Understanding Revenue Recognition: Key Principles Under IFRS for SMEs
Revenue recognition is a basic but important concept in accounting. It’s all about knowing when to record the money your business earns. For CIBA members working with small and medium-sized businesses, understanding how to correctly recognise revenue under IFRS for SMEs is crucial. This article explains the key ideas in simple terms, making it easier for you to apply them in your daily work.
What Is Revenue Recognition?
Revenue recognition is about recording income in your financial statements. But it’s not just about when the money hits your bank account—it’s about when your business has actually earned that money. This can sometimes be tricky, especially when dealing with different types of income, like selling products, providing services, or earning interest.
The Five Steps to Recognise Revenue
Under IFRS for SMEs, recognising revenue usually follows these five steps:
Identify the Contract with the Customer
A contract is any agreement between a buyer and seller that creates obligations—things you’ve promised to do. It can be written, spoken, or even just implied. Before you recognise revenue, make sure you have a clear agreement with your customer.Identify What You’ve Promised to Do
In your contract, you’ve made promises to deliver something to the customer, whether it’s a product, a service, or both. Each promise needs to be identified to figure out when and how to recognise revenue.Figure Out How Much You’ll Be Paid
The transaction price is the amount you expect to receive for fulfilling your promises. Sometimes, this might involve estimating the price, especially if there are discounts, rebates, or other factors involved.Match the Price to What You’ve Promised
If your contract includes multiple promises, you need to divide the transaction price among them. This is usually done based on the price of each product or service if it were sold separately.Recognise Revenue When You’ve Fulfilled Your Promises
Revenue is recognised when you’ve done what you promised. This could happen all at once (like delivering a product) or over time (like providing a service). The key is to record the revenue in the period when the work is done.
Key Points for SMEs
Transfer of Risks and Rewards: One of the most important things in revenue recognition is knowing when the risks and rewards of ownership have been transferred to the customer. For example, this often happens when a customer physically receives the product. For services, it could be when the service is completed.
Reliable Measurement: Revenue should only be recognised when you’re confident about the amount. This means you should have a good estimate of the revenue and make sure all uncertainties are considered.
Customer Payment: While receiving cash is not always necessary to recognise revenue, it’s important to consider whether payment is likely. If there’s significant doubt about getting paid, you might need to wait before recognising the revenue.
Practical Examples for the South African Market
Example 1: Selling Agricultural Products
Imagine a small farming business in the Free State that sells maize to a large buyer. The contract says the maize will be delivered to the buyer’s warehouse, and payment will be made 30 days later. The risks and rewards pass to the buyer when the maize is delivered. So, the farmer should recognise revenue when the maize is delivered, even though the payment comes later. This shows the true economic activity—the sale—happened during the delivery period.
Example 2: Rendering IT Services
Consider a small IT company in Johannesburg that builds websites for local businesses. They agree to create and launch a website for a client, with an estimated completion time of three months. The contract stipulates that the client will pay in two installments: 50% upfront and 50% upon completion. The IT company should recognise revenue based on the stage of completion of the project.
For example, if at the end of the reporting period, the company estimates that the project is 60% complete, they should recognise 60% of the total contract revenue at that time, provided all the following conditions are met:
The amount of revenue can be measured reliably.
It is probable that the economic benefits will flow to the company.
The stage of completion can be measured reliably.
The costs incurred and costs to complete the project can be measured reliably.
If, however, the company cannot reliably estimate the stage of completion, they should only recognise revenue to the extent of the costs incurred that are expected to be recoverable.
Conclusion
Revenue recognition under IFRS for SMEs is about more than just recording income. It’s about making sure you record revenue at the right time, showing the true performance of your business. By following these five steps and considering key factors like the transfer of risks and rewards, reliable measurement, and customer payment, CIBA members can ensure their financial statements accurately reflect their business’s activities.
In the next article, we’ll look at how to recognise revenue from selling goods, with practical examples to help you apply these principles in your work. Stay tuned!
Get access to the CIBA Academy IFRS for SMEs Section 23 Revenue CPD here.
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