Rendering of Services: Easy Guide to Revenue Recognition Under IFRS for SMEs
When businesses provide services, knowing when and how to recognise revenue can be tricky. For small and medium-sized enterprises (SMEs), the IFRS for SMEs standard gives clear rules for this, but let’s break it down into simpler terms so it’s easy to follow.
This article will help you, as a business accountant, understand how to correctly recognise revenue when your clients provide services. We’ll keep things simple and practical, with examples to make it easy to apply.
How to Recognise Revenue for Services
When a business provides a service, revenue (money earned) is recognised as the service is being done, not just when it’s fully completed. This method is known as the percentage of completion (POC) method.
However, for this method to be used, four important conditions must be met:
The revenue amount can be measured accurately.
It’s likely the business will get paid for the service.
The stage of completion of the service can be measured.
The costs to finish the service can be estimated.
If all these conditions are met, then revenue can be recognised bit by bit as the service is done.
Percentage of Completion Method (POC)
The POC method means businesses can recognise revenue as they perform the service, instead of waiting until the end of the project. This method works best for services that take time to complete.
Example:
Let’s say you run an IT support company and you’re helping a client with their systems over six months. The contract is for R120,000. If, after three months, you’ve completed 50% of the work, you would recognise R60,000 as revenue at that point.
This approach matches revenue to the work you’ve already done, making sure income is recognised along the way.
Straight-Line Method for Ongoing Services
Sometimes, a business provides services evenly over a period of time, like a year. In these cases, it’s often best to recognise revenue in equal parts over that period (this is called the straight-line method), unless a different method better represents how the service is being completed.
Example:
You run a landscaping service and have a contract to maintain a corporate garden for a year, worth R240,000. Since you do the same amount of work each month, you would recognise R20,000 in revenue each month using the straight-line method.
However, if one part of the year involves a lot more work (like a big redesign), you might wait to recognise some of the revenue until that heavier work is completed.
What to Do When the Outcome is Uncertain
Sometimes, you can’t estimate how much of the service has been completed or how much it will cost to finish. When this happens, the business can only recognise revenue equal to the recoverable costs—that means just enough revenue to cover the expenses that can definitely be recovered.
Example:
Suppose you’re hired to solve a tricky IT problem, but you’re not sure how long it will take or how much it will cost to fix. In this case, you would only recognise revenue equal to your costs, making sure you don’t overestimate what you’ll earn. Once the outcome is clearer, you can start recognizing more revenue.
Real-Life Examples from the Standard
Here are a few practical examples to show how this works in real situations:
1. Installation Fees
If a business charges for installation services (like setting up home appliances), they should recognise revenue based on how much of the installation is completed. But if the installation is a small part of selling the product, they can recognise all the revenue when the product is sold.
2. Service Fees Included with a Product
If a product’s price includes future services (like software updates), the business should set aside that part of the revenue and recognise it as the service is provided over time.
3. Advertising Commissions
Media companies recognise advertising revenue when the ad is shown to the public. For other services (like producing the ad), revenue is recognised as the work is done.
4. Insurance Agency Commissions
If an insurance agent receives a commission for starting or renewing a policy, they recognise the revenue when the policy starts—unless the agent has to keep providing service during the policy. In that case, the commission is recognised over the life of the policy.
Making It Practical for Business Accountants
As a business accountant, you need to follow these steps to apply revenue recognition properly:
Understand the Service Contract: Look at how long the service will take and whether progress can be measured. This will help decide which method to use.
Pick the Right Method: For longer, more complex services, use the percentage of completion method. For simpler services, use the straight-line or completed contract method.
Review Payment Terms: Check when and how the business gets paid, as this can affect how revenue is recognised.
Track Costs and Progress: Make sure to measure the costs and progress throughout the service to accurately recognise revenue.
Conclusion
Revenue recognition for services under IFRS for SMEs might seem confusing, but when broken down, it’s straightforward. Remember:
POC method: Recognise revenue as the service is being completed.
Straight-line method: Recognise revenue evenly over time for ongoing services.
Recognise only recoverable costs when the outcome is uncertain.
By following these simple rules and understanding the service contract, you can help your clients recognise their revenue accurately and in line with their business activities.
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