Last updated on 2024年8月8日

How can you recognize revenue for long-term contracts?

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Revenue recognition is a crucial aspect of financial management, especially for businesses that engage in long-term contracts with customers. Long-term contracts are agreements that span more than one accounting period and involve the delivery of goods or services over time. How can you recognize revenue for long-term contracts in a way that reflects the economic reality of your transactions and complies with the accounting standards? Here are some tips to help you.

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Muzammil Hussain Korai

CA Finalist | Auditor | IFRS/GAAP Expert
BARTHOLOMEW MULILANDUBA

Chartered Accountant

1 Identify the contract

The first step is to identify the contract with the customer and determine its scope and duration. A contract is an agreement that creates enforceable rights and obligations between the parties. You need to verify that the contract has been approved by both parties, has clear terms and conditions, has commercial substance, and has collectability of the consideration. You also need to assess whether the contract can be modified, combined, or terminated in the future.

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Muzammil Hussain Korai

CA Finalist | Auditor | IFRS/GAAP Expert
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Actually, the five steps you mentioned are part of the 'Five-Step Revenue Recognition Model' outlined in IFRS 15. This international accounting standard provides clear rules for when and how companies should record income. According to IFRS 15, the very first step to recognizing revenue is identifying a contract with a customer. Without a contract, revenue can not be booked. However, this contract does not necessarily need to be in written form. This can also be oral or implied.

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2 Identify the performance obligations

The next step is to identify the performance obligations in the contract. A performance obligation is a promise to deliver a distinct good or service to the customer. A good or service is distinct if the customer can benefit from it on its own or together with other resources, and if it is separately identifiable from other promises in the contract. You need to analyze the nature and timing of the goods or services you provide, and whether they are transferred to the customer over time or at a point in time.

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BARTHOLOMEW MULILANDUBA

Chartered Accountant
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Accurately determining performance obligations is a common problem. Improperly identified performance obligations can be difficult to change and restatement of financial statements may be required.

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3 Determine the transaction price

The third step is to determine the transaction price, which is the amount of consideration you expect to receive from the customer in exchange for the goods or services. The transaction price may include fixed or variable components, such as discounts, incentives, penalties, or changes in scope. You need to estimate the variable consideration using either the expected value or the most likely amount method, and apply the constraint to avoid overstatement of revenue. You also need to adjust the transaction price for any significant financing components, non-cash considerations, or consideration payable to the customer.

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4 Allocate the transaction price

The fourth step is to allocate the transaction price to the performance obligations in the contract. The allocation should reflect the relative stand-alone selling prices of the goods or services, which are the prices at which you would sell them separately to a similar customer. You need to use observable evidence, such as market prices, list prices, or historical data, to determine the stand-alone selling prices. If there is no observable evidence, you need to use an estimation method, such as cost plus margin, residual, or adjusted market assessment.

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5 Recognize revenue

The final step is to recognize revenue when you satisfy each performance obligation by transferring control of the good or service to the customer. Control is the ability to direct the use and obtain the benefits of the good or service. You need to evaluate whether control is transferred over time or at a point in time, based on criteria such as whether the customer has a present right to payment, whether you have a present obligation to perform, whether the customer has physical possession, legal title, or significant risks and rewards of ownership, and whether the customer has accepted the good or service. You need to measure your progress towards completion using either an input or an output method, and recognize revenue accordingly.

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6 Here’s what else to consider

This is a space to share examples, stories, or insights that don’t fit into any of the previous sections. What else would you like to add?

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How can you recognize revenue for long-term contracts?

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1 Identify the contract

2 Identify the performance obligations

3 Determine the transaction price

4 Allocate the transaction price

5 Recognize revenue

6 Here’s what else to consider

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