How to Recognize Revenue in Ifrs 15

Table of Content

1.0 Executive Summary

2.0 Introduction

3.0 The importance of the recognition of revenue under IFRS 15

4.1 Step 1: identify the contract with the customer

4.2 Step 2: Identify the separate performance obligations

4.3 Step 3: Determine the transaction price

4.4 Step 4: Allocate the transaction price to the performance obligation

4.5 Step 5: Recognize revenue when a performance obligation is satisfied

5.0 Conclusion

6.0 Bibliography

1.0 Executive Summary

IFRS 15 is the regulation for a company on how to recognize revenue in the contracts with customers. Recognizing the correct revenue at the right is extremely important for a company. This report will identify why recognize revenue is important and demonstrate how to recognize revenue by strictly following the five steps under IFRS 15. To begin with, step 1 clearly demonstrates the time of revenue recognition in different situations. It also discusses the situation of the combined contracts. After that, step 2 focuses on analyzing the special situation for the separate obligation. Also, in order to recognize the precise revenue, it is important for a company to calculate the correct price of the product after considering business practice, discount rates and refund rates. In addition, because of the different obligation in one contract, the transaction price will be allocated to the different obligation to calculate or estimate the revenue. Moreover, distinguishing at point a time and over time is important. It will have deep influence on recognizing revenue for a company. At the end, this report concludes that IFRS 15 is a extremely good rule for a company to recognize revenue accuracy.    

2.0 Introduction

On May 28, 2014, the new revenue recognition polices – IFRS 15 was issued. “IFRS 15 is an International Financial Reporting Standards promulgated by the International Accounting Standards Board (IASB) providing guide on accounting for revenue from contracts with customers” ("IFRS 15", 2017). This standard sets a regulation of the amount and timing of the revenue recognition.

The core principle of revenue recognition is that the way in which the entity recognizes revenue should reflect the pattern of the transfer of goods and services to the client. The accounting entity needs follow the five steps for the revenue recognition. According to the IFRS 15, the objective of IFRS 15 is “to establish the principle that an entity shall apply to report useful information to users of financial statement about nature, amount, timing, and uncertainty of revenue and cash flows arising from a contract with a customer” (IFRS 15:1). This report will analyze and give example on the importance and how to recognize revenue under IFRS 15.

3.0 The importance of the recognition of revenue under IFRS 15

Recognition revenue plays a pivotal role on a company. Revenue is a key indicator of the performance for the company. “Revenue typically drives the success of most business, as it is a means of generating profits and increasing equity” ("Revenue Recognition – Why Is It So Important? | Resources | Connecticut Innovations", 2017). Since profitability is always a goal, if the profitability is not good enough, the operation management should be improved. “According to the principle of revenue recognition, revenues are recognized in the period when it is earned (buyer and seller have entered into an agreement to transfer assets) and realized or realizable (cash payment has been received or collection of payment is reasonably assured)” ("The Importance of Timing: Revenue and Expense Recognition", 2017). In other words, different accounting standards will lead to different net income for a company. Since company revenue is typically related to the manager’s bonus, without clear rules, it will increase the risk of occupational fraud. For example, managers can make fake sales records to increase the revenue of the company. The total amount of shipped out units may not be the same as sales units if customers never received their purchases due to loss of express delivery or cancellation of orders. This form of action will increase the revenue for the company only on financial statements. Also, manager will receive more bonuses because of sales fraud. If these fraudulent behaviors are reported publicly, a company’s reputation will be damaged and ultimately, investors and banks will no longer trust this company. A company may suffer from refusal of extending its business loans from financial institutions. In addition, inaccurate information will have negative effects on decision making and forecasting. Since revenue determines whether the company meets the shareholders’ expectations, different principals will have an impact on the company’s stock price. As a result, how to recognize revenues under the IFRS 15 rule has significant influence on the long term development of a company.

4.1 Step 1: identify the contract with the customer

According to the IFRS 15 rules, a contract is “an agreement between two or more parties that creates enforceable rights and obligations” (IFRS 15: Appendix A). There several forms of the contracts which including written contract, verbal contract, customary business practices, and so on. In order to recognize the revenue from the contract, the contract needs meet all 5 requirements which are listed in the IFRS 15. If the contract cannot meet these 5 criteria, company need to achieve either of the following policy to recognize the revenue.  

1. “The entity has no remaining performance obligations and all or substantially all the consideration for the performance obligations in the contract has been received and is non-refundable” [IFRS 15:15(a)].
2. “The contact is terminated and the consideration received is non-refundable” [IFRS 15:15(b)].

In other words, company can recognize the revenue if entity has already fulfilled the obligations under the contract and refund will not happen in the future.

In addition, when a project has multiple parts need to be built under the same commercial objective; several contracts will be combined into one single contract. For example, when a builder is building a house, he or she may sign a number of contracts with the owner of the house. The multiple parts that may be built in this house can include: constructing main structure of the house, installing pipeline and developing water electricity as well as wooden floors. Thus, these four contracts have been combined into one single objective which is to complete the project of building a single house.