Revenue recognition is a crucial aspect of accounting, especially when dealing with complex transactions. Companies must follow standardized guidelines to determine when and how revenue should be recognized. The main accounting standards that govern revenue recognition are:
IFRS 15: Revenue from Contracts with Customers (for companies following IFRS)
ASC 606: Revenue from Contracts with Customers (for companies following US GAAP)
These standards introduced a five-step model to recognize revenue accurately. However, real-world scenarios often involve complexities like multiple performance obligations, variable consideration, long-term contracts, and consignment sales.
Both IFRS 15 and ASC 606 use a five-step model for recognizing revenue:
1️⃣ Identify the contract with the customer
2️⃣ Identify performance obligations (goods/services promised in the contract)
3️⃣ Determine the transaction price (considering discounts, bonuses, penalties, etc.)
4️⃣ Allocate the transaction price to performance obligations
5️⃣ Recognize revenue when (or as) performance obligations are satisfied
Now, let’s look at how revenue recognition works in complex scenarios.
Sometimes, a company sells a bundle of goods and services, each with different delivery timelines. In such cases, revenue must be allocated based on the standalone selling price of each component.
📌 Example: A software company sells a software license + one year of technical support for $12,000. The standalone prices are:
Software License: $10,000
Support Service: $2,000
How to recognize revenue?
The company must allocate revenue between both components.
Software revenue is recognized immediately when the license is delivered.
Support revenue is recognized over 12 months as the service is provided.
Journal Entries:
At contract signing (when software is delivered):
Dr. Accounts Receivable $12,000
Cr. Revenue - Software License $10,000
Cr. Deferred Revenue - Support $2,000
Dr. Deferred Revenue - Support $166.67
Cr. Service Revenue $166.67
If a contract includes bonuses, discounts, or penalties, companies must estimate the most likely amount of revenue they will receive.
📌 Example: A construction company agrees to complete a project for $500,000, but will receive an extra $50,000 bonus if it finishes within 6 months. Based on past experience, the company estimates a 75% probability of earning the bonus.
Revenue Calculation:
Total revenue to recognize = $500,000 + (75% × $50,000) = $537,500
Journal Entry (upon contract completion):
Dr. Accounts Receivable $537,500
Cr. Revenue $537,500
If the company later realizes it won’t receive the bonus, it must adjust revenue accordingly.
For long-term projects (e.g., construction, consulting, aerospace manufacturing), revenue is recognized over time using Percentage of Completion (POC) Method or at the end using the Completed Contract Method.
📌 Example: A company is building a bridge for $1,000,000, estimated to take 3 years. After Year 1, 40% of the work is complete.
Under POC Method, the company recognizes 40% of revenue in Year 1:
Dr. Accounts Receivable $400,000
Cr. Revenue $400,000
Under Completed Contract Method, no revenue is recognized until the project is finished.
In consignment sales, a manufacturer (consignor) sends goods to a retailer (consignee), but revenue is not recognized until the goods are sold to the final customer.
📌 Example: A clothing brand sends $50,000 worth of shoes to a retail store. The store sells $30,000 worth of shoes in the first month.
Revenue Recognition:
The clothing brand recognizes only $30,000 as revenue (not $50,000).
The remaining $20,000 remains in inventory.
Journal Entry (when shoes are sold):
Dr. Accounts Receivable $30,000
Cr. Revenue $30,000
Cr. Inventory $30,000
For companies that earn revenue through licensing (e.g., music, patents, trademarks), revenue recognition depends on:
Right to use (static license) → Recognized immediately
Right to access (dynamic license, ongoing use) → Recognized over time
📌 Example: A musician licenses a song to a streaming service for $100,000 upfront + 2% royalty per stream.
$100,000 is recognized immediately (right to use).
Royalties are recognized when earned based on streams.
Journal Entry (for upfront fee):
Dr. Cash $100,000
Cr. Revenue - Licensing $100,000
Journal Entry (for royalties earned later):
Dr. Accounts Receivable $5,000
Cr. Revenue - Royalties $5,000
Revenue recognition can become complex, but following IFRS 15 / ASC 606 helps standardize reporting across industries. Key takeaways:
✅ Identify performance obligations carefully to allocate revenue properly.
✅ Estimate variable consideration accurately to avoid misstating revenue.
✅ Use the right method for long-term contracts to match revenue with progress.
✅ Delay revenue recognition in consignment sales until the final sale occurs.
✅ Apply correct treatment for licensing revenue based on contract type.
Proper revenue recognition ensures financial statements remain accurate, transparent, and compliant with accounting standards.