Revenue accounting under the current FRS 102 Standard is in the main a distinction between the sale of goods and of services, and construction contracts. The Periodic Review amendments update this to align with International Financial Reporting Standard IFRS 15 under which a five-step model is applied to recognising revenue from all contracts with customers. These changes will be effective for accounting periods commencing on or after 1 January 2026 with early adoption permitted but not required (FRS105 for microentities will also be amended to reflect this change).

The five-step model does not necessarily result in different accounting outcomes. For many contracts, the amount and timing of revenue recognition may well be the same as at present. In other cases, there will be significant differences.

There is no specific mention of construction contracts and the accounting treatment of these will generally be unaffected, either using output methods (e.g. valuation certificates) or input methods (e.g. costs incurred to date) to measure progress towards the satisfaction of a performance obligation.

The five-step model is also expected to provide more useful information about the nature, amount and timing of revenue and should make accounting for revenue recognition more comparable. Enhanced disclosure requirements also ensure an entity clearly describes the goods or services it promises to transfer, when it satisfies performance obligations, and the significant payment terms.

Changes to revenue recognition

The five-step model focuses on identifying the distinct goods or services promised to the customer, determining the amount of consideration that the entity will be entitled to in exchange, and the pattern of fulfilment of those distinct elements.

For many straightforward businesses, this approach will not alter how much revenue they recognise or when they recognise it, but for others, there will be more significant changes to the amount and timing of revenue recognition.

The five steps

Step 1: Identify the contract(s) with a customer

The criteria that a contract must meet to be in scope of this revenue recognition model are set out below and all of the following must be met: 

(a) The parties to the contract have approved the contract and are committed to perform their respective obligations;
(b) The entity can identify each party’s rights regarding the goods or services to be transferred;
(c) The entity can identify the payment terms for the goods or services to be transferred;
(d) The contract has commercial substance; and
(e) It is probable that the customer will have the ability and intention to pay the consideration to which the entity will be entitled when it is due.

Contracts with the same customer should be combined when they are entered into:

• At, or near the same time and are negotiated as a package;
• The amount paid in one contract depends on the other; or
• The goods or services promised are a single performance obligation.

The treatment of contract modifications depends on the scope of the changes and the corresponding change in price. Modifications might be accounted for as a separate contract, a termination of the existing contract and the creation of a new contract, or with a cumulative “catch up”.

Step 2: Identify the performance obligations in the contract

Promises to transfer distinct, or a series of distinct, goods or services to a customer should be identified as separate performance obligations.

When a good or service promised to a customer is not distinct, it must be combined with other goods or services in the contract until the entity identifies a bundle of goods or services that is distinct.

Promises in a contract that are inputs to a combined item or items and are therefore not distinct include, but are not limited to, the following:

(a) The entity provides a significant service of integrating the goods or services with other goods or services promised in the contract into a bundle of goods or services that represent the combined output or outputs for which the customer has contracted. In other words, the entity is using the goods or services as inputs to produce or deliver the combined output or outputs specified by the customer. A combined output or outputs might include more than one phase, element or unit. An example is a construction contract when an entity provides an integration (or contract management) service to manage and co-ordinate the various construction tasks necessary for the construction of an asset.

(b) One or more of the goods or services significantly modifies or customises, or is significantly modified or customised by, one or more of the other goods or services promised in the contract. An example is a software contract when an entity promises to provide existing software and to customise that software, if the customisation service significantly modifies the software.

(c) The goods or services are highly interdependent or highly interrelated. In other words, each of the goods or services is significantly affected by one or more of the other goods or services in the contract. For example, in some cases, two or more goods or services are significantly affected by each other because an entity would not be able to fulfil its promise by transferring each of the goods or services independently.

Performance obligations do not include activities that an entity must undertake to fulfil a contract unless those activities transfer a good or service to the customer. For example, administrative tasks that do not transfer a good or service to the customer would not be considered performance obligations.

Step 3: Determine the transaction price

The transaction price is the amount of consideration an entity is entitled to receive in exchange for transferring goods or services to a customer. Often, the transaction price includes a variable amount. This may arise because of the contract including features such as discounts, rebates, refunds, penalties or performance bonuses. The amount of variable consideration to include in the transaction price must be estimated using either the expected value method or the most likely amount method depending on which method the entity believes better predicts the amount it will be entitled to. Variable consideration must also only be included to the extent that it is ‘highly probable’ that the entity will be entitled to it once the associated uncertainty is resolved.

FRS 102 also considers how the time value of money, noncash consideration and consideration payable to a customer should be treated in this step of the model.

Step 4: Allocate the transaction price to the performance obligations in the contract

The transaction price should be allocated to each distinct performance obligation based on a relative standalone selling price. This is the price at which an entity would sell a good or service promised in a contract separately to a customer.

If a standalone selling price is not directly observable, it should be estimated by considering all information that is reasonably available, including market conditions, entity-specific factors and information about the customer or class of customer.

Discounts or variable consideration may also require allocation to the performance obligations in the contract, depending on the specific circumstances.

Subsequent changes to the transaction price, e.g. due to the estimate of variable consideration being updated or due to contract modifications, may lead to the allocation of the transaction price being reassessed.

Step 5: Recognise revenue when (or as) the entity satisfies a performance obligation

A performance obligation is satisfied by transferring the promised good or service to the customer. A good or service is transferred when the customer obtains control.

Performance obligations can be satisfied over time or at a point in time, depending on the facts and circumstances.

The model defines the criteria that must be met for a performance obligation to be satisfied over time. If a performance obligation is not satisfied over time, it is satisfied at a point in time.

What happens in the first year the new rules come into force?

The changes are effective for accounting periods beginning on or after 1 January 2026.

On transition the FRC has provided two choices:

• Entities can apply the requirements retrospectively, including restatement of comparatives (practical expedients are available when choosing this option); or
• Entities may apply the requirements retrospectively but without restating comparatives (the cumulative effect of initially applying the standard will be recognised as an adjustment to opening retained earnings). Under this option, only incomplete contracts at the date of initial application need be adjusted for (some of the practical expedients referred to in the option above may also be used).

What are the disclosure requirements?

The Standard sets out that the following should be disclosed:

• Revenue split into categories that depict how revenue and cash flows are affected by economic factors, e.g. by type of goods\service, by geographical market, revenue earned as agent or as principal;
• Opening and closing balances of receivables, contract assets and contract liabilities from contracts withcustomers, if not otherwise separately presented or disclosed;
• Revenue recognised in the reporting period that was included in the contract liability balance at the beginning of the period (i.e. deferred revenue that has been released);
• Revenue recognised in the reporting period from performance obligations satisfied or partially satisfied in previous periods (e.g. changes in estimates of variable consideration):
• Information about performance obligations in contracts with customers, including a description of:
  • When the entity typically satisfies its performance obligations (e.g. upon shipment, upon delivery, as services are rendered or upon completion of service)*
  • The significant payment terms (e.g. when payment is typically due, whether the contract includes a financing transaction, and whether the consideration amount is variable)*
  • The nature of the goods\services that the entity has promised to transfer, highlighting any promises to arrange for another party to transfer goods\services (i.e. entity is acting as agent)*
  • Obligations for returns, refunds and other similar obligations
  • Types of warranties and related obligations

For small entities adopting FRS102 Section1A only those items above marked with an asterisk are required to be disclosed. 

What should you be considering now?

Whilst the first period for which the new five-step model will apply may be more than a year away, we recommend reviewing the details of your current contacts with customers in good time to establish the extent of any impact on your income recognition policies.

It is anticipated that entities that offer ‘bundled contracts’ or have complex revenue transactions will be the most directly affected. Examples of some particular areas to consider would be:

• Warranties – where the warranty is an additional service over and above just an assurance that the product works, it likely represents a separate performance obligation.
• Non-refundable up-front fees – often this is an up-front payment for future goods or services which will need to be recognised as those future goods or services are provided
• Customer options for additional goods or services – where customers are granted the option to acquire additional goods or services for free or at a discount, that provides the customer with a material right that they would not receive without entering into that contract, the option gives rise to a separate performance obligation.

New reporting systems may need to be developed to capture information relevant for applying the new five-step model.

If you require advice, need assistance in assessing the impact on the current terms of your contracts with customers or have any concerns, please contact your team at Rickard Luckin, or if not already a client, contact Neil Brewer at neil.brewer@rickardluckin.co.uk or on 01702 606823.

Illustrative example

A company sells a two-year phone contract for telecom services to a customer for £30 a month. As part of this contract, the customer receives a ‘free’ phone, which is worth £200. The same contract is available without the free phone for £25 a month, making the standalone selling price of the 24 months of telecom services £600 (£25 x 24 months).

Step 1: Identify the contract(s) with a customer

The contract is for the sale of the mobile phone and 24 months of telecom services.

The rights and obligations are clear, the payment terms are outlined, and the customer intends to pay. The criteria for a contract have been met.

Step 2: Identify the performance obligations in the contract

The contract has two distinct performance obligations: the first is the provision of the mobile phone, and the second is the provision of telecom services over 24 months.

Step 3: Determine the transaction price

The transaction price is £720, being £30 x 24 months.

Step 4: Allocate the transaction price to the performance obligations in the contract

The £720 must be allocated to each of the two performance obligations, the provision of the mobile phone and the provision of 24 months of telecom services, in proportion to their SSP (i.e. the price that the company would charge if it sold the same goods and services separately to similar customers in similar circumstances).

The SSP of the phone is £200. So 200/(600+200) x £720 = £180 of revenue would be allocated to the phone.

The SSP of the telecom services is £600. So 600/(600+200) x £720 = £540 would be allocated to the telecoms services.

Step 5: Recognise revenue when\as performance obligations are satisfied

The £180 of revenue allocated to the phone is recognised immediately. Control of the phone has transferred to the customer on sale, satisfying this obligation at that time.

The £540 of revenue allocated to the telecom services is recognised evenly over the 24 month term of the contract, i.e. £22.50 per month. The benefits of the telecom services are received and consumed by the customer over the 24 month time period.