Revenue Recognition Under IFRS for SMEs Just Got Smarter
This article will count 0.25 units (15 minutes) of unverifiable CPD. Remember to log these units under your membership profile.
Revenue is the number everyone looks at first. It is at the top of the income statement. It drives profit. It drives bonuses. It drives how a bank decides whether to lend to your client.
And for most SMEs applying the old IFRS for SMEs Standard, the rules for recognising it came from IAS 18, a standard that was written in 1993 and officially withdrawn in 2018. Eight years ago. Most of your clients have been using guidance that the rest of the accounting world has already moved on from.
The third edition of the IFRS for SMEs Standard changes this completely. Section 23 has been rewritten from scratch. It introduces the five-step revenue recognition model, which is the same framework used under IFRS 15, but with SME-friendly simplifications built in. It applies to almost every transaction where your client sells goods or provides services to a customer.
This article covers Steps 1 to 3 of that model. Session 8 covers Steps 4 and 5, and works through how the model applies to specific contract types your clients deal with every day.
Why the Old Rules Were Not Good Enough
The old Section 23 worked fine for simple transactions. Sell a product, get paid, recognise revenue. Done.
But the moment things got slightly complicated, the old rules ran out of road. What do you do when a client sells a product and includes two years of free maintenance? How do you split the revenue between the product and the maintenance? What happens when the customer pays a deposit now but the work only gets done in six months? What about a construction contract that runs over three years?
The old standard gave vague answers to these questions, or no answer at all. Different accountants were accounting for similar transactions in completely different ways. The new five-step model fixes this by giving you a consistent framework that works for every type of contract, simple or complex.
The Core Idea Behind the New Model
Before walking through the steps, it helps to understand the principle the whole model is built on.
Revenue is recognised when your client transfers control of a promised good or service to the customer, in the amount the client expects to receive in exchange for that transfer.
The key word is control. Not risk. Not reward. Control. When does the customer get the ability to use the asset and get the benefit from it? That is the moment revenue is recognised. This shift from a risk-and-reward model to a control model is the fundamental change in the new Section 23.
Step 1: Do You Have a Contract?
The model starts with a simple question: is there a contract with a customer?
A contract does not have to be a formal written document. It can be written, verbal, or just implied by your client's normal business practice. But for it to qualify under the new Section 23, it must meet five conditions.
• Both parties have agreed to the contract and are committed to performing their obligations.
• Your client can identify what rights each party has in relation to the goods or services.
• The payment terms are identifiable.
• The contract has commercial substance, meaning it actually changes the risk, timing, or amount of your client's future cash flows.
• It is probable that your client will collect the consideration it is entitled to.
That last condition is worth pausing on. If your client regularly sells to customers who never pay, the contract may not qualify under Step 1 and revenue recognition may not be appropriate. This is not a new concept, but the new standard makes it explicit.
How to apply Step 1:
For most transactions your clients do every day, Step 1 passes quickly and automatically. A signed purchase order, a booking confirmation, a service agreement, a verbal order at a counter: all of these are contracts. Where you need to think more carefully is when collectability is genuinely in doubt, when a customer has a poor payment history, or when the arrangement has no real commercial substance, such as a transaction between related parties at artificial prices. In those cases, assess whether all five conditions are genuinely met before recognising any revenue.
Step 2: What Did Your Client Actually Promise?
Once you have a contract, you need to identify exactly what your client promised to deliver. In the new model, each distinct promise is called a performance obligation, and each one gets its own revenue recognition treatment.
A promise is distinct if the customer can benefit from the goods or services on their own or together with other things they already have, and if the promise is separately identifiable from other promises in the contract.
This step is where the new model changes things most significantly for SMEs with bundled contracts.
• A software company sells a licence and includes 12 months of technical support. Two separate promises. The customer can use the software without the support, and vice versa. Two performance obligations. Revenue is split and recognised separately for each.
• A builder constructs a custom home on the client's land. One performance obligation. You cannot separate the foundations from the walls from the roof. It is one integrated promise to deliver a completed home.
• A retailer sells a dishwasher and includes free installation. This one requires judgement. If installation is simple and routine, the customer could have arranged it themselves, making it a separate promise. If installation is complex and integral to the product working, it may be one combined promise. Think about whether the customer genuinely benefits from each element independently.
How to apply Step 2:
Go through every contract your client has and list all the things they promised to deliver. Then ask two questions about each promise: can the customer benefit from this on its own? And is this promise separable from the others in the contract? If both answers are yes, it is a separate performance obligation. If either answer is no, bundle it with the related promise. Getting this step right matters because it determines how many performance obligations you have, which directly affects when and how much revenue gets recognised.
Step 3: What Is the Price?
Once you know what was promised, you need to determine the transaction price. This is the amount your client expects to receive in exchange for transferring the promised goods or services to the customer. It excludes amounts collected on behalf of third parties, such as VAT.
For straightforward transactions with a fixed price, this step takes about five seconds. But three situations deserve specific attention.
Variable consideration.If the amount your client will receive depends on something that has not happened yet, such as a volume rebate, a performance bonus, a penalty clause, or a refund right, you have variable consideration. You need to estimate what you will actually receive. Use the most likely amount if there are only two realistic outcomes (you get the bonus or you do not). Use an expected value (probability-weighted average) if there are many possible outcomes.
Once you have an estimate, you apply a constraint: only include variable consideration in the transaction price to the extent that it is highly probable that a significant reversal of revenue will not occur later. If there is genuine uncertainty, be conservative.
Significant financing component. If your client is effectively providing the customer with finance because payment is deferred well beyond when the goods or services are delivered, the transaction price needs to reflect the time value of money. The revenue recognised is the present value of the future payment, and the financing element is recognised separately as interest income over the credit period.
However, there is an important simplification: if at the start of the contract your client expects to be paid within 12 months of delivering the goods or services, you do not need to adjust for any financing element at all. For most SME clients on normal 30 or 60 day payment terms, this simplification covers them completely.
Non-cash consideration. If the customer pays in something other than cash, such as goods, services, or shares, you measure the transaction price at the fair value of what you receive. If that fair value cannot be determined, use the standalone selling price of what your client transferred.
How to apply Step 3:
For most everyday transactions, the transaction price is simply the price on the invoice, adjusted for any early settlement discounts or rebates your client normally offers. The important check is variable consideration: if your client offers volume discounts, has performance bonuses built into contracts, or allows customers to return goods, you need to estimate the effect of those and constrain them appropriately. For credit terms beyond 12 months at non-market rates, check whether a financing component exists. For the majority of SMEs, the 12-month simplification means discounting is not required.
Steps 4 and 5 Are Coming Next
Steps 1 to 3 lay the groundwork. You have confirmed the contract exists, you know what was promised, and you know the price. Our next article covers Steps 4 and 5: how to split the price across multiple promises when there is more than one performance obligation, and when to actually put the revenue in the income statement.
The next article also works through how the model applies to the contract types your clients deal with most often: construction contracts, service agreements, software licences, warranties, and property sales. Those are the sessions where the model becomes fully practical.
One thing to think about before then: go through your client list and identify anyone with contracts that include more than one element, variable pricing, extended credit terms, or long-term delivery. Those are the clients where the new Section 23 will have the most visible impact on the numbers. Getting your head around their contracts before 1 January 2027is the right place to start.
Choose Your Path to Exclusive Insights
Stay ahead in the world of accounting with premium content designed for professionals like you. Access expert articles, industry trends, and essential resources. Become a CIBA member and claim your CPD hours from CIBA.
CIBA Member Access
R250.00 FREE!
100% Discount when you become a CIBA Member. Join now to claim your CPD Hours. Register here: https://accounts.myciba.org/register
