Practical Tips to recognise revenue for your 2018 financial statements
2018 has come and gone. We are now in 2019 and preparing to close the 2018 books in order to produce financial reports for the 2018 financial year ending 31 December 2018 (or starting in 2018 and ending in 2019).
One of the profound developments of 2018 was the coming into force of IFRS 15: Revenue from contracts with customers. This standard replaces all the standards and interpretations that, hitherto, dealt with revenue. These are IAS18: Revenue; IAS 11: Construction contracts (dealt with long term contracts); IFRIC 13: Customer loyalty programs; IFRIC 15: Agreements for the construction of real estate; IFRIC 18: Transfer of assets from customers; SIC 31: Revenue – Barter transactions involving advertising services. The biggest achievement of IFRS15 was to consolidate the revenue accounting standards and giving more detailed guidance.
IFRS15 provides a five-step model of recognizing revenue. This is a clear thought process that should be applied in the process of recognizing and accounting for revenue. These are:
Identify the contract with the customer: There has to be a contract with a customer as a starting point for recognizing revenue. Contracts can be as simple as verbal or written or implied by a business practice or established by custom or tradition.
- Identify the performance obligations in the contract: Contracts will have performance obligations for the contracting parties, the entity and the customer. From the outset, the performance obligations should be identified. This is critical in the revenue recognition process. For example, a cellphone company offers to provide a handset and a cell line with airtime on a monthly basis. The cell company has the obligation to supply three things – the cellphone, the line and the monthly airtime. In other words, this calls for clear understanding of the contract and its disaggregation into its respective components.
- Determine the transaction price: The transaction price is the amount of consideration that the entity would expect to be entitled to in exchange for transferring goods or services to the customer. In the cellphone company example, the company will expect to be paid an upfront deposit and monthly payments for the duration of the contract.
- Allocate the transaction price: The transaction price should be allocated to each of the performance obligations relative to their stand-alone selling prices.
Recognise revenue when a performance obligation is satisfied: The entity shall recognize revenue when (or as) it satisfies a performance obligation by transferring a promised good or service to a customer. In the cellphone company example, when the handset is delivered, the sale of the cellphone is recognized, when the line is delivered, the sale of the line is recognized and when airtime is given on a monthly basis, the airtime sales are recognized.
IFRS15 does not change the revenue recognition principles as such but provides clearer guidance thus correcting some challenges that arose from the lack of proper guidance. The area that is affected by the new standard most is bundled products. This is common in the telecommunications, software development and real estate development. However, it does not mean that problems are confined to these sectors. Entities in other sectors should still critically look at all their contracts and apply the 5-step model and ensure that revenue is properly recognized.
The new standard is effective for annual periods beginning on or after 1 January 2018. This means the principles in the new standard should be applied to the financial statements for the year ending 31 December 2018 and after. The standard is applicable to contracts that were running on 1 January 2018 and those that were entered into after that.