5 steps in IFRS 15
Under IFRS 15 Revenue from contracts with customers, entities apply the 5 steps in IFRS 15 to determine when to recognize revenue, and at what amount. The model specifies that revenue is recognized when or as an entity transfers control of goods or services to a customer at the amount to which the entity expects to be entitled. Depending on whether certain criteria are met, revenue is recognized:
- over time, in a manner that best reflects the entity’s performance; or
- at a point in time, when control of the goods or services is transferred to the customer.
IFRS 15 provides application guidance on numerous related topics, including warranties and licenses. It also provides guidance on when to capitalize the costs of obtaining a contract and some costs of fulfilling a contract (specifically those that are not addressed in other relevant authoritative guidance – e.g. for inventory).
5 steps in IFRS 15 – What is IFRS 15?
Step 1: Identify the contract with a customer
A contract with a customer is in the scope of IFRS 15 when the contract is legally enforceable and certain criteria are met. If the criteria are not met, then the contract does not exist for purposes of applying the general model of IFRS 15, and any consideration received from the customer is generally recognized as a deposit (liability). Contracts entered into at or near the same time with the same customer (or a related party of the customer) are combined and treated as a single contract when certain criteria are met.
A contract with a customer is in the scope of IFRS 15 when it is legally enforceable and meets all of the following criteria. [IFRS 15.9]
Step 2: Identify the performance obligations in the contract
The process of identifying performance obligations requires an entity to determine whether it promises to transfer either goods or services that are distinct, or a series of distinct goods or services that meet certain conditions. These promises may not be limited to those explicitly included in written contracts. IFRS 15 provides indicators to help determine when the ‘distinct’ criteria are met.
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 goods or services to a customer, excluding amounts collected on behalf of third parties – e.g., some sales taxes. To determine this amount, an entity considers multiple factors. [IFRS 15.47]
An entity estimates the transaction price at contract inception, including any variable consideration, and updates the estimate each reporting period for any changes in circumstances. When determining the transaction price, an entity assumes that the goods or services will be transferred to the customer based on the terms of the existing contract and does not take into consideration the possibility of a contract being cancelled, renewed, or modified. [IFRS 15.49]
In determining the transaction price, an entity considers the following components.
Step 4: Allocate the transaction price to the performance obligations in the contract
The transaction price is allocated to each performance obligation – generally each distinct good or service – to depict the amount of consideration to which an entity expects to be entitled in exchange for transferring the promised goods or services to the customer. [IFRS 15.73, IFRS 15.75]
An entity generally allocates the transaction price to each performance obligation in proportion to its stand-alone selling price. However, when specified criteria are met, a discount or variable consideration is allocated to one or more, but not all, performance obligations. [IFRS 15.74]
This step of the revenue model comprises two sub-steps that an entity performs at contract inception. [IFRS 15.76]
Step 5: Recognize revenue when or as the entity satisfies a performance obligation
An entity recognizes revenue when or as it satisfies a performance obligation by transferring a good or service to a customer, either at a point in time (when) or over time (as). [IFRS 15.35 – 37, IFRS 15.38]
A good or service is ‘transferred’ when or as the customer obtains control of it.
At contract inception, an entity first evaluates whether it transfers control of the good or service over time – if not, then it transfers control at a point in time.
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