset, momentarily, because that asset is simultaneously received and consumed by the customer. In these cases, the customer obtains control of the entity’s output as the entity performs.
Therefore, the performance obligation is satisfied over time. [IFRS 15 BC125] While this criterion most often applies to service contracts, there are instances in which commodity contracts (e.g., electricity, natural gas, heating oil) are recognised over time. These situations arise if the facts and circumstances of the contract indicate that the customer will simultaneously receive and consume the benefits (e.g., a continuous supply contract to meet immediate demands). IFRS 15 Revenue recognition
There may be contracts in which it is unclear whether the customer simultaneously receives and consumes the benefit of the entity’s performance over time. To assist entities, IFRS 15 B3 – B4 provides application guidance. IFRS 15 Revenue recognition
In assessing whether a customer simultaneously receives and consumes the benefits provided by an entity’s performance, all relevant facts and circumstances need to be considered. This includes considering the inherent characteristics of the good or service, the contract terms and information about how the good or service is transferred or delivered. However, as noted in IFRS 15 B4(a), an entity disregards any contractual or practical restrictions when it assesses this criterion. IFRS 15 Revenue recognition
IFRS 15 provides an example (#13) that illustrates a customer simultaneously receiving and consuming the benefits as the entity performs in relation to a series of distinct payroll processing services in IFRS 15 IE67 – IE 68. IFRS 15 Revenue recognition
For some service contracts, the entity’s performance will not satisfy its obligation over time because the customer does not consume the benefit of the entity’s performance until the entity’s performance is complete. The standard provides an example (see link below) of an entity providing consulting services that will take the form of a professional opinion upon the completion of the services. In this situation, an entity cannot conclude that the services are transferred over time based on this criterion. Instead, the entity must consider the remaining two criteria in IFRS 15 35 (see Example 14 in IFRS 15 IE69 – IE 72). IFRS 15 Revenue recognition
See also: The IFRS Foundation