Revenue from contracts with customers (PFRS 15)

Revenue is where FAR meets almost every business a candidate can imagine, so the board tests it heavily and precisely. PFRS 15 replaced a scatter of old rules with one disciplined framework: the five-step model. If you can run the five steps in order on any fact pattern, you can price a bundled sale, split a warranty, and time recognition correctly. That is a lot of guaranteed points from a single structure.

The five-step model

Step 1: identify the contract. A contract exists only when the parties have approved it and are committed, each party's rights and the payment terms can be identified, the contract has commercial substance, and it is probable that the entity will collect the consideration to which it will be entitled. The collectibility gate matters: if collection is not probable, there is no PFRS 15 contract yet.

Step 2: identify the performance obligations. A performance obligation is a promise to transfer a distinct good or service. A good or service is distinct when the customer can benefit from it on its own or with readily available resources (capable of being distinct) and the promise is separately identifiable within the contract. Bundle the parts that are not distinct into a single obligation.

Step 3: determine the transaction price. This is the consideration the entity expects to be entitled to. It captures variable consideration (discounts, rebates, bonuses), estimated using either the expected value (probability-weighted) or the most likely amount, whichever better predicts the outcome. Variable consideration is included only to the extent it is highly probable that a significant revenue reversal will not later occur (the constraint). The price also reflects any significant financing component, non-cash consideration at fair value, and consideration payable to the customer.

Step 4: allocate the transaction price. Spread the price across the performance obligations in proportion to their stand-alone selling prices. When the sum of stand-alone prices exceeds the contract price, every obligation absorbs its share of the discount.

Step 5: recognize revenue when (or as) each obligation is satisfied. Recognize revenue over time when any one of three criteria is met: the customer simultaneously receives and consumes the benefits as the entity performs; the entity creates or enhances an asset the customer controls; or the entity's performance creates an asset with no alternative use and the entity has an enforceable right to payment for performance completed to date. If none is met, recognize revenue at the point in time control transfers, indicated by a present right to payment, legal title, physical possession, the risks and rewards of ownership, and customer acceptance.

Worked example: a bundled sale

Dasmarinas Systems sells a printing machine together with two years of maintenance for a single price of P468,000. Sold separately, the machine has a stand-alone selling price of P400,000 and the two-year maintenance has a stand-alone selling price of P120,000.

The machine and the maintenance are two distinct performance obligations. The combined stand-alone price is 400,000 plus 120,000 equals P520,000, so the customer is receiving a discount. Allocate the P468,000 by relative stand-alone selling price:

• Machine: 468,000 x (400,000 / 520,000) equals P360,000
• Maintenance: 468,000 x (120,000 / 520,000) equals P108,000

The machine is a point-in-time obligation, so recognize its P360,000 when the customer takes control on delivery. The maintenance is satisfied over time, so recognize its P108,000 evenly across the two years, or P54,000 per year.

Traps the board plants

Fact pattern	Correct treatment
Assurance-type warranty (product works as promised)	Not a separate obligation; provide for it under PAS 37
Service-type warranty (extra coverage the customer can buy)	A separate performance obligation; allocate price and recognize over the coverage period
Entity is the principal (controls the good before transfer)	Recognize revenue gross
Entity is the agent (arranges for another party to provide)	Recognize revenue net, only the fee or commission

Two more points earn easy marks. Incremental costs of obtaining a contract (such as a sales commission) are capitalized as an asset when the entity expects to recover them. A significant financing component means a sale with extended payment terms is split into revenue at the cash selling price plus interest income over time, rather than reporting the whole nominal amount as sales revenue.

Exam-day strategy

• Run the five steps in order every time; most wrong answers come from allocating (step 4) before splitting the obligations (step 2).
• Test each promise with the distinct question first: capable of being distinct and separately identifiable, or bundled into one obligation.
• Allocate a bundled discount by relative stand-alone selling prices, then time each piece separately: the good usually at a point in time, the service usually over time.
• Read every warranty as either assurance-type (a PAS 37 provision) or service-type (a separate obligation), and decide principal versus agent before you choose gross or net revenue.
• When payment is stretched over years, strip out the financing component; sales revenue is the cash selling price, and the rest is interest income.