IFRS 15 - how to measure revenue recognised over time

In April’s article we looked at the criteria for recognising revenue over time rather than at a point in time: but once you conclude it should be recognised over time – how do you calculate the portion of revenue to recognise?

Methods that can be used to calculate the stage of completion

IFRS 15 contains guidance on how to measure revenue over time using an appropriate method which includes the two methods detailed within the standard:

The output method, which looks at the measure of progress of the asset being transferred to the customer itself, or
The input method, which looks at the resources used to date to create the asset being transferred.

The output method uses direct measurement of value to the customer of the goods or services transferred to date. This includes using the appraisal of results achieved, milestones reached or units produced or delivered, eg when two floors of a ten floor construction have been built you recognise 2/10ths of revenue.

The input method uses the entity’s efforts or inputs to the satisfaction of a performance obligation. This includes using the resources consumed, labour hours expended, costs incurred, time lapsed or machine hours used, eg when £100k of costs have been incurred out of an estimated total project cost of £1m you recognise 1/10th of revenue.

A company can choose which method is adopted but the method used must be appropriate for the nature of the contract and the pattern of delivery of the performance obligation. It must also be applied consistently to similar contracts.

In most cases, the measurement of revenue (when recognised over time) will not be the same as amounts invoiced to a customer. In these circumstances, the vendor will recognise either a contract asset (accrued income) or a contract liability (deferred income) for the difference between cumulative revenue recognised and cumulative amounts billed for that contract. As a practical expedient, IFRS 15 allows that if the vendor’s right to consideration from a customer corresponds directly with the value to the customer of the vendor’s performance completed to date (for example as will be the case for a service contract in which a vendor bills a fixed amount for each hour of service provided), the vendor can recognise revenue at the amount to which the vendor has the right to invoice.

Are there any differences in these calculations compared to IAS 18 / IAS 11?

It is important that whichever method is used, only those goods or services for which the vendor has transferred control are included. For example, inventory in the vendor’s warehouse that has not yet been incorporated into the asset will remain as inventory and will not be recognised as a cost forming part of the stage of completion calculation until:

It is integrated into the asset, or
Control passes to the customer (for example if it is delivered to the customer and they control it in advance of its installation).

IFRS 15 provides more detailed guidance on the treatment of ‘uninstalled materials’ when applying the input method of measurement (not previously given in IAS 18/IAS 11) which may affect the amount of revenue recognised. This is because one of the shortcomings of the input method is that there may not be a direct relationship between a vendor’s inputs and the transfer of control of goods or services to a customer such that the cost incurred in relation to uninstalled materials does not depict the vendor’s progress in satisfying a performance obligation.

An example of this is provided in IFRS 15 (IE 95-100) where a construction company delivers a lift to a client’s premises (and control therefore passes to customer) before installing it. As it is uninstalled materials, it is not factored into the stage of completion calculation but instead treated as ‘uninstalled materials’ with revenue and cost in relation to the lift being recognised upon delivery but at £nil margin.

Another change that arises from an IFRS 15 based measure of progress is in relation to the output method and its impact on profit margin. Under IAS 11, a company could recognise costs as work in progress inventory, effectively smoothing the margin throughout the life of the project. However under IFRS 15, costs incurred in relation to satisfied or partially satisfied performance obligations (ie costs related to past performance) must be expensed as they are incurred. Therefore, once a performance obligation starts being performed, the costs will be written off to the income statement as they are incurred which could result in more lumpy margins than under previous accounting standards.

For help and advice on revenue recognition issues please get in touch with your usual BDO contact.