International Financial Reporting Standard 15 – Revenue from Contracts with Customers
Why is revenue recognition such a significant accounting issue?
The question of when and how to recognise revenue is one of the most significant and sensitive accounting issues. This is due, among other things, to the substantial weight revenue carries in understanding an entity’s size, strength and growth potential, as well as its importance as a starting point for financial analysis. This importance is particularly pronounced in internet-based companies, where revenue often drives market valuations — to the point that investors use revenue multiples instead of earnings multiples. Consequently, revenue reporting attracts significant scrutiny by investors and regulators, and it is one of the most common areas of restatements in the U.S.
How is revenue defined under IFRS?
Revenue is defined as “an increase in economic benefits during the period arising in the course of the ordinary activities of an entity, resulting in increases in equity, other than those relating to contributions from equity participants.”
This definition mirrors that of income in the Conceptual Framework but is narrower, as it only includes increases in economic benefits arising from the entity’s ordinary activities. The Conceptual Framework defines income as “increases in economic benefits during the reporting period in the form of inflows or enhancements of assets or decreases of liabilities that result in increases in equity, other than those relating to contributions from equity participants.”
What is the difference between revenue and income?
In other words, income includes both revenue (from ordinary activities) and gains (from non-ordinary activities). For example, income from selling machinery by an entity whose main business is selling machinery is classified as revenue. However, income from selling machinery by an entity whose main business is not selling machinery is considered a gain (or loss), not revenue under IFRS 15.
Income from non-ordinary activities is generally presented on a net basis as gains or losses. However, the principles for recognising and measuring such gains or losses (e.g., from the sale of property, plant and equipment or intangible assets) are identical to those used for revenue under IFRS 15.
Do owner contributions count as revenue?
Revenue does not include owner contributions. For example, when a shareholder, in its capacity as a shareholder, forgives a loan receivable from the reporting entity, the forgiveness is accounted for as an equity contribution rather than income.
What is the core principle of revenue recognition?
Revenue is recognised to depict the transfer of promised goods or services to customers in an amount that reflects the consideration the entity expects to receive in exchange for those goods or services.
When is revenue recognised?
Under this core principle, revenue is recognised on an accrual basis, i.e., when control of goods or services transfers to the customer, rather than on a cash basis when payment is received.
Thus, an entity recognises revenue when it satisfies its performance obligation by transferring control of promised goods or services to the customer.
What is the scope of IFRS 15?
IFRS 15 is a modern and comprehensive standard that applies to all entities across all industries, and addresses revenue recognition for virtually all contracts with customers, except those within the scope of other IFRS Accounting Standards, such as IFRS 16 Leases, IFRS 9 Financial Instruments and IFRS 17 Insurance Contracts (previously IFRS 4).
What is the five-step model under IFRS 15?
IFRS 15 introduces a detailed five-step model for determining both the recognition and measurement of revenue, as follows:
Identify the contract with the customer.
Identify the performance obligations in the contract.
Determine the transaction price.
Allocate the transaction price to the performance obligations.
Recognise revenue when (or as) the entity satisfies a performance obligation.
What additional items are addressed by IFRS 15?
IFRS 15 also addresses the accounting treatment for certain items not normally considered revenue — such as costs to obtain or fulfill a contract, or contracts for the sale of non-financial assets (e.g., property, plant and equipment, or investment property).
How does IFRS 15 apply to the construction and real estate industry?
Revenue from Contracts with Customers in the Construction Industry
The real estate sector includes reporting entities engaged in the construction of real estate projects in general and residential housing in particular. These entities can generally be divided into two main types:
What is the difference between construction contractors and real estate developers?
Construction contractors – entities that build properties under a construction contract, usually on land owned by the customer.
Real estate developers – entities that develop land, construct housing units for sale, and bear the sales and market risks.
What is the key distinction between contractors and developers?
The key distinction between these two types is that a construction contractor faces minimal uncertainty regarding realisation of payment, as work is performed according to the customer’s order and specifications. Conversely, a real estate developer undertakes entrepreneurial activity involving significant sales and pricing risks, which lead to unique recognition and measurement challenges that differ from those faced by contractors.
What are “off-plan sales”?
In practice, entities that construct real estate for sale, either directly or through subcontractors, often sign agreements with multiple customers before construction begins, or even before receiving building permits or zoning approvals. Such transactions are commonly referred to as “off-plan sales.” Under these arrangements, the customer signs a contract to purchase a specific residential unit (e.g., an apartment) according to a predefined specification and typically pays an advance deposit that is refundable only if the developer fails to fulfill its contractual obligations. The size of this deposit varies by country and sometimes by entity. For example, in the UK deposits typically amount to around 10% of the purchase price upon signing, whereas in China they can reach up to 20% for first-time buyers and up to 30% subsequently. The remaining balance is paid in installments until the possession is delivered, based on the financing terms agreed upon.
What is the main accounting issue for construction contractors?
In contrast, construction contractors engage in providing services for the construction and development of buildings, infrastructure, bridges and other structures. The main accounting issue in their financial statements is how to allocate contract revenue and costs across the reporting periods during which the construction work is performed.
What is the percentage-of-completion method?
Traditionally, long-term service contracts were accounted for using the percentage-of-completion method (or “stage of completion” method). Under this approach, as long as reliable estimates can be made, each stage of completion is viewed as a separate service that gives rise to a right to consideration. Therefore, revenue is recognised as the work progresses. Consequently, based on the matching principle, costs incurred to generate that revenue are recognised as expenses in the same periods.
What are the limitations of the percentage-of-completion method?
This method provides useful information regarding the progress of contract performance and results during the reporting period. However, it relies heavily on estimates, which may change over the project’s life, including estimates of total expected costs to complete and the determination of the stage of completion. The method is applied on a cumulative basis, using updated estimates of contract revenue and costs at each reporting date. Any effect of changes in estimates on revenue or expenses previously recognised is reflected in profit or loss in the period when the change becomes known or occurs, whichever comes first.
What is the zero-profit margin method?
In the early stages of a project, reliable estimates often cannot be made. Since services have already been rendered and costs must be recognised as expenses, IFRS 15 allows under certain conditions the use of the zero-profit margin method, whereby revenue is recognised only up to the amount of costs incurred, as long as recovery of those costs is expected.
How are onerous contracts treated?
When a loss is expected on a contract (an “onerous contract”), a liability arises as defined in the Conceptual Framework. In such cases, the expected loss shall be recognised immediately in accordance with IAS 37 Provisions, Contingent Liabilities and Contingent Assets, regardless of the stage of completion or the method of revenue recognition.
When is revenue recognised over time?
IFRS 15 focuses on whether the contractor is creating or enhancing an asset controlled by the customer, such as building a road, bridge or another structure on the customer’s land. If the work is performed on an asset controlled by the customer as it is created or enhanced, revenue is recognised over time to reflect the economic benefits expected in return. For example, when an entity performs work on a customer’s site, control is generally deemed to transfer continuously, and thus revenue is recognised over time rather than upon completion.
When is revenue recognised over time for assets not controlled by the customer?
Conversely, if the contractor is producing an asset not controlled by the customer, two criteria are required to be met before revenue is recognised. This is the case with a contractor that fulfils a specific order from a customer, e.g., an order for an aircraft or a vehicle. This is also the case for real estate developers. In those cases, revenue can be recognised over time only if both of the following criteria are met:
The asset has no alternative use to the contractor.
The contractor has an enforceable right to payment for work completed to date (including costs incurred plus a reasonable margin) if the contract is canceled for reasons other than the contractor’s failure to perform.
Can customised assets always be recognised over time?
Thus, even if the asset is highly customised for the customer, revenue cannot necessarily be recognised over time unless the second condition above is satisfied.
What is the objective of recognising revenue over time?
Recognising revenue over time aligns with the objective of IFRS 15 — to provide useful information about the nature, amount, timing and uncertainty of revenue and cash flows arising from contracts with customers.
What other IFRS standards affect real estate revenue accounting?
Additional IFRS Accounting Standards affect the accounting treatment of real estate development projects:
IAS 2 – Inventories: Defines which costs are included in measuring inventory of buildings held for sale and sets out principles for impairment testing.
IAS 23 – Borrowing Costs: Determines which borrowing costs should be capitalised as part of the cost of inventories.
What is the overall outcome of applying these standards?
Together, these Standards ensure consistent recognition, measurement and presentation of revenue, costs and assets in real estate development projects under IFRS.