IFRS 15 vs. IAS 18: Huge Change Is Here!
When to recognize revenue? This simple question is one of the most controversial issues in today’s accounting.
Well, it’s simple and easy when you sell goods, but how about long-term contracts or some sort of services?
You need to have some rules on WHEN to recognize the revenue from all these things, because all your profits and losses, your reputation in front of the outside world and your taxes depend on this.
Revenue recognition rules have just changed and later in this article, you’ll find an example showing you the impact of this change.
Revenue Recognition: IFRS vs. US GAAP
Until now, revenue recognition was exactly one of the biggest gaps between IFRS and US GAAP.
As you know, IAS 18 Revenue contains principles for revenue recognition, but they are quite broad and as a result, many companies use their judgment to apply them in their specific situation. Some companies even developed their own IFRS policies based on the US GAAP rules.
Opposed to IFRS, US GAAP guidance about revenues is very detailed – US GAAP contains about 100 separate documents and protocols about revenue recognition in specific areas (often conflicting, by the way).
Finally, these 2 standards came closer and tried to solve all these differences on 28 May 2014.
IFRS 15 Revenue from Contracts with Customers
New revenue recognition standard was issued: IFRS 15 Revenue from Contracts with Customers and it should fill the gap between IFRS and US GAAP.
FASB (the US GAAP standard setting body) issued the new revenue recognition standard, too: Topic 606, which is almost a mirror of IFRS 15 (full text of Topic 606 is here).
Although I’ll cover this standard in one of my videos in the following months, here are the basic points for your information:
- You’ll need to apply IFRS 15 for reporting periods beginning on or after 1 January 2018 (early application permitted);
- IFRS 15 will replace the following standards and interpretations:
- IAS 18 Revenue,
- IAS 11 Construction Contracts
- SIC 31 Revenue – Barter Transaction Involving Advertising Services
- IFRIC 13 Customer Loyalty Programs
- IFRIC 15 Agreements for the Construction of Real Estate and
- IFRIC 18 Transfer of Assets from Customers
- The core principle of IFRS 15 is that an entity will recognize revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration (payment) to which the entity expects to be entitled in exchange for those goods or services.
To apply this principle, you need to follow a five-step model framework described below.
- IFRS 15 contains guidance for transactions not previously addressed (service revenue, contract modifications);
- IFRS 15 improves guidance for multiple-element arrangements;
- IFRS 15 requires enhanced disclosures about revenue.
Five-Step Model Framework
Every company must follow the five-step model in order to comply with IFRS 15. We’ll not go into details, just let me brief you a bit:
- Step 1: Identify the contract(s) with a customer.
IFRS 15 defines a contract as an agreement between two or more parties that creates enforceable rights and obligations and sets out the criteria for every contract that must be met.
- Step 2: Identify the performance obligations in the contract.
A performance obligation is a promise in a contract with a customer to transfer a good or service to the customer.
- Step 3: Determine the transaction price.
The transaction price is the amount of consideration (for example, payment) to which an entity expects to be entitled in exchange for transferring promised goods or services to a customer, excluding amounts collected on behalf of third parties.
- Step 4: Allocate the transaction price to the performance obligations in the contract. For a contract that has more than one performance obligation, an entity should allocate the transaction price to each performance obligation in an amount that depicts the amount of consideration to which the entity expects to be entitled in exchange for satisfying each performance obligation.
- Step 5: Recognize revenue when (or as) the entity satisfies a performance obligation.
Who Will Feel the Biggest Impact of IFRS 15?
The experts say that the most impacted industries are telecom, software development, real estate and other industries with long-term contracts.
If you work in an industry where bundled contracts of “product + service” are quite common, then you should pay attention.
I’m referring mainly to software development or telecommunications, where customers usually buy a prepayment plans with a handset or software development comes with implementation and post-delivery service in 1 package, or any similar arrangements.
Under the new model, companies in telecom and software will probably recognize revenue earlier than under older rules.
Why is that?
Well, because under new IFRS 15, the transaction price must be allocated to the individual performance obligations in the contract and recognized when these obligations are delivered or fulfilled.
It means that under new IFRS 15, telecom operator must allocate a part of the revenue from prepayment plan with free handset to the sale of handset, too.
Under IAS 18, the revenue is defined as a gross inflow of economic benefits arising from ordinary operating activities of an entity.
It means that if the operator gives a handset for free with the prepayment plan, then the revenue from handset is 0.
OK, if that sounds a bit confusing, we’ll better look at numbers.
Example: IAS 18 vs. IFRS 15
Johnny enters into a 12-month telecom plan with the local mobile operator ABC. The terms of plan are as follows:
- Johnny’s monthly fixed fee is CU 100.
- Johnny receives a free handset at the inception of the plan.
ABC sells the same handsets for CU 300 and the same monthly prepayment plans without handset for CU 80/month.
How should ABC recognize the revenues from this plan in line with IAS 18 and IFRS 15?
OK, let’s ignore a couple of things here, like a price of a SIM kit, or the situations when Johnny hangs on the phone for hours and spends some minutes in excess of his plan. Let’s focus just on these 2 things.
Revenue under IAS 18
Current rules of IAS 18 say that ABC should apply the recognition criteria to the separately identifiable components of a single transaction (here: handset + monthly plan).
However, IAS 18 does not give any guidance on how to identify these components and how to allocate selling price and as a result, there were different practices applied.
For example, telecom companies recognized revenue from the sale of monthly plans in full as the service was provided, and no revenue for handset – they treated the cost of handset as the cost of acquiring the customer.
Some companies identified these components, but then limited the revenue allocated to the sale of handset to the amount received from customer (zero in this case). This is a certain form of a residual method (based on US GAAP’s cash cap method).
For the simplicity, let’s assume that ABC recognizes no revenue from the sale of handset, because ABC gives it away for free. The cost of handset is recognized to profit or loss and effectively, ABC treats that as a cost of acquiring new customer.
Revenue from monthly plan is recognized on a monthly basis. The journal entry is to debit receivables or cash and credit revenues with CU 100.
Revenue under IFRS 15
Under new rules in IFRS 15, ABC needs to identify the contract first (step 1), which is obvious here as there’s a clear 12-month plan with Johnny.
Then, ABC needs to identify all performance obligations from the contract with Johnny (step 2 in a 5-step model):
- Obligation to deliver a handset
- Obligation to deliver network services over 1 year
The transaction price (step 3) is CU 1 200, calculated as monthly fee of CU 100 times 12 months.
Now, ABC needs to allocate that transaction price of CU 1 200 to individual performance obligations under the contract based on their relative stand-alone selling prices (or their estimates) – this is step 4.
I made it really simple for you here, so let’s do it in the following table:
|% on total||Revenue (=relative selling price = 1 200*%)|
|Network services||960.00 (=80*12)||76.2%||914.40|
|Total||1 260.00||100.0%||1 200.00|
The step 5 is to recognize the revenue when ABC satisfies the performance obligations. Therefore:
- When ABC gives a handset to Johnny, it needs to recognize the revenue of CU 285.60;
- When ABC provides network services to Johnny, it needs to recognize the total revenue of CU 914.40. It’s practical to do it once per month as the billing happens.
The journal entries are summarized in the following table:
|285.60||FP – Unbilled revenue||P/L – Revenue from sale of goods||When handset is given to Johnny|
|Network services||100.00 (= monthly billing to Johnny)||FP – Receivable to Johnny||When network services are provided; on a monthly basis according to contract with Johnny|
|76.20 (=914.40/12)||P/L – Revenue from network services|
|23.80 (=285.60/12)||FP – Unbilled revenue|
So as you can see, Johnny effectively pays not only for network services, but also for his handset.
What’s the Impact of the IFRS 15?
The biggest impact of the new standard is that the companies will report profits in a different way and profit reporting patterns will change.
In our telecom example, ABC reported loss in the beginning of the contract and then steady profits under IAS 18, because they recognized the revenue in line with the invoicing to customers.
Under IFRS 15, ABC’s reported profits are the same in total, but their pattern over time is different.
Why does it matter?
Well, because some contracts surpass one accounting period. They are long-term and reporting revenues in incorrect accounting periods might cause wrong taxation, different reporting to stock exchange and other things, too.
Don’t believe me?
Just look at ABC. Let’s say that contract started on 1 July 20X1 and ABC’s financial year-end is 31 December 20X1. Just look how much profits ABC reports from the same contract with Johnny under IAS 18 and IFRS 15 in the year 20X1:
|Performance obligation||Under IAS 18||Under IFRS 15|
|Network services||600.00 (=100*6)||457.20 (=76.2*6)|
How to Prepare for IFRS 15
I really do think that IFRS 15 is a huge change and it requires a massive amount of work not only from accountants, but also from IT departments, tax people and maybe other departments in your company, too.
A few ideas for your future steps:
- Go through your contracts and evaluate
Your profit reporting will depend on the specific contract terms. If your company has a number of different types of contracts, you need to assess each type separately and decide how to deal with that type in line with IFRS 15.
- Change your accounting system
OK, how many customers does the “average” telecom company have?How many contracts are there?
Thousands. Millions. Tens of millions.
And once you decide how to recognize revenue for each type of contract that you have, then you need to implement this accounting process into your accounting software or system.
Whether you realize it or not, the implementation of IFRS 15 will cost affected companies significant amount of money for system upgrades, consultants, training the employees and other related activities.
That’s why IFRS 15 must be implemented starting 1 January 2018 – some time is left for making these changes.
- Go back and restate existing contracts
I did not want to scare you in my previous point, but this is going to be a bit scary:All companies need to look back and recalculate profits and revenue reporting from all contracts.
When you apply IFRS 15, you need to apply it as the new rules have always been in place, that is retrospectively.
Let’s say that Johnny and ABC enter into 2-year plan on 1 July 2015 and IFRS 15 has not applied yet; thus ABC recognized zero revenue for handset and monthly revenues from network services in line with the billing.
On 1 January 2017, ABC will apply IFRS 15 and contract with Johnny is still open (it expires on 30 June 2017). ABC needs to perform all the calculations as shown above and adjust opening balances related to the contract.
What does it mean?
Companies will need to gather lots of numbers, fair values, estimates, stand-alone selling prices and other things and then perform lots of recalculations and adjustments.
Just imagine you work in a construction of real estate and you’re affected by IFRS 15. Some contracts run for 10 or 15 years … OK, I finish here and leave it to your imagination.
UPDATE 2018: I have written few articles about IFRS 15 and you can check them out here:
- IFRS 15 Examples: How IFRS 15 affects your company
- Accounting for discounts under IFRS
- How to account for customer incentives under IFRS
- Principal or agent – revenue or liability?
- Short summary of IFRS 15 Revenue from Contracts with Customers (with video)
Now, I’d really love to hear your view. Do you think IFRS 15 will hit you hard? Are you making your plans to adopt or implement it? Please leave a comment below and if you liked reading this article, share it with your friends here.
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Don’t you believe that the sale of the handset to Johnny involves financing cost that supposed to be accounted for by the ABC Telecom?
Hi Abdalla, not in this case, because it’s 12 months. But sure, if the plan is longer, then you have a significant financing component there and you must take this into account. Anyway, I don’t want to complicate the things when explaining the basics, that’s why I picked up a simple case. S.
i began to enjoy the world of IFRS!
I thank you very much Silvia for this explanation!
Hi Silvia ,
Thanks for the great effort, I am thinking of buying your IFRS KIT and then apply for the EXAM.
But I have a concern that it will not have enough examples for construction and engineering industries which will not be very helpful for me.
So would you please give an honest advice ?
Hi Mostafa, thanks for your interest! Please, for further information about the IFRS Kit, write me an e-mail 🙂 Silvia
May I know how does iFRS 15 affect manufacturing companies that produce alum, ore,etc ? And how to anticipate the transaction price in the contract since the market price for the product is vary? Lastly, if the promised quantity stated in the existing agreement did not meet, do I need to restate contract ?
firstly, you are doing an amazing job simplifying these standards which are usually worded to be complex!!!
as for the example on pricing the phone and service price i was thinking more in terms of having the usual service price fixed at 80 per month and considering the delta of 240(1200-(80*12)) as the price for the handset i.e. in effect the handset is discounted and not the service. makes sense?
I see your point, but this is not the case. You would allocate the full discount to the handset and IFRS 15 does not permit it (there are some exceptions though). S.
I am new to IFRS and you make it so easy to read and understand. My question to you is that would the revenue for a one-year training passport that gives customers unlimited access right to online materials be recognized immediately once the access right is granted? Under ASC 605, we recognize such revenue over 12 months. Thanks!
Hi,Can you please explain why IAS 18 was replaced by IFRS 15?
Can you plz through some light how revenue recognition is done in case of fixed bid and time and material contract with help of an example
How will IFRS 15 affect a school that receives money in advance. Some parent register their kids soon after birth.
I am a big fan of yours, always refer your articles on ifrs whenever i need some clarification or understanding. You have made all the standards very easy to grasp. I don’t have to refer so many pages to get what i want and still be nowhere.
Thank you and all the very best to you, so that you can always keep up the good work.
Hi Shilpa, great to read this 🙂 can I include your quote to testimonials? All the best 🙂
What if the company is offering free credits with every purchase of a prepaid SIM Card. what would be the impact of IFRS 15?
in this case, the company must allocate the transaction price (to be received from customer) to the individual performance obligations, i.e. to credits within SIM card and free credits. S.
Thanks. Your explanations are Simple, Excellent and very useful to understand.
Regards&Thanks in Advance,
Hi silvia , please write short compare between IFRS15 and IAS 18
Thank you in advance
How about sale return’s recognition ?
Hi Ki Ki,
you need to take the probability of returns into account, based on past statistics or other data. I solved the complex example about it in my IFRS Kit. S.
Hello Ms. Sylvia. How about for installment sales wherein there is no reasonable assurance for estimating the degree of collectibility of your receivables, are we going to recognize the revenue at the point of sale or can we depart from it.
Hi Elaine, it all depends on what the contract says – when the control over the asset is passed to the customer. If at the inception, then yes, recognize sale at the inception. However, you should take the probability of collecting the revenue into account when determining the transaction price. S.
Does the following wording in Step 4
“allocate the transaction price to each performance obligation in an amount that depicts the amount of consideration to which the entity expects to be entitled in exchange for satisfying each performance obligation.”
mean that should the company deem it appropriate, they could recognise the full CU300 for the handset and have the “discounted” element applied to the monthly rental income? i.e. 900 / 12 = 75 per month
all that matters: relative stand-alone prices. So no, if these standalone prices would have been like in the above example, then the company cannot allocate 75/month and 300. S.
You always do the right thing. God Bless you.
For determining the transaction price, do we need to consider the probable excess usage that over and above the contract benefits based on history of that customer segment? In that case, the revenue is extrapolated than contract price and there is always an realization of that amount from customer to customer.
Secondly, if customer opts for any service add-on, does it need to be factored as part of original contract price?
Good day and Happy New Year!
As the others say, a very nice article. You presented the details with great simplicity and clarity. This will surely help me in my course work in the graduate school on Revenue Recognition. I am really having a hard time with this one since my background is in finance, management accounting and IT accounting, not on financial accounting.
Just some questions and clarifications related with your example, as follows:
1) What if the monthly price of the plan with the head set is much lower than the normal price of the plan without the headset (e.g. at CU 70), how will this affect the transaction price, allocation of the price and the recognition of revenues?
Although this seems to be unusual because when we offer a bundle, the price of the plan with the headset is normally higher than the price of the plan without the headset (to cover portion of the cost of the headset). This is just for illustration purposes.
2) In relation to no.1), what if the price of the plan with the headset is just the same with the price of the plan without the headset (meaning price is CU 80), how will this affect the transaction price, allocation of the price and recognition the revenues?
Again, this seems unusual. Just for the purpose of illustration.
3) What if ABC separately offers an extended warranty for two years, in addition to the one year quality assurance of one year, amounting to CU 60. The extended warranty is paid immediately upon purchase of the plan in addition to the monthly payments of CU 100. How will this affect the transaction price, allocation of the price and the recognition the revenues?
Thank you very much Silvia. Your response will really be of great help. GB:)
Excellent explanation , GOOD WORK ….
I am in foods FMCG company. What would be the impact to our business. We have open contract with customer and currently recognize revenue as and when deliver the products to them.
Also, we have to pay rebates based on agreements. For example 5% on sales as rebate on using supermarket shelves and currently accounting under trade marketing cost (selling and distribution)
Appreciate your feedback.
very well explained But I want 100s of scenarios with solution as above to get prepared for upcoming exams in March for ICAP papers.
I want that too, Ali! 🙂
Well explained article. Thank You
Thank u well understood
Well explained article. Thank You
Nice Article with very easy example. Can you please confirm if along with handsets and monthly subscription Fee, ABC also provide 100 free call minutes (standalone price of minutes is CU 1) for 1st month. My question is…. Will these mins price be allocated with handsets and subscription fee.
2) Also if ABC decide to give these mins after 6 months of the contract. (as mentioned in contract as subsidy)
3) Under normal scenario (No free Mins) What if customer terminate the contract after 3 months and return the handset. what would be accounting entries.:(
Thanking you for your descriptions. Would you please give us another real life example ?
Would be great if you can offer some insight on how IFRS 15 will impact on revenue recognition for university offering scholarship to students.
E.g. normal tuition fee is $100. A student is admitted and only needs to pay $50 (remaining $50 is scholarship, hence no payment to be made by student).
Thanks a ton and keep up the great work!
Good day!! I have 2 questions
1) the previously IAS 11 stated that eg if a profti is expected to be made then the same sould be made on stage of completion. How does this link with IFRS 15.
2) on your example with the phone device + network, is it correct to recognise full 12 momths of the network charge at the start of the contract as deferred income and release revenue on a monthly basis?
i am not an expert but just helping with an opinion. on the issue of question 2. what i understand is that you only defer revenue if you have received money for services yet to be performed. but in the example of Silvia, the services have not yet been rendered so no deferred revenue. Hope this is helpful
can you please explain
1. Transition guidance for contract that will be completed after jan 2018
2. also do we have to make adjustment to the contract that will get completed before Jan 2018.
How is credit rating of customers related with IFRS 15? I have heard credit rating of customers will be required because of IFRS 15.
Arif, it’s quite tough to explain this in the comments, but I try shortly: under IFRS 15, you account for a “contract asset” sometimes. That’s when you supplied more than your billing is (very simply said). You should test this contract asset for an impairment and in this case, you should take customer’s credit risk into account. But, you don’t need to ask for credit rating necessarily if you are able to assess customer’s credit risk in some other way. S.
I have a question .We use IFRS 15 Revenue recognition point of time.Supply of machineries.Payment terms are like (1) 50% advance (2) 30% on delivery (3) 10% after 1 month of delivery,(4) 10 % after 1 year warranty period. How to record the receivables .Can we debit the full amount in customer a/c at the time of delivery ? actually the payment 3 & 4 is not due on the date of revenue recognition. please advise on this
if you are reasonably sure that you will receive the full revenue, you can recognize it in full. However, you should discount the payment due in 1 year to its present value. S.
Could you please elaborate How to calculate discount it into present value . Should we consider this charges (discount rate) while pricing the item to the Customer.means charge it from the Customer
Is is it worth if we use Installment payment method installment sales method, cost recovery method.
You’re awesome. Your way of explaining complex things with ease is what makes you different fro others. I really like it as it makes learning more interesting. Can you please explain the impact of IFRS 15 on revenue contracts entered with related parties? What could be the impact is such contracts are on arms length price or at a price agreed by related parties?
I am grateful for your hard research and clear explanation on this monster IFRS15 standard – I feel like it’s a bomb when hearing about it!
Can I please ask how IFRS15 would affect the university sector where there are typically 2 types of contracts:
1. Student Fees
2. Research Contracts
If you could give an example about this situation, it would be much appreciated.
Hi Sylvia – Thanks for the article.
I am working for a medical device and we only work via distributor contracts. So we sell our tangible products to the distributor and he sells it further to hospitals etc. We recognize the revenue when we invoice and ship the goods and he pays in x days. Is there any impact of the IFRS 15 on our set up on how we do things?
Thanks for your answer
if the situation is that straightforward as you described, then I think there would be no change. You should be just careful when delivering at discounts, providing some post-delivery services, making returns/refunds, etc. S.
Thank you silvia, this is very nice and easy to understand the concept clearly. Thanks a lot.
Hi Sylvia. Your explanations help so much, thank you for all the hard work. I just wanted to ask about the old IFRIC 13 and how that will now be accounted for in terms of IFRS 15. I wanted to specifically know if the customer uses loyalty programs and pays a fee in advance per annum and uses his card for discounts etc during the year. Will revenue be calculated over time or at a point in time ?
if Company is offering handset free and other network services are charged at 80 per month Than what would be the treatment under IFRS 15.
Hmmm, I think the process is described in the article. You need to alocate the total contract cost of 80*number of monhts between the handset and monthly services based on their relative stand-alone selling prices. Then the journal entries are the same in principle (just the numbers are different) S.
Will IFRS 15 effect the financial Ratio’s of a company? And Which one?
One more cringe worthy point to add:
In the example given above (wrt Johnny), the Telecom company will report higher revenue in the period from Jan’17 to Jul’17. Whereas, a part of that revenue is already TAXED in the previous period. I don’t think any Tax authority in any country will give a credit for the tax already paid in prior period. This resulting in single income taxed twice. And beauty of it is : Many of the companies will not even know the exact quantum of impact.
this is a valid point. But, the taxation depends on the country rules. Some countries tax the profits based on IFRS rules and in this case, the tax effect will be just OK. However, if the legislation asks to calculate taxable profit under the rules different from IFRS, then yes, you are right and here, the deferred tax needs to be recognized. Not mentioning the cash flow effect. S.
Hi Silvia, could you provide revenue recognition examples like how you did for the network plan for property development under IAS 18 and IFRS 15?
I wrote another article with examples on IFRS 15 and I think I included one related to property development. You can check them out here. S.
What if you have three contract with different names and different price how could you show them in financial statement ?
Hi Silvia, I have a question on a scope exemption for IFRS 15. If an entity has an interest in a joint operation accounted for under IFRS 11, and the joint operation has a contract with a customer, is that contract scoped out of IFRS 15? Thank you.
Your article is very easy to understand. Can you make article about IFRS 16: Lease?or do you have reference for me about that?I am going to learn that IFRS for implementation. Thanks Silvia.
Hi Dea, try this one. S.
Woooww, thanks you so much silvia. I really appreciate it. I will start read now hehehe. Thanks.
I wonder that ABC Co. can recognise a revenue from headset on delivery day however ABC Co. will get money montly. So the money of headset will be delayed. Is interest should be calculated for delayed money of headset?
I think a part of recognised headset revenue is an interest income based on IFRS-15, 61,b (i).
Not in this example as the revenue is spread over 12 months. S.
Thank you, Silvia. Do you have some examples about software industry based on IFRS 15? I am writing an article. Thanks again.
I wrote about one example in this article, please check it out! S.
what is the application of the new accounting policy to Microsoft company?
Could you plaese provide a snapshot of all the IFRs which are changing and have effective dates of 1st January 2017
I red in IFRS-15 that it also deal with cost incurred for fulfillment of contract. What does it mean?
Please elaborate below:
How does IAS 11 Construction Contracts affect IFRS 15 and can you please provide some explanations and video on IAS 37.
IFRS 15 will replace IAS 11 eventually. The video on IAS 37 is here. S.