IFRS 15 Revenue from Contracts with Customers (contents page is here) introduced a single and comprehensive framework which sets out how much revenue is to be recognised, and when. The core principle is that a vendor should recognise revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the vendor expects to be entitled in exchange for those goods or services. See a summary of IFRS 15 here. Input method – Measuring progress to completion
This section is part of step 5 Recognise revenue as or when each performance obligation is satisfied and the sub-step Measuring progress toward complete satisfaction of a performance obligation. Input methods result in revenue being recognised based on the vendor’s efforts or inputs towards the satisfaction of a performance obligation. When the vendor’s efforts or inputs are expended evenly throughout the performance period, it may be appropriate for a vendor to recognise revenue on a straight-line basis. Input method – Measuring progress to completion
A drawback of input methods is that there may not be a direct relationship between the vendor’s inputs and the transfer of goods or services to a customer. Therefore, when using a cost-based input method, an adjustment to the measure of progress may be required if certain costs incurred do not contribute to the vendor’s progress in satisfying its performance obligation(s).
This would be the case when costs incurred are attributable to significant inefficiencies in the vendor’s performance which were not reflected in the price of the contract. In addition, certain costs may not be proportionate to the vendor’s progress in satisfying a performance obligation, and IFRS 15 then requires an adjustment to be made to the amount of profit recognised to date.
For example if, as part of a contract to refurbish a building, a vendor needs to purchase new elevators from a third party, the vendor will recognise revenue when control of the elevators is transferred to the customer, but will recognise no incremental profit. This is because arranging the delivery of the elevators to the customer’s premises does not result in any progress being made towards the refurbishment of the building.
In some cases, a vendor may not be able reasonably to measure the outcome of a performance obligation, but may expect to recover the costs incurred in satisfying that performance obligation (e.g. in the early stages of a contract). In these circumstances, the vendor recognises revenue only to the extent of the costs incurred to date, until such time that it can reasonably measure the outcome of the performance obligation.
This guidance is similar to the practice in IAS 11 Construction Contracts when a vendor cannot estimate the costs in a long term contract and applies the zero margin method. Input method – Measuring progress to completion