Revenue recognition
The rules that decide when a business records revenue, based on when it delivers what it promised to the customer.
In short
- Revenue is recognized when control of goods or services passes to the customer, not when cash arrives.
- IFRS 15 and ASC 606 set out a five-step model used by public companies.
- Payments received before delivery are deferred revenue, a liability.
Revenue recognition determines the period in which revenue appears in the financial statements. The principle is that revenue is recorded when it is earned: when the business transfers the goods or services it promised, in the amount it expects to be entitled to.
The five-step model
IFRS 15 and its US equivalent, ASC 606, set out five steps:
- Identify the contract with the customer.
- Identify the separate performance obligations, the distinct goods or services promised.
- Determine the transaction price.
- Allocate the price to each performance obligation.
- Recognize revenue when, or as, each obligation is satisfied.
Private companies in Canada using ASPE follow a simpler standard based on similar ideas: revenue is recognized when the risks and rewards have passed, the amount can be measured and collection is reasonably assured.
Point in time or over time
A product sale is usually recognized at a point in time, when the customer takes control. A subscription or a service contract is recognized over time as the service is delivered. A construction project may be recognized over time based on progress.
Deferred revenue
When a customer pays in advance, such as an annual subscription paid up front, the cash is recorded as deferred revenue, a liability, and moved to revenue as the service is delivered.
Worked example
A bundle split into parts
A software company sells a $12,000 package including a one-year subscription (standalone price $10,000) and onboarding (standalone price $2,500). The price is allocated in proportion: $9,600 to the subscription and $2,400 to onboarding. Onboarding revenue is recognized when it is completed in month one; the subscription is recognized at $800 a month.