Day 9: IFRS 15 – Revenue from Contracts with Customers (Part 2)
As we continue our journey through the world of International Financial Reporting Standards (IFRS), we arrive at Day 9, where we delve into the intricacies of IFRS 15, Revenue from Contracts with Customers. In our previous post, we explored the five-step model for revenue recognition and identifying performance obligations. Today, we will dive deeper into the principles of IFRS 15, focusing on determining transaction price, allocating transaction price to obligations, and revenue recognition timing.
Determining Transaction Price
The transaction price is the amount of consideration to which an entity expects to be entitled in exchange for transferring goods or services to a customer. IFRS 15 requires that the transaction price be determined at the inception of the contract, taking into account all of the following:
- The amount of consideration promised by the customer: This includes the fixed amount, variable amount, or a combination of both.
- The existence of a significant financing component: If the contract contains a significant financing component, the transaction price should be adjusted to reflect the time value of money.
- The effect of time value of money: The transaction price should be adjusted to reflect the time value of money, if it is significant.
- Non-cash consideration: If the customer provides non-cash consideration, such as goods or services, the transaction price should be adjusted to reflect the fair value of the non-cash consideration.
To determine the transaction price, entities should consider all of the above factors and adjust the price accordingly. For example, if a customer promises to pay $100,000 for a product, but the payment is due in 12 months, the entity should adjust the transaction price to reflect the time value of money.
Allocating Transaction Price to Obligations
Once the transaction price is determined, the entity must allocate it to each performance obligation in the contract. IFRS 15 requires that the transaction price be allocated to each performance obligation based on the relative stand-alone selling price of each obligation.
The relative stand-alone selling price is the price at which an entity would sell a promised good or service separately to a customer. If the stand-alone selling price is not directly observable, the entity should estimate it using one of the following methods:
- Adjusted market assessment approach: This approach involves estimating the stand-alone selling price by adjusting the market price of a similar good or service.
- Expected cost plus a margin approach: This approach involves estimating the stand-alone selling price by adding a margin to the expected cost of fulfilling the performance obligation.
- Residual approach: This approach involves estimating the stand-alone selling price by subtracting the sum of the observable stand-alone selling prices of other performance obligations from the total transaction price.
For example, if a contract contains two performance obligations, A and B, with a transaction price of $100,000, the entity must allocate the transaction price to each obligation based on their relative stand-alone selling prices. If the stand-alone selling price of obligation A is $60,000 and obligation B is $40,000, the transaction price would be allocated as follows:
Obligation A: $60,000 (60% of the transaction price)
Obligation B: $40,000 (40% of the transaction price)
Revenue Recognition Timing
Revenue recognition is a critical aspect of IFRS 15, as it determines when an entity can recognize revenue from a customer contract. IFRS 15 requires that revenue be recognized when (or as) the entity satisfies a performance obligation by transferring a promised good or service to a customer.
There are two types of revenue recognition:
- Over time: Revenue is recognized over time if the entity’s performance creates or enhances an asset that the customer controls as the asset is created or enhanced.
- At a point in time: Revenue is recognized at a point in time if the entity’s performance does not create or enhance an asset that the customer controls as the asset is created or enhanced.
To determine the revenue recognition timing, entities should consider the following factors:
- The nature of the promised good or service: Is the good or service a tangible or intangible asset?
- The customer’s control: Does the customer have control of the good or service as it is created or enhanced?
- The entity’s performance: Does the entity’s performance create or enhance an asset that the customer controls?
For example, if an entity provides a service to a customer over a period of 12 months, revenue would be recognized over time if the customer controls the service as it is provided. However, if the entity provides a product to a customer at a single point in time, revenue would be recognized at that point in time.
Concluding our topic “IFRS 15 – Revenue from Contracts with Customers (Part 2)”
In conclusion, IFRS 15 provides a comprehensive framework for revenue recognition from customer contracts. By understanding the principles of determining transaction price, allocating transaction price to obligations, and revenue recognition timing, entities can ensure that they are recognizing revenue in accordance with the standard.
As we continue our journey through the world of IFRS, we will explore more topics and provide practical examples to help you understand the standards. Stay tuned for our next post, where we will delve into the world of IFRS 16, Leases.
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