Revenue (IFRS 15)
Revenue is usually the largest number in the statements, and the one most open to pressure: management may want sales recognised early, and investors watch revenue growth closely. IFRS 15 Revenue from Contracts with Customers answers one question for every contract: how much revenue, and when? It does this with a single five-step model. In FR you will meet it in objective test questions on the steps and the special arrangements, in calculations on contracts that run over more than one year, and as adjustments in preparation questions, where revenue booked too early must be taken out.
The five steps
| Step | What you do | The key idea |
|---|---|---|
| 1. Identify the contract | Confirm there is an enforceable agreement with a customer | Approved, with identifiable rights and payment terms, commercial substance, and collection probable |
| 2. Identify the performance obligations | List each distinct promise to transfer goods or services | A promise is distinct if the customer can benefit from it on its own and it is separate from the other promises |
| 3. Determine the transaction price | Find the consideration the entity expects to be entitled to | Adjust for variable consideration, financing, non-cash consideration and amounts payable to the customer |
| 4. Allocate the price | Share the price between the obligations | In proportion to their stand-alone selling prices |
| 5. Recognise revenue | When, or as, each obligation is satisfied | When control of the good or service passes to the customer |
Step 2: performance obligations. A machine sold with two years of servicing is two obligations; the bricks, labour and design in a construction contract are usually one, because the customer is buying the finished building. Warranties need care: a warranty that only assures the product works as promised is not a separate obligation, and its expected cost is provided under IAS 37. A warranty the customer can buy separately, or one that provides an extra service, is a separate obligation and receives part of the price.
Step 3: the transaction price. Variable consideration, such as bonuses, discounts or penalties, is estimated using the expected value or the most likely amount, but is included only to the extent that it is highly probable there will not be a significant reversal later. If payment is deferred well beyond delivery, the price contains a significant financing component: revenue is the cash price (the present value of the payment) and the rest is interest income, recognised over time. You need not adjust when the gap between delivery and payment is one year or less.
Step 4: allocation. Stand-alone selling prices are what the entity would charge for each item sold separately. A discount for buying a bundle is normally spread across all the items in proportion.
Step 5: over time or at a point in time
A performance obligation is satisfied over time if any one of these is met:
- the customer receives and uses the benefit as the entity performs, as with cleaning or security services;
- the entity's work creates or improves an asset the customer controls as it is built, such as a building on the customer's land; or
- the work creates an asset with no alternative use to the entity, and the entity has an enforceable right to payment for work done to date.
Otherwise it is satisfied at a point in time, when control passes. Indicators that control has passed include a present right to payment, legal title, physical possession, the significant risks and rewards of ownership, and the customer's acceptance.
For obligations satisfied over time, revenue follows progress. Output methods measure what has been delivered, such as surveys of work completed. Input methods measure effort, such as costs incurred to date as a proportion of total expected costs. If progress cannot yet be measured but the costs will be recovered, recognise revenue only to the extent of costs incurred. If the whole contract is expected to make a loss, recognise the entire expected loss immediately, as an onerous contract.
Contract assets, contract liabilities and receivables
| Balance | What it means | Measured as |
|---|---|---|
| Contract asset | Revenue recognised before the entity has an unconditional right to bill | Revenue to date less amounts billed, when positive |
| Contract liability | The customer has paid, or been billed, ahead of the entity's performance | Amounts billed less revenue to date, when positive |
| Trade receivable | An unconditional right to payment: the invoice is issued and only time must pass | Amounts billed less cash received |
Special arrangements
| Arrangement | The question to ask | Treatment |
|---|---|---|
| Principal or agent | Does the entity control the goods before they pass to the customer? Look at who is responsible for delivery, who bears inventory risk and who sets the price | A principal records the gross sale; an agent records only its commission |
| Bill-and-hold | Has control passed although the goods are still on the seller's premises? | Revenue only if the arrangement has a substantive reason (such as a customer request), the goods are identified as the customer's, ready for delivery, and cannot be used or sent elsewhere by the seller |
| Sale or return (right of return) | How many goods will come back? | Revenue only for goods not expected to be returned; a refund liability for the rest, and an asset for the right to recover the goods |
| Consignment | Is the dealer obliged to pay, or can it return unsold goods? | No revenue on delivery to the dealer; revenue when the dealer sells to the end customer |
| Sale and repurchase | Must or may the seller buy the item back? | If the seller must or may repurchase at a price at or above the selling price, it is a financing arrangement: keep the asset and record a loan, with the extra as interest |
Two short calculations show the numbers.
Right of return. A company sells 1,000 units at $50 (cost $30 each) and expects 5% to be returned. Revenue is $47,500, with a refund liability of $2,500. Cost of sales is $28,500, with an asset of $1,500 for the 50 units it expects to recover.
Financing component. Goods are delivered on 1 January 20X5 for $1,210,000 payable on 31 December 20X6. The financing rate is 10%. Revenue on delivery is $1,210,000 ÷ 1.21 = $1,000,000. Interest income is $100,000 in 20X5 (receivable $1,100,000) and $110,000 in 20X6, bringing the receivable to $1,210,000 when it is paid.
Worked example
Example 1: a contract satisfied over time. Abuja Build, a fictional contractor, signs a fixed-price contract for $10m to build offices on a customer's land, so the obligation is satisfied over time. Progress is measured by costs incurred as a proportion of total expected costs. The year end is 31 December.
| $'000 | 20X5 | 20X6 |
|---|---|---|
| Costs incurred to date | 2,800 | 6,000 |
| Expected costs to complete | 4,200 | 2,000 |
| Total expected costs | 7,000 | 8,000 |
| Progress (costs to date ÷ total) | 40% | 75% |
| Amounts billed to date | 3,500 | 7,000 |
Expected total costs rose in 20X6. That is a change in estimate, so the cumulative figures are recalculated and the year's figures are the difference.
| $'000 | Cumulative to 20X5 | Cumulative to 20X6 | Recognised in 20X6 |
|---|---|---|---|
| Revenue ($10,000k × progress) | 4,000 | 7,500 | 3,500 |
| Cost of sales (total costs × progress) | (2,800) | (6,000) | (3,200) |
| Profit | 1,200 | 1,500 | 300 |
The contract asset at 31 December 20X6 is revenue to date less amounts billed: $7,500k − $7,000k = $500k. A useful cross-check: costs to date $6,000k plus profit to date $1,500k less billed $7,000k gives the same $500k. If the customer has paid $6,200k of the $7,000k billed, there is also a trade receivable of $800k.
Had total costs risen to more than $10m, the contract would be loss-making and the whole expected loss would be recognised in that year.
Example 2: a bundle. On 1 October 20X5 a company sells a machine with two years of servicing for $100,000, paid in advance. Sold separately, the machine would cost $90,000 and the servicing $30,000. The year end is 31 December.
| Allocation | Stand-alone price ($) | Share | Allocated ($) |
|---|---|---|---|
| Machine | 90,000 | 90/120 | 75,000 |
| Servicing | 30,000 | 30/120 | 25,000 |
| Total | 120,000 | 100,000 |
The machine is delivered on 1 October: $75,000 revenue at that point. The servicing is satisfied over 24 months: $25,000 × 3/24 = $3,125 for 20X5. Revenue for 20X5 is $78,125, and the contract liability at 31 December 20X5 is $25,000 − $3,125 = $21,875.
Common mistakes
- Recognising the full price of a bundle on delivery, ignoring the service still to be performed.
- Calculating the current year's contract revenue directly instead of as cumulative revenue less revenue recognised in earlier years.
- Spreading an expected contract loss over the contract instead of recognising it all at once.
- Confusing the contract asset (revenue not yet billed) with the trade receivable (billed, not yet paid).
- Recording the gross amount when the entity is only an agent, or recording revenue on goods sent to a dealer on consignment.
Exam technique
Work every revenue question through the five steps in order, even in a ten-second sketch: the step you skip is usually where the trap is. For contracts over time, build the cumulative table first, then subtract the previous year. In preparation questions, look for revenue recorded too early (goods on sale or return, bill-and-hold, a sale with a repurchase) and reverse it: debit revenue and credit receivables (or record a liability for any cash already received), and put the goods back in inventory at cost.
Study with AI
I am studying ACCA Financial Reporting (FR), IFRS 15 revenue. Give me five short
scenarios, one at a time: a bundle needing allocation, a contract over time across two
years with a change in estimate, a principal versus agent case, a sale or return, and a
deferred payment with a financing component. Wait for my answer each time, then show
the correct revenue figures and the IFRS 15 step that decides each. Use $ and 20X5.AI assistants can mix up contract assets, contract liabilities and receivables: check every answer against these notes before you rely on it.
Lecturer's note: Behind all five steps is one idea: revenue is earned when the customer gets control of what it paid for, not when the cash or the invoice moves. Ask "what has the customer actually received so far?" and most questions answer themselves. A deposit received is a liability because the customer has received nothing yet; a half-built office on the customer's land is half the revenue because the customer already controls it; a bill-and-hold sale is revenue only if the goods truly belong to the customer already.
Key points
- IFRS 15 has five steps: contract, performance obligations, transaction price, allocation, recognition.
- The price is allocated on relative stand-alone selling prices; variable consideration is included only if a significant reversal is highly unlikely.
- Revenue is recognised over time if one of three criteria is met, measured by progress; otherwise at the point control passes. Expected contract losses are recognised immediately.
- Revenue to date less amounts billed gives a contract asset (if positive) or a contract liability (if negative); billed but unpaid amounts are receivables.
- Agents record commission only; bill-and-hold, consignment, sale or return and repurchase agreements all turn on whether control has passed.
Quick check
- A contract has a price of $6m. Costs to date are $2.4m and total expected costs are $4.8m. Progress is measured by costs. What revenue and profit are recognised to date?
- For the contract in question 1, $2.5m has been billed to date. What is the contract balance?
- A travel agent sells a holiday for $3,000 and passes $2,640 to the tour operator, which is responsible for providing the holiday. What revenue does the agent recognise?
Answers
- Progress $2.4m ÷ $4.8m = 50%. Revenue $6m × 50% = $3.0m; cost of sales $2.4m; profit $0.6m.
- Revenue to date $3.0m less billed $2.5m = a contract asset of $0.5m.
- The agent does not control the holiday, so it recognises only its commission: $3,000 − $2,640 = $360.