The Five-Step Model Approach to Revenue Recognition under IFRS 15

Step 1 – Identify the Contract with the Customer
A contract can be written, verbal, or implied. A contract falls under the scope of IFRS 15 when:

(i) Both parties have approved it and are committed to it;
(ii) Each party’s rights regarding the goods and services to be transferred can be identified;
(iii) The payment terms are clearly defined;
(iv) The contract has commercial substance (i.e., the contract is expected to affect the company’s financial position); and
(v) It is probable that the consideration will be received.

Step 2 – Identify the Separate Performance Obligations
A performance obligation is a promise in a contract with a customer to transfer:

(i) A good or service (or a bundle of goods or services) that is distinct; or
(ii) A series of distinct goods or services that are substantially the same and that have the same pattern of transfer to the customer.

A good or service is considered distinct if the customer can benefit from it on its own or with other readily available resources. If a good or service cannot be used without another good or service that has not yet been delivered, it may not be distinct. In such cases, the entity should combine those goods or services into one performance obligation.

Step 3 – Determine the Transaction Price
The transaction price is the amount of consideration the entity expects to receive in exchange for transferring the promised goods or services. To determine the transaction price, the entity must consider:

(i) The terms of the contract and its customary business practices;
(ii) The assumption that the contract will not be cancelled, renewed, or modified;
(iii) The transaction price is not adjusted for the customer’s credit risk.

Additionally, the entity must consider the following factors when determining the transaction price:

• Variable consideration (e.g., discounts, rebates, performance bonuses);
• The constraint on variable consideration (to prevent recognition of revenue that may not be received);
• Time value of money (if the contract contains a significant financing component);
• Non-cash consideration (if goods or services are exchanged instead of cash);
• Consideration payable to the customer (e.g., rebates or incentives).

Step 4 – Allocate the Transaction Price to the Performance Obligations
Once the transaction price is determined, the entity allocates the price to each separate performance obligation in the contract. This allocation is done on a relative stand-alone selling price basis at the contract’s inception.

(i) The stand-alone selling price is the price at which the entity would sell the good or service separately to the customer.
(ii) IFRS 15 suggests three methods for estimating the stand-alone selling price:

• Adjusted market assessment approach
• Expected cost plus margin approach
• Residual approach

Step 5 – Recognize Revenue When or As the Entity Satisfies Performance Obligations
Revenue is recognized when or as the entity satisfies the performance obligations, which occurs when the customer obtains control of the good or service.

(i) A transfer of control takes place when the customer can direct the use of, and obtain substantially all of the remaining benefits from, the asset.
(ii) Indicators of control include:

• The entity has a present right to payment for the asset;
• The customer has legal title to the asset;
• The customer has physical possession of the asset (with some exceptions like bill-and-hold arrangements);
• The customer has the significant risks and rewards of ownership; and
• The customer has accepted the asset.

The benefits of an asset refer to the potential cash flows the customer can derive directly or indirectly from the asset.