Revenue Recognition (PFRS 15): Revenue from Contracts with Customers

How do we recognize revenue?

Revenue is a vital information to users of financial position in determining an entity’s financial

performance and condition. The core principle on revenue recognition is that an entity shall
recognize revenue to depict the transfer of promised goods or services to customers in an
amount that reflects the consideration to which the entity expects to be entitled in
exchange for those goods or services.

An entity shall apply revenue recognition standard to all contracts with customers,
EXCEPT the following:

a. lease contracts within the scope of IAS 17 Leases;

b. insurance contracts within the scope of IFRS 4 Insurance Contracts;
c. financial instruments and other contractual rights or obligations within the
scope of IFRS 9 Financial Instruments, IFRS 10 Consolidated Financial
Statements, IFRS 11 Joint Arrangements, IAS 27 Separate Financial
Statements and IAS 28 Investments in Associates and Joint Ventures; and
d. non-monetary exchanges between entities in the same line of business to
facilitate sales to customers or potential customers. For example, this
Standard would not apply to a contract between two oil companies that agree
to an exchange of oil to fulfil demand from their customers in different specified
locations on a timely basis

To meet the core principle, the following Five-Steps Model Frameworks must be applied:

Step 1 – Identify the contract with a customer

The standard defines a ‘contract’ as an agreement between two or more parties

that creates enforceable rights and obligations and specifies that enforceability
is a matter of law. Contracts can be written, oral or implied by an entity’s
customary business practices

It is necessary that the counterparty to the contract is a customer. A

customer is a party that has contracted with an entity to obtain goods or services
that are an output of the entity’s ordinary activities in exchange for consideration.

A counterparty to the contract would not be a customer if, for example, the
counterparty has contracted with the entity to participate in an activity or process
in which the parties to the contract share in the risks and benefits that
result from the activity or process rather than to obtain the output of the
entity’s ordinary activities (such as developing an asset in a collaboration
arrangement).
Criteria for a contract to exist:

1. Legally enforceable
2. Collection of consideration is probable
3. Rights to goods or services and payment terms can be identified
4. It has commercial substance
5. It is approved and the parties are committed to their obligation

Combination of contracts – An entity shall combine two or more contracts

entered into at or near the same time with the same customer (or related
parties of the customer) and account for the contracts as a SINGLE contract if
one or more of the following criteria are met:

a) the contracts are negotiated as a package with a single commercial

objective;
b) the amount of consideration to be paid in one contract depends on the
price or performance of the other contract; or
c) the goods or services promised in the contracts (or some goods or
services promised in each of the contracts) are a single performance
obligation.
Example: Sale of Equipment and Customization Services

Contract modification – A contract modification exists when the parties to a

contract approve a modification that either creates new or changes existing
enforceable rights and obligations of the parties to the contract.

An entity shall account for a contract modification as a SEPARATE contract

if both of the following conditions are present:

a) the scope of the contract increases because of the addition of promised

goods or services that are distinct; and
b) the price of the contract increases by an amount of consideration that
reflects the entity’s stand-alone selling prices of the additional promised
goods or services and any appropriate adjustments to that price to reflect
the circumstances of the particular contract.

If a contract modification is not accounted for as a separate contract, an

entity shall account for the promised goods or services not yet transferred at the
date of the contract modification (ie the remaining promised goods or services)
in whichever of the following ways is applicable:
 a) An entity shall account for the contract modification as if it were a
termination of the existing contract and the creation of a new
contract, if the remaining goods or services are distinct from the goods
or services transferred on or before the date of the contract modification.
The amount of consideration to be allocated to the remaining
performance obligations is the sum of:
i. the consideration promised by the customer (including amounts
already received from the customer) that was included in the
estimate of the transaction price and that had not been recognized
as revenue; and
ii. the consideration promised as part of the contract modification.

b) An entity shall account for the contract modification as if it were a part

of the existing contract if the remaining goods or services are not
distinct and, therefore, form part of a single performance obligation that
is partially satisfied at the date of the contract modification. The effect
that the contract modification has on the transaction price, and on the
entity’s measure of progress towards complete satisfaction of the
performance obligation, is recognized as an adjustment to revenue
(either as an increase in or a reduction of revenue) at the date of the
contract modification (ie the adjustment to revenue is made on a
cumulative catch-up basis).

Free Trial Period Offers - In some cases, an entity will offer customers the
right to obtain its services for free for a period, during which time the customer
can decide to contract for future services.

In these cases, no contract exists until the customer accepts the entity’s
offer to provide services after the free trial period because the customer can
opt out any time during the free trial period. No enforceable right to consideration
exists for the entity until the customer contracts for post-free trial period
services.

Services provided during the free trial period, before the customer accepts the
entity’s offer to provide services beyond the free trial period, are generally
accounted for as sales incentives.

Success-based Fee Arrangements – In some cases, an entity may be

entitled to consideration for services performed only if a specific outcome is
achieved and the customer can withdraw from the contract at any time before
that event without compensating the entity. These arrangements are often
referred to as ‘success-based fee arrangements. It appears that these
arrangements, in which the entire amount of the promised consideration is
contingent on the achievement of a specific outcome, are NOT contracts with
a customer in the scope of the revenue standard before the specific outcome
is achieved.
The determination of the CONTRACT TERM is important because it may affect
the measurement and allocation of the transaction price, the collectability
assessment, the timing of revenue recognition for up-front non-refundable fees,
contract modifications, and the identification of material rights If a contract
can be terminated by compensating the other party and the right to
compensation is considered substantive, then its duration is either the
specified period or the period up to the point at which the contract can be
terminated without compensating the other party. However, if a contract
can be terminated by either party without substantive compensation, then its
term does not extend beyond the goods and services already provided

Some contracts with customers may have no fixed duration and can be
terminated or modified by either party at any time. Under the standard, a
contract does not exist when each party has the unilateral right to
terminate a wholly unperformed contract without compensation. A contract
is wholly unperformed if both of the following criteria are met:

a. the entity has not yet transferred any promised goods or services to the
customer; and
b. the entity has not yet received, and is not yet entitled to receive, any
consideration in exchange for promised goods or services.

Considerations received before a contract exist – If the criteria are not

initially met, then an entity continually reassesses the contract against them and
applies the requirements of the standard to the contract from the date on which
the criteria are met. Any consideration received for a contract that does not meet
the criteria is accounted for as a LIABILITY (DEPOSIT) until criteria are
subsequently met.

However, the entity shall recognize the consideration received from customer
as REVENUE even when a contract does not meet the criteria only when either
of the following events has occurred:

a) the entity has no remaining obligations to transfer goods or services to

the customer and all, or substantially all, of the consideration promised
by the customer has been received by the entity and is non-refundable;
or
b) the contract has been terminated and the consideration received from
the customer is non-refundable

If a contract meets all of the criteria at contract inception, then an entity does
not reassess the criteria unless there is an indication of a significant change
in the facts and circumstances. If on reassessment an entity determines that
the criteria are no longer met, then it ceases to apply the standard to the contract
from that date, but does not reverse any revenue previously recognized.
Step 2 – Identify the performance obligations in the contract

The process of identifying performance obligations requires an entity to

determine whether it promises to transfer either goods or services that are
distinct, or a series of distinct goods or services.

A “PERFROMANCE OBLIGATION” is the unit of account for revenue

recognition. A single contract may contain promises to deliver more than one
good or service. At contract inception, an entity evaluates the promised goods
or services to determine which goods or services (or bundle of goods or
services) are distinct and therefore constitute a performance obligation.

A good or service that is promised to a customer is DISTINCT if both of the

following criteria are met:

a) the customer can benefit from the good or service either on its own or
together with other resources that are readily available to the customer
(ie the good or service is capable of being distinct); and

b) the entity’s promise to transfer the good or service to the customer is

separately identifiable from other promises in the contract (ie the
good or service is distinct within the context of the contract).

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Example: Telco T has a contract with Customer R that includes the

delivery of a handset and two years of voice and data services. The
handset can be used by R to perform certain functions – e.g. calendar,
contacts list, email, internet access, accessing apps via Wi-Fi and to play
music or games.

Additionally, there is evidence of customers reselling handsets on an

online auction site and recapturing a portion of the selling price of the
phone. T also regularly sells its voice and data services separately to
customers, through renewals or sales to customers who acquire
handsets from an alternative vendor – e.g. a retailer.

The handset and the wireless services are two separate performance
obligations based on the following evaluation.
Capable of being distinct
– R can benefit from the handset either on its own (i.e. because the handset
has stand-alone functionalities and can be resold for more than scrap
value and has substantive, although diminished, functionality that is
separate from T’s network) or together with the wireless services, which
are readily available to R because T sells those services separately.
– R can benefit from the wireless services in conjunction with readily
available resources – i.e. either the handset is already delivered at the
time of contract set-up, it could be purchased from alternative retail
vendors or the wireless service could be used with a different handset

Distinct within the context of the contract

– The handset and the wireless services are separable in this contract
because they are not inputs into a single asset (i.e. a combined output),
which demonstrates that T is not providing a significant integration
service.
– Neither the handset nor the wireless service significantly modifies or
customises the other.
– R could purchase the handset and the voice/data services from different
parties (e.g. R could purchase the handset from a retailer), which provides
evidence that the handset and voice/data services are not highly
dependent on, or highly inter-related with, each other.

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A good or service that is NOT DISTINCT is combined with other promised

goods and services until it identifies a bundle of goods or services that is
distinct. This can result in the entity accounting for all of the goods or services
promised in a contract as a single performance obligation.

A contract may contain promises to deliver a series of distinct goods or

services that are substantially the same. At contract inception, an entity
assesses the goods or services promised in the contract and determines
whether the series of goods or services is a single performance obligation.

This is the case when they meet all the following criteria.

a) The goods or services are substantially the same

b) Each distinct good or service in the series is a performance obligation
satisfied over time.
c) The same method would be used to measure progress towards
satisfaction of each distinct good or service in the series
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Example: Cable Company R enters into a two-year service contract with

Customer M to provide cable television service for a fixed fee of 100 per
month.

R has concluded that its cable television service is satisfied over time
because M consumes and receives the benefit from the service as it is
provided – e.g. customers generally benefit from each day that they have
access to R’s service

R determines that each increment of its service – e.g. day or month – is

distinct because M benefits from that period of service on its own.
Additionally, each increment of service is separately identifiable from
those preceding and following it – i.e. one service period does not
significantly affect, modify or customize another.

However, R contract with M is a single performance obligation to provide two

years of cable television service because each of the distinct increments of
service is satisfied over time. Also, R uses the same measure of progress to
recognize revenue on its cable television service regardless of the contract’s
time period

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To apply the series guidance, it is not necessary for the goods to be delivered
or services performed consecutively over the contract period. There may be a
gap or an overlap in delivery or performance and this would not affect the
assessment of whether the series guidance applies

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Example: Carmaker M enters into a 10-year maintenance contract with

Customer C. M provides C with an integrated service of maintenance and
related activities for equipment that M sold to C. C pays M based on the
equipment hours used during the contract period, regardless of whether
M performs maintenance or makes repairs during that period.
M is providing a stand-ready service to C because the nature of the
promise is to deliver an unknown quantity of the underlying activities as
an integrated service when and as needed by C for 10 years.
Each day of service is distinct, because C can continually benefit from
the equipment covered by the contract and each day is separately
identifiable – i.e. one service period does not significantly affect, modify
or customize another.

However, M should apply the series guidance and that its contract with C is a
single performance obligation to provide 10 years of maintenance, because
revenue will be recognized over time as C consumes the benefit of the service
as it’s provided and the same measure of progress would be applied for each
distinct increment because the promise is the same for each increment

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The transfer of a promised good or service requires the customer to be able to

obtain the benefit from that good or service. Therefore, an activity that does not
provide any benefit beyond access to other goods or services is generally an
administrative task or set-up activity. Administrative task to set up a contract
does NOT transfer a good or service to a customer and are NOT
considered performance obligations.

The performance obligations identified in a contract with a customer may NOT

be limited to the goods or services that are explicitly stated in that
contract. This is because a contract with a customer may also include
promises that are implied by an entity’s customary business practices,
published policies or specific statements if, at the time of entering into the
contract, those promises create a valid expectation of the customer that the
entity will transfer a good or service to the customer.

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Example: Carmaker N has a historical practice of offering free

maintenance services – e.g. oil changes and tire rotation – for two years
to the end customers of dealers who buy its vehicles. However, the two
years’ free maintenance is not explicitly stated in the contract with its
dealers, but it is typically stated in N’s advertisements for the vehicles. –
Identify the performance obligation/s.

Therefore, the maintenance is treated as a separate performance obligation

in the sale of the vehicle to the dealer. Revenue from the sale of the vehicle
is recognized when control of the vehicle is transferred to the dealer. Revenue
from the maintenance services is recognized as the maintenance services are
provided to the retail customer.
 However, if N did not have a customary business practice of offering free
maintenance, and instead announced a maintenance program as a limited-
period sales incentive after control of the vehicle has transferred to the dealer,
then the free maintenance would not be a separate performance obligation
in the sale of the vehicle to the dealer. In this case, N would recognize the
full amount of revenue when control of the vehicle was transferred to the dealer.
If N subsequently created an obligation by announcing that it would provide
incentives, then N would accrue as an expense its expected cost of providing
maintenance services on the vehicles in the

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Step 3 – Determine the transaction price

TRANSACTION PRICE is the amount of consideration in a contract 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 –
e.g. sales taxes.

The transaction price can be a FIXED AMOUNT of customer consideration, but

it may sometimes include variable consideration or consideration in a form other
than cash. The transaction price is also adjusted for the effects of the time
value of money if the contract includes a significant financing component
and for any consideration payable to the customer.

If the consideration is VARIABLE, an entity estimates the amount of

consideration to which it will be entitled in exchange for the promised goods or
services. The estimated amount of variable consideration will be included in the
transaction price only to the extent that it is highly probable that a significant
reversal in the amount of cumulative revenue recognized will not occur when
the uncertainty associated with the variable consideration is subsequently
resolved.

An entity estimates the transaction price at CONTRACT INCEPTION,

including any variable consideration, and updates the estimate each reporting
period for any changes in circumstances. When determining the transaction
price, an entity assumes that the goods or services will be transferred to the
customer based on the terms of the existing contract and does not take into
consideration the possibility of a contract being cancelled, renewed or
modified
In determining the transaction price, an entity considers the following
components:

a. Fixed amount of customer consideration

b. An entity estimates the amount of variable considerations to which it
expects to be entitled, giving consideration to the risk of revenue reversal in
making the estimate.
c. Non-cash consideration is measured at fair value, if that can be
reasonably estimated; if not, then an entity uses the stand-alone selling price
of the good or service that was promised in the exchange for non-cash
consideration.
d. For contracts with a significant financing component, an entity adjusts the
promised amount of consideration to reflect the time value of money

A contract does not have a significant financing component if any of the

following factors exist:

1. An entity receives an advance payment, and the timing of the transfer of

goods or services to a customer is at the discretion of the customer.
Example – A prepaid phone card or customer loyalty points
2. A substantial portion of the consideration is variable, and the amount or
timing of the consideration is outside the customer’s or entity’s control.
Example – A transaction whose consideration is a sales-based royalty
3. The difference between the amount promised consideration and the
cash selling price of the promised goods or services arises for non-
finance reasons. Example – Protection against a counterparty not
completing is obligations under the contract

e. An entity needs to determine whether consideration payable to a

customer represents a reduction of the transaction price, a payment for a
distinct good or service, or a combination of the two

Customer credit risk is NOT considered when determining the amount to

which an entity expects to be entitled – instead, credit risk is considered when
assessing the existence of a contract. However, if the contract includes a
significant financing component provided to the customer, then the entity
considers credit risk in determining the appropriate discount rate to use

The transaction price may include amounts that are not paid by the
customer. For example, a healthcare company may include amounts to be
received from the patient, insurance companies and government organizations
in determining the transaction price. In another example, a retailer may include
in the transaction price amounts received from a manufacturer as the result of
coupons or rebates issued by the manufacturer directly to the end customer
Variable considerations. Items such as discounts, rebates, refunds, rights of
return, early settlement discounts, credits, price concessions, incentives,
performance bonuses, penalties or similar items may result in variable
consideration. Promised consideration can also vary if it is contingent on the
occurrence or non-occurrence of a future event – e.g. the sale of an office
building in which the consideration depends on the level of occupancy of the
building at a future date. Variability may be explicit or implicit, arising from
customary business practices, published policies or specific statements, or any
other facts and circumstances that would create a valid expectation by the
customer.

An entity recognizes a refund liability for consideration received or receivable if

it expects to refund some or all of the consideration to the customer.

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Illustration: Telco B enters into an agreement to provide data hosting

services to a large business customer, Company C, for a period of five
years. Certain service-level agreements (SLAs) are signed by B as
part of the contract with C. Specifically, the SLAs will result in a
reduction of consideration paid by C to B, if B does not meet a specified
level of service. Because the SLAs are part of the contract with C, the
SLA penalties create variable consideration. Therefore, B should
estimate the amount of the penalties at contract inception in
determining the transaction price.

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Consideration can be deemed to be variable even if the price indicated in

the contract is fixed. The promised consideration may be variable if an entity’s
customary business practices and relevant facts and circumstances indicate
that the entity may accept a lower price than what is stated in the contract
– i.e. the contract contains an implicit price concession or the entity has a history
of providing price concessions or price support to its customers

An entity assesses whether, and to what extent, it can include an amount of

variable consideration in the transaction price at contract inception by:

a. Estimate the amount using the (1) expected value or (2) most likely
amount.

EXPECTED VALUE – The entity considers the sum of probability-

weighted amounts for a range of possible consideration amounts. This
may be an appropriate estimate of the amount of variable consideration
if an entity has a large number of contracts with similar characteristics

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Illustration: Electronics Manufacturer M sells 1,000

televisions to Retailer R for 500,000 (500 per television). M
provides price protection to R by agreeing to reimburse R for
the difference between this price and the lowest price that it
offers for that television during the following six months. Based
on M’s extensive experience with similar arrangements, it
estimates the following outcomes

Price reduction Probability

0 70%
50 20%
100 10%

After considering all relevant facts and circumstances, the expected

value method provides the best prediction of the amount of
consideration to which it will be entitled. As a result, it estimates the
transaction price to be 480 per television – i.e. (500 × 70%) + (450
× 20%) + (400 × 10%) – before considering the constraint

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When an entity has a population of similar transactions, it may be

appropriate to use this portfolio of data to estimate the transaction price
for an individual contract using the expected value method. In this case,
the transaction price may be an amount that is not a possible
outcome for an individual contract but that is still representative of the
expected transaction price

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Illustration: if there are three possible outcomes for the

transaction price, then the entity calculates an expected value as
follows:

Transaction price Probability Weighting

100,000 30% 30,000
110,000 45% 49,500
130,000 25% 32,500
Expected value 112,000
 Although 112,000 is not a possible outcome, when the conditions are
met, the expected value is appropriate because the entity is really
estimating that 30% of the transactions will result in 100,000, 45% of the
transactions will result in 110,000 and 25% of the transactions will result
in 130,000 which, in the aggregate, will be representative of the entity’s
expectations of the price for each transaction

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MOST LIKELY AMOUNT – The entity considers the single most likely
amount from a range of possible consideration amounts. This may be an
appropriate estimate of the amount of variable consideration if the
contract has only two possible outcomes

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Illustration: Construction Company C enters into a contract

with Customer E to build an asset. Depending on when the
asset is completed, C will receive either 110,000 or 130,000.

Outcome Consideration
Probability
Complete on time 130,000 90%
Delayed 110,000 10%

Because there are only two possible outcomes under the contract,
C determines that using the most likely amount provides the best
prediction of the amount of consideration to which it will be entitled.
C estimates the transaction price – before it considers the constraint
(see 3.1.2) – to be 130,000, which is the single most likely amount

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b. Apply the CONSTRAINT – determine the portion, if any, of that amount

for which it is highly probable that a significant revenue reversal will not
subsequently occur. The constraint introduces a downward bias into
estimates, requiring entities to exercise prudence before they recognize
revenue

After estimating the variable consideration, an entity may include some

or all of it in the transaction price – but only to the extent that it is highly
probable that a significant reversal in the amount of cumulative revenue
will not occur when the uncertainty associated with the variable
consideration is subsequently resolved.
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Illustration: Bank B enters into a contract with Customer E to

help it with an equity placement. Under the contract, in addition to
a fixed amount B will receive a bonus of 1 million if the placement
is successful.

Outcome Bonus Probability

Successful 1 million 75%
Unsuccessful - 25%

Because there are only two possible outcomes related to the bonus
under the contract, Using the most likely amount provides the best
prediction of the amount of consideration to which it will be entitled.
Therefore, using the most likely amount method, B estimates the
variable consideration that it expects to be entitled to as 1 million.
B should also apply the constraint to evaluate whether it is limited in the
amount of this estimate that it can include in the transaction price. As
part of evaluating the application of the constraint, B should consider the
magnitude of the variable amount and the likelihood of a reversal.
Although B may have a lot of experience with these arrangements
(equity placement), the payment is highly susceptible to market
volatility, which is outside the control of both B and E. B therefore
concludes that the variable consideration should be constrained to
zero until the equity placement is undertaken.

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For contracts with a significant financing component, the financing

component is recognized as interest expense (when the customer pays in
advance), or interest income or revenue (when the customer pays in arrears),
and is presented separately from revenue from contracts with customers

Consideration payable to a customer includes cash amounts that an

entity pays or expects to pay to the customer or to other parties that purchase
the entity’s goods or services from the customer. Consideration payable to a
customer also includes credits or other items – e.g. a coupon or voucher – that
can be applied by the customer against the amount owed to the entity or to other
parties that purchase the entity’s goods or services from the customer
An entity evaluates the consideration payable to a customer to determine
whether the amount represents a reduction of the transaction price, a
payment for distinct goods or services or a combination of the two

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Illustration: Customer C has a two-year network service contract with

Telco T. In Month 6, T experiences two days of service quality issues.
Past experience indicates that service quality issues are infrequent for
T.

In Month 7, C receives a bill of P100 for Month 6 services. On receiving

the bill, C calls T and requests a credit for the service outage. Although
it is not its usual practice, T grants C a credit of P5.

Because the credit can be applied against amounts owed to T, it is accounted

for as consideration payable to the customer. And, because the payment is
not in exchange for a distinct good or service, the consideration is accounted
for as a reduction in the transaction price

Illustration: Consumer Goods Manufacturer M enters into a one-year

contract with Retailer R to sell goods. R commits to buying at least
P1,500 worth of the products during the year. M also makes a non-
refundable payment of P15 to R at contract inception to compensate
R for the changes that it needs to make to its shelving to accommodate
M’s products.

The payment to R is not in exchange for a distinct good or service, because

M does not obtain control of the rights to the shelves. Consequently, the
payment of P15 is a reduction in the transaction price. M accounts for the
consideration paid as a reduction in the transaction price when it recognizes
revenue for the transfer of the goods

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Revenue does not include amounts collected on behalf of tax authorities – e.g.
some sales taxes, excise duties or value added taxes (VAT). The amount of
taxes or duties may be computed as a percentage of either the selling price or
the production cost.
Step 4 – Allocate the transaction price to the performance obligations in
the contract

An entity typically allocates the transaction price to each performance obligation

on the basis of the relative stand-alone selling prices of each distinct good or
service promised in the contract. If a stand-alone selling price is not observable,
an entity estimates it. Sometimes, the transaction price includes a discount or a
variable amount of consideration that relates entirely to a part of the contract.
The requirements specify when an entity allocates the discount or variable
consideration to one or more, but not all, performance obligations (or distinct
goods or services) in the contract.

This step of the revenue model comprises two sub-steps that an entity performs
at contract inception:
• Determine the stand-alone selling price
• Allocate the transaction price

Determine the stand-alone selling price. The ‘STAND-ALONE SELLING

PRICE’ is the price at which an entity would sell a promised good or service
separately to a customer. The best evidence of this is an observable price from
stand-alone sales of the good or service to similarly situated customers. A
contractually stated price or list price may be the stand-alone selling price of
that good or service, but this is not presumed to be the case. If the stand-alone
selling price is not directly observable, then the entity estimates the amount
using a suitable method.

If there is no observable price available, an estimate price is may be

computed using:

• Adjusted market assessment approach – evaluate the market in

which goods or services are sold and estimate the price that customers
in the market would be willing to pay

• Expected cost plus a margin approach – Forecast the expected cost

of satisfying a performance obligation and then add an appropriate
margin for that good or service

• Residual approach – Subtract the sum of the observable stand-alone

selling prices of the other goods or services promised in the contract
from the total transaction price.

The residual approach is a technique to estimate the stand-alone selling

price of a good or service, rather than an allocation method. Therefore,
the timing of the transfer of control of each performance obligation is not
relevant when applying the residual approach to estimate the stand-
alone selling price of a promised good or service. In some cases, it may
be appropriate to use a residual method to estimate the stand-alone
selling price of an item that is transferred on contract commencement;
in other cases, it may be appropriate to use a residual method to
estimate the stand-alone selling price of an item that is transferred later
in the contract

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Illustration: Software Vendor M enters into a contract with

Customer C to provide rights to use Licenses S and T for three
years, as well as PCS services for both licenses. The contract
price is 100,000.

The PCS services comprise telephone technical support for

each license. M has identified four performance obligations in
the contract:

– Licence S;
– PCS services for S;
– Licence T; and
– PCS services for T

The stand-alone observable price of 12,500 is available for the

technical support for each of the licenses, based on renewals
that are sold separately. However, the average prices at which
M has sold licenses similar to S (at 40,000) and T (at 60,000)
have been in a broad range of amounts with the selling prices
of the licenses are highly variable and not directly observable.
Also, the level of discounting in the bundled arrangements
varies based on negotiations with individual customers.

M estimates the stand-alone selling prices of the performance

obligations in the contract as follows.

Product Selling Price Approach

Licenses S and T 75,000 Residual approach
(100T-12.5T-12.5T)
PCS services for S 12,500 Directly observable
Price
PCS services for S 12,500 Directly observable
Price
.
Total 100,000
 Product Ave. SP Ratio Allocation
License S 40,000 40% 30,000 (75,000 x 40%)
License T 60,000 60% 45,000 (75,000 x 60%)
Total 100,000 100% 75,000

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Allocate the transaction price. At contract inception, the transaction price

is generally allocated to each performance obligation on the basis of
relative stand-alone selling prices. However, when specified criteria are met,
a discount or variable consideration is allocated to one or more, but not all, of
the performance obligations in the contract. After initial allocation, changes in
the transaction price are allocated to satisfied and unsatisfied performance
obligations on the same basis as at contract inception.

Allocating a discount. If the sum of the stand-alone selling prices of a bundle

of goods or services exceeds the promised consideration in a contract, then the
discount is generally allocated proportionately to all of the performance
obligations in the contract. However, this does not apply if there is observable
evidence that the entire discount relates to only one or more but not all of the
performance obligations.

Step 5 – Recognize revenue when (or as) the entity satisfies a

performance obligation

An entity recognizes revenue when (or as) it satisfies a performance obligation

by transferring a promised good or service to a customer (which is when the
customer obtains control of that good or service). The amount of revenue
recognized is the amount allocated to the satisfied performance obligation. A
performance obligation may be satisfied at a point in time (typically for promises
to transfer goods to a customer) or over time (typically for promises to transfer
services to a customer).

An entity shall determine at contract inception whether it satisfies the

performance obligation over time or satisfies the performance obligation at a
point in time.

When performance obligation is satisfied AT A POINT IN TIME, recognize

revenue at the point in time at which control of the goods or service is transferred

For performance obligations satisfied OVER TIME, an entity recognizes

revenue over time by selecting an appropriate method for measuring the entity’s
progress towards complete satisfaction of that performance obligation
The analysis of when control transfers is performed primarily from the
perspective of the customer. A good or service is ‘transferred’ when or as the
customer obtains control of it. Control of an asset refers to the ability to
direct the use of, and obtain substantially all of the remaining benefits
from, the asset. Control includes the ability to prevent other entities from
directing the use of, and obtaining the benefits from, an asset

The benefits of an asset are the potential cash flows (inflows or savings in
outflows) that can be obtained directly or indirectly in many ways, such as by:

(a) using the asset to produce goods or provide services (including public
services);
(b) using the asset to enhance the value of other assets;
(c) using the asset to settle liabilities or reduce expenses;
(d) selling or exchanging the asset;
(e) pledging the asset to secure a loan; and
(f) holding the asset.

Indicators of transfer of control includes, but not limited to, the following:

(a) The customer is obligated to pay the asset

(b) The customer has legal title to the asset
(c) The customer has physical possession of the asset
(d) The customer has significant risks and rewards of ownership of the asset
(e) The customer has accepted the asset.

An entity transfers control of a good or service over time and, therefore,

satisfies a performance obligation and recognizes revenue over time, if one of
the following criteria is met:

(a) the customer simultaneously receives and consumes the benefits

provided by the entity’s performance as the entity performs;
(b) the entity’s performance creates or enhances an asset (for example, work
in progress) that the customer controls as the asset is created or
enhanced; or
(c) 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.

If an entity does not satisfy a performance obligation over time, the performance
obligation is satisfied at a point in time. To determine the point in time at which
a customer obtains control of a promised asset and the entity satisfies a
performance obligation, the entity shall consider the requirements for control.
An entity shall recognize revenue by measuring the progress towards
complete satisfaction of that performance obligation. The objective when
measuring progress is to depict an entity’s performance in transferring control
of goods or services promised to a customer.