Understanding the 5-Step Model for Revenue Recognition under IFRS 15
IFRS 15: Revenue from Contracts with Customers is essential for accurate and consistent revenue recognition. For business accountants advising clients, this standard helps ensure financial statements reflect a true and fair view of their operations.
Why Is IFRS 15 Important for Your Clients?
Revenue is a critical measure of a company’s performance. Applying IFRS 15 ensures revenue is recognised when goods or services are delivered to customers, not just when payments are received. This improves financial transparency, builds trust with stakeholders, and reduces the risk of non-compliance during audits.
This article explains the 5-step model with examples tailored for business accountants serving diverse clients, from retailers to service providers.
The 5-Step Model of IFRS 15
The 5-step model applies to all contracts with customers. Whether your client runs a retail store or a telecom business, these steps help them account for revenue correctly:
Identify the Contract with the Customer
A contract is an agreement that creates enforceable rights and obligations. For example, a signed contract, an online purchase agreement, or a verbal agreement that complies with local laws.Identify the Performance Obligations in the Contract
Performance obligations are the promises made to a customer to deliver specific goods or services. Each distinct good or service is treated as a separate obligation.Determine the Transaction Price
The transaction price is the total amount the customer is expected to pay in exchange for the promised goods or services.Allocate the Transaction Price to the Performance Obligations
The transaction price is divided among the performance obligations based on their relative standalone selling prices.Recognise Revenue as Performance Obligations Are Satisfied
Revenue is recognised when (or as) the client fulfills their promises by transferring goods or services to the customer.
Example 1: A Retail Store Transaction
Scenario:
A customer visits a local shop, buys a newspaper for ZAR 30 and a chocolate bar for ZAR 10, pays at the counter, and leaves.
Here’s how the 5-step model applies:
Identify the Contract
The contract is formed when the customer agrees to the shop’s terms by making the purchase.Identify the Performance Obligations
The obligations are delivering the newspaper and the chocolate bar—two distinct goods.Determine the Transaction Price
The total transaction price is ZAR 40 (ZAR 30 for the newspaper and ZAR 10 for the chocolate bar).Allocate the Transaction Price
Since there are no discounts or complexities, ZAR 30 is allocated to the newspaper and ZAR 10 to the chocolate bar.Recognise Revenue
Revenue is recognised at the point of sale because the customer immediately receives the goods.
Journal Entry:
Debit: Cash ZAR 40
Credit: Revenue ZAR 40
Simple and straightforward. Now let’s look at a more complex scenario.
Example 2: A Telecom Contract with a Free Handset
Scenario:
Your client, XYZ Telecom, offers a 12-month plan to John:
John pays ZAR 1,000 per month for the plan.
John receives a “free” handset valued at ZAR 5,000 upfront.
XYZ Telecom offers the same plan without a handset for ZAR 800/month.
Here’s how your client applies the 5-step model:
Identify the Contract
The signed agreement between John and XYZ Telecom creates enforceable rights and obligations.Identify the Performance Obligations
Delivering the handset immediately.
Providing network services over 12 months.
Determine the Transaction Price
The total transaction price is ZAR 12,000 (ZAR 1,000 x 12 months).Allocate the Transaction Price
Allocation is based on the relative standalone selling prices:Handset: ZAR 5,000
12-month plan: ZAR 9,600 (ZAR 800 x 12)
Total standalone price = ZAR 14,600 (ZAR 5,000 + ZAR 9,600)
Allocation:
Handset: ZAR 4,110 [(5,000 ÷ 14,600) x 12,000]
Network services: ZAR 7,890 [(9,600 ÷ 14,600) x 12,000]
Recognise Revenue
Handset revenue (ZAR 4,110) is recognized when Sipho receives the phone.
Network services revenue (ZAR 657.50/month) is recognised over time.
Journal Entries for the Telecom Contract
At the Start of the Contract (Handset Delivery):
Debit: Contract Asset ZAR 4,110
Credit: Revenue (Handset) ZAR 4,110
The "Contract Asset" reflects revenue earned for the handset but not yet invoiced.
At the End of Each Month (Network Service):
Debit: Receivables ZAR 1,000
Credit: Revenue (Network Services) ZAR 657.50
Credit: Contract Asset ZAR 342.50
Over 12 months, the contract asset decreases to zero as all revenue is recognised.
Why IFRS 15 Matters for Business Accountants
Key Insights to Share with Your Clients:
Revenue Reflects Performance: Revenue is recognised when goods or services are delivered, ensuring it aligns with the client’s actual performance.
"Free" Items Aren’t Free: Items like “free” handsets must be accounted for as revenue, based on their standalone value.
Avoid Revenue Manipulation: IFRS 15 enhances the transparency and reliability of financial statements, a must for investor confidence and audit readiness.
Supporting Your Clients with IFRS 15
As a trusted advisor, your role is to guide clients through the complexities of revenue recognition. By applying the 5-step model, you help them stay compliant, improve financial reporting, and build credibility with stakeholders.
Join us at cpd.myciba for a webinar on Understanding Revenue Recognition under IFRS for SMEs. Register here.
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💻 Format: Webinar
📅 Date: 24 February 2025
⏰ Time: 15:00 (Duration: 2 hours)
📚 CPD Units: 3
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