Revenue Recognition under IFRS 15 and ASC 606: Principles, Frameworks, and Applications
- Graziano Stefanelli
- 1 day ago
- 23 min read
Definition of Revenue Recognition
Revenue recognition is the accounting principle that determines when and how revenue is recorded in financial statements.
Under accrual accounting, revenue is recognized when it is earned (i.e. when a company has satisfied its performance obligations to the customer) and the amount is realizable (collection is reasonably assured), rather than simply when cash is received.
IFRS 15 (International Financial Reporting Standard 15) and ASC 606 (Accounting Standards Codification 606 under US GAAP) provide a unified framework focusing on revenue from contracts with customers.
The core principle in both standards is that an entity should recognize revenue in a way that “depict[s] the transfer of promised goods or services to the customer in an amount that reflects the consideration to which the entity expects to be entitled”.
In other words, companies recognize revenue when control of goods or services passes to the customer, in the amount the company expects to receive in exchange.
These standards replaced earlier industry-specific and rule-based guidance with a single, principles-based model, vastly improving consistency and comparability across industries. (Notably, IFRS 15 and ASC 606 are largely converged, with only minor differences such as some U.S. GAAP policy elections and threshold nuances for collectibility.)
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The Five-Step Model under IFRS 15 and ASC 606
Both IFRS 15 and ASC 606 use a five-step model to apply this core principle in practice (illustrated below).
This model provides a systematic method for evaluating contracts and determining revenue recognition in a consistent manner. It ensures that revenue is recognized when control of goods or services is transferred to the customer (either over time or at a point in time) and that the amount recognized reflects the transaction price the company expects to receive. The five steps are as follows:
Identify the contract with a customer: A contract is an agreement (written, oral, or implied) that creates enforceable rights and obligations. Under the standards, a contract exists only if it has commercial substance, the parties have approved it, rights to goods/services and payment terms can be identified, and collection of consideration is probable. If those criteria aren’t met, revenue recognition is deferred until they are. (Contracts entered into at or near the same time with the same customer may be combined if certain criteria are met, and contract modifications are treated as either new contracts or adjustments to existing ones depending on the circumstances.)
Identify the performance obligations in the contract: A performance obligation is a promise to transfer a distinct good or service (or bundle of goods/services) to the customer. In this step, the company breaks down the contract into all the distinct deliverables. A good or service is distinct if the customer can benefit from it on its own or with other readily available resources, and if it is separately identifiable from other items in the contract (i.e. the product/service doesn’t significantly modify or depend on others in the contract). For example, a software sale might include distinct elements like a software license, installation services, updates, and support. Each distinct element is a separate performance obligation to be accounted for separately. If promised goods or services are not distinct (highly interrelated or integrated into a single combined output), they are treated as a single combined obligation. Clearly identifying performance obligations is critical because it affects when and how revenue is recognized for each component of the contract.
Determine the transaction price: The transaction price is the amount of consideration the company expects to be entitled to in exchange for fulfilling its performance obligations. This is usually the contractually stated price, but it may need adjustment for various factors. Companies must consider variable consideration (e.g. performance bonuses, rebates, volume discounts, refund rights, royalties) and only include it in the transaction price to the extent it is not probable that a significant reversal of revenue will occur when uncertainties are resolved. The standard provides methods for estimating variable consideration (expected value or most likely amount) and a constraint to ensure revenue isn’t overstated. For instance, if a contract pays a bonus of $5,000 for early completion, with a 75% estimated chance of achieving it, the company might include $3,750 (75% of $5,000) in the transaction price initially – this reflects the expected value while considering the risk of not earning the bonus. The transaction price determination also considers significant financing components (if payment timing provides a significant benefit to either party, the price should be adjusted for the time value of money), non-cash consideration (measured at fair value), and consideration payable to the customer (like coupons or credits to customers, which reduce the transaction price).
Allocate the transaction price to performance obligations: If a contract has multiple performance obligations, the total transaction price is allocated to each performance obligation in proportion to the stand-alone selling price of each distinct good or service. The stand-alone selling price is the price at which the company would sell that good or service separately to a customer. Often, the contract itself provides observable prices for each item; if not, the company must estimate them (using adjusted market assessment, expected cost plus margin, or residual approaches, as appropriate). This allocation ensures that each performance obligation has an apportioned share of the total consideration that reflects the relative value of that obligation. For example, consider a SaaS company selling a bundle of a software license, training services, and one year of support for a single combined price. If the software alone is normally $8,000, training $1,500, and support $1,000, these stand-alone prices would sum to $10,500. If the bundle is sold for $10,000, the transaction price is allocated proportionately: revenue allocated to software license, training, and support would be based on their relative standalone values (approximately $7,619 to software, $1,429 to training, $952 to support in this case. This step is crucial when contracts bundle items, ensuring each distinct obligation is reported fairly in line with its value.
Recognize revenue when (or as) each performance obligation is satisfied: Finally, revenue is recorded when or as control of the goods or services is transferred to the customer, in the amount allocated to that performance obligation. A performance obligation can be satisfied at a point in time (typically for one-off transfers of goods) or over time (typically for services or obligations delivered continuously or over a period). The timing of recognition for each obligation is determined by the nature of the promise: the company must assess when the customer obtains control of the good or service. For obligations satisfied over time, revenue is recognized progressively as the company performs (with an appropriate measure of progress, such as percentage of completion). For obligations satisfied at a point in time, revenue is recognized at the moment control passes (e.g. upon delivery or completion of the service). This step links back to the performance obligations identified in Step 2 – each distinct obligation will have its own pattern of revenue recognition based on when it is fulfilled. We delve further into the timing criteria in the next section.
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Performance Obligations: Identification and Satisfaction
A performance obligation is a promise in the contract to transfer a distinct good or service to the customer. The concept of performance obligations underpins the entire revenue recognition framework – it dictates the unit of account for applying the five steps. Key considerations include:
Identifying Distinct Goods or Services: As noted, a good or service must be distinct to be a separate performance obligation. The customer should be able to benefit from it on its own or with other resources readily available, and it must be separately identifiable in the context of the contract (i.e. not highly interdependent with other promises). For example, the sale of a machine that includes installation and training services might require judgment: if the installation service significantly customizes the machine, it may not be distinct from the machine itself (treated together as one combined performance obligation). Conversely, a software license sold with customer support would usually consist of two distinct obligations (the software and the support service), since the software can function on its own and the support is a separate service. Proper identification ensures that each obligation is accounted for appropriately. In many straightforward contracts (e.g. selling a single product), there may be only one performance obligation; in complex contracts (bundled products, long-term projects, etc.), there could be multiple. Companies sometimes need to unbundle contracts into separate obligations or bundle certain promises together if they are not distinct, to reflect the economic substance of the deal.
Satisfaction of Performance Obligations: A performance obligation is satisfied either over time or at a point in time, which determines when revenue is recognized for that obligation. IFRS 15 and ASC 606 provide specific guidance to evaluate this. If an obligation is satisfied over time, the company will recognize revenue progressively as work is performed or services are delivered. If satisfied at a point in time, revenue is taken at the moment the obligation is completely fulfilled. To determine this, the standard asks when the customer obtains control of the good or service. “Control” in this context means the ability to direct the use of and obtain substantially all the remaining benefits from the asset (or to prevent others from doing so). For tangible product sales, control often transfers upon delivery (when the customer has possession, legal title, and risks/rewards of ownership). For services or work in progress on assets, control might transfer continuously as the service is provided or asset constructed. We use specific criteria (discussed below) to decide the timing. Each performance obligation should be assessed against those criteria. Importantly, an entity might satisfy different performance obligations in a single contract at different times – hence the need to account for each one separately as identified in Step 2. Once a performance obligation is satisfied, the revenue allocated to it is recognized in the income statement, and any related contract asset or liability is updated (for example, reducing a contract liability when revenue that was paid in advance is now earned).
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Timing of Revenue Recognition: Point in Time vs. Over Time
Timing is crucial – it dictates when revenue hits the income statement. IFRS 15/ASC 606 prescribe that an entity first determine whether each performance obligation is satisfied over time or at a point in time. This evaluation is done for each performance obligation separately, based on criteria set out in the standards:
Revenue Recognition Over Time: Revenue is recognized over time if any of the following criteria is met:
The customer simultaneously receives and consumes the benefits provided by the entity’s performance as the entity performs. (This is common for routine or recurring services. For instance, a cleaning service or a subscription-based service where the customer continuously benefits from each day of service.)
The entity’s performance creates or enhances an asset that the customer controls as it is being created or enhanced. (For example, constructing a building on the customer’s land. As the construction progresses, the partially completed building is controlled by the customer, so the builder’s work is transferred to the customer over time.)
The entity’s performance does not create an asset with an alternative use to the entity, and the entity has an enforceable right to payment for performance completed to date. (This often applies to made-to-order or highly customized goods/services. “No alternative use” means the asset being produced is so customized that the seller cannot readily redirect it to another customer; an enforceable right to payment means if the customer were to cancel, the seller is entitled to payment for work done thus far. For example, a manufacturer building a specialized machine to a customer’s specifications would meet this criterion if the contract ensures the manufacturer can bill for work in process if the contract is terminated early.)
If any one of these conditions is met, the performance obligation is satisfied over time, and revenue should be recognized progressively. Companies measure progress using either an output method or an input method. Output methods recognize revenue based on direct measurements of value transferred to the customer to date (e.g. milestones reached, units delivered, surveys of work performed). Input methods recognize revenue based on the entity’s efforts or inputs toward fulfilling the obligation (e.g. costs incurred to date relative to total expected costs, labor hours used, or resources consumed). The goal is to faithfully depict the transfer of control. For instance, in a construction project meeting the over-time criteria, a common approach is the percentage-of-completion method based on costs: if 50% of total expected costs have been incurred by year-end, about 50% of the revenue (and related profit) would be recognized, reflecting that half the project’s value has been delivered to the customer. Over-time recognition tends to align revenue with the work as it is performed, which often better reflects performance for long-term contracts.
Revenue Recognition at a Point in Time: If a performance obligation does not meet any of the above criteria for over time, then by default it is satisfied at a point in time. Revenue for such obligations is recognized at the moment when control of the good or service passes to the customer. Determining that exact point requires considering indicators of control transfer. Key indicators include: the company has a present right to payment, the customer has legal title, the customer has physical possession, the customer has assumed the significant risks and rewards of ownership, and the customer has accepted the asset. For a typical retail sale of goods, this point might be when the customer takes delivery of the item from the store (physical possession and legal title transfer at checkout). For a software license granted for on-premise use, it could be when the license key is delivered and the customer can use the software. Essentially, at some identifiable moment, the customer gains control, and that triggers revenue. If there are formal customer acceptance provisions, companies may wait until acceptance is obtained or any uncertainties are resolved.
In practice, many goods sales are point-in-time (one clear transfer event), whereas many services are over-time (continuous transfer) – though not always, as it depends on contract terms and the criteria. For example, a software-as-a-service subscription (cloud software access) is usually over time (the customer receives benefit throughout the subscription period), whereas a perpetual software license delivered upfront might be point in time. It’s also worth noting that some contracts can have a mix: e.g. a contract to deliver a product (point in time) and provide maintenance services (over time). Each performance obligation’s timing is assessed separately, as required by Step 5 of the model.
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Examples and Applications in SaaS and Construction
The five-step framework and timing rules apply across industries. Here we illustrate how IFRS 15/ASC 606 work in two distinct contexts – Software-as-a-Service (SaaS) and Construction – highlighting the identification of performance obligations and timing of revenue recognition in each case.
Example – Software-as-a-Service (SaaS): SaaS companies often sell subscriptions for access to software platforms, sometimes bundled with additional services (such as setup, training, or customer support). Consider a contract where a SaaS provider sells a 1-year subscription to its cloud software, including onboarding/training services and ongoing technical support. Under the five-step model, the company identifies potentially three performance obligations: (1) the core software service (access to the platform for one year), (2) the one-time onboarding/training service, and (3) technical support (if distinct from the basic platform access). The transaction price might be a fixed annual fee (e.g. $120,000 for the year). The company would then allocate this price to the identified obligations based on their stand-alone selling prices – for instance, if the training is sold separately for $10,000 and the support for $20,000 per year, those proportions would be assigned, with the remainder to the core software access. Revenue recognition: The software access is a service delivered continuously over the year, so revenue for that portion is recognized over time (perhaps on a straight-line basis, i.e. $120,000 minus allocated training and support, spread evenly over 12 months, assuming the customer receives consistent benefit). The one-time training service revenue would be recognized at a point in time – likely when the training session is delivered (since that obligation is fulfilled at that point). The support services, if considered distinct, would be recognized over time over the support period (e.g. ratably over the year, or based on support hours if they fluctuate). If the software itself and support are considered one combined performance obligation (say, if support is an integral part of providing the service), then the entire bundle might be recognized over time. In most cases, though, SaaS subscriptions with included support are treated as separate obligations: the software service (subscription) revenue is recognized over time, and the support is also over time (essentially concurrently over the same period), while any distinct one-off services are point in time. For instance, if a company sells a software license bundled with one year of support, and the software is made available immediately but support will be provided throughout the year, the company can recognize the license portion of revenue upfront when the customer gains access, and recognize the support portion over 12 months. SaaS arrangements also frequently involve updates or feature upgrades during the subscription – if these are promised, they may indicate that the obligation is to provide a right to access evolving software over time (common in SaaS, hence over-time recognition). Additionally, SaaS companies must consider customer cancellations or refunds: if historical data shows, say, 5% of customers cancel early and get a partial refund, the company should only recognize revenue for the portion it expects to keep (maybe 95% of the full contract value), with the rest treated as a refund liability until uncertainty is resolved. Overall, IFRS 15/ASC 606 forces SaaS providers to carefully delineate each element of their sales and recognize revenue in line with service delivery, preventing over-acceleration of revenue for undelivered services.
Example – Construction Contracts: In the construction industry
, such as building construction or large engineering projects, contracts are often long-term and were historically accounted for using the percentage-of-completion method under previous standards. Under IFRS 15/ASC 606, these contracts are treated just like any other, but typically they meet criteria for over time recognition. Consider a construction company that enters into a contract to build a custom office building for a client for $10 million, over a two-year period. The contract involves various activities (design, site preparation, construction, finishing) but is negotiated as a single package with one overall price. Step 2 (Identify performance obligations): The company assesses that the project is one combined performance obligation – the various tasks are integrated and together deliver a single completed asset to the customer. It wouldn’t make sense to treat design, construction, and finishing as separate promises to the customer; the client expects one finished building (and the tasks are highly interdependent). Step 3 (Transaction price) is $10 million (assuming no significant variable consideration in this fixed-price contract). Step 4 (Allocate) is trivial here since there’s only one performance obligation – the entire $10 million is allocated to that one obligation. Step 5 (Recognize revenue): The key question is timing. Does the construction project meet any over-time criterion? Typically yes – for instance, the building is being constructed on the customer’s land, so the customer controls the asset as it is created, satisfying an over-time criterion. Alternatively (or additionally), such bespoke construction often has no alternative use for the contractor and an enforceable right to payment for work done to date, meeting the third criterion. Thus, revenue will be recognized over time. The company will measure its progress towards completion to determine how much revenue to record at each reporting period. A common approach is an input method like cost-to-cost: if by the end of Year 1 the contractor has incurred 60% of the total expected costs, it would recognize about 60% of the revenue (i.e. $6 million) in Year 1 (and the associated proportionate profit) – subject to any adjustments for inefficiencies or uninstalled materials as required by the standard. This reflects that 60% of the work (and value) has been transferred to the customer. Over-time recognition provides a faithful representation of performance in construction contracts, and indeed most construction contracts have performance obligations satisfied over time. In contrast, if a construction company builds speculatively (on its own land for sale, or builds standard units for multiple buyers without a specific contract per unit), those might not meet over-time criteria and would be recognized at a point in time (e.g. when the completed building is delivered to a buyer). But for contracted customer-specific projects, revenue is recognized as the project progresses. By the project’s completion, the full $10 million would be recognized as revenue. Throughout, the company will report a contract asset (e.g. “Unbilled revenue”) if it has earned more revenue than it has billed, or a contract liability (e.g. “Customer advances / Deferred revenue”) if the billing (or cash received) outpaces the revenue earned to date. These concepts replace the old “construction-in-progress” and “billings” accounts with a more unified view of contract assets/liabilities. The end result is that users of the financial statements see revenue being recognized in alignment with the transfer of control to the customer over time, and any amounts billed in excess or below that are shown as liabilities or assets, respectively.
These examples show how the five-step model adapts to different industries. In SaaS, distinct deliverables like software access vs. support must be parsed and timed appropriately. In construction, the emphasis is on measuring progress for a long-term obligation that is satisfied over time. Other industries face their own nuances (for example, licenses of intellectual property, telecommunications contracts with phone+service bundles, media contracts with royalties, etc.), but the same principles apply. The goal in all cases is to ensure revenue is reported when the company’s obligations to the customer are fulfilled and in the amount the company is entitled to, no more and no less.
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Common Challenges and How to Handle Them
Implementing IFRS 15/ASC 606 can be complex. Companies often encounter common challenges in applying the standards, but understanding the intent of the rules helps in addressing them. Below are several typical challenges and approaches to handle them:
Identifying Distinct Performance Obligations in Complex Contracts: Determining what promises in a contract should be accounted for separately can require significant judgment. Bundled offerings (multi-element arrangements) may blur the lines between one or multiple obligations. The key is to use the criteria for “distinct” diligently. How to handle: Analyze whether each good/service has standalone value to the customer and whether it’s separable from others. If a deliverable is highly interrelated with another, it might not be distinct (combine it with others). If it provides benefit on its own, treat it separately. For example, in a bundle of a product and a service, ask: Could the customer take the product without the service and still derive value (perhaps by hiring another service provider)? If yes, account for two performance obligations and allocate revenue accordingly. Document the rationale for conclusions, as this is often an area auditors will scrutinize.
Estimating Variable Consideration and Avoiding Revenue Reversals: Many contracts have bonuses, penalties, royalties, or discounts that make the consideration variable. Recognizing revenue on estimates of these amounts can be risky if not done carefully – too high an estimate could lead to a future reversal of revenue. How to handle: Follow the constraint guidance – include variable consideration in revenue only to the extent it is not likely to result in a significant reversal later. Use either the expected value method (probability-weighted average) or the most likely amount method, whichever better predicts the amount. Importantly, consider historical experience and current conditions. If there’s high uncertainty (e.g. sales-based royalties), it may be appropriate to wait until the uncertainty is resolved (like reporting royalty revenue only when sales occur). By being conservative and evidence-based in estimates, companies can avoid the pitfall of reversing revenue. For instance, if a construction contract includes a hefty bonus for early completion that the company has little experience with, it might be prudent to defer recognizing that bonus until it’s virtually certain it will be earned. The standards encourage judgment but with an emphasis on not overstating revenue under uncertainty.
Timing Recognition: Over Time vs. Point in Time Judgments: Determining whether a performance obligation meets the criteria for over-time recognition can be challenging in certain scenarios. It may not be immediately obvious if a customer “receives benefits as you perform” or if an asset has alternative use, etc. How to handle: Carefully evaluate the contract against each over-time criterion. Gather evidence of customer control or simultaneous consumption. If mixed indicators, lean on the specific guidance (e.g., for services like subscription software or routine maintenance, simultaneous consumption is usually clear; for manufacturing a custom good, examine contract termination clauses for enforceable right to payment). If none of the criteria are met, be disciplined in recognizing revenue at a point in time – even if the company traditionally might have wanted to use percentage-of-completion, the new standard might not allow it unless criteria are met. It’s also a challenge when over-time is met, to select a measure of progress that faithfully reflects performance (e.g. deciding between an input method like costs incurred vs. an output method like milestones). Companies should choose a method that best depicts how control transfers and apply it consistently, updating estimates of progress at each reporting date. Transparent disclosures of these judgments (discussed below) help users understand the choices made.
Handling Contract Modifications and Scope Changes: Contracts often change – scope is added or removed, prices renegotiated, etc. The new standards have specific rules on when a modification is treated as a separate new contract, or as a cumulative catch-up adjustment to the existing contract, or as a prospective adjustment. How to handle: Evaluate modifications based on the guidance. If new goods/services are added and they are priced at their stand-alone selling prices, it’s treated as a new separate contract (no impact on existing revenue). If the remaining goods/services are not distinct from those already delivered, or if the pricing is at a discount, you may have to blend the change with the existing contract (either prospectively for future performance or through a catch-up for past performance, depending on specifics). In practice, this means re-allocating and adjusting the transaction price and re-assessing progress for the remaining work. Companies should establish processes to monitor contract changes and have accounting policies for common modification scenarios. Not addressing modifications correctly can lead to misstated revenue (either too much or too little in a period).
Principal vs. Agent Considerations (Gross vs. Net Reporting): When a company is involved in providing goods or services but through a third party or platform, it might be unclear whether the company is the principal (providing the product/service itself and thus recognizing gross revenue) or an agent (arranging for another party to provide it, and thus recognizing only a fee or commission as revenue). How to handle: Determine who controls the goods or services before they are transferred to the customer. If the company obtains control (even momentarily) and is primarily responsible for fulfilling the promise, it’s likely the principal and should recognize revenue gross. Indicators of control include having discretion in setting price, being responsible for acceptability of the product, or taking inventory risk. If the company never controls the goods/services and is more of a facilitator (earning a fee), then it’s an agent and should report net revenue. This analysis can be tricky for online marketplaces, franchise arrangements, or reseller situations. The new standards removed some industry-specific bright lines, so judgment is needed, guided by the control principle. Getting this wrong can dramatically misstate revenue (though gross profit would be the same, the topline could be off by orders of magnitude), so companies must document their reasoning for whether they act as principal or agent in significant arrangements.
Accounting for Costs of Obtaining or Fulfilling Contracts: While not a revenue recognition issue per se, IFRS 15 and ASC 606 introduced guidance on contract costs. Companies might struggle with whether to capitalize certain costs (like sales commissions) or expense them immediately. How to handle: Remember that incremental costs of obtaining a contract (e.g. a sales commission that wouldn’t have been incurred if not for winning that contract) should be capitalized as an asset if they are expected to be recovered, and then amortized to expense over the period of benefit (usually the contract term). Costs of fulfilling a contract (e.g. setup costs) that aren’t in the scope of other standards (like inventory or PPE) should be capitalized if they create an asset related to future performance. Ensure to amortize these along with the revenue recognition pattern. This matching can be complex if a contract renews or has an initial term and expected renewals (you might need to consider the expected customer life for amortizing commissions, for example). Companies should establish clear policies for cost capitalization and train their finance teams accordingly, as this was a change from past practice (where many companies expensed all such costs as incurred).
Ensuring Compliance with Disclosure Requirements: The new standards brought significantly expanded disclosures. Meeting these can be challenging (systems and processes need to capture new data, like performance obligation details or backlog). We highlight these disclosures in the next section. How to handle: Companies should implement internal reporting that tracks required information, such as contract asset/liability rollforwards, disaggregated revenue by category, and information on remaining performance obligations. Many companies found it necessary to upgrade IT systems or use software solutions to handle the volume of data (especially if dealing with thousands of contracts as in telecom or software subscription businesses). Early preparation and ongoing refinement of disclosure processes help avoid last-minute scrambles. The effort is worthwhile, as the enhanced disclosures provide valuable insight to investors and analysts about a company’s revenue quality and future performance.
So we can say that while IFRS 15 and ASC 606 provide a clear framework, applying it requires careful analysis and sometimes significant judgment. Documentation of judgments and assumptions is essential, both for audit trail and for disclosure. Many companies formed cross-functional implementation teams (accounting, IT, sales operations, etc.) when these standards were first adopted to ensure all angles were covered – from contract review to systems configuration. The challenges can be managed with a solid understanding of the standard’s principles and attention to detail in contracts. Continuous training and staying updated on guidance (for example, the IASB/FASB occasionally issue clarifications or illustrative examples) are also part of handling these challenges effectively.
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Disclosure Requirements under IFRS 15 and ASC 606
Both IFRS 15 and ASC 606 dramatically increased the disclosure requirements related to revenue. The aim is to provide financial statement users with comprehensive information about the nature, amount, timing, and uncertainty of revenue and cash flows arising from contracts with customers. Entities must include both quantitative and qualitative disclosures to illuminate how the revenue recognition principles are applied. Key disclosure areas include:
Disaggregation of Revenue: Companies must break down reported revenue into categories that illustrate how the nature, timing, and risk of revenue differ. The standards do not prescribe a specific format, but suggest categories by product/service type, geography, market or customer type, contract duration, timing of transfer (goods vs. services, or point-in-time vs over-time), sales channels, or a combination that makes sense for the business. For example, a company might disclose revenue split into “software licenses,” “subscription services,” and “consulting services,” or by business segments or regions, or by customer industry. The goal is to help users understand the composition of revenue streams and their drivers. This disaggregation often ties to how management views the business or how different revenue streams have different margin or risk profiles.
Contract Balances: Firms need to present and explain contract assets and contract liabilities. Disclosure should include the opening and closing balances of receivables, contract assets, and contract liabilities (like deferred revenue). They should also explain significant changes in these balances during the period (for instance, if a big increase in contract liabilities occurred due to advance billings on new multi-year contracts). Additionally, companies disclose the amount of revenue recognized in the period that was previously included in the opening contract liability (i.e. how much of last year’s deferred revenue became revenue this year), and revenue recognized in the period from performance obligations satisfied in previous periods (this can happen due to changes in estimates of variable consideration or contract modifications). These disclosures link the balance sheet accounts to revenue and help users see how much revenue was drawn down from advance payments or how much is yet to be billed.
Performance Obligations Information: There is a requirement to describe qualitatively the significant performance obligations in contracts – the nature of goods or services promised, typical timing of satisfying them (when control typically transfers — e.g. upon shipment, upon delivery, over a service period), and payment terms (e.g. when payment is typically due, whether contracts have financing components, etc.). Companies must also disclose certain details about remaining performance obligations (sometimes referred to as order backlog or deferred revenue backlog) at the reporting date. Specifically, they should disclose the aggregate amount of the transaction price allocated to performance obligations that are unsatisfied (or partially unsatisfied) as of the end of the period, and an explanation of when they expect to recognize that revenue (either quantitatively with time bands or qualitatively). For instance, if a software company has $50 million of subscription contracts booked for future years that are not yet recognized, it might say “$30 million will be recognized in the next 12 months, and $20 million thereafter.” This gives investors insight into future revenue that is under contract. The standards provide a practical expedient that if the contract is one year or less, you don’t need to include it in the remaining performance obligation disclosure, to avoid cluttering with short-term contracts.
Significant Judgments and Estimates: Given the judgments involved in applying the revenue standards, companies must disclose the significant judgments made in determining the timing of revenue recognition and determining the transaction price (and allocating it). This includes, for example, methods used to recognize revenue for performance obligations satisfied over time (and why those methods are appropriate), how the company estimated any variable consideration and constrained it, and any other critical judgments (such as determining if the company is principal or agent, or identifying distinct performance obligations in a complex arrangement). If there are changes in judgments (say, a change in estimate in measuring progress, or a different conclusion about a contract’s outcome that impacts variable consideration), those changes should be explained as well. These disclosures help users understand the areas of revenue recognition that are not straightforward and rely on management’s assumptions.
Assets Recognized from Costs to Obtain or Fulfill Contracts: If the company has capitalized significant costs under the guidance (like sales commissions or setup costs), it must disclose about those contract cost assets – for instance, the closing balances, amount of amortization and any impairment recognized, and the method of amortization. This informs users about the amount of deferred costs on the balance sheet that will hit future earnings. It also ties into revenue, since the amortization of these costs is usually in the same pattern as revenue recognition.
Practical Expedients Used: IFRS 15 and ASC 606 allow certain practical expedients (simplifications), such as the one mentioned for remaining performance obligations (ignoring those under one year), or treating shipping as a fulfillment cost (under US GAAP) or not adjusting for financing components if the period is one year or less. If a company uses any of these expedients, it should disclose that fact. This alerts users that the company has taken advantage of allowable shortcuts in the standard, which might slightly affect comparability or the detail provided.
Overall, the disclosure objective is to provide a comprehensive picture of a company’s revenue pipeline and how revenue is recognized. Under IFRS 15/ASC 606, financial statement footnotes related to revenue are often much more extensive than under previous guidance. For example, where previously a company might simply disclose total revenue by segment, now it will provide breakdowns by category, explanations of policies for various revenue streams, and quantitative data on contract-related balances and future revenues. These disclosures require gathering data from contract management systems, billing systems, and accounting records, and often involve collaboration between finance and operational teams.
Finance professionals should ensure that their company’s revenue disclosures align with these requirements. Good disclosures not only keep the company in compliance but also enhance transparency, enabling analysts to model the business better. For instance, knowing how much unearned revenue is on the books and when it will be recognized can help in forecasting future revenue. Knowing the nature of performance obligations can shed light on how a company’s business model works (e.g. a company might reveal that a significant portion of its contracts are multi-year service contracts recognized over time, which signals stable future revenue).
It’s worth noting that while IFRS and US GAAP are aligned on these disclosure requirements, there are some differences in emphasis and scope (for example, ASC 606 provides certain disclosure reliefs for nonpublic (private) entities, allowing them to omit some of the detailed disclosures, whereas IFRS 15 applies fully to all IFRS reporters unless they use the simplified IFRS for SMEs standard). Public companies under both regimes, however, are expected to provide the full breadth of disclosures as outlined.
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