IFRS 15 Revenue: The Five-Step Model, Identifying the Contract and Performance Obligations

Revenue is the first line of the statement of profit or loss and often the most scrutinised figure in the accounts. The older standards on revenue left room for judgement that was hard to check, so reported revenue was not always comparable.

International Financial Reporting Standard (IFRS) 15 Revenue from Contracts with Customers, which replaced International Accounting Standard (IAS) 18 Revenue and IAS 11 Construction Contracts, sets out a single principle and a five-step model that every contract with a customer must follow. This topic covers the principle, the five steps in outline, step 1 (identifying the contract, including combined and modified contracts) and step 2 (separating the performance obligations). The next topic covers the transaction price and its allocation.

The topic is examined directly. In November Diet, 2021, part of Question 3 asked for the core principle (2 marks) and the five steps (5 marks). In May Diet, 2022, Question 5 asked for six criteria for assessing a contract (6 marks) and for contract modifications with two ways of accounting for them (4 marks). Read inventories first.

The core principle and the five-step model

Revenue is income arising in the course of an entity’s ordinary activities. A customer is a party that has contracted with the entity to obtain goods or services that are an output of its ordinary activities. IFRS 15 sets principles for reporting useful information on the nature, amount, timing and uncertainty of revenue and cash flows from a contract with a customer. Its core principle is that an entity recognises revenue:

• in a manner that depicts the transfer of goods or services to customers; and
• at an amount that reflects the consideration the entity expects to be entitled to in exchange for those goods or services.

IFRS 15 was issued in May 2014 to give a more robust and verifiable basis than the standards it replaced. The earlier criteria were more subjective, which made reported revenue harder to check and weakened the faithful representation that useful information needs.

For a contract to sell a software licence, install it and provide updates and support for two years, the steps ask in turn whether the contract is in scope, whether the licence, installation, updates and support are separate obligations, what the price is and whether it varies, how the price is shared among the obligations, and whether each is satisfied over time or at a point in time.

Revenue recognition and invoicing are two separate processes: the revenue recognised and the amounts invoiced are often the same, but not always.

Step 1: identify the contract

A contract is an agreement between two or more parties that creates enforceable rights and obligations. It may be written, oral or implied by the entity’s customary business practices. A contract does not exist if each party has an enforceable right to terminate a wholly unperformed contract without compensating the other party.

Criteria for the model to apply

The five-step model applies to a contract only when:

1. the parties have approved the contract and are committed to perform their obligations (approval and commitment are sometimes counted as two points, which is how a question may ask for six criteria);
2. the entity can identify each party’s rights to the goods or services to be transferred;
3. the entity can identify the payment terms;
4. the contract has commercial substance, meaning it is expected to change the risk, timing or amount of the entity’s future cash flows; and
5. it is probable that the entity will collect the consideration to which it is entitled.

If a contract fails the criteria, any consideration received is recognised as a liability. It stays a liability until the criteria are later met, or until the entity has completed its performance and received substantially all the consideration, which is non-refundable, or the contract is terminated and the consideration received is non-refundable. At that point it is recognised as revenue.

Consider a developer that sells a building for ₦10 million to a buyer who plans a restaurant in a crowded market, has little experience and no other assets, pays a non-refundable deposit of ₦500,000 and finances the rest by a loan that is repaid from the restaurant’s income, with the developer able to take back the building but unable to claim more.

The parties are committed, rights and terms are clear and the contract has substance, but it is not probable that the developer will collect the consideration. The model does not apply, and the ₦500,000 is a liability.

Combining contracts

Two or more contracts entered into at or near the same time with the same customer, or related parties, are combined and treated as one contract if one or more of these apply:

• they are negotiated as a package with a single commercial objective
• the consideration in one depends on the price or performance of the other
• the goods or services in them are a single performance obligation

Contract modifications

A contract modification is a change in the scope, the price or both of a contract, approved by the parties. It can be approved in writing, orally or by customary business practice. It is accounted for in one of three ways.

1. As a separate contract, if the scope grows because of added goods or services that are distinct and the price rises by an amount that reflects their stand-alone selling prices.
2. As a termination of the old contract and creation of a new one (prospectively), if the modification is not a separate contract and the remaining goods or services are distinct from those already transferred. The remaining consideration plus the consideration promised in the modification is allocated to the remaining obligations.
3. As part of the existing contract (a cumulative catch-up adjustment to revenue at the modification date), if the remaining goods or services are not distinct and are part of a single obligation that is partly satisfied.

Step 2: identify the performance obligations

A performance obligation is a promise in a contract to transfer to the customer either a good or service (or a bundle) that is distinct, or a series of distinct goods or services that are substantially the same and have the same pattern of transfer.

Obligations are normally in the contract but may also arise from the entity’s customary practices, published policies or specific statements that create a valid expectation that goods or services will be transferred.

A good or service is distinct if both of these hold:

• the customer can benefit from it on its own or together with other resources that are readily available to the customer; and
• the promise to transfer it is separately identifiable from the other promises in the contract.

If a promised good or service is not distinct, it is combined with others until a distinct bundle is found, which may mean the whole contract is one obligation. The step really asks whether the contract is for one deliverable or several, because revenue is recognised as each is delivered.

• A hospital build. A contractor promises engineering, site clearance, foundations, structure, equipment installation and finishing, and manages the whole project. Many of these are sold separately by it and others, so the customer could benefit from each. But the contractor provides a significant service of integrating them into the hospital, the combined output the customer wants, so the promises are not separately identifiable. The whole is one performance obligation.
• A software contract. A developer promises a licence, installation, unspecified updates and technical support for two years. It sells each separately, others perform the installation routinely, and installation does not significantly modify the software. The customer can benefit from each, and each is separately identifiable. There are four performance obligations.

The ideas in more depth

Why the number of obligations matters

Each obligation has its own revenue timing. A handset delivered on day one is revenue on day one, while a 24-month service is revenue over 24 months. If these were treated as a single package, revenue would be spread evenly and would not show when the handset was handed over.

Why collection must be probable

Recognising revenue on a contract the customer may not be able to pay would overstate income. The test stops revenue from appearing before the contract is a real, collectable claim.

Sources and references

• IFRS 15 Revenue from Contracts with Customers: objective and core principle, the five-step model, contract identification, combination and modification, and performance obligations.
• IAS 18 Revenue and IAS 11 Construction Contracts, which IFRS 15 replaced.

These points are stated as at 5 November 2026.

Worked examples

1. Criteria. Approval and commitment, rights, payment terms and commercial substance are all met.
2. Collection. It is not probable the supplier will collect, because repayment depends on a risky business and the loan is non-recourse.
3. Result. The contract fails the criteria, so the ₦400,000 is recognised as a liability, not revenue, until the criteria are met or the contract is complete or terminated with non-refundable consideration.

1. Handset. The customer can benefit from it on its own, and it is separately identifiable from the service.
2. Service. The customer can benefit from it with the handset, which is readily available, and it is separately identifiable.
3. Result. Two performance obligations: the handset, satisfied at a point in time, and the service, satisfied over 24 months.

1. Separate contract? No: the price for the added units is not at stand-alone selling price.
2. Treatment. A termination of the old contract and creation of a new one, applied prospectively. The ₦50,000 already recognised for 50 units is left alone.
3. Remaining consideration.
   50 × ₦1,000 + 25 × ₦880 = ₦50,000 + ₦22,000 = ₦72,000 for 75 units.
4. Revenue per unit.
   ₦72,000 ÷ 75 = ₦960 as each remaining unit is delivered.

How to answer in the exam

• State the core principle. Two parts: depicts the transfer, and the amount the entity expects to be entitled to.
• List the five steps. One line each, in order, with a few words on what each decides.
• List the contract criteria. Write the five, splitting approval and commitment if six are asked for.
• Modifications. State what a modification is, then the three ways, and say when each applies.
• Performance obligations. Apply the two distinct tests to each promise and state the number of obligations.

Common mistakes in the exam

• Recognising revenue as soon as cash is received, or as soon as an invoice is issued.
• Missing that a contract fails when collection is not probable, and recording a deposit as revenue.
• Treating a bundle that needs significant integration as separate obligations.
• Restating revenue already recognised when a modification is accounted for prospectively.
• Describing the steps out of order.

Quick revision

• Core principle: depict transfer; amount expected to be entitled to.
• Steps: contract; obligations; price; allocation; recognition.
• Contract: enforceable; approved and committed; rights; payment terms; commercial substance; collection probable.
• Failing contract: consideration is a liability.
• Combine contracts negotiated as a package. Modifications: separate contract, termination and new contract, or catch-up.
• Performance obligation: distinct good or service or a series of distinct ones.

Practice questions

These are original questions written in the style of the Institute’s exams. Try each one before you open the answer. Section A is a recall check, because the paper itself is written.

Recall check: multiple choice

Section B style: written questions

A further written question

Model answers

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