Can someone walk me through the IFRS 15 five-step revenue recognition model with a practical example?

Question

AcadiFi · Accepted Answer

The IFRS 15 five-step model is the universal framework for recognizing revenue from contracts with customers. Here is each step with a concrete example.

**Scenario:** Pinnacle Software Inc. signs a contract with a retail chain, GreenMart, to deliver a customized inventory management system for $400,000 and provide 2 years of technical support worth $100,000.

```mermaid
flowchart TD
    A["Step 1: Identify the Contract"] --> B["Step 2: Identify Performance Obligations"]
    B --> C["Step 3: Determine Transaction Price"]
    C --> D["Step 4: Allocate Transaction Price"]
    D --> E["Step 5: Recognize Revenue"]
    E --> F["Over Time or At a Point in Time?"]
```

**Step 1 -- Identify the Contract**
A valid contract exists because both parties approved the deal, the consideration is clear ($500,000 total), and GreenMart has the ability and intent to pay. Commercial substance is present because Pinnacle's cash flows will change.

**Step 2 -- Identify Performance Obligations**
There are **two** distinct performance obligations:
- Obligation A: Delivery and installation of the software system
- Obligation B: 2-year technical support agreement

They are distinct because GreenMart can benefit from each independently -- the software works on its own, and the support could theoretically be purchased from a third party.

**Step 3 -- Determine the Transaction Price**
The total transaction price is **$500,000**. There are no variable components, financing elements, or non-cash consideration in this example.

**Step 4 -- Allocate the Transaction Price**
Pinnacle estimates standalone selling prices: software at $420,000 and support at $105,000 (total $525,000).

| Obligation | Standalone Price | Ratio | Allocated Revenue |
|---|---|---|---|
| Software | $420,000 | 80% | $400,000 |
| Support | $105,000 | 20% | $100,000 |

**Step 5 -- Recognize Revenue**
- Software: Revenue of $400,000 is recognized **at a point in time** when the system is delivered and GreenMart gains control.
- Support: Revenue of $100,000 is recognized **over time** -- $50,000 per year as the support service is provided.

**Common Exam Trap:** Students forget that the allocation uses standalone selling prices, not the contract prices. If standalone prices differ from contract prices, the allocation ratios change.

Practice more revenue recognition scenarios in our CFA Level I question bank.

Can someone walk me through the IFRS 15 five-step revenue recognition model with a practical example?

Master Level I with our CFA Course

Related Questions

Practice Questions