Preparing for change: Revenue recognition

The FRS 102 periodic review 2024, which incorporates the proposals from FRED 82, will largely align Revenue Recognition under UK GAAP with IFRS 15’s comprehensive five-step model, with some simplifications. Changes may impact the timing and amount of revenue entities recognise, to varying degrees, depending on the nature and terms of customer contracts and current revenue recognition policies.  While the revisions to FRS 102 are effective for periods commencing on or after 1 January 2026, we recommend using the intervening time to prepare and understand the impact on your accounts, and any contracts which currently exist, or are being considered, that refer to financial information or KPIs.

How will this impact the financial information?

Revenue is still recognised at a point in time or over time, but the new requirements are more prescriptive on how different elements of a customer contract are disaggregated (or combined) and taken into consideration to do this.

The five steps are as below.

1. identify customer contract(s). 
2. identify the performance obligations in the contract.
3. determine the transaction price (ie the consideration you expect to be entitled to in exchange for transferring goods or services).
4. allocate the transaction price to the performance obligations in the contract. 
5. recognise revenue when (or as) the entity satisfies a performance obligation.

On the face of it, this may seem relatively familiar. Steps 1 to 4 allocate the transaction price to goods or services in the contract, and we currently do that in practice under FRS 102. Step 5 uses a single approach instead of the current distinction to consider when significant risks and rewards of ownership are transferred for goods, and the stage of completion for services. However, the devil really is in the detail, and this can result in very different revenue profiles.

The tricky part comes in moving from the previous challenges of identifying an appropriate policy in the absence of current guidance to some of the complexities in applying the five-step model, including new prescriptive requirements for:

• identifying the performance obligations in a contract;
• licensing and royalties;
• non-refundable up-front fees;
• consideration that is variable including refunds to customers; and
• warranties, rights of return and customer acceptance clauses, and options.

Revenue may also be impacted by the new principal versus agent considerations, requirements if the contract scope, price (or both) change, and how costs incurred to obtain or fulfil a contract are accounted for.

Enhanced disclosure requirements about classes of revenues, how and when revenue has been recognised, and unsatisfied performance obligations may lead to more useful disclosures under the revisions. Where significant judgements have been made in recognising revenue, these will also require disclosure. 

Entities can choose to either amend their comparatives and apply the new model to all customer contracts or apply the model to incomplete contracts at the start of the current period and adjust equity for the cumulative effect at that date.

What should the finance team be doing first?

While your first financial reports that apply the new revenue recognition model may be over two years away, we recommend using this time to revisit your customer contracts to understand terms that could affect the pattern of revenue recognition. As a practical starting point, you may wish to identify the different types of contracts you currently have in place, and whether planned or potential changes to future revenue streams will introduce new contractual terms or remove existing ones.

What impact will the new FRS 102 revenue model have on management information systems?

Andy Ka, partner at RSM UK, advised: ‘Assessing the impact of the new accounting can take time and may be complex, so it makes good business sense to consider the requirements now to develop your implementation plan, including any updates you’ll need to make to reporting and management information systems. The earlier you start, the better prepared you will be to manage the transition.’ 

What are the wider considerations for implementation of the new FRS 102 revenue model?

Head of financial reporting at RSM UK, Danielle Stewart OBE, said: ‘Revenue is a crucial number to users of financial statements, in its own right, and in its impact on profit. Changes from applying the five-step model can impact tax payments, the profits available to distribute and key performance indicators used in many business agreements, such as lending covenants, earn-outs and performance-related pay. Identifying potential impacts on financial information at an early stage will allow time for mitigating actions to be taken, where appropriate, and facilitate informed and timely communications with key stakeholders.’

If you would like to discuss how the amendments to revenue recognition under UK GAAP might impact your business, please get in touch with Danielle Stewart OBE, Andy Ka, or your usual RSM contact.