hi and welcome to this video and here I'll lead you through the basic principles of the revenue recognition standard IFRS 15 and it has been here for a while I am Sylvia of cpdb box.com the place to be if you want to understand and apply IFRS easily I have created a learning platform teaching you to apply International financial reporting rules helping you to pass your exams get your cpds if needed Lads of another great stuff for pros so you're welcome to check all ad CPD box.com so one of the hottest and biggest accounting issues whatsoever is the question when and how to recognize Revenue very important mainly for the companies who run the long-term contracts or complex transactions now let me tell you that in 2014 there was a huge change in IFRS related to revenue recognition guidance because before the change the guidance on revenues was spread all over the standards and there various interpretations too for example we had is8 is1 sic 31 and a few more interpretations all guiding us when and how to recognize Revenue at various circumstances and it was quite difficult to identify what standard to choose in your specific situation and also it was something conflicting and confusing too so to come out of this unfavorable situation ISB work with American standard setting body fasb and they came up with the totally new Revenue recognition standard IFRS 15 revenue from contracts with customers you need to apply the standard for the period starting on or after 1 January 2018 mandatorily from that day all previous guidance was superseded and as I have already mentioned fasb issued almost identical standard FAS toic 606 well there are some small differences from IFRS 15 IFRS 15 applies to all contracts with customers with some exceptions so here's the list of types of transactions where you look to Outer standards for guidance so not to IFRS 15 and you also do not apply IFRS 15 to barter transactions if they're done between companies within same business for example sometimes two companies trade oil or out commodity swap them in order to meet the demand now let me stress here that you apply IFRS 15 only to contract with customer not with some other party for example you do not apply IFRS 15 to contracts with collaborating parties right so let's see pharmaceutical companies come to my mind as an example because they have contracts where they cooperate on the development of certain truck and you must assess here very carefully if they act as a customer or collaborator the absolutely essential thing what IFRS 15 does is that it introduces five-step model for Revenue recognition if you want to determine how and when to account for Revenue in your particular situation or transaction all you need to do is go through this model so let's briefly take a look and then we will touch each step a bit step number one identify the contract with the customer step number two identify individual performance obligations in that contract step number three is to determine the transaction price step number four is to allocate the transaction price to the individual performance obligations in the contract and the last step number five recognized Revenue when or as the entity satisfies performance obligations each each of these five steps has its own considerations and complications and iars 50 deeply analyzes and guides Us in every single step and that's why most of IFRS 15 text is about this model in this short summary we'll just take a look very briefly at every step and outline what possibly you should look at there also I Illustrated this model on a very short example which is available on my website so don't forget to check that out let's start with the step number one identify the contract with the customer so the contract is a certain agreement between two or more parties and it creates enforceable rights and obligations the contract can be in both written or oral form however it must be enforceable and this will depend on the legislation in the particular country now let me add here that even if you go to the shop and buy something you're entering into some sort of a contract right although such a situation is very simple and straightforward on the other hand there can be quite complex contracts for some transactions iars 15 also describes the attributes for each contract and now there could be two basic issues related to the identification of contract the first one is a combination of contracts so sometimes you will have two or more separate contracts going on and they might need to be accounted for as one because they are interrelated so we have some rules when you need to take these separate contracts and account for them as for one contract so after all substance or form applies here right another complication with identifying the contract can be contract modifications in other words what happens if you modify amand or change existing contracts either in its price or scope or the things you need to deliver under the contract IFRS 15 gives a good guidance on this one too you may have to account for a modification as for a separate contract or as for some catchup adjustment or some combination depending on what the modification is about step number two in the five-step revenue recognition model in IFRS 15 is to identify the performance obligations in the contract but what are they well it is a certain promise in the contract to deliver to the customer either some good or service or a bundle of goods or services that is distinct or a series of goods or services that are almost the same so for example when you sign up for monthly cleaning services or for monthly accounting services and these services are basically the same each month a contract us usually explicitly States the goods or services that should be transferred to a customer so we consider it as explicit performance obligations but sometimes there could also be implicit performance obligations that are implied by something for example by entities customary business practices so for example some guarantees that company usually provides to all customers without explicitly saying that in the contract now when there is no transfer of anything to the customer then there is no performance obligation and I want you to remember that so for example when some company must buy new it system in order to fulfill the contract and it must perform some setup activities these activities transfer nothing to the customers so there are not a performance obligations here in the Second Step The crucial thing is to assess whether the performance obligations should be treated separately for accounting purposes or in other words whether they are distinct and I fors 15 then sets the whole guidance about what's distinct and what's not distinct plus some other considerations related to this topic the step number three in the five step Revenue recognition model is to determine the transaction price but what that is so basically it's the expected amount of consideration that an entity has a right to receive under that contract for delivered goods or services how shall we determine the transaction price well basically we look to the contract but it's not always the full case so sometimes the transaction price can be variable and sometimes it can be fixed so we need to take into account the nature and timing of consideration from the customer so when you determine the transaction price you should consider the effect of variable consideration for example so the amount of consideration or the revenue can vary because of some discounts bonuses rebates or refunds performance bonuses various incentives and also it can depend on some future events for example supplier can get a bonus for meeting the deadline right or decrease its revenue for not meeting the deadline then you should also take into account some constraining estimates of variable consideration or you also need to consider whether there is a significant financing component in the contract so that happens when there is a delayed payment for the goods or services just as an example when the contract involves a non-cash consideration in the form of goods or services or something else then entity includes it in the transaction price in its fair value so let me remind you IFRS 13 fair value measurement covered in another video we should also consider the consideration payable or paid to a customer so it can include either cash amount paid or payable to the customer but also some credits for other items like vouchers coupons and similar items so the accounting for consideration paid to a customer depends on what it is right now step number four is to allocate the transaction price to the individual performance obligations in the contract and now let me explain what that means because this might not be clear what we're doing here and why so I better illustrate it I love hiking and so I saw this super special promotion in my favorite shop for hikers if you buy the new hiking shoes for 100 Curren units you will get new free hiking socks what an amazing special I cannot resist that but from the accounting point of view the hiking shop has two performance obligations right shoes and socks and the transaction price is 100 that's what I will pay however how does the shop recognize the revenue under iOS 15 you cannot recognize 100 for shoes and nothing for socks right instead you must allocate 100 currency units to both shoes and socks that's the point of this step well how in general you would do this in proportion to relative Standalone selling prices and there are some exceptions to this rule but let's focus on the basics here so the Standalone selling price is basically the price at which the hiking shop would sell shoes and socks if sold separately let's say that it's 100 for shoes and 20 for socks that's just regular selling price of these socks so the total is 120 and we need to allocate 100 that I pay based on relative price to 100 and 20 so to hiking shoes I used a fraction of Standalone selling price of shoes of 100 divided by total Standalone selling price of 120 and multiply that with a transaction price of 100 so I get about 83 currency units allocated to the shoes and to socks I do the same I use a fraction of Standalone selling price of socks of 20 divided by total Standalone selling price of 120 and multiply with a transaction price of 100 so I get 17 currency units allocated to socks so sorry for my rounding here now why why does it matter why to do this exercise well it doesn't really matter that much and it does give the same total result when the shop delivers shoes and socks at the same time because revenue is recognized at the same time but this has to do with step number five that we will check out soon but to finish this imagine the situation that a promotion is so successful that the shop runs out of Free socks so you go go there on day one you pay 100 but you get only shoes and the shop tells you to come back the next day or the next year or the day two to get your free socks so you get there on day two or the next year or whenever and the socks are delivered then and since the revenue can be recognized only when the performance obligation is satisfied or Goods delivered to the customer in this case the shop yes it would get 100 on day one in cash but it can account only 83 in revenues on day one for the shoes and the remaining 17 on day two when it gives socks to you so you're doing this allocation due to the precise timing of the revenue recognition well what about the difference there are accounting details I don't want to get into in this short summary so you would use a contract liabil account but again let's focus on the basics here the final step in the revenue recognition model is to recognize Revenue when or as an entity satisfies a performance obligation and it is satisfied when a promised good or service is delivered to a customer or transferred and that happens at the moment when the control of that good or service is transferred let me mention here two different ways of satisfying a performance obligation it could be overtime so in this case the revenue is recognized overtime too and this means that you would need to recognize a revenue gradually over the contract period and not as a single amount when the contract is completed just as an example some real estate development projects or construction contracts are usually on overtime basis or performance obligation can be satisfied at the point of time with Revenue recognized at the point of time and IFRS 15 sets three criteria when you need to recognize Revenue over time and if one of them is met then it's overtime otherwise it's at a point of time so timing of revenues has tremendous impact on everything from the Financial Health of a company to its taxes so it's important to take care about it we have just finished an extremely Brief Review of the five step model for Revenue recognition but IFRS 15 specifically guides us also on other related topics and one of them very important one is contract costs IFRS 15 specifies the accounting treatment of costs to obtain a contract and costs to fulfill a contract costs to obtain a contract are incremental costs in other words cost that would not have been incurred without obtaining that contract for for example sales commissions paid for the acquisition of the contract and here let me warn you about the commissions paid to some agents for acquiring customers for example when his agents acquire customers for three-year contract with tcom operator or whatever then the agent commission should be pretty much advertised over three years not immediately in profit or loss and that's quite a huge issue another type is legal fee associated with the preparation of the contract bonuses to employees specifically provided for obtaining a contract and other so ifar S5 requires capitalizing these costs if entity expects to recover them and amortise them on a systematic basis right basically reflecting the pattern how the goods or services are transferred costs of fulfilling the contract are costs incurred in connection with satisfying performance obligations and the standard says that if these costs are in the scope of some other standard like is-2 inventories is6 or is 38 then you need to treat these costs in line with the relevant standard if these costs are not within the scope of other standard then these cost should be capitalized or recognized as an asset if they meet the conditions specified in IFRS 15 to do so so this was extremely short summary of The Standard IFRS 15 revenue from contracts with customers if you're interested in more detailed explanation of the revenue recognition or our case studies or answered questions on our website check out the courses on our website cpdb box.com check out our free article subscribe to our free newsletter and share this video with your friends bye and thanks for watching