IFRS 15 The revenue recognition standard provides a single comprehensive standard that applies to nearly all industries and has changed revenue recognition quite significant.
IFRS 15 introduced a five step process for recognising revenue, as follows:
Step two, identifying the performance obligations in the contract, is a critical step because it impacts both how much revenue will be recognised, as well as when a company can record revenue. Identify the performance obligations in the contract Identify the performance obligations in the contract Identify the performance obligations in the contract
IFRS 15 defines a performance obligation as a promise to provide a good or service to a customer. The promise can be explicitly stated, implicit, or assumed based on customary business practices. Identify the performance obligations in the contract
Understanding all of the promises in a contract is a challenging part of IFRS 15 24. The contract definition is very broad and is not limited to the goods or services clearly described in the contract. The definition encompasses promises implied by other means such as customary business practices, published policies and specific statements through email or other communication. If any of those promises lead to an expectation by the customer that the entity will deliver a good or service, under the new guidelines, it must be honoured. [IFRS 15 24]
In order to allocate the transaction price to performance obligations the good or service has to be:
- A distinct good or service or bundle of goods or services, or Identify the performance obligations in the contract
- A series of distinct goods or services that are materially the same and have the same pattern of transfer to the customer [IFRS 15 22]
IFRS 15 27(a) describes a distinct good or service as one that generates an economic benefit to the customer on its own or together with other readily available resources. A readily available resource would be a good or service that is sold separately or a resource that the customer already has. A good measure of whether a good or service is distinct, is to determine if it can be sold on a standalone basis. [IFRS 15 28] Often times there are multiple performance obligations in a contract. These are accounted for on a standalone basis if they are separately identifiable or distinct from other promises in the contract. [IFRS 15 29] Identify the performance obligations in the contract
A series of distinct goods or services has the same pattern of transfer if each good or service in the series can be considered a performance obligation satisfied over time. The same method is used to measure progress toward completion for each distinct good or service in the series. [IFRS 15 30] Identify the performance obligations in the contract
Performance obligations are satisfied and revenue can be recognised when a customer obtains control of the asset or benefits from the services provided. Performance obligations are completed and revenue is recognised either at a point in time or over a period of time, depending on certain facts. [IFRS 15 32]
- At a point in time – a company has to go through the criteria to determine if a performance obligation is satisfied over time. If it does not meet those criteria, then the performance obligation is satisfied and revenue recognised at the point in time when control of the good or service is transferred to the customer. [IFRS 15 33]
- Over a period of time – a performance obligation is satisfied and revenue is recognised over time if any one of the following are met:
- The customer receives and consumes the benefits of the goods or services as they are provided by the entity (routine, recurring services like a cleaning service are an example of a series of services that are substantially the same and have the same pattern of transfer)
- The goods or services create or enhance an asset that the customer controls as that asset is created or enhanced (this would be common for contractors who may renovate a home owned by the customer, or build a structure on land owned by the customer)
- The asset created does not have an alternative use to the entity and the entity has an enforceable right to payment for performance completed to date. [IFRS 15 35] Some examples are custom design services, or construction of a custom product to customer specifications. An enforceable right to payment for performance completed to date should include the right to costs incurred to date and a reasonable profit margin.
When a performance obligation and revenue is recognised over time, it is similar to what is known as percentage of completion. The primary difference is that the revenue is intended to be recognised in a pattern that represents the transfer of control to the customer. The standard provides two acceptable methods of measuring progress (IFRS 15 41):
Output method – Revenue is recognised based on the value transferred to the customer relative to the remaining value to be transferred. Some examples would be, surveys of performance completed to date, appraisals of results, milestone reached, time elapsed and units produced.
Input method – Revenue is recognised based on the entity’s effort to satisfy the performance obligation, relative to the total expected effort to satisfy the performance obligation. Some examples are, resources consumed, labour hours expended, costs incurred, time elapsed and machine hours used. The input method has to carefully consider if the inputs truly measure progress to completion. For example, materials may be purchased and recorded as inputs to the project, but due to uninstalled materials or inefficiencies resulting in wasted material, the full amount may not properly depict progress.
Once the performance obligations have been identified, then it is time to move to Step 3: Determining the transaction price.