This is from the “Accounting Makes Cents” podcast episode #39 released on Monday, 8 May 2023.
In today’s episode, we are going to talk about IFRS 15 or the Revenue from Contracts with Customers. This is a fairly new standard, only coming about in 2018 to replace a previous standard with regards revenue, I think it was IAS 18 that it replaced.
Jump to show notes.
So with the IFRS 15 standard, there are a few steps that we need to remember in order to identify whether we are following the rules when it comes to recognising revenue.
The core principles surrounding IFRS 15 is delivered in a 5-step model:
- Identify the contract with the customer
- Identify the performance obligation in the contract
- Determine the transaction price
- Allocate the transaction price to the performance obligation in the contract
- Recognise revenue as and when the company satisfies a performance obligation
If you have trouble remembering this, just remember COPAR mnemonic. COPAR stands for customer, obligation, price, allocation, recognition. Easy, right?
I think if we read through the 5 steps needed to recognise revenue, it does sound easy enough. It doesn’t seem like there’s a way where you might not be able to apply or at least have trouble applying it. But the truth of the matter is, there are some issues or situations where you will pause a little bit to try and understand the situation and then be able to apply it. I’ll talk about those a bit more towards the end of the episode.
IFRS 15 – Objective
But for now, let’s do this first. Let’s talk about why this standard came into effect. The objective of the standard is to ensure revenues are properly recognised, wherein we ensure the nature, the amount, the timing and the uncertainties of those revenues are addressed.
Step 1 – Identify the contract with the customer
On the first step of identifying contracts with customers. The contract would need to have some basic information like who the customer is, what are the rights and obligations to be met by both sides, the price of the contract, the payment of the contract, and when the obligation transfers from seller to buyer.
Step 2 – Identify the performance obligation in the contract
On the second step, the goods or service is identified. This good or service needs to be distinct, which means that the customer can consume this good on its own or with other goods that are regularly available to the customer. Additionally, the transfer of that good or service to the customer can be separately identified from other transfers in the contract. We may encounter that obligation in a contract is not just one obligation, it could be a series of obligations and what this does is ensure that each of those obligations under the series are individually identified and you can separate it from the series or group.
Step 3 – Determine the transaction price
Third step is to determine the transaction price. This seems easy enough. But what does make this a little more complicated is when the contract names a non-cash element to the price, like instead of cash, you may get your payment in product or service form. Another way to make this difficult is when there is a variable element to the price, like maybe you get a buy-one-get-one kind of contract with these purchases, then the determination of the price may change and it’s not as straightforward anymore.
Step 4 – Allocate the transaction price to the performance obligation in the contract
The fourth step is to allocate the transaction price to the obligation in the contract. So it is important to ensure we understand what types of obligations are there, when does the obligation transfer, meaning when does the customer start enjoying and benefitting from the product. We can start recognising once this transfer has happened. But as mentioned, there are some situations where it can get murky. So situations like when there are warranties involved. Do note there are different types of warranties as well. Some types don’t need separate recognition and other times, they do.
Step 5 – Recognise revenue as and when the company satisfies a performance obligation
The fifth step is to recognise. Control of the product needs to transfer over to the customer. The recognition part can happen over time or at a point in time. We must be careful when looking at when control passes, that is when the recognition needs to happen.
Key points to remember
- Things like BOGO, buy one get one, buy a monthly plan and get a free item, earn points so you can use them later for purchases, etc. can affect the application of IFRS 15. There are many rules to remember for these. I’d ask if you wish to find out more, there are a lot of resources online to find these out. You just need to be patient in researching them.
- It’s important to understand that the timing of the payment does not necessarily rule when the revenue is recognised. Sometimes you ask for a deposit, which does not mean that you can already recognise these funds as revenues since we must first determine what types of obligations have been met. And if none have been met, then there is no recognition.
- Warranties are trickier. There are warranties where it covers the product from failure for the next 2 years (let’s say). This type of warranties are what’s known as assurance types warranties. The tendency is it happens when it happens, not that it will definitely happen. The rule for this is that it goes under IAS 37 Provisions. The other kind of warranty is something called service-type warranty. The tendency for this one is that it is something more than just assurance being offered. Typically, you can separate this type of warranty as another job, another work, another step. And seeing that you can separate the action, you can also then separate the obligation.
Show notes simplified
In this episode, MJ the tutor discusses some basics around revenue recognition or better known as IFRS 15. It’s a common topic on the CIMA syllabus, which students may find helpful while they are preparing for their case studies or objective tests.
“Ding Ding Small Bell” (https://freesound.org/s/173932/) by JohnsonBrandEditing (https://www.youtube.com/channel/UC1RImxnsbfngagfXd_GWCDQ) licensed under CC0 Licence.