Revenue is recognized when the promised goods or services are transferred to the customer. Goods and services are assets, even if only momentarily and an asset is transferred when the customer obtains control of that asset.
The promise to transfer the goods or services is known as a performance obligation of an entity. Revenue is recognized when the performance obligations are satisfied. Depending on the nature of the contract with customer, performance obligations are either satisfied at a point in time or the performance obligations are satisfied over time.
Performance obligations satisfied at a point in time
According to the guidance of IFRS 15, some performance obligations are satisfied at a point in time and for recognizing revenue, an entity should consider when control of the goods or services is transferred to the customer. Besides that, an entity should consider the following indicators of transfer of control:
- The entity has a present right to payment for the asset
- The customer has legal title of the asset
- The entity has transferred physical possession of the asset to the customer
- The customer has significant risks and rewards of ownership of the asset
- The customer has accepted the asset
Above scenarios are mere indicators and the entity should come to a conclusion regarding satisfaction of performance obligation and recognition of revenue only after assessing the criteria for over time revenue recognition (explained below).
Performance obligations satisfied over time
Generally speaking, when goods or services are transferred continuously, and the customer has control over the goods or services transferred to date, it means that performance obligations are satisfied over time; for example, contract for the usage of internet services for 6 months etc.
However, an entity should conclude on the basis of criteria given by “IFRS 15 – Revenue from contracts with customers“. As per IFRS 15, para 35, if any one of the following criteria is met, it means that performance obligation is satisfied over time. If none of the following criteria is met, it means that performance obligation is satisfied at a point in time.
Criteria for over time revenue recognitions is as follows:
- The customer simultaneously receives and consumes the benefits of the goods and services provided by the entity.
- As the asset is being created or enhanced by the entity, the control of that asset is with the customer.
- 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 any one of the above criteria is met, revenue should be recognized over time by measuring progress towards complete satisfaction of the performance obligation. An entity shall apply a single method of measuring progress for a performance obligation and shall apply that method consistently to similar performance obligations and in similar circumstances.
An entity can use output methods as well as input methods to measure progress of performance obligation. These methods are explained in our next chapter Input vs output methods.