IFRS 15

IFRS 15 requires entities to apply a five-step model to determine when and how much revenue to recognize: (1) Identify the contract with a customer, (2) Identify the performance obligations in the contract, (3) Determine the transaction price, (4) Allocate the transaction price to the performance obligations, (5) Recognize revenue when (or as) the entity satisfies a performance obligation.

The 5-step model is a checklist for recording sales:

1. Do you have a real agreement with a customer?

2. What exactly did you promise to deliver?

3. How much will you get paid (including estimates for discounts, bonuses, or refunds)?

4. If you promised multiple things, how do you split the total price between them?

5. Record the revenue when you actually deliver what you promised.

Imagine your friend pays you $20 for a birthday cake AND delivery:

1. You both agree on the deal (contract)

2. You figure out you made TWO promises: bake the cake AND deliver it

3. The total price is $20

4. You decide the cake is worth $15 and delivery is worth $5

5. You earn the $15 when you finish baking, and the $5 when you deliver it

You don't earn all $20 the moment your friend pays you - you earn it as you keep your promises.

Without a structured model, companies could record revenue whenever they wanted - some might record it too early (making profits look bigger than they are) and others too late. The 5-step model ensures everyone records revenue at the right time: when they actually deliver what the customer paid for.

The most common mistake is recognizing revenue when cash is received rather than when the performance obligation is satisfied. Receiving payment and earning revenue are two different events.

A performance obligation is a promise in a contract to transfer to the customer either: (a) a good or service (or a bundle of goods or services) that is distinct, or (b) a series of distinct goods or services that are substantially the same and that have the same pattern of transfer to the customer.

A performance obligation is each separate promise you made to the customer. If you sold someone a phone AND a two-year warranty, those are two separate promises. You need to account for each one separately because you deliver them at different times - the phone immediately, and the warranty over two years.

When you order a Happy Meal, you get a burger, fries, a drink, AND a toy. Each of those is a separate promise from the restaurant. If they gave you the burger but forgot the toy, they haven't finished everything they promised. Each item is like a separate 'performance obligation' - a promise they need to keep.

ABC Software sells a package for $12,000 containing:

- Software license: delivered immediately

- Installation services: completed in week 1

- One-year technical support: provided over 12 months

These are three separate performance obligations because each is distinct - the customer could buy them separately from different vendors. ABC must allocate the $12,000 across all three and recognize revenue as each obligation is satisfied:

- License revenue: recognized when software is delivered

- Installation revenue: recognized when installation is complete

- Support revenue: recognized evenly over 12 months

The transaction price is the amount of consideration to which an entity expects to be entitled in exchange for transferring promised goods or services to a customer. It includes fixed amounts, variable consideration (estimated using the expected value or most likely amount method), the time value of money (if significant financing component exists), non-cash consideration, and consideration payable to a customer.

The transaction price is how much you expect to actually receive. This sounds simple, but it gets complicated when:

- The price includes bonuses or penalties (variable consideration)

- The customer pays much later (time value of money)

- The customer pays with something other than cash

- You give the customer rebates or discounts

If someone says they will pay you $10 for mowing their lawn, plus a $2 bonus if you do it before noon - how much is the 'price'? You need to estimate whether you will probably earn that bonus. If you usually finish before noon, you might count the price as $12. If you rarely make it, you might count it as $10.

Construction Co. signs a contract for $1,000,000 with a $100,000 bonus if completed by December 31.

Based on experience with similar projects, Construction Co. estimates an 80% probability of meeting the deadline.

Using the 'most likely amount' method: the most likely outcome is receiving the bonus (80% > 50%), so the transaction price is $1,100,000.

Using the 'expected value' method: $1,000,000 + (80% x $100,000) = $1,080,000.

The entity uses whichever method better predicts the amount it will receive.

When did IFRS 15 become effective?

IFRS 15 became effective for annual periods beginning on or after 1 January 2018. It replaced IAS 18 (Revenue) and IAS 11 (Construction Contracts).

Is IFRS 15 the same as ASC 606?

IFRS 15 and ASC 606 are substantially the same standard. They were developed jointly by the IASB and FASB and use the same 5-step model. Minor differences exist in some implementation guidance and transition provisions.

What is the core principle of IFRS 15?

The core principle is that revenue should be recognized to depict the transfer of promised goods or services to customers in an amount that reflects the consideration the entity expects to be entitled to in exchange for those goods or services.