New 5 step model for revenue recognition
In March this year, the Financial Reporting Council (FRC) confirmed the latest amendments to Generally Accepted Accounting Practice in the UK (UK GAAP).
The five steps are to:
- Identify the contract or contracts with a customer
- Identify the goods or services promised in the contract – the performance obligations
- Determine the transaction price for delivering the goods or services
- Allocate the transaction price to the performance obligations in the contract based on the individual selling price of each good or service
- Recognise revenue in your accounts as/when a good or service is provided to the customer
The key point of this standard is to consider what your business has promised to deliver to its customers, and what it is providing them. The price for those individual elements can then be calculated and the revenue relating to them can be recognised accordingly.
Below is an example to better illustrate the impact that this change could have:
If we buy a mobile phone contract, we could get a handset and a 24 month data plan paying £30 per month. Under current UK accounting, it's likely that the provider might recognise £30 per month for that contract and spread it equally over the 24 months.
What this five step model makes the provider think about is that they are providing 2 items, the handset on day one and access to data for the next 24 months, therefore the £30 per month is split between those two different items. If the cost of the handset on its own was £200 and the cost of the data plan on its own was £25 a month then you would work out the relative selling prices and apply that to the consideration being paid. So for the phone that would be £200/(£200 + 24*£25) applied to the total consideration of £720 (£30 x 24). The £180 for the handset would be recognised on day one as revenue, with the remaining balance spread over the remaining 24 months for which that data plan is provided (£22.50 a month).
We are here to help
If you would like to further discuss how you can prepare for the introduction of the new five step model, or would like some advice with your accounts, please get in touch with our business advisor, Claire Needham via the form below, or reach out to your usual Azets advisor.
