Have You Ever Faced These Challenges?
- Your entity manufactures goods to a customer’s bespoke specification and has always recognised revenue at delivery — but your auditors have questioned whether over-time recognition might be required
- You apply an input method to measure progress on long-term contracts, but struggled to explain to the audit committee why certain costs were excluded from the progress calculation
- A revision to your total estimated contract costs caused a significant shift in the revenue recognised in the period, and you were uncertain how to present and explain the adjustment
What You Will Learn From This Article
- How to determine whether a performance obligation is satisfied over time or at a point in time — using the three over-time criteria and five point-in-time indicators
- How to select and apply a progress measurement method — output methods versus input methods — and what to do when costs do not faithfully depict progress
- How to account for changes in estimates of total contract costs and the cumulative catch-up mechanism
Who This Article Is For
- Finance professionals in construction, IT development, and bespoke manufacturing industries
- Those responsible for period-end cut-off judgements on long-term contracts
- Practitioners transitioning from percentage-of-completion accounting under IAS 11 to the IFRS 15 framework
The Core Principle: Control Transfer
Step 5 asks a single question: when does control of the promised good or service transfer to the customer?
Control is defined as the ability to direct the use of, and obtain substantially all of the remaining benefits from, an asset (IFRS 15.33). The benefits of an asset include its potential cash flows — either directly through use or indirectly through sale or other disposition.
This control-based framework replaced the IAS 18 concept of “transfer of risks and rewards” for goods and the IAS 11 percentage-of-completion model for construction contracts. While the practical outcome is often similar, the analytical starting point is different — and for certain contract types, the difference in framework produces materially different results.
Revenue is recognised when or as a performance obligation is satisfied — meaning either at a specific point in time, or progressively over a period. The determination of which applies is not a policy choice. It follows from the facts and circumstances of each performance obligation.
Over-Time Recognition: The Three Criteria
A performance obligation is satisfied over time if any one of the following three criteria is met (IFRS 15.35). These criteria are applied independently — satisfying any single criterion is sufficient to require over-time recognition.
Criterion 1: Simultaneous Receipt and Consumption of Benefits
The customer simultaneously receives and consumes the benefits provided by the entity’s performance as the entity performs.
This criterion applies where the entity’s output is consumed in real time — where the benefit to the customer accrues continuously as the work is performed, and where, if the entity were replaced mid-contract by another entity, the replacement would need to start from the current state rather than from the beginning.
Clear examples: Routine cleaning services, payroll processing, security guarding, transaction processing, call centre operations, and similar recurring services where there is no accumulation of a discrete deliverable.
The continuity test: A useful practical test is to ask whether a hypothetical replacement entity would need to re-perform any of the work done to date. If the answer is no — because the customer has already consumed and benefited from each unit of service as it was delivered — Criterion 1 is satisfied.
Criterion 2: Customer Controls the Asset as It Is Created or Enhanced
The entity’s performance creates or enhances an asset that the customer controls as it is created or enhanced.
The distinguishing feature of this criterion is asset ownership during the creation process. Where the work in progress belongs to the customer — because it is being created on the customer’s land, within the customer’s systems, or using the customer’s infrastructure — control transfers progressively as the asset takes shape.
Clear examples: Construction of a building on land owned by the customer; installation of equipment permanently affixed to the customer’s facility; development of software within the customer’s proprietary environment where the customer owns all work in progress as it is created.
Contrast with Criterion 3: The key distinction between Criteria 2 and 3 is ownership of the asset during performance. Under Criterion 2, the customer owns the asset as it is built. Under Criterion 3, the entity retains the asset during performance but cannot redirect it to another customer.
Criterion 3: No Alternative Use and Enforceable Right to Payment
This is the most judgement-intensive criterion and the one most frequently debated in practice. It requires both of the following conditions to be present simultaneously:
Condition A — No alternative use to the entity: The entity’s performance does not create an asset with an alternative use to the entity (IFRS 15.36).
An asset has no alternative use where the entity is unable — either by contract or in practice — to redirect the asset to another customer without incurring significant economic penalties. The analysis focuses on whether redirection is practically possible, not merely whether it is contractually restricted.
- No alternative use (over-time recognition supported): A vessel constructed to highly bespoke specifications that are unique to the contracting customer — physical or engineering constraints make it impractical to sell to another party
- Alternative use exists (over-time recognition not supported on this basis): A standardised product being manufactured to stock that happens to have been designated for a specific customer order — the entity could redirect it to another customer without significant cost or penalty
A contractual restriction alone is not sufficient to establish no alternative use. If the entity could substitute an identical asset from inventory or redirect the in-progress asset at minimal cost, the asset has an alternative use even if the contract prohibits it.
Condition B — Enforceable right to payment for performance completed to date: The entity has an enforceable right to payment for performance completed to date if the contract is terminated for reasons other than the entity’s failure to perform as promised (IFRS 15.37).
The payment to which the entity must have a right is an amount that approximates the selling price of the goods or services transferred to date — it must at minimum cover the entity’s costs incurred plus a reasonable profit margin. A right to recover only costs, without a profit margin, does not meet this condition.
Critical practical point — legal enforceability: The enforceability of the payment right depends on the laws of the relevant jurisdiction. A contractual clause that appears to confer a payment right may not be legally enforceable under the applicable contract law. For contracts governed by foreign law, or for industries subject to specific statutory frameworks, legal counsel should be consulted to confirm that the right is genuinely enforceable before over-time recognition is applied on this basis.
Point-in-Time Recognition: The Five Indicators
Where none of the three over-time criteria is met, the performance obligation is satisfied at a point in time. Revenue is recognised at the moment control transfers to the customer.
IFRS 15.38 provides five indicators to assist in identifying when control transfers. No single indicator is determinative — the assessment requires consideration of all relevant facts and circumstances.
| Indicator | Description | Practical focus |
|---|---|---|
| Present right to payment | The entity has a current right to receive payment for the asset | Invoice date vs delivery date — are they aligned? |
| Legal title | The customer has legal title to the asset | Contract terms, bill of lading, title transfer clauses |
| Physical possession | The entity has transferred physical possession to the customer | Delivery confirmation, shipping records |
| Risks and rewards | The customer has the significant risks and rewards of ownership | Incoterms, insurance obligations, risk of loss in transit |
| Customer acceptance | The customer has accepted the asset | Acceptance testing procedures, sign-off protocols |
The Shipping and Delivery Question
For goods sold on commercial terms that specify risk of loss in transit (governed by Incoterms in international transactions), the point of revenue recognition depends on when the risks and rewards of ownership — and specifically the risk of loss — transfer to the customer.
- FOB Shipping Point / EXW: Risk transfers when goods are dispatched. Revenue recognised at shipment.
- CIF / DAP / DDP: Risk remains with the seller until goods arrive at the named destination. Revenue recognised at delivery.
Japanese entities transitioning to IFRS from local GAAP — where shipment-based recognition was widespread — need to carefully review their Incoterms and standard trading conditions to determine whether revenue recognition should be deferred to the point of arrival rather than shipment.
Customer Acceptance Clauses
Where a contract includes a customer acceptance clause, the entity must assess whether the clause is substantive or perfunctory.
Substantive acceptance clause: The customer performs testing or evaluation that could result in rejection. The acceptance clause affects when control transfers — revenue is deferred until acceptance is obtained or the right of rejection expires.
Perfunctory acceptance clause: Acceptance is a formality. Historical experience shows that the customer has never rejected goods meeting the contractual specification, and acceptance is essentially an administrative step. In such cases, acceptance does not delay the transfer of control, and revenue may be recognised at delivery.
The distinction requires judgement and should be supported by documentation of the entity’s historical experience with similar contracts and customers.
Measuring Progress Toward Complete Satisfaction: Over-Time Obligations
For performance obligations satisfied over time, revenue is recognised based on the entity’s progress toward complete satisfaction of the obligation (IFRS 15.41). The method chosen must faithfully depict the transfer of control to the customer.
Output Methods
Output methods measure progress by reference to the value of goods or services already transferred to the customer relative to the total value promised.
Common output measures:
- Milestones achieved (where milestones are defined to reflect the value transferred at each stage)
- Units of output delivered or processed
- Time elapsed (for uniform services delivered continuously over time)
When output methods work well: Where the deliverables are clearly defined, measurable, and where each unit of output has consistent value, output methods provide a direct and transparent measure of progress.
Limitation — uninstalled materials: Where an output measure based on surveys or units produced does not account for materials or components that have been delivered but not yet installed or consumed, revenue may be overstated relative to actual progress. In such cases, an adjustment is required.
Input Methods
Input methods measure progress by reference to the entity’s inputs — the resources consumed in satisfying the performance obligation — relative to total expected inputs.
Common input measures:
- Costs incurred to date as a proportion of total estimated costs (the cost-to-cost method)
- Labour hours expended as a proportion of total estimated labour hours
When input methods work well: For complex, long-duration contracts where the output is a single integrated deliverable and progress cannot be directly observed, cost-based input methods provide a practical proxy for progress.
Costs That Must Be Excluded From Input-Method Calculations
Not all costs incurred in connection with a contract represent progress toward satisfying the performance obligation. IFRS 15.B19 requires the following to be excluded from progress calculations under cost-based input methods:
Uninstalled materials: Where significant quantities of materials have been purchased and delivered to a project site but have not yet been incorporated into the work, including these costs in the progress numerator would overstate progress. The cost of such materials should be excluded from both the numerator and denominator — or, alternatively, revenue should be recognised for the cost of those materials only (zero margin), with the remaining revenue recognised as the materials are incorporated.
Inefficiencies and wasted resources: Costs arising from abnormal waste, rework, or inefficiencies that were not reflected in the original cost estimate should not be included in the progress calculation, as they do not represent value transferred to the customer.
Practical system implication: Excluding these costs from progress calculations requires a cost tracking system capable of distinguishing between costs that represent progress and costs that do not. Entities applying cost-based input methods should review their project accounting systems to ensure this distinction can be maintained reliably at period-end.
Changes in Estimates: The Cumulative Catch-Up Mechanism
Over the life of a long-term contract, the entity’s estimates of total costs — and therefore of the progress percentage — will change. Changes in estimates are treated as changes in accounting estimates under IAS 8, not as errors or changes in accounting policy. They are accounted for prospectively using the cumulative catch-up approach.
How the cumulative catch-up works:
At each reporting date, the entity calculates the total cumulative revenue that should have been recognised to date based on the updated estimates. The difference between that amount and the revenue recognised in prior periods is recognised in the current period.
Worked example:
| End of Year 1 | End of Year 2 | |
|---|---|---|
| Contract price | USD 100m | USD 100m |
| Total estimated costs (revised) | USD 80m | USD 100m |
| Costs incurred to date | USD 24m | USD 60m |
| Progress percentage | 24/80 = 30% | 60/100 = 60% |
| Cumulative revenue to recognise | USD 30m | USD 60m |
| Revenue recognised in prior periods | — | USD 30m |
| Revenue recognised in current period | USD 30m | USD 30m |
If total estimated costs had remained at USD 80m at the end of Year 2 and costs incurred were USD 60m, progress would have been 75% and cumulative revenue USD 75m — a Year 2 revenue of USD 45m. The cost overrun reduces Year 2 revenue from USD 45m to USD 30m through the catch-up mechanism.
Onerous contracts: Where revised estimates indicate that total contract costs will exceed total contract revenue, the contract is onerous. The expected loss is recognised immediately in its entirety under IAS 37, not spread over the remaining contract period.
Comparison with Japanese GAAP
| Area | IFRS 15 | Japanese GAAP (ASBJ No. 29) |
|---|---|---|
| Over-time criteria | Three criteria, any one sufficient | Same |
| Shipment vs delivery | Based on control transfer / risk of loss | Shipment-based recognition permitted as practical expedient |
| Progress measurement | Output or input methods | Same (cost-to-cost widely used) |
| Excluded costs in input methods | Required exclusion of uninstalled materials and inefficiencies | Same |
| Onerous contracts | IAS 37 — immediate loss recognition | Similar treatment under Japanese GAAP |
The most significant practical difference for Japanese entities is the shipment versus delivery question. Under Japanese GAAP, a practical expedient permits revenue recognition at the time of shipment for domestic sales. Under IFRS 15, the recognition point is determined by when control transfers — which depends on the specific risk-of-loss terms of each transaction.
Summary
The key takeaways from Step 5 are as follows:
- Revenue is recognised when or as control transfers — the analysis starts with whether any of the three over-time criteria is met
- Criterion 3 (no alternative use plus enforceable right to payment) requires careful analysis: both conditions must be present, the no-alternative-use assessment focuses on practical rather than contractual constraints, and the enforceability of the payment right must be confirmed under the applicable law
- For point-in-time obligations, the five indicators are assessed in combination — no single indicator is determinative
- Shipping terms (Incoterms) directly affect the revenue recognition point for physical goods; entities should ensure their terms are documented and consistently applied
- Progress measurement under input methods requires active exclusion of costs that do not represent progress — uninstalled materials and inefficiencies must be stripped out
- Changes in total cost estimates are accounted for prospectively through the cumulative catch-up mechanism; onerous contracts trigger immediate full loss recognition under IAS 37
The next and final article in this series examines the IFRS 15 disclosure requirements — what must be included in the notes to the financial statements, and what level of detail is expected in practice.
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