Our Simple Guide to IFRS 15 Revenue Recognition
You may have heard about IFRS 15 revenue recognition as a business that requires financial reporting, but have no idea what it is. Being IFRS 15 compliant is necessary if you want to remain transparent and attract the attention of potential investors.
In this article, we unpack everything about IFRS 15 to help you understand exactly what it is and how to apply it to your financial reporting.
When Does IFRS 15 Revenue Recognition Come into Effect?
Why Was IFRS 15 Created?
IFRS 15 was created to eliminate the inconsistent ways that businesses handled transaction accounting. Without standardized financial reporting, investors and other parties interested in financial statements found it difficult to compare results within a specific industry as well as across different industries.
IFRS 15 created a uniform way of recognizing revenue and standardized reporting across the board. This consistent reporting method has improved comparative reporting and analysis and has simplified how financial statements are prepared.
What is the Core Principle of IFRS 15?
Essentially, IFRS 15 exists to ensure that an entity recognizes revenue when the control of goods or services is transferred to the buyer. In exchange, the entity expects to receive the agreed amount for the goods or services.
What is the 5 Step IFRS Revenue Recognition Model?
To adhere to the core principle of IFRS 15, a five-step process is followed for each transaction. This provides the framework that achieves consistency throughout all business financial reporting. Let’s look at each of the five steps of IFRS 15 in more detail.
Step 1: Identify the Contract
Before a transaction is made, the buyer and seller must enter into a contract. The contract consists of the enforceable rights and obligations of each party. However, this doesn’t necessarily mean that the contract is a written one. It could be established orally or implied by usual business practice.
The contract sets out the terms that must be met in order to supply goods or services. It could be as simple as the promise to hand over the goods at the point of sale when the payment is made.
Step 2: Identify Separate Performance Obligations
Once the contract has been established, the performance obligations must be identified. These are the promises you make to the customer, such as the provision of goods or a service. It could also signify the provision of ongoing goods and services. For example, a subscription to a service or a lengthy construction contract is divided into several performance milestones.
Step 3: Determine Transaction Price
This step determines the final agreed price the customer will pay in exchange for their goods or service. It could be a one-off payment or an ongoing payment. When variability of a price exists from factors such as rebates and incentives, the business must evaluate the probability of this occurring and adjust the transaction price accordingly.
Step 4: Allocate Transaction Price to Performance Obligations
When you are in a shop, and you take an item to the cash register to be rung up, the performance obligation is for the cashier to carry out the transaction so you can take the item. The transaction price, in this case, is the cost of the item.
For ongoing or lengthy contracts, payment in installments is typically put into place. Most subscriptions or license agreements are paid for on a monthly or yearly basis. In this case, the performance obligation is to provide the service over the course of the year. The transaction price is the full cost of the yearly service regardless of whether or not it is split into installments.
Large contracts will have terms that dictate a portion of the cost that will be paid at various completion points along the way. Take a construction project as an example. The entire project will be split into milestones, with the final milestone being the completion of the project. A transaction price will therefore be assigned to each milestone and is payable when it has been fulfilled.
Step 5: Recognize Revenue When Each Performance Obligation is Satisfied
For financial reporting, revenue recognition IFRS can be met when each performance obligation is met. In other words, when the customer gains control of the goods or services they were promised, the amount owed for said goods or services can be recognized.
What are the Benefits of Adopting IFRS 15 Revenue Recognition?
By providing a proper framework of accounting standards, IFRS 15 brings far more accountability, efficiency, and transparency worldwide.
Reducing the information gap between those who provide capital and those who have been entrusted with the money really strengthens accountability. IFRS 15 holds management bodies to account and provides vital information to regulators around the globe.
Efficiency is achieved through IFRS 15 because the standards help investors to identify what is a risky opportunity and what is viable to invest in. This, in turn, improves capital allocation, lowers the overall cost of capital, and results in a reduction of international reporting costs and fees.
Finally, the whole framework brings transparency through the enhancement of international comparability and the provision of high-quality information. This gives market participants and investors the ability to make better, well-informed decisions.
What Does IFRS 15 Mean for Businesses?
IFRS revenue recognition means that businesses have to adhere to the framework and follow the five-step process to ensure they’re compliant. The main change is going to be the implementation of new procedures and policies that incorporate the five steps into their business practices.
This is also going to mean adopting and embracing new ways of collecting additional data. Therefore, in some cases, new technologies and software are required. For smaller businesses that don’t typically employ a financial team, they’re going to need to source financial expertise from somewhere to carry out IFRS 15.
The biggest changes are felt by businesses that offer ongoing contracts such as renewable licenses, subscriptions, ongoing services, and long-term contracts. It also affects businesses that apply conditional remuneration or variable prices to their contracts.
The most notably affected industries are:
- Real estate
- IT
- Pharmaceuticals and Healthcare
- Energy
- Media
- Telecommunications
- Technology
- Construction
- Automotive
How is Revenue Recognized With IFRS 15?
The main change introduced by IFRS 15 is contract revenue recognition. Revenue is now recognized when the transfer of control of the goods or services has been given to the customer, not necessarily when payment has been made. This means that revenue can be recognized before the entity has received the actual money.
The impact is that companies have a far better overview of their revenue at each point of the year and financial reports give an accurate account of the health of the business.
As an example, before IFRS 15, if a business sold 12-month software licenses, it was only allowed to apply six months of revenue to its books even though the customer had full control over the product. The other six months could only be recorded after the 12-month period had finished. Now, thanks to IFRS 15, this company would be able to record the whole 12 month’s worth of revenue all at once.
A car purchase is another example. If you buy a new car, you will typically pay for it over a series of installments. Under IFRS 15, the seller can now recognize the full cost of the car as revenue as soon as you, as the customer, receive the keys and assume control over the vehicle.
How Does IFRS 15 Change the Way Investors View Financial Performance?
The way IFRS turnover is reported is especially beneficial if you want to attract investors. Since the standards offer transparency, it allows investors to understand what is classed as a risk and what looks like a good opportunity.
They’re going to take notice of any business that has adopted IFRS 15 because they know they’ll be able to get an accurate overview of the business’s health as well as all the clear data to back it up. That all-important alignment with a company’s performance and revenue is what investors are looking for, and this is achieved through IFRS 15.
How Do I Get Professional Help with IFRS 15?
Unfortunately, there’s no IFRS 15 for dummies book, so it falls on the financial team to learn how to apply it to their business transactions. As the framework can be complex, qualified accountants are required to implement the system since they have the technical know-how and expertise to make sense of it all.
This is fairly straightforward for larger businesses because they will already have a sizeable team of accountants and other resources on board.
Unfortunately, many small businesses simply don’t have the financial expertise and resources on their payroll to put the system in place. This can leave them floundering and unable to become IFRS 15 compliant.
Hiring a virtual accountant is the best solution to help you implement the IFRS 15 system. At Finvisor, we have a team of financial experts on hand who are all familiar with IFRS 15 and how to set it up within a business.
All Finvisor accountants are highly qualified and experienced; however, you only pay for the resources you need. This means you can have high-quality expertise when you need it without taking on a full-time accountant.
For more information on IFRS 15 or for any other financial accounting or bookkeeping requirement, get in touch and chat with our team today.
To learn more about what we do, or to request a quote, contact us at hello@finvisor.com or 415-416-6682. We’re here to help you navigate deferred revenue journal entries so you can make the most of your assets!
*This blog does not constitute solicitation or provision of legal advice and does not establish an attorney-client relationship. This blog should not be used as a substitute for obtaining legal advice from an attorney licensed or authorized to practice in your jurisdiction.*
- Last Modified
- June 19, 2023
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