In the proposed changes to revenue accounting, ‘FRED’ 82 proposes to align FRS 102 with IFRS 15: Revenue from Contracts with Customers, albeit a simplified version concerning ‘promises’ rather than ‘performance obligations’ as under IFRS 15.
Applying the changes to revenue to contracts can be complex, especially for businesses with long-term contracts, technology businesses, and those in the construction sector. Investing the time early is key to a successful, low-stress adoption of the new standard and establishing efficient processes.
What is ‘FRED’ 82, and when will the revenue accounting changes take effect?
FRED 82 has an anticipated effective date of accounting periods beginning on or after 1 January 2026. This seems quite far away at face value, but you must collect data, make accounting judgements and implement systems/tools ahead of this date.
Where do I start?
If you still need to, we recommend that you perform an initial impact assessment to understand better how the proposed changes will affect your business. To do this, you should ask yourself the following questions:
- Do I understand the five-step model and which revenue streams might be impacted?
- How confidently can I apply the proposed five-step model to each type of revenue contract?
- Do I have contracts containing multiple goods/services that might need unbundling?
- Do I have variable considerations, contract modifications, discounts/rebates, and other complexities which may need detailed accounting judgements?
- Do I need to update processes, systems, and controls?
‘IFRS 15’ Revenue from Contracts with Customers
Here, we summarise the following five steps of revenue recognition and illustrative practical application for the most common scenarios:
- Identify the contract
- Identify separate performance obligations
- Determine the transaction price
- Allocate transaction price to performance obligations
- Recognise revenue when each performance obligation is satisfied.
1. Identify the contract
- The contract can have a written and non-written form or be implied (the contract may not be limited to goods or services explicitly mentioned in a contract but also include those expected to be delivered due to business practices or statements made)
- Should be approved by parties and have a commercial basis
- Should create enforceable rights and obligations between parties
- Should have a consideration established taking into account ability and intention to pay
New contracts may arise when the terms of existing contracts are modified. Contract modifications:
- This could result in retrospective or prospective adjustments to an existing contract, the creation of a new contract alongside the old one, or termination of the original contract and the creation of a new one.
- New contract arises as a result of modifications if:
- A new performance obligation is added to a contract. If a customer orders additional units at a later date, the additional order is considered distinct, even if the order is for identical goods.
- The price at which the additional units are sold represents a standalone selling price at the time of modification. This is a price at which the product would be sold on the market, rather than a significantly different price, for example, heavily discounted despite the product being the same and of the same quality (for example, to entice more future business from that customer)
- Continuation of an existing contract arises when:
- No distinct goods or services are provided as part of the modification.
- Performance obligation can be satisfied at the modification date – for example, a customer negotiates a discount in relation to units already delivered, for instance, due to unsatisfactory quality or service relating to the delivered units only.
2. Identify separate performance obligations
- A performance obligation is a promise to transfer specific goods or services distinct from others.
- Performance obligation is distinct when its fulfilment:
- provides specific benefits associated with it, in its own right or together with other fulfilled obligations
- Is separable from other obligations in the contract – goods or services offered are not integrated or dependent on different goods or services provided already under the contract; the obligation provides goods or services rather than only modifies goods or services already provided
The following are examples of circumstances which do not give rise to a performance obligation:
- providing goods at scrap value
- activities relating to internal administrative contract set-up
Identifying performance obligations may result in unbundling contracts into performance obligations or combining contracts into a performance obligation to recognise revenue correctly.
Unbundling a contract may apply when incentives, such as free servicing or enhanced warranties, are offered during the sale. In this case, servicing and warranties are distinct performance obligations and revenue relating to them needs to be recognised separately from the goods or services promised on the contract to which they relate.
Circumstances which could result in contracts being combined:
- it is negotiated as a package with a single commercial objective
- consideration for one contract depends on the price or performance of the other contract
3. Determine the transaction price
- The transaction price is the most likely value the entity expects to be entitled to in exchange for the promised goods or services supplied under a contract.
- May include significant financing components and incentives and non-cash amounts offered, which affect how revenue is recognised (see below)
Variable amounts of consideration:
- may arise as a result of discounts, rebates, refunds, credits, concessions, incentives, performance bonuses, penalties, and contingent payments
- Variable consideration is only recognised when it is highly probable that there will not be a significant reversal in the cumulative amount of revenue recognised to date.
- No revenue is recognised if the vendor expects goods to be returned.
- Instead, a provision matching the asset is recognised simultaneously as the asset, with an adjustment to the cost of sales.
- Compared with current accounting, the restriction results in a later recognition of revenue and profit (once there is certainty the goods will not be returned).
- Variable consideration is measured by reference to two methods.
- expected value for the contract portfolio (for a large number of contracts) or
- Single most likely outcome amount (if there are only two potential outcomes)
Adjustments for the effects of the time value of money (a ‘financing component’):
- If a financing component is significant, IFRS 15 requires an adjustment for the effect of implicit financing.
- cash received in advance from buyer–vendor to recognise finance cost and increase in deferred revenue
- cash received in arrears from buyer–vendor to recognise finance income and reduction in revenue
- No adjustment for a financing component is needed if payment is settled within one year of goods or services transferred.
- The following does not give rise to a financing component (and hence, no adjustment is needed):
- Customer has discretion over the timing of the transfer of control of the goods or services.
- Consideration is variable, and the amount or timing depends on factors outside of the parties’ control.
- The difference between the consideration and cash selling price arises for other non-financing reasons (i.e. performance protection)
4. Allocate the transaction price to performance obligations
- Allocation is based on the standalone selling price of goods or services forming that performance obligation
Allocation of transaction price may include allocation of discounts, which are applied:
- on a proportionate basis to all performance obligations based on the standalone selling price of each performance obligation (observable or estimated) or
- to specific performance obligations only if
- Observable evidence exists evidencing that the discount relates to those specific obligations only, and
- goods/services stipulated in the performance obligation are regularly sold as standalone and at a discount, and
- Discount is substantially the same as the discount usually given when goods/services are sold on a standalone basis.
Variable consideration is applied to a specific performance obligation if:
- Terms relating to varying the consideration relate to satisfying that specific performance obligation.
- The amount of variable consideration allocated is what the entity expects to receive for satisfying the performance obligation.
Contract modifications may require a reassessment of how consideration is allocated to performance obligations.
5. Recognise revenue when each performance obligation is satisfied
- The point of revenue recognition is the point when the performance obligation is satisfied per each distinctive obligation.
- This may result in revenue recognition at a point in time or over time.
Recognition over time applies when:
- The customer simultaneously receives and consumes the asset/service as the vendor performs the service or
- The vendor’s performance creates or enhances an asset (for example, work in progress) that the customer controls as the work progresses.
The vendor’s performance creates an asset when:
- The asset has no alternative use to the vendor:
- For example, the vendor is restricted from using the asset for any other purpose other than selling it to that specific customer.
- The asset is manufactured to specific specifications or delivery time, meaning that from the point of commencement of asset creation, it is clear the asset is in a particular customer.
- The entity cannot practically or contractually sell the asset to a different customer as it would be practically and contractually prohibitive (for example, it would require a costly rework, selling at a reduced price, or if the customer can prohibit redirection)
- No such practical or contractual limitations would apply if the entity production is that of identical assets in bulk and those assets are interchangeable.
- The vendor has an enforceable right to be paid for work completed.
- The vendor does not have an enforceable right to pay when for example:
- terms of the contract allow the customer to cancel or modify the contract
- The contract allows for circumstances where a customer does not have to pay at all.
- The customer can pay an amount other than the value of the asset or service created to date (i.e. compensation only)
- For compensation to be treated as consideration and fulfil the condition of the enforceable right to be paid, the compensation would have to approximate the selling price for the asset or part of it equal to the proportion of work completed.
How to recognise revenue over time:
- To the extent that each of the performance obligations has been satisfied. This can be established using two methods:
- output method – direct measurement of the value of goods or services transferred to date, for example, per surveys of completion to date, appraisals of results achieved, milestones reached, units produced/delivered, or
- Input method – based on measures such as resources consumed, costs incurred (but see below re contract set up costs), number of hours per time sheets or machine hours, which are directly related to the vendor’s performance
- Contract set-up activities and preparatory tasks necessary to fulfil a contract do not form part of revenue and may meet capital recognition asset requirements (see below)
Capitalisation of costs associated with a sale contract (for example, bidding costs, sales commission)
- Only incremental costs of obtaining a contract (which would not have been incurred if the contract had not been received) are to be considered, for example:
- Direct sales commissions payable if the contract is awarded – including
- costs of running a legal department proving an across-business legal support function – exclude
- Capitalise – is expected to be recovered (contract will generate profits)
- Amortise on a basis that is consistent with the transfer of the goods or services specified in the contract