The Financial Reporting Council published its amendments to UK GAAP (“the amendments”) in March 2024, following feedback from its public consultation in FRED 82 issued back in December 2022. These changes are effective for accounting periods that start on or after 1 January 2026, however, they can be applied early provided all changes are applied at the same time.
Within the amendments are changes relating to revenue recognition, which focus on more consistent, clear, and accurate revenue reporting. The changes introduce important updates to the way in which entities recognise revenue, aligning UK GAAP more closely with IFRS and international best practices.
Alignment with IFRS 15: Revenue from Contracts with Customers
The objective of these amendments is to bring UK GAAP in line with IFRS 15, and the recognition of revenue under UK GAAP being more consistent with international accounting standards.
The amendments clarify how entities should recognise revenue, by using a principles-based approach which focuses on when control is passed to the customer. Therefore, revenue will be recognised in a way that reflects both the timing, and the amount, involved in the transfer of control.
FRS 102 introduces a five-step revenue recognition model, which is based on the principles of IFRS 15. The aim of this model is to help entities identify the specific goods and services, the amount of consideration, and how the contract will be fulfilled. You will find these steps laid out in the following diagram.
Example
An IT business sells hardware to customers with the provision of technical support included for a year; and is provided for an agreed price which is paid for upon delivery of the hardware for £50,000 as detailed in the sales order.
The business’ year end is 31 December, and the order was placed and delivered in the September of the same accounting period.
- The IT business has received a sales order from a customer to provide hardware, therefore confirmation of the order constitutes an agreement or contract with the customer.
- The supply of the hardware and the provision of the technical support are separately identifiable.
- The transaction price is £50,000.
- The price of the hardware on a standalone basis would be £45,000, therefore the price of the technical support can be determined by: –
- Using an adjusted market assessment approach
- Using an expected cost plus a margin approach; or
- Using a residual approach (£5,000 in this example).
Using the adjusted market assessment or expected cost plus a margin approach would result in the total transaction price being provided at a discount (e.g. £45,000 + £10,000, resulting in a total of £55,000 and a discount of £5,000 for the transaction price agreed on).
- The supply of the hardware would be recognised in full in the period, however the provision of the technical support is recognised over time across the accounting periods.
Performance obligations and contract identification
Entities will need to identify the different performance obligations within their contracts, especially where there are several components, such as where goods and services are sold together.
If a contract lists separate goods and services, entities need to decide whether these are separate enough to be accounted for individually. This could impact entities that usually package goods and services together.
For contracts which have more than one performance obligation, where goods and services are packaged together for example, entities will need to determine a transaction price for each performance obligation. This is usually based on standalone selling prices; however, this can involve complex judgements around individual pricing and needs to be thought through carefully.
Revenue recognition over time versus at a point in time
The amendments do clarify when to recognise revenue over time or at a point in time.
Revenue is recognised over time where a customer simultaneously receives and consumes the benefits, for example with service contracts or where the entity has no alternative use for an asset (e.g. long-term construction contracts). The standard sets out a clearer basis for using an output method (e.g. milestones) or an input method (e.g. costs incurred) to track the progress towards completion.
When it comes to simpler contracts, such as the sale of goods, revenue should be recognised when control passes to the customer. Assessing whether control has passed to the customer can be based on the legal title, physical possession, and whether the customer has accepted the goods.
Contract modifications and adjustments
Another significant change relates to contract modifications and adjustments, which are defined as when the terms of the contract are changed, such as adding or changing the scope or price of the contract.
The amendment specifies whether the modification should be treated as a separate contract or adjusted in the existing contract. If the modification significantly changes the contract’s scope or price, it may be treated as a new contract and hence avoid the recognition of revenue either too early or too late.
Entities must determine the effect of modifications on the timing of revenue recognition, particularly when a contract is altered in a way that changes the allocation of the transaction price.
Example
Further to the earlier example, the customer approaches the business after 6 months and requests an additional supply of hardware for another £50,000.
In accordance with the guidance, this scenario would not be treated as a modification to the original contract, as the new obligation is distinct from that already provided. Therefore, this would be accounted for as a separate contract and follow the same five-step model as the earlier example.
Disclosure requirements
In addition to the reporting requirements for the recognition of revenue, the amendments also include a significant change in the disclosure requirements compared with existing FRS 102.
Accounting policies will have to disaggregate revenue by economic factors, provide a description of the performance obligations and, if settled over time, the method used, an explanation of unsatisfied performance obligations and when they are expected to be settled, and contract balance and movements thereof.
What about FRS 105?
FRS 105 also introduces the same five-step revenue recognition model as FRS 102, therefore all entities reporting under UK GAAP will report revenue in a consistent manner. However, there are some key differences to the amendments made to FRS 102, with a more simplified version of the changes brought in for FRS 105 with more of the complicated matters being excluded (e.g. contract modifications and accounting policy options).
How to apply the amendments
Entities can choose how to apply the amendments in preparing their financial statements, they can either apply the changes retrospectively with cumulative catch-up or retrospectively in full.
Applying the amendments with a cumulative catch-up would involve initially applying an adjustment to the opening balance of retained earnings at the initial date of application. Therefore, the comparative information would not be restated, but the amendments would be applied retrospectively to contracts that are not completed at the date of initial application.
Whilst applying the amendments in full, the comparative information would be restated in full, but where contracts were completed before the beginning of the comparative period or for contracts which begin and end in the same reporting period, no restatement is needed.
Conclusion
In summary, the amendments are a significant step in aligning UK GAAP with international standards, particularly IFRS 15, and emphasise the importance of recognising revenue in a way that reflects the transfer of control to customers, with clear guidance on performance obligations, contract modifications, and a more consistent framework for revenue recognition.
While the transition may require considerable effort, especially for entities with complex contracts, this could potentially be performed well in advance of the first reporting date following the transition.