Published in March 2024, the Financial Reporting Council’s (FRC) periodic review amendments provide a new approach to accounting for revenue. A five-step revenue recognition model is being introduced to FRS 102 The Financial Reporting Standard applicable in the UK and Republic of Ireland. The same model, but with appropriate simplifications, is being introduced to FRS 105 The Financial Reporting Standard applicable to the Micro-entities Regime. In both cases, the changes are effective for accounting periods beginning on or after 1 January 2026. Early adoption is permitted, however, provided all amendments are applied at the same time. 

It is hoped that the new five-step model will enable more consistent and comparable accounting, which should ultimately make life easier for preparers and provide more useful information to users of financial statements.

The new model focuses on identifying the distinct goods or services promised to the customer, determining the amount of consideration that the entity will be entitled to in exchange and the pattern of fulfilment of those distinct elements. For many businesses, this approach will not alter how much revenue they recognise or when they recognise it. For others, there will be more significant changes. However, it is important that all entities take a step back from current practice to assess the impact and implementation of this new model.

Step 1: Identify the contract(s) with a customer

The first step is to identify the contract, or contracts, to provide goods or services to a customer. Criteria that a contract must meet to be in scope of Section 23 Revenue from Contracts with Customers are listed in the standard. Contracts with the same customer should be combined when they are entered into at – or near – the same time and are negotiated as a package; the amount paid in one contract depends on the other; or the goods or services promised are a single performance obligation.

Step 2: Identify the performance obligations in the contract

Promises to transfer distinct, or a series of distinct, goods or services to a customer should be identified as separate performance obligations. Section 23 provides criteria to determine if a good or service promised is distinct within the context of the contract. Performance obligations do not include activities that an entity must undertake to fulfil a contract unless those activities transfer a good or service to the customer.

Step 3: Determine the transaction price

The transaction price is the amount of consideration an entity is entitled to receive in exchange for transferring goods or services to a customer. Often, the transaction price includes a variable amount – this may arise because of the contract including features such as discounts, rebates, refunds, penalties or performance bonuses. The amount of variable consideration to include in the transaction price must be estimated using either the expected value method or the most likely amount method. 

Step 4: Allocate the transaction price to the performance obligations in the contract

The transaction price should be allocated to each distinct performance obligation based on a relative standalone selling price (SSP). This is the price at which an entity would sell a good or service promised in a contract separately to a customer. If an SSP is not directly observable, it should be estimated by considering all information that is reasonably available, including market conditions, entity-specific factors and information about the customer or class of customer.

Step 5: Recognise revenue when (or as) the entity satisfies a performance obligation

The final step is to recognise revenue as the performance obligation is satisfied. A performance obligation is satisfied by transferring the promised good or service to the customer. A good or service is transferred when the customer obtains control. Performance obligations can be satisfied over time or at a point in time, depending on the facts and circumstances. 

Transition

The FRC has provided two choices for entities transitioning to the revised Section 23. Entities can apply the requirements retrospectively, including restatement of comparatives. Alternatively, entities may apply the requirements retrospectively but without restating comparatives. Instead, the cumulative effect of initially applying the standard will be recognised as an adjustment to opening retained earnings. Under this option, only incomplete contracts at the date of initial application need be adjusted for. 

Georgina Chalk, Technical Manager, Corporate Reporting Faculty, ICAEW

A longer version of this article, including a five steps in practice example, is available in By All Accounts, the Corporate Reporting Faculty’s online collection of articles exploring corporate reporting trends.