When to recognise revenue
Revenue is recognised when/as performance obligations are satisfied in the amount of transaction price allocated to satisfied performance obligations (IFRS 15.46). A performance obligation is satisfied by transferring a promised good or service to a customer (IFRS 15.31).
A good or service is transferred to a customer when he obtains control of that asset, i.e. the ability to direct the use of, and obtain substantially all of the remaining benefits from, the asset (IFRS 15.33). The definition of control can be split into three parts (ability, direct the use of, obtain the benefits from) as discussed further by the IASB in paragraph IFRS 15.BC120. The assessment of when control has been transferred should be made from the perspective of a customer (IFRS 15.BC121).
Performance obligation can be satisfied (and revenue recognised) at a point in time or over time. If a performance obligation is not satisfied over time, it must be treated as satisfied at a point in time (IFRS 15.32).
A performance obligation is a promise to transfer to the customer a good or service (or a bundle of goods or services) that is distinct (IFRS 15.22). At a contract inception, entities need to identify the goods or services promised in that contract. This is a starting point in identifying performance obligations. In addition to the goods or services explicitly stated in the contract, all implied promises (e.g. by past business practices or published policies) that create a valid expectation of the customer that the entity will transfer a distinct good or service are also treated as separate performance obligations even though they may not be enforceable by law (IFRS 15.24, BC87).
Activities that do not transfer a good or service to a customer are not a performance obligation even though they may be necessary to fulfil a contract (IFRS 15.25). Examples of such activities are setup of a manufacturing process or connecting a customer to a telecommunications network.
Distinct goods or services
Definition of distinct goods or services
A good or service is distinct if both of the following criteria are met (IFRS 15.27):
a/ the customer can benefit from the good or service either on its own or together with other resources that are readily available to the customer (in other words: the good or service is capable of being distinct); and
b/ the entity’s promise to transfer the good or service to the customer is separately identifiable from other promises in the contract (in other words: the promise to transfer the good or service is distinct within the context of the contract).
A 2-step approach seems to work best. At first, entities look at point a/ and assess whether the good or service is capable of being distinct (more discussion on this point below). If the answer is no, the good/service is not distinct. If the answer is yes, entities move on to point b/ and assess whether this good/service is distinct within the context of the contract (again, more discussion on this point below). If the answer is yes, the good/service is distinct. If no – the good/service is not distinct. Examples of distinct goods or services are given in IFRS 15.26.
If a promised good or service is not distinct, it should be combined with other promised goods or services until they become distinct together (‘a bundle’). Such a bundle is then treated as a single performance obligation (IFRS 15.30).
A good or service should be treated as a separate performance obligation irrespective of the business model adopted by an entity. For example, a telecommunications company may want to consider a ‘free’ handset provided to a customer as a marketing expense as its business model is to provide telecommunications services, not to sell handsets. Such an approach is not allowed under IFRS 15 (IFRS 15.BC88-BC90).
The good or service is capable of being distinct
For some goods or services, such as a piece of furniture, it is obvious that a customer will benefit from them on his own. Sometimes a customer can benefit from the good or service only by using them with other readily available resources (e.g. a mobile phone that needs a provider of telecommunications services). A readily available resource is defined in IFRS 15.28 as a good or service that is sold separately (by the entity or another entity) or a resource that the customer has already obtained from the entity (including goods or services that the entity will transfer to the customer under the contract before the good or service in question is transferred) or from other transactions or events. See Example 11 Cases A/E, Example 12 and Example 56 Case A accompanying IFRS 15.
Paragraph IFRS 15.BC100 notes that the assessment of whether the customer can benefit from the goods or services on its own should be based on the characteristics of the goods or services themselves instead of the way in which the customer may use the goods or services. Consequently, an entity would disregard any contractual limitations that might preclude the customer from obtaining readily available resources from a source other than the entity. See Example 11 Case D accompanying IFRS 15.
The good or service is distinct within the context of the contract
A good or service promised to the customer is not separately identifiable from other promises in the contract when, in substance, the customer contracted for a combined good or service. In such cases, goods or services that seem to be distinct are in fact only inputs to the combined item. For example, when a customer places an order to print 10,000 copies of a book, the paper used for printing that book is not a distinct good, although the customer would be able to take that paper with him and print the book in a different place. Similarly, construction companies do not recognise revenue when they deliver building materials to the construction site if the customer contracted them to construct a building. See Example 10 Case A, Example 11 Cases B/E and Example 55 and Example 56 Case B accompanying IFRS 15.
Paragraph IFRS 15.29 lists three most common circumstances in which two or more promises to transfer goods or services to a customer are not separately identifiable (a non-exhaustive list):
a/ The entity provides a significant service of integrating the goods or services with other goods or services promised in the contract into a bundle of goods or services that represent the combined output or outputs for which the customer has contracted. In other words, the entity is using the goods or services as inputs to produce or deliver the combined output or outputs specified by the customer. A combined output or outputs might include more than one phase, element or unit. (e.g. construction contracts).
b/ One or more of the goods or services significantly modifies or customises, or are significantly modified or customised by, one or more of the other goods or services promised in the contract (e.g. sale of software with significant customisation).
c/ Each of the goods or services is significantly affected by one or more of the other goods or services in the contract (they are highly interdependent or highly interrelated).
Examples of distinct goods or services
- A car manufacturer sells its cars to a dealer and promises in the contract to provide a free maintenance to a final customer (i.e. to a customer of a dealer) for 3 years after the purchase. Such a promise of free maintenance is a distinct service and constitutes a separate performance obligation for a car manufacturer.
- A telecommunications company promises a free smartphone to each customer who subscribes for a premium telecommunications service. Additionally, it charges a one-off connection fee. Free smartphone is a distinct good and constitutes a separate performance obligation for the telecommunications company. Connection fee is not a distinct service and does not constitute a separate performance obligation as it does not result in a transfer of goods or services to the customer.
- A manufacturer contracts with its customer for a production of 100,000 pieces of sporting equipment. The manufacturer charges $0.5 million of up-front setup costs and $100 for each manufactured piece. The setup of manufacturing line is not a distinct service and does not constitute a separate performance obligation as it does not result in a transfer of goods or services to the customer.
- Entity B produces a specialised equipment which is installed at customer’s premises. Only Entity B is able to install the equipment. Entity B charges $5 million for the equipment and 0.5$ million for the installation. The equipment and its installation as treated as a single performance obligation as the customer would not be able to benefit from the equipment or installation service on its own.
A series of distinct goods or services that are substantially the same
Another important type of a performance obligation is a series of distinct goods or services that are substantially the same and that have the same pattern of transfer to the customer (IFRS 15.22(b)). In practice, this most often applies to repetitive services, such as cleaning services or transaction processing (IFRS 15.BC114).
A series of distinct goods or services is treated as one performance obligation when both of the following criteria are met (IFRS 15.23):
a/ each distinct good or service in the series would meet the criteria to be a performance obligation satisfied over time; and
b/ when measuring progress towards complete satisfaction of a performance obligation, the same method would be used to measure the entity’s progress towards complete satisfaction for each distinct good or service in the series.
See Examples 7, 13, 25 accompanying IFRS 15 and the examples below.
Example: A series of distinct goods or services that are substantially the same
Entity A is a company manufacturing car parts. It contracts with a car producer to manufacture 1 million car seats over the next three years. Each car seat is a distinct good, but Entity A treats the whole contract as one performance obligation under paragraph IFRS 15.22(b). It does so, because in concludes that conditions in paragraph IFRS 15.35(c) are met (more on performance obligations satisfied over time below). It does not matter whether the production will be spread evenly over time.
Performance obligations satisfied over time
Criteria for performance obligations to be satisfied over time
Performance obligation is satisfied over time if one of the criteria given in IFRS 15.35 is met:
a/ The customer simultaneously receives and consumes the benefits provided by the entity’s performance as the entity performs.
b/ The entity’s performance creates or enhances an asset that the customer controls as the asset is created or enhanced.
c/ The entity’s performance does not create an asset with an alternative use to the entity and the entity has an enforceable right to payment for performance completed to date.
Customer simultaneously receives and consumes benefits
This criterion is met in routine or recurring services, such as access to the Internet charged on a flat fee basis or cleaning services, but can also apply in more complex contracts. When applying this criterion is not straightforward, it is crucial to focus on assessing whether another entity would need to substantially re-perform the work that the entity has completed to date if that other entity were to fulfil the remaining performance obligation. In making this assessment an entity should (IFRS 15.B4):
- disregard potential contractual restrictions or practical limitations that otherwise would prevent the entity from transferring the remaining performance obligation to another entity; and
- presume that another entity fulfilling the remainder of the performance obligation would not have the benefit of any asset that is presently controlled by the entity and that would remain controlled by the entity if the performance obligation were to transfer to another entity
IASB stated that this criterion for performance obligation satisfied over time is not intended to be applied when an asset (e.g. work-in-progress) is created that is not consumed immediately by the customer (IFRS 15.BC128).
See Examples 13,18 and 25 accompanying IFRS 15 and the example below.
Example: satisfaction of performance obligation in a transportation service
Entity A contracts to transport a package from Madrid to Moscow. At the reporting period, the package has already been transported to Berlin. Entity A should recognise revenue for the transportation completed to date (i.e. from Madrid to Berlin) as another entity would not need to substantially re-perform the work that Entity A has completed to date if that other entity were to fulfil the remaining performance obligation to the customer and transport the package from Berlin to Moscow (IFRS 15.B4).
Entity’s performance creates or enhances an asset that the customer controls
This is the second (out of three) criterion that, if met, makes a performance obligation satisfied over time. The most typical application of this criterion is in construction industry, when an asset is created on enhanced on the customer’s land.
See more discussion on the control of an asset by a customer.
Asset without an alternative use to the entity and enforceable right to payment
Overview of the conditions to be met
This is the third criterion that, if met, makes a performance obligation satisfied over time. A performance obligation is satisfied over time under this criterion when both of the following criteria are met:
1/ the entity’s performance does not create an asset with an alternative use to the entity due to legal and/or practical restrictions and
2/ the entity has a contractual or legal enforceable right to receive reasonable compensation for performance completed to date if the contract were to be terminated before completion for reasons other than the entity’s failure to perform as promised.
No alternative use
An asset created by an entity’s performance does not have an alternative use to an entity if the entity is either restricted contractually from readily directing the asset for another use during the creation or enhancement of that asset or limited practically from readily directing the asset in its completed state for another use (as is the case when assets are significantly customised for the customer). The assessment of whether an asset has an alternative use to the entity is made at contract inception (IFRS 15.36). See paragraphs IFRS 15.B6-B8 and BC134-BC141 for more discussion.
Enforceable right to payment
The fact that the customer is obliged to pay for the work performed to date is a crucial indicator that the customer controls the asset and performance obligation is satisfied over time. This does not mean that an entity must have an unconditional right to payment at the reporting date but, instead, it must have an enforceable right to demand payment for performance completed to date if the customer were to terminate the contract before completion. It is also important that the right to payment is legally enforceable. See IFRS 15.37;B9-B13;BC142-BC147 for more discussion on this criterion. See also Examples 14, 15, 16 and 17 accompanying IFRS 15.
Measuring progress towards complete satisfaction of a performance obligation over time
Methods for measuring progress
If a performance obligation is satisfied over time, revenue is recognised based on the progress towards complete satisfaction of performance obligation. Measurement of progress can be based on the output or the input. Only one method should be used for measuring progress for a particular performance obligation and also for performance obligations with similar characteristics (IFRS 15.BC161). This can be especially challenging for performance obligations consisting of several non-distinct goods/services.
Output methods are covered in IFRS 15.B15-B17. Output methods are based on direct measurement of the value to the customer of the goods or services transferred to date relative to the remaining goods or services promised under the contract. Measurement methods include surveys, milestones reached, time elapsed or units delivered. Measurement method should take into account all goods and services promised in the contract. The advantage of output methods is that they it directly measures the value of the goods or services transferred to the customer.
Paragraph IFRS 15.B16 offers a practical expedient and allows to recognise revenue as the customer is billed, provided that this corresponds directly with the value to the customer of the entity’s performance completed to date. This may be a very useful practical expedient as it effectively applies also to determining the transaction price and allocating it to performance obligations.
Input methods are covered in IFRS 15.B18-B19. Measuring progress using an input method may be based on e.g. direct labour hours, time elapsed, resources consumed. IFRS 15 states also that it is possible to recognise revenue on a straight-line basis if the entity’s efforts or inputs are spread evenly throughout the performance period.
See Example 8 accompanying IFRS 15.
Basis for Conclusions to IFRS 15 and Example 19 include specific discussion on uninstalled materials (IFRS 15.BC170-BC175) and inefficiencies and wasted materials (IFRS 15.BC176-BC178).
Inability to measure the progress reliably
When the entity is unable to measure the progress reliably, revenue is recognised only to the extent of the costs incurred provided that the entity expects to recover them. Such costs cannot be deferred and recognised as assets unless they meet the criteria of recognising costs to fulfil a contract. Once the reliable measurement of progress becomes possible, the entity applies output or input methods as described above (IFRS 15.44-45).
Performance obligations satisfied at a point in time
Performance obligations satisfied at a point in time as the default option
We can say that performance obligation satisfied at a point in time is the default option, i.e. if a performance obligation does not meet the criteria of being satisfied over time (discussed above), it is assumed to be satisfied at a point in time. It is then a matter of deciding when exactly a performance obligation is satisfied, which is the date when a customer obtains control of a promised good or service (‘an asset’) (IFRS 15.38).
Control of an asset
Control is the ability to direct the use of, and obtain substantially all of the remaining benefits from, the asset, or to restrict the access of other entities to those benefits (IFRS 15.31-34). As noted earlier, the definition of control of an asset can be split into three parts:
- ability (a present right),
- direct the use of and
- obtain the benefits from the asset.
These discussed further by the IASB in paragraph IFRS 15.BC120. The assessment of when control has been transferred to a customer should be made from his perspective (IFRS 15.BC121).
Paragraph IFRS 15.38 provides additional indicators of the transfer of control which are discussed below.
Present right to payment for the asset
When a contract execution comes to a point when the entity has the right to a payment, it is an indicator that the control of the asset has been passed to a customer.
Transfer of legal title to a customer
When the entity has transferred a legal title to a customer under a contract, it is an indicator that the control of the asset has been passed to a customer. The control may have been passed to a customer even without the transfer of legal title, e.g. when the entity keeps the legal title until all receivables are paid by a customer.
Transfer of physical possession
Transfer of physical possession is another indication of transfer of control, but there are notable exceptions:
- repurchase agreements (including call and put options) covered in IFRS 15.B64-B76 and in Example 62 accompanying IFRS 15
- consignment arrangements (e.g. with a dealer or distributor) covered in IFRS 15.B77-B78
- bill-and-hold arrangements covered in IFRS 15.B79-B82 and in Example 63 accompanying IFRS 15
Requirements relating to repurchase agreements can be summarised as follows:
Transfer of significant risks and rewards of ownership of the asset
Transfer of significant risks and rewards of ownership of the asset is an indication of transfer of control.
Acceptance of the asset by a customer
For contracts that require an acceptance by a customer of the good or service in question, the entity does not consider a performance obligation to be satisfied until such acceptance is obtained. An exception to this rule applies when the entity can objectively determine that the agreed specifications are met, such as weight or size (IFRS 15.B83-B85).
For arrangements with trial/evaluation periods, revenue is not recognised until the customer accepts the asset or trial period ends and customer becomes committed to pay consideration for the asset (IFRS 15.B86).
More about IFRS 15
See other pages relating to IFRS 15:
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Excerpts from IFRS Standards come from the Official Journal of the European Union (© European Union, https://eur-lex.europa.eu). The information provided on this website does not constitute professional advice and should not be used as a substitute for consultation with a certified accountant.