The Revenue Recognition Principle is the concept that determines how revenue should be recognized and reflected in a business’ balance sheets and Financial Preparation services statements. It differs in how one accounting principle does it than the other. The International Financial Reporting Standard (IFRS 15) was introduced by the Accounting Standards Board to provide a way to determine the revenue recognition model in its unique way. This helps improve comparisons within industries, across industries and in different parts of the capital market.
Why is the IFRS 15 Important?
The IFRS 15 is important as it helped outline the difference and therefore make a common ground between the revenue recognition of IASB and IFSB. As the guidance and principles of both differed, the IFRS 15 brought consensus to the same.
Since when is IFRS 15 in Effect?
The fresh IFRS rules have been in effect since May 2014 and the annual reporting period has begun from January 2018 and replaces all the previous revenue recognition principles.
The principle that IFRS 15 detects revenue only on the basis of whether there was an actual transfer of goods and services at the designated price. Here are the steps that need to be followed to recognize the revenue for any business:
Step 1: Identify the contract with the customers that mark their rights and obligations clearly in a transaction.
Step 2: It is then required to separate these performance obligations in the contract.
Step 3: The transaction price is then required to be determined for the exchange from thereon.
Step 4: Different transaction prices need to be allocated for distinct performance obligations.
Step 5: Recognizing revenue when the now promised goods and services are transferred under the obligations of the contract.
This five-step model is required to recognize the revenue effectively.
Let us now look into each of the steps in greater detail.
Step 1: Identify Contract with the Customer
It is imperative to first identify the contract that needs to be approved by both the parties concerned. The rights in relation to each of them needs to be specified. This is also the step where the terms for payment need to be specified. This is the step where the organization needs to make it certain that a detailed guidance for the approved contract is made to the finest details. If there is a chance of certain conditions being met, then the contract modification will be counted as a separate contract with the customer.
Step 2: Identify the Performance Obligations in the Contract
Right at the beginning, it is important and necessary to assess the goods and services that are obligated to the customer and therefore identify as a performance obligation. This could either be:
- Goods and services that are different and distinct in nature.
- Or, goods and services that are similar in nature and have the same pattern of transfer to the customer.
Step 3: Determine the Price of Transaction
The transaction price is defined as the price which is expected by the organization as an entitlement and obligation of exchange for the goods and services in trade. This assessment is done by going beyond the customary business prices.
Step 4: Allocating the Transaction Price
Although, any variable element is already considered in the agreement, but an estimation is still made available. This is done by recognizing the amount of uncertainty and variables that will be recognized. The only way that is determined is to associate it with whether its inclusion or exclusion will result in any degree of significant revenue reversal.
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Step 5: Recognizing the Revenue as the Entity Completes the Performance Obligation
The control over an asset includes the ability to use and obtain benefits from an asset majorly. This includes the ability to use and obtain the actual benefits of an asset. These benefits are cash flows and they can be gotten either directly or indirectly.
To Sum Up
Revenue recognition is the base of any financial statement and the clear ability to make an analysis of what can be accounted as revenue and what not, is essential. The IFRS 15 helps entities and organizations take this call by demarcating a clear and concise process of recognizing revenue.
It’s 5 step model can help your business determine the nature of transactions, conditions of transactions, pricing and the parties of association that come together to make revenue.