IFRS 15, which is Revenue from Contracts with Customers, introduced a comprehensive framework for recognizing revenue. It’s essentially a mandatory, five-step process that companies must follow to determine when to recognize revenue and how much to recognize.
Here is an explanation of the IFRS 15 five-step model in bullet points, keeping the word count concise:
- Step 1: Identify the Contract(s) with the Customer.
- The contract must be approved by the parties, identify the rights of each party, contain payment terms, have commercial substance, and it must be probable that the entity will collect the consideration.
- Step 2: Identify the Performance Obligations (POs) in the Contract.
- A PO is a promise to transfer a distinct good or service (or a bundle) to the customer. This requires companies to “unbundle” contracts to separately account for distinct promises (e.g., a phone and a 12-month service plan).
- Step 3: Determine the Transaction Price.
- This is the amount of consideration the entity expects to be entitled to, which can include fixed amounts, variable consideration (like rebates or bonuses), and adjustments for the time value of money if there’s a significant financing component.
- Step 4: Allocate the Transaction Price to the Performance Obligations.
- The total transaction price must be allocated to each distinct PO based on its relative stand-alone selling price (the price at which the good or service would be sold separately).
- Step 5: Recognize Revenue When (or As) the Entity Satisfies a Performance Obligation.
Revenue is recognized when the customer obtains control of the promised asset or service. This transfer of control can occur either at a point in time (like handing over a product) or over time (like providing a continuous service).