Revenue differs from income because income includes gains that are related to secondary activities. The basic principle in revenue recognition is that it is independent of the relevant cash flow movements. Revenue is recognized when it is earned even if cash is not received. This results in recognition of accounts receivable. Similarly, unearned revenue (a liability) is recognized when cash is received before associated revenue is earned.
Differences between IFRS and US GAAP in revenue recognition
Even though there were many differences in IFRS and US GAAP related to revenue recognition historically, the new standards (IFRS 15 and ASC Topic 606) are greatly converged.
The core principle is that revenue should be recognized when the transfer of promised goods and services occurs in an amount that reflects the consideration to which the company expects to be entitled.
Steps in revenue recognition process
The standard prescribes a five-step method in applying the principle:
- Identify the contracts (the legal agreement of commercial substance),
- identify the separate and distinct performance obligations (such that the customer can benefit from the good or service either on its own or together with other readily available resources, and that the obligation is separately identifiable from others),
- Determine the transaction price (which reflect expectations about collectability),
- Allocate the transaction price to the performance obligations, and
- Recognize revenue when the entity satisfies a performance obligation.
Revenue recognition principle
Revenue (including any variable consideration) should be recognized when it is highly probable that it would not be reversed in the future and when the entity is able to satisfy the performance obligation by transferring control. Deciding whether control has been transferred depends on whether the entity has a present right to payment, the customer has legal title, physical possession, significant risks and rewards of ownership, and/or has accepted the asset. Incremental costs of obtaining the contract and certain costs incurred to fulfill a contract must be capitalized.
Revenue recognition disclosure requirements
Disclosure requirements related to revenue recognition are quite extensive. Companies are required to disclose contracts disaggregated into categories based on the type of product, geographic region, duration, pricing terms, etc. together with related assets and liabilities and associated changes, and remaining performance obligations (including their value).
The converged standard affects industries where bundled sales are common, such as telecommunications and software, more than others.