CFA Program Level I

IFRS 15 five-step revenue recognition model: CFA Level I

IFRS 15 recognises revenue in five steps: identify the contract, identify the performance obligations, determine the transaction price, allocate that price to the obligations by relative stand-alone selling prices, and recognise revenue as each obligation is satisfied. Variable amounts such as bonuses are estimated and included in the transaction price.

The five steps

1. Identify the contract or contracts with a customer.

2. Identify the performance obligations. A performance obligation is a promise in the contract to transfer a distinct good or service to the customer.

3. Determine the transaction price: the consideration the entity expects to be entitled to for transferring the promised goods or services. If part of it is variable, such as a bonus, the entity estimates that amount.

4. Allocate the transaction price to each performance obligation on the basis of relative stand-alone selling prices.

5. Recognise revenue when, or as, each performance obligation is satisfied, which is when the customer obtains control of the good or service. The IASB issued IFRS 15 in May 2014, together with the FASB's introduction of Topic 606 into US GAAP.

Allocation, worked

Example: a contract sells a machine and two years of support for EUR1,200 in total. Sold separately, the machine is EUR1,000 and the support EUR500, so stand-alone prices total EUR1,500.

Machine: 1,200 x 1,000 / 1,500 = EUR800. Support: 1,200 x 500 / 1,500 = EUR400. The EUR300 discount falls on both obligations in proportion to their stand-alone prices.

The machine is a good, typically satisfied at a point in time, so EUR800 is recognised on delivery. The support is a service, typically satisfied over time, so EUR400 is recognised across the two years using a measure of progress, here EUR200 a year if the work is even.

Point in time or over time

A promise to transfer goods is typically satisfied at a point in time. A promise to provide services is typically satisfied over time.

For an obligation satisfied over time, the entity chooses a measure of progress and recognises revenue as the work is done, not when the contract ends and not when the customer pays.

Where the exam catches people

Believing a performance bonus is left out until it is received: variable consideration is estimated and included in the transaction price.
Believing a bonus or discount is a separate performance obligation: it changes the transaction price, not the list of promises.
Believing a bundle discount goes entirely to one item: it is spread across the obligations by relative stand-alone selling prices.
Believing service revenue is recognised when the customer pays: it is recognised as the obligation is satisfied, usually over time.
Believing allocation comes before determining the transaction price: the price is set in step 3 and allocated in step 4.

Written from CFA Institute's documentation

IFRS Foundation: IFRS 15 Revenue from Contracts with Customers

Try 3 questions on this

Pick an answer to see why each option is right or wrong.

Under IFRS 15, Vantor AG sells equipment and two years of maintenance in one contract for EUR900,000. Both are distinct performance obligations. Vantor sells the equipment separately for EUR600,000 and the maintenance separately for EUR400,000. The transaction price allocated to the equipment is closest to:
Right. In the game that’s Renown for your Financial Statement Analysis building.
Not that one: C is right. In the game your Financial Statement Analysis building would lose a little Renown, and this question would come back later.
Your answerA.EUR450,000An equal split ignores the stand-alone selling prices: 900,000 / 2 = 450,000. IFRS 15 allocates in proportion to relative stand-alone selling prices.Your answerB.EUR500,000This charges the maintenance its full EUR400,000 and puts the entire EUR100,000 discount on the equipment: 900,000 − 400,000 = 500,000. Allocating by relative stand-alone prices spreads the discount over both obligations.The answerC.EUR540,000IFRS 15 allocates the transaction price to each performance obligation on the basis of relative stand-alone selling prices. Total stand-alone prices = 600,000 + 400,000 = 1,000,000.
Show the full explanation and doc quotes
Equipment share = 600,000 / 1,000,000 = 60%. Allocation = 0.60 × 900,000 = EUR540,000; the maintenance receives EUR360,000.
Written from www.ifrs.org/issued-standards/list-of-standards/ifrs-15-revenue-from-contracts-with-customers/
Under IFRS 15, Shire Systems signs a contract to install a network for a fixed fee of EUR400,000 plus a EUR50,000 bonus if the work is finished by a set date. Based on its record on similar contracts, Shire is confident it will earn the bonus. In measuring the consideration for the contract, the bonus is most likely:
Right. In the game that’s Renown for your Financial Statement Analysis building.
Not that one: C is right. In the game your Financial Statement Analysis building would lose a little Renown, and this question would come back later.
Your answerA.Treated as a separate performance obligationA performance obligation is a promise to transfer a distinct good or service to the customer. The bonus is not something Shire transfers; it is a variable part of what Shire is paid for the installation.Your answerB.Excluded until the bonus is received in cashIFRS 15 does not wait for cash. The transaction price is the consideration the entity expects to be entitled to, and a variable amount is estimated, so the expected bonus is included.The answerC.Estimated and included in the transaction priceDetermining the transaction price is the third of IFRS 15's five steps. The transaction price is the consideration the entity expects to be entitled to for transferring the promised goods or services, and when the promised consideration includes a variable amount, such as a completion bonus, the entity must estimate it.
Show the full explanation and doc quotes
Shire estimates the bonus and includes it in the transaction price.
Written from www.ifrs.org/issued-standards/list-of-standards/ifrs-15-revenue-from-contracts-with-customers/
Under IFRS 15, Halden Ltd signs a one-year contract to clean a customer's offices every week for EUR240,000. The customer receives the benefit of each cleaning as it is done. Halden most likely recognises revenue from this contract:
Right. In the game that’s Renown for your Financial Statement Analysis building.
Not that one: C is right. In the game your Financial Statement Analysis building would lose a little Renown, and this question would come back later.
Your answerA.At a point in time, when the contract endsPoint-in-time recognition is typical for goods. The customer here receives the benefit of each week's cleaning as it is done, so the obligation is satisfied over time, not at the end.Your answerB.When the customer pays the final invoicePayment is not the trigger. IFRS 15 recognises revenue as the performance obligation is satisfied by transferring the service to the customer, which happens each week as Halden cleans.The answerC.Over time, using a measure of progressIFRS 15 recognises revenue when a performance obligation is satisfied, that is, when the customer obtains control of the good or service. Obligations to transfer services are typically satisfied over time, and for an obligation satisfied over time the entity selects a measure of progress to determine how much revenue to recognise.
Show the full explanation and doc quotes
Halden recognises revenue across the year as it cleans.
Written from www.ifrs.org/issued-standards/list-of-standards/ifrs-15-revenue-from-contracts-with-customers/