When exactly does a company recognize revenue under the IFRS 15 five-step model?

Question

AcadiFi · Accepted Answer

Revenue recognition under IFRS 15 (and its US GAAP counterpart ASC 606) follows a five-step model that replaced the older 'risks and rewards' framework. Here is how it works:

```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 Price to Obligations]
    D --> E[Step 5: Recognize Revenue When Obligation Satisfied]
    E --> F{Over Time or Point in Time?}
    F -->|Over Time| G[Use Input or Output Method]
    F -->|Point in Time| H[Recognize at Transfer of Control]
```

**The Five Steps in Practice:**

**Step 1 — Identify the contract.** Both parties must approve the contract, rights and payment terms are identifiable, and collection is probable. For example, Meridian Construction signs a $4.2 million contract to build a warehouse for Lyndale Industries.

**Step 2 — Identify separate performance obligations.** If Meridian also promises to install a security system, that is a distinct obligation because the customer can benefit from it independently.

**Step 3 — Determine the transaction price.** This is $4.2M but may require adjustment for variable consideration (e.g., a $200,000 bonus if completed early), time value of money, or non-cash consideration.

**Step 4 — Allocate the transaction price.** If the warehouse alone sells for $3.9M and the security system for $400,000, allocate based on standalone selling prices: warehouse gets ~$3.81M and security gets ~$0.39M.

**Step 5 — Recognize revenue when (or as) each obligation is satisfied.** This is where 'transfer of control' matters. Control transfers either:
- **Over time** — the customer simultaneously receives and consumes benefits (e.g., construction on customer's land). Use percentage-of-completion via input method (costs incurred / total estimated costs) or output method (units delivered).
- **At a point in time** — control passes at delivery, legal title transfer, or customer acceptance.

**Key distinction from the old model:** Under IAS 18 (now superseded), revenue was recognized when 'risks and rewards' transferred. IFRS 15 focuses on 'control,' which is broader — a customer can have control even if some risk remains with the seller.

For CFA Level I, expect questions testing whether revenue should be recognized over time vs. at a point in time, and how variable consideration affects the transaction price.

Explore our CFA Level I FRA course for more worked examples on revenue recognition.

When exactly does a company recognize revenue under the IFRS 15 five-step model?

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