IFRS 15 Five-Step Model Explained — Core Rule

Under IFRS 15, revenue is recognised when (or as) an entity transfers promised goods or services to a customer, measured at the amount of consideration to which the entity expects to be entitled in exchange for those transfers (IFRS 15.46).

How IFRS 15 Five-Step Model Explained Works

The IFRS 15 Five-Step Model Explained provides a structured framework that replaces the previous patchwork of IAS 18, IAS 11, and related interpretations. Each step must be completed sequentially before revenue can be recognised.

• Step 1 — Identify the contract (IFRS 15.9–16): A contract exists when it is approved, each party's rights are identifiable, payment terms are clear, commercial substance exists, and collection of consideration is probable. Contracts can be written, oral, or implied by customary business practice. Combination of contracts is required where they are entered simultaneously with the same customer and meet specific linkage criteria (IFRS 15.17).

• Step 2 — Identify performance obligations (IFRS 15.22–30): A performance obligation is a promise to transfer either a distinct good or service, or a series of distinct goods or services that are substantially the same with the same pattern of transfer. A good or service is distinct if the customer can benefit from it on its own (capable of being distinct) and it is separately identifiable from other promises in the contract (distinct within the contract context — IFRS 15.27). Bundled goods and services must be carefully disaggregated.

• Step 3 — Determine the transaction price (IFRS 15.47–72): The transaction price is the amount of consideration the entity expects to receive, adjusted for variable consideration (estimated using expected value or most likely amount — IFRS 15.53), significant financing components (IFRS 15.60–65), non-cash consideration, and consideration payable to the customer. Variable consideration is included only to the extent it is highly probable that a significant revenue reversal will not occur (the constraint — IFRS 15.56–58).

• Step 4 — Allocate the transaction price (IFRS 15.73–90): The transaction price is allocated to each performance obligation based on relative standalone selling prices (SSP). Where SSP is not directly observable, it must be estimated using approaches such as adjusted market assessment, expected cost plus margin, or residual method (IFRS 15.78–79). Discounts and variable consideration may need to be allocated entirely to one obligation if specific criteria are met (IFRS 15.82–83).

• Step 5 — Recognise revenue (IFRS 15.31–38): Revenue is recognised over time if one of three criteria is met: the customer simultaneously receives and consumes the benefits; the entity's performance creates or enhances an asset the customer controls; or the asset has no alternative use and the entity has an enforceable right to payment for performance to date. If none apply, revenue is recognised at a point in time when control transfers, considering indicators such as transfer of legal title, physical possession, risks and rewards, and customer acceptance (IFRS 15.38).

IFRS 15 Five-Step Model Explained — Practical Example

Scenario: A software company sells a licence (SSP: $60,000) and one year of post-sale support (SSP: $20,000) for a bundled price of $72,000. Licence transfers on Day 1; support is delivered over 12 months.

Allocation

• Licence: $72,000 × (60/80) = $54,000
• Support: $72,000 × (20/80) = $18,000

Journal entry on Day 1 (licence recognised at point in time, control transferred)

Journal entry — monthly support recognition ($18,000 ÷ 12 = $1,500/month)

IFRS 15 Five-Step Model Explained — Common Pitfalls

• Misjudging the distinct criterion (Step 2): Practitioners frequently default to treating each deliverable as a separate obligation without rigorously testing whether the promise is separately identifiable within the contract. Highly integrated or customised solutions often form a single combined performance obligation (IFRS 15.29).

• Unconstrained variable consideration (Step 3): Including the full expected value of bonuses, penalties, or rebates without applying the constraint leads to premature revenue recognition and potential restatement. Auditors scrutinise management's basis for concluding a reversal is not highly probable (IFRS 15.56).

• Ignoring the significant financing component (Step 3): Where payment is deferred beyond 12 months, entities must adjust the transaction price for the time value of money using the rate that would apply in a standalone financing transaction (IFRS 15.64), impacting both revenue and interest income/expense.

IFRS 15 Five-Step Model Explained — Key Paragraphs

• IFRS 15.9 — Core conditions for a valid contract with a customer
• IFRS 15.27–29 — Distinct good or service; separately identifiable test
• IFRS 15.56–58 — Variable consideration constraint (highly probable threshold)
• IFRS 15.31–38 — Over-time vs. point-in-time recognition criteria
• IFRS 15.73–79 — Allocation of transaction price using standalone selling prices
• IFRS 15.113–129 — Disclosure requirements including disaggregation of revenue and remaining performance obligations