IFRS 15

IFRS 15 (full title: 'Revenue from Contracts with Customers') is the global rulebook from the International Financial Reporting Standards that tells companies how and when they can book revenue. Think of it as the ultimate referee for scoring points (i.e., revenue) in the game of business. Issued by the International Accounting Standards Board (IASB), it replaced a patchwork of older, often industry-specific guidance, creating one comprehensive framework for nearly all industries. Its goal is simple: to make company revenues more reliable and comparable, whether you're looking at a software giant in Silicon Valley or a construction firm in Frankfurt. It was developed jointly with the U.S. Financial Accounting Standards Board (FASB), whose nearly identical standard is called ASC 606. For a value investor, understanding this standard isn't just for accountants; it's about peering behind the curtain of the income statement to truly understand how a company makes money. It helps you answer the critical question: “Is this revenue real, reliable, and likely to continue?”

At its heart, IFRS 15 is built around a single principle: a company should recognize revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the company expects to be entitled. To apply this principle, companies follow a surprisingly logical five-step recipe. Let's use a simple example: You sign a 24-month mobile phone contract for €50/month that includes a “free” high-end smartphone.

1. Step 1: Identify the contract with the customer. This is straightforward. The signed 24-month agreement is the contract. It's legally enforceable and lays out the terms.
2. Step 2: Identify the separate performance obligations. This is a crucial step. A performance obligation is a promise to deliver a distinct good or service. In our example, the “free” phone is not actually free. The telecom company has two promises to fulfill:
   • Deliver a physical smartphone.
   • Provide 24 months of network service.

These are two separate “to-do” items on the company's list.

1. Step 3: Determine the transaction price. The total transaction price is the total amount the company expects to receive. Here, it's €50/month x 24 months = €1,200.
2. Step 4: Allocate the transaction price. The €1,200 must be split between the two performance obligations (the phone and the service) based on their standalone selling prices. If the phone sells for €720 on its own and a service-only plan costs €20/month (€480 over 24 months), the total standalone value is €720 + €480 = €1,200. The company would allocate €720 of the contract value to the phone and €480 to the service.
3. Step 5: Recognize revenue when (or as) a performance obligation is satisfied. The company recognizes the €720 for the phone immediately when you walk out of the store with it. The remaining €480 for the service is recognized evenly over the 24-month contract term (€20 per month).

This process prevents the company from booking all €1,200 upfront, giving investors a much more accurate picture of how revenue is actually earned over time.

This isn't just accounting nitpicking; it’s a toolkit for better investment analysis.

Before IFRS 15, two companies in the same industry could account for similar contracts in wildly different ways, making true side-by-side comparison impossible. One software company might have recognized a 3-year license fee upfront, while its competitor spread it over the three years. IFRS 15 forces them onto the same playing field, governed by the same principles. This harmonization is a massive win for investors trying to figure out which company is genuinely performing better.

The standard forces management to be more transparent about the nature, timing, and uncertainty of its revenue streams. By breaking down contracts into distinct performance obligations, it helps investors spot aggressive accounting. It makes it harder for companies to pull revenue forward from future periods to meet quarterly earnings targets, leading to higher-quality, more sustainable reported profits.

The real gold for an investor is often buried in the notes to the financial statements. IFRS 15 mandates a wealth of new disclosures. Most importantly, companies must disclose their “remaining performance obligations.” This is essentially the company's backlog of legally contracted, but not yet delivered, revenue. It’s a fantastic forward-looking indicator of future sales that was previously difficult or impossible for investors to find.

While IFRS 15 is an improvement, it’s not a magic bullet. Astute investors should remain vigilant.

The standard is principles-based, not rules-based, which means it requires significant management judgment. Deciding what constitutes a “distinct” performance obligation or how to estimate a standalone selling price can be subjective. Be extra cautious with companies whose business models rely on highly complex, bundled contracts, as this is where accounting shenanigans can hide.

The transaction price can include variable amounts like bonuses, discounts, or rebates. Companies have to estimate these, and changes in those estimates can swing reported revenue from one quarter to the next. If you see large and frequent revisions to these estimates, it warrants a closer look.

IFRS 15 also provides rules for costs incurred to obtain or fulfill a contract. Certain costs, like a sales commission, can now be capitalized (put on the balance sheet as an asset) and expensed over the life of the contract, rather than being expensed immediately. While often logical, this can be used to flatter short-term profits, so watch for aggressive capitalization of costs.