IFRS 15 Revenue Recognition (Replaced IAS 18 & IAS 11): The Five-Step Model with a Worked Example

Revenue is usually the largest number in the income statement and one of the most closely examined by auditors, lenders and regulators. IFRS 15 Revenue from Contracts with Customers, effective since 2018, replaced IAS 18 and IAS 11 with one model that applies to almost every industry: manufacturing, trading, services, software, construction and more. Leases, insurance contracts and financial instruments are covered by other standards.

The core principle is that an entity recognises revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which it expects to be entitled. This guide walks through the five steps with a worked example and highlights the areas where judgement most often goes wrong.

1. The five steps at a glance

2. Step 1 — Identify the contract

A contract exists for IFRS 15 purposes when it has been approved and the parties are committed, each party’s rights and the payment terms can be identified, the contract has commercial substance, and it is probable that the entity will collect the consideration. Contracts can be written, oral or implied by customary business practice. In export businesses, a buyer’s purchase order accepted under a master supply agreement usually forms the contract; the agreement supplies terms such as Incoterms, claims and payment.

3. Step 2 — Identify performance obligations

A performance obligation is a promise to transfer a good or service (or a bundle) that is distinct: the customer can benefit from it on its own or with readily available resources, and the promise is separately identifiable from other promises in the contract. Goods that are significantly integrated or modified into a combined output are a single obligation. A series of substantially the same services transferred in the same pattern — such as monthly support — is also treated as one obligation.

4. Step 3 — Determine the transaction price

The transaction price is the amount the entity expects to be entitled to, excluding amounts collected for third parties such as VAT. It must reflect:

• Variable consideration — discounts, rebates, penalties, volume incentives, claims — estimated using the expected value or the most likely amount, and included only to the extent it is highly probable that a significant reversal will not occur (the “constraint”).
• Significant financing components where payment timing provides a significant financing benefit (a practical expedient applies where the gap is one year or less).
• Non-cash consideration at fair value, and consideration payable to the customer, which is usually a reduction of revenue.

Buyer claims and chargebacks in the garment sector are a classic example of variable consideration: if history shows that a predictable percentage of shipments attracts claims, revenue should reflect that estimate rather than waiting for the claim to arrive.

5. Step 4 — Allocate the transaction price

When a contract has more than one performance obligation, the price is allocated on the basis of relative stand-alone selling prices (SSP) — the price at which the entity would sell each item separately. If an observable price is not available, SSP is estimated (adjusted market assessment, expected cost plus margin, or, in limited cases, the residual approach).

Our illustrative example is a software company that sells a licence, installation and 12 months of support for a bundled price of BDT 108,000, invoiced upfront in January. Sold separately, the items would cost BDT 120,000, so the customer receives a 10% discount, which is spread proportionally:

Figures are illustrative. Whether a licence is recognised at a point in time or over time depends on whether it is a right to use or a right to access the intellectual property, which requires analysis of the specific contract.

6. Step 5 — Recognise revenue when control transfers

Revenue is recognised over time if any one of three criteria is met: the customer simultaneously receives and consumes the benefits as the entity performs; the entity’s performance creates or enhances an asset the customer controls; or the entity’s performance creates an asset with no alternative use to the entity and the entity has an enforceable right to payment for performance completed to date. Otherwise, revenue is recognised at a point in time, when control passes — indicated by factors such as a present right to payment, legal title, physical possession, transfer of significant risks and rewards, and customer acceptance.

For exporters, Incoterms are an important input to the control assessment. Under FOB, for example, risk usually passes when goods are loaded on board, and revenue is often recognised at shipment. However, the analysis should consider all the indicators in the contract — not the Incoterm alone. Manufacturers producing customer-specific goods should also consider whether the “no alternative use plus enforceable right to payment” criterion leads to over-time recognition.

7. Contract assets, receivables and contract liabilities

When the customer pays or is invoiced before the entity performs, the entity recognises a contract liability (often called deferred revenue). When the entity performs before it has an unconditional right to payment, it recognises a contract asset. A receivable is an unconditional right to consideration — only the passage of time is required. In the example, the January invoice creates a receivable of BDT 108,000 and, at the end of January, a contract liability of BDT 21,000 for obligations not yet performed.

8. Contract costs and disclosures

Incremental costs of obtaining a contract, such as sales commissions, are capitalised if the entity expects to recover them (with a practical expedient to expense them when the amortisation period would be one year or less). Costs to fulfil a contract are capitalised if they relate directly to a contract, generate or enhance resources used to satisfy future obligations, and are expected to be recovered. IFRS 15 also requires extensive disclosures: disaggregation of revenue, contract balances, performance obligations, remaining performance obligations and significant judgements.

9. Common mistakes

• Recognising revenue on invoicing rather than on transfer of control.
• Ignoring variable consideration such as rebates, claims and penalties until they are settled.
• Allocating a bundle discount entirely to one item.
• Missing implied promises, such as free maintenance or material rights from customer options.
• Not reconciling contract liabilities and contract assets each month as part of the close.

Standards referenced in this article

IAS and IFRS are one body of standards — IFRS Accounting Standards, issued by the IASB. Standards issued before 2001 keep their IAS numbers and remain fully in force unless replaced. See the full IFRS & IAS standards list for every number and replacement.

Frequently asked questions

What are the five steps of IFRS 15?

Identify the contract with a customer; identify the performance obligations; determine the transaction price; allocate the transaction price to the performance obligations; and recognise revenue when (or as) each performance obligation is satisfied.

When is revenue recognised over time under IFRS 15?

When the customer simultaneously receives and consumes the benefits as the entity performs, when the entity's performance creates or enhances an asset the customer controls, or when the asset created has no alternative use to the entity and the entity has an enforceable right to payment for performance completed to date.

What is a contract liability?

A contract liability is the entity's obligation to transfer goods or services for which it has already received consideration, or for which consideration is due. It is often described as deferred revenue or customer advances.

Conclusion

IFRS 15 asks one question in five steps: what has the entity promised, for how much, and when does the customer obtain control? Documenting performance obligations, estimating variable consideration carefully, allocating on stand-alone selling prices and reconciling contract balances every month will produce revenue figures that withstand audit — and that management can trust.

Written by Liakat Hossain

Finance and accounts professional with experience in FP&A, SAP FICO, Power BI, internal control, reporting, audit, tax, VAT and export-oriented business operations.

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This article is original educational content based on professional finance practice. Real-project examples are anonymized, and scenario figures are identified as model outputs rather than guaranteed results.