IFRS 15 Five-Step Revenue Recognition Model: Worked Examples for Auditors

What does the IFRS 15 five-step model require from the auditor?

You’re reviewing a client’s revenue note and the recognition policy reads “revenue is recognised when services are rendered.” That sentence worked under IAS 18. Under IFRS 15, it tells you almost nothing. The standard requires the client to identify every performance obligation in a contract, determine whether each one transfers over time or at a point in time, and allocate the transaction price accordingly. If the client hasn’t done that analysis, neither the policy note nor the revenue balance is supportable.

IFRS 15 requires entities to apply a five-step model to recognise revenue: identify the contract (IFRS 15.9), identify performance obligations (IFRS 15.22), determine the transaction price (IFRS 15.47), allocate the price to each obligation (IFRS 15.73), and recognise revenue as each obligation is satisfied (IFRS 15.31).

IFRS 15.IN7 replaced IAS 18 and IAS 11 with a single framework. The standard doesn’t ask “when is the revenue earned?” It asks a sequence of more specific questions: does a contract exist, what did the entity promise, how much will it receive, how should that amount be split across promises, and when is each promise fulfilled?

For auditors, this matters because each step produces a separate assertion. Contract existence is an occurrence assertion. Performance obligation identification is a completeness assertion (are all obligations identified?). The transaction price determination is a valuation assertion. Allocation is an accuracy assertion. And the timing of recognition hits cut-off.

A single revenue balance now requires you to test five distinct things, not one. The IFRS 15 Revenue Recognition Calculator automates the allocation arithmetic, but the judgment calls at each step are yours.

IFRS 15.BC18 explains why the IASB moved to this model: IAS 18 provided limited guidance on multi-element arrangements, variable consideration, and contracts that change over time. The five-step model forces disaggregation. That disaggregation is exactly what you audit.

Identifying the contract under IFRS 15.9

IFRS 15.9 sets five criteria that must all be met before revenue accounting begins. The parties must have approved the contract. Each party’s rights regarding goods or services must be identifiable. Payment terms must be identifiable. The contract must have commercial substance. And it must be probable that the entity will collect the consideration.

The fourth criterion (commercial substance) rarely causes problems for non-Big 4 clients. The fifth (collectibility) is where files get flagged. IFRS 15.9(e) asks whether it is probable the entity will collect “substantially all” of the consideration. The question is not a credit risk assessment in the IAS 39 or IFRS 9 sense. It asks something narrower: given this specific customer and these specific payment terms, will the client get paid?

When the answer is no, the entity doesn’t recognise a contract under IFRS 15 at all. It recognises cash received as a liability until the criteria in IFRS 15.15 are met. This catches auditors out on clients with high credit-risk customers or clients that routinely renegotiate prices downward after delivery.

Identifying performance obligations under IFRS 15.22

This is the step most clients skip entirely, and the step that produces the most restatement risk. IFRS 15.22 requires the entity to identify each promise to transfer a good or service that is “distinct.” IFRS 15.27 defines distinct: the customer can benefit from the good or service on its own (or with readily available resources), and the promise is separately identifiable from other promises in the contract.

The second criterion is the harder one. IFRS 15.29 gives indicators: does the entity provide a significant integration service, does one item significantly modify or customise the other, are the items highly interdependent? If yes, they’re a single performance obligation even if they could theoretically be sold separately.

For a typical mid-tier client selling industrial equipment with installation and a two-year maintenance agreement, you likely have two performance obligations: the equipment-plus-installation (combined, because installation significantly customises the delivered equipment) and the maintenance agreement (distinct, because maintenance can be performed by a third party and doesn’t modify the equipment).

Determining the transaction price under IFRS 15.47

The transaction price is the amount of consideration the entity expects to be entitled to in exchange for transferring goods or services. IFRS 15.47 lists four complications that adjust it away from the contract’s face value: variable consideration (IFRS 15.50–55), constraining estimates of variable consideration (IFRS 15.56–58), significant financing components (IFRS 15.60–65), and non-cash consideration (IFRS 15.66–69).

Variable consideration is the most common adjustment for non-Big 4 clients. Volume rebates, performance bonuses, early payment discounts, rights of return, and price concessions all create variable consideration. IFRS 15.53 requires estimating variable consideration using either the expected value method (probability-weighted) or the most likely amount, whichever better predicts the outcome.

The choice between these two methods isn’t arbitrary. IFRS 15.53(a) says expected value works better for a large number of contracts with similar characteristics. IFRS 15.53(b) says most likely amount works better when a contract has only two possible outcomes (the client either earns the bonus or doesn’t). Clients that use expected value for a binary outcome, or most likely amount for a portfolio of similar variable-price contracts, have chosen the wrong method.

IFRS 15.56 then imposes a constraint: include variable consideration only to the extent it is “highly probable” that a significant reversal will not occur when the uncertainty resolves. Documentation matters most at the constraint step. Your working paper needs the client’s estimate, the method used (expected value or most likely amount), the factors considered under IFRS 15.57 when applying the constraint, and your assessment of whether the constraint was applied appropriately.

For clients with significant financing components (payment terms beyond 12 months), IFRS 15.63 requires adjusting the transaction price for the time value of money. IFRS 15.63 provides a practical expedient: if the period between transfer of goods and payment is one year or less, the entity can skip the adjustment. Most non-Big 4 clients fall within this expedient. Document that the expedient applies and why.

Allocating the transaction price under IFRS 15.73

Once you’ve identified the performance obligations and the transaction price, IFRS 15.73 requires allocating the price to each obligation based on relative standalone selling prices. IFRS 15.77 defines the standalone selling price as the price at which the entity would sell the good or service separately to a customer.

Observable prices are the best evidence (IFRS 15.77). When the client sells the same good or service separately, the price is observable. When it doesn’t, IFRS 15.79 requires an estimate using one of the permitted approaches.

IFRS 15.79 lists the adjusted market assessment approach, the expected cost plus a margin approach, and the residual approach (permitted only when the standalone selling price is highly variable or uncertain per IFRS 15.79(c)). Each approach requires different inputs and produces different allocations. The choice isn’t cosmetic.

The residual approach deserves attention. Clients prefer it because it’s arithmetically simple: assign observable prices to the other obligations, give the remainder to the uncertain one. But IFRS 15.79(c) restricts it to cases where the selling price genuinely varies significantly across customers or where the entity has not yet established a price. If neither condition is met, the residual approach isn’t available. Document which approach the client used for each obligation without an observable price, and why it was appropriate under IFRS 15.79.

Recognising revenue as obligations are satisfied

IFRS 15.31 distinguishes two patterns of satisfaction: over time and at a point in time. If a performance obligation meets any of the three criteria in IFRS 15.35, it’s satisfied over time. If none are met, it’s satisfied at a point in time under IFRS 15.38.

The three over-time criteria (IFRS 15.35) are: the customer simultaneously receives and consumes the benefits (common in services), the entity’s performance creates or enhances an asset the customer controls as work progresses (common in construction), and the entity’s performance doesn’t create an asset with alternative use and the entity has an enforceable right to payment for performance completed to date.

That third criterion catches out manufacturing and construction clients. “No alternative use” under IFRS 15.36 means the client is contractually or practically restricted from redirecting the asset to another customer. “Enforceable right to payment” under IFRS 15.37 means payment for costs incurred plus a reasonable profit margin, not just reimbursement of costs. Many mid-tier manufacturing clients assume over-time recognition applies because “it takes a long time to build.” That alone doesn’t satisfy IFRS 15.35(c).

For point-in-time recognition, IFRS 15.38 lists indicators of when control transfers: the client has a present right to payment, the customer has legal title, the client has transferred physical possession, the customer has the significant risks and rewards, and the customer has accepted the asset. These indicators replaced the IAS 18 “risks and rewards” test with a “control” test, but in practice, for straightforward product sales, the outcome is often the same.

The input method (typically costs incurred as a percentage of total expected costs) is the default for most construction and long-term service contracts. But IFRS 15.B19 requires that the input measure faithfully depicts the transfer of control. If the client incurred a disproportionate cost early in the contract (buying materials that haven’t been installed), including those costs in the progress measure would overstate revenue. IFRS 15.B19(b) addresses this directly: recognise revenue for uninstalled materials only to the extent of their cost, unless the cost, margin, and transfer pattern all align. The IAS 37 provision calculator can help test related contract loss provisions when costs exceed the transaction price.

Worked example: Bakker Industrial B.V.

Client scenario: Bakker Industrial B.V. is a Rotterdam-based manufacturer of industrial water filtration systems. Annual revenue is €38M. On 1 March 2024, Bakker signs a contract with Stadler Brauerei GmbH (a German brewery) for a custom filtration unit (€220,000), on-site installation (€45,000), and a 24-month maintenance agreement (€36,000). Total contract price: €301,000. Payment terms: 30% on signing, 50% on commissioning, 20% over the maintenance period. Bakker does not sell installation services separately. Bakker sells maintenance agreements separately for comparable equipment at €1,500 per month.

1. Contract identification (IFRS 15.9)

Both parties signed the agreement on 1 March 2024. Bakker’s rights are defined (deliver, install, maintain). Stadler’s payment obligations are specified. The contract has commercial substance (Stadler needs the filtration system for production compliance). Stadler has no history of payment default and operates a profitable brewery with stable cash flows.

2. Performance obligation identification (IFRS 15.22)

The custom filtration unit requires on-site installation to function. Installation involves configuring the unit to Stadler’s existing water supply infrastructure. A third-party installer could not perform this without Bakker’s proprietary specifications. Under IFRS 15.27(b) and the integration indicator in IFRS 15.29(a), the unit and installation form a single performance obligation.

The maintenance agreement is distinct. Stadler could engage another provider for maintenance (IFRS 15.27(a)). The maintenance doesn’t modify the filtration unit (IFRS 15.27(b)). Two performance obligations: (1) filtration unit with installation, (2) 24-month maintenance.

3. Transaction price (IFRS 15.47)

The total contract price is €301,000. No variable consideration exists (fixed prices, no rebates, no performance bonuses). Payment terms: the longest gap between transfer and payment is 24 months for the maintenance component. However, the maintenance payments correspond to monthly service delivery, so each payment aligns with the period of service. No significant financing component under IFRS 15.62. No non-cash consideration.

4. Allocation (IFRS 15.73)

Standalone selling prices:

• Filtration unit with installation: no observable standalone price (Bakker never sells installation separately). Estimated using the expected cost plus margin approach (IFRS 15.79(b)). Bakker’s cost data: unit manufacturing cost €130,000, installation cost €28,000, standard margin 35%. Estimated standalone selling price: (€130,000 + €28,000) × 1.35 = €213,300.
• Maintenance: observable standalone price. Bakker sells comparable agreements at €1,500/month × 24 months = €36,000.

Allocation based on relative standalone selling prices (IFRS 15.73):

• Total standalone selling prices: €213,300 + €36,000 = €249,300
• Unit with installation: (€213,300 / €249,300) × €301,000 = €257,496
• Maintenance: (€36,000 / €249,300) × €301,000 = €43,504

5. Revenue recognition (IFRS 15.31)

The filtration unit with installation is satisfied at a point in time. The unit has alternative use (Bakker could sell a standard unit to another customer before customisation). And even after customisation, Bakker retains title until commissioning. IFRS 15.35 criteria are not met. Revenue of €257,496 recognised on commissioning (control transfers per IFRS 15.38 indicators: physical possession, legal title, and acceptance all transfer at commissioning).

The maintenance obligation is satisfied over time under IFRS 15.35(a): Stadler simultaneously receives and consumes the benefits of preventive maintenance as Bakker performs. Revenue of €43,504 recognised on a straight-line basis over 24 months (€1,813 per month), as the effort is evenly distributed and straight-line faithfully depicts the transfer pattern.

Practical checklist for your next engagement

1. Obtain a sample of contracts and test each against all five criteria of IFRS 15.9. Pay particular attention to IFRS 15.9(e) (collectibility) for any customer with a history of write-offs or price concessions.
2. For every contract in your sample, list each promised good or service and assess whether it is distinct under IFRS 15.27. Document the conclusion for each promise, not just the final grouping.
3. Check the client’s variable consideration estimates against IFRS 15.56. The constraint requires “highly probable” that a significant reversal won’t occur. If the client estimated variable consideration without applying the constraint, that is a misstatement.
4. Verify the standalone selling prices used in allocation. For observable prices, agree to the client’s price list or comparable transactions. For estimated prices, inspect the method (IFRS 15.79) and the inputs. If the client used the residual approach, verify that IFRS 15.79(c) conditions are met.
5. For each performance obligation recognised over time, confirm which of the IFRS 15.35 criteria is met and document the progress measurement method. For point-in-time obligations, document which IFRS 15.38 indicator triggered recognition.
6. Cross-reference the revenue note disclosure against IFRS 15.113–129. The note must describe the entity’s performance obligations, significant judgments (IFRS 15.123), and the methods used to recognise revenue. If the note still reads like an IAS 18 policy, flag it.

Common mistakes

• Treating the five-step analysis as a policy exercise rather than a contract-level exercise. IFRS 15.BC68 is clear: the model applies to each contract individually, not as a blanket policy. The AFM’s 2021 thematic review on revenue recognition found that several firms documented the five-step analysis only at the policy level without testing it on individual contracts.
• Using the residual approach (IFRS 15.79(c)) as a default allocation method. The ESMA 2020 enforcement report flagged cases where entities applied the residual approach without demonstrating that the standalone selling price was “highly variable or uncertain.” If the entity could have estimated a standalone price using cost-plus-margin, the residual approach is not available.
• Failing to reassess the transaction price for variable consideration at each reporting date. IFRS 15.59 requires updating the estimate. If the client’s initial estimate of variable consideration changed by the reporting date (e.g., higher-than-expected returns), the revenue balance must reflect the updated amount.

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Frequently asked questions

Further reading and source references

• IFRS 15, Revenue from Contracts with Customers: effective 1 January 2018. The five-step model is codified in paragraphs 9–45 and the allocation guidance in paragraphs 73–90.
• IFRS 15.BC18: the IASB’s basis for conclusions explaining why IAS 18 and IAS 11 were replaced with a single framework.
• AFM 2021 thematic review on revenue recognition: findings on policy-level versus contract-level five-step analysis documentation.
• ESMA 2020 European Common Enforcement Priorities: enforcement findings on improper use of the residual approach for standalone selling price estimation.
• Revenue recognition: Ciferi glossary entry covering the core IFRS 15 definitions and how they differ from the IAS 18 framework.