Auditing Revenue Recognition under IFRS 15: Key Challenges and Auditor Considerations
Revenue is a fundamental indicator of a business’ operational success and a critical metric for investors, regulators, and stakeholders. However, it is also one of the most complex and subjective areas in financial reporting.
Since the introduction of IFRS 15: Revenue from Contracts with Customers, auditors have faced increased pressure to navigate the intricacies of the standard while maintaining audit quality and professional scepticism. This article explores key challenges encountered when auditing revenue recognition under IFRS 15 and highlights the main areas of auditor focus.
Understanding IFRS 15 and the 5-Step Model
IFRS 15 introduced a single, principles-based model for revenue recognition across all industries. The objective is to ensure that entities recognise revenue in a way that reflects the transfer of goods or services to customers, while recognising an amount that is representative of the consideration to which the entity expects to be entitled.
The standard outlines a five-step model:
While the model is systematic, applying it can be highly subjective, especially for businesses with complex revenue arrangements, bundled services, or performance-based pricing. This has created new challenges for auditors, particularly in identifying and assessing audit risks, testing estimates and judgements, and evaluating appropriate disclosures.
Key Challenges Under IFRS 15
- Judgements in Identifying Performance Obligations
One of the most judgemental aspects of IFRS 15 is the identification of distinct performance obligations within a contract. This would be common in the telecommunications industry, for example, whereby the contract would include the sale of a mobile together with a service plan for a monthly fee. Auditors must assess whether these elements are distinct and can be separated for revenue recognition purposes.
If management identifies fewer performance obligations than appropriate, it may result in accelerated revenue recognition. Auditors must carefully review the terms of contracts, consider industry norms, and evaluate management’s conclusions about which goods and services are “distinct.”
- Estimating Variable Consideration
Many contracts contain elements of variable consideration, such as discounts, rebates, refunds, penalties, or performance bonuses. IFRS 15 requires management to estimate the amount of variable consideration to include in the transaction price, using either the expected value or the most likely amount method.
From an audit perspective, auditors must assess the reliability of historical data, the reasonableness of assumptions, and whether any constraints on revenue recognition have been appropriately applied.
- Determining the Timing of Revenue Recognition
One of the key decisions under IFRS 15 is when the performance obligation is satisfied, as this will determine when to record the revenue. This would depend on the nature of the performance obligation and when control of the good or service is passed to the customer (usually either gradually as work is done or all at once).
For example, in long-term projects such as construction, it’s common to recognise revenue over time, depending on the percentage of completion. To do this, companies often use measures such as costs incurred to date compared to total estimated cost and milestones achieved during the project.
As auditors, it's important to understand how these projects work, assess whether progress is being measured appropriately, and check the accuracy of cost estimates and any assumptions used.
Mistakes or overly optimistic assumptions in this area can lead to revenue being recorded too early or too late, which can significantly affect the amounts recorded in the financial statements.
- Principal vs. Agent Considerations
Determining whether a company is acting as a principal (recognising gross revenue) or an agent (recognising net revenue) is another area involving significant judgement and is usually encountered within industries such as travel, e-commerce, and telecommunications.
Auditors must evaluate who controls the goods or services, before they are transferred to the customer. Incorrectly classifying an agent as a principal could result in a substantial overstatement of revenue.
- Contract Modifications
Businesses frequently amend contracts over time by changing scope, pricing, or performance obligations. IFRS 15 requires companies to account for modifications either as a separate contract or as part of the existing one, depending on the nature of the change.
Auditors need to obtain a detailed understanding of these modifications, assess how management has accounted for them, and ensure that Judgements are well-documented and consistently applied.
Auditor Responsibilities and Areas of Focus
Alongside the complexities within this standard, the auditor should also consider that fraud related to revenue recognition is assumed to be a significant risk according to ISA240 – The Auditor’s Responsibilities Relating to Fraud in an Audit of Financial Statements.
Ultimately, the risk here is the timing of when the performance obligation is being satisfied and consequently when the revenue is being recognised. One must be more sceptical towards the end of the year as revenue may be recognised prematurely to ensure that the company’s targets are reached.
Other key responsibilities include:
Understanding Revenue Streams and Assessing Key Controls
Understanding the entity and its control environment is key to determining the audit approach. In the case of revenue, the risk of material misstatement is always present. Therefore, as part of our understanding, we are required to understand the key business process surrounding this financial statement line item as well as the controls that the company has in place to mitigate such risk.
A well-designed control environment may support reliance on controls, while weaknesses may necessitate a higher focus on substantive testing. The auditor’s responsibility is to apply a risk-based approach, focusing testing efforts on the areas with the highest risk within the revenue process.
Applying Analytical Procedures and Cut-off Testing
Unusual fluctuations in revenue, large year-end transactions, or inconsistent patterns may indicate risks of improper cut-off or misstatement. To identify such anomalies, auditors should compare revenue trends against relevant benchmarks such as prior year figures, approved budgets or forecasts, and industry data. These comparisons help assess whether reported results align with expected business activity and market conditions.
Testing Key Estimates and Judgements
This includes challenging management’s assumptions, reviewing historical data, and considering alternative outcomes. Documentation on these judgements is essential to support the audit opinion.
Reviewing Disclosures
IFRS 15 includes extensive disclosure requirements, including disaggregated revenue information, significant judgements, and contract balances.
Examples of significant judgements include the timing of revenue recognition, the identification of performance obligations, and the estimation of variable consideration.
Auditors must ensure these disclosures are complete, transparent, and consistent with other parts of the financial statements, as they provide critical insight into how management applies the standard in practice.
Conclusion
Revenue recognition remains a high-risk and high-focus area in audits, particularly under IFRS 15. The standard’s principles-based approach introduces both flexibility and complexity, making auditor judgment and scepticism more critical than ever. By deeply understanding the client's business, rigorously evaluating estimates, and proactively addressing risks, auditors can enhance audit quality and provide valuable assurance over one of the most scrutinised figures in the financial statements.
