The Five-Step Model of IFRS 15: Understanding Each Stage

Posted In | Finance | Accounting Software

International Financial Reporting Standard (IFRS) 15, 'Revenue from Contracts with Customers', has transformed how businesses recognize revenue. To simplify the application of this comprehensive standard, a five-step model has been developed, aiming to provide a systematic approach to revenue recognition. This article seeks to dissect this model, providing a deeper understanding of each step.

 

 

Step 1: Identify the Contract(s) with a Customer

The first stage in revenue recognition under IFRS 15 is identifying a contract with a customer. A contract is defined as an agreement between two or more parties that creates enforceable rights and obligations. For a contract to be considered within the scope of IFRS 15, it must be probable that the entity will collect the consideration to which it is entitled in exchange for the goods or services that will be transferred to the customer.

 

Step 2: Identify the Performance Obligations in the Contract

Once the contract has been identified, the next step is to determine the distinct performance obligations. A performance obligation is a promise in a contract to transfer a good or service to the customer. Goods or services that are distinct are capable of being separated from other promises in the contract, and the customer can benefit from the good or service either on its own or together with other resources readily available to the customer.

 

Step 3: Determine 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, excluding amounts collected on behalf of third parties. In determining the transaction price, an entity must consider variable consideration, time value of money, non-cash consideration, and consideration payable to the customer.

 

Step 4: Allocate the Transaction Price to the Performance Obligations in the Contract

After the transaction price has been determined, it needs to be allocated to each distinct performance obligation in the contract in a manner that depicts the amount of consideration to which the entity expects to be entitled in exchange for transferring the promised goods or services. The transaction price is generally allocated based on the standalone selling prices of the goods or services underlying each performance obligation.

 

Step 5: Recognize Revenue When (or As) the Entity Satisfies a Performance Obligation

The final step involves recognizing revenue when (or as) a performance obligation is satisfied, i.e., when control of the promised good or service is transferred to the customer. Control is transferred over time if one of the following criteria is met:

 

• The customer simultaneously receives and consumes the benefits provided by the entity’s performance as the entity performs.
• The entity’s performance creates or enhances an asset that the customer controls as the asset is created or enhanced.
• 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.

 

If none of these criteria is met, the entity recognizes revenue at a point in time when the customer obtains control of the good or service.

 

In conclusion, understanding and correctly applying the five-step model of IFRS 15 is critical for businesses to accurately recognize revenue in accordance with this comprehensive standard. This model offers a consistent and systematic approach to revenue recognition, enhancing comparability and transparency in financial reporting.