A new five-step model for revenue recognition

The Financial Reporting Council (FRC) has introduced a large major overhaul to Section 23 of FRS 102, effective for accounting periods beginning on or after 1 January 2026.

A new five-step model for revenue recognition

The Financial Reporting Council (FRC) has introduced a large major overhaul to Section 23 of FRS 102, effective for accounting periods beginning on or after 1 January 2026. This change replaces the previous risks-and-rewards approach with a comprehensive five-step model, aligning Irish and UK GAAP more closely with IFRS 15: Revenue from Contracts with Customers. For businesses across the Ireland and the UK, this update significantly impacts how revenue is recognised, particularly for entities with complex contracts or bundled goods and services.

Why the Change?

The previous model under FRS 102 focused on transferring risks and rewards of ownership, which often led to inconsistencies in practice. The new approach aims to provide a clearer, principle-based framework that better reflects the transfer of goods or services to customers. This alignment with IFRS 15 enhances comparability for businesses operating internationally and improves transparency for stakeholders. However, it also introduces complexity, requiring detailed contract analysis and robust systems to ensure compliance.

The Five-Step Model Explained

Under the revised Section 23, revenue recognition will follow these five steps:

1. Identify the Contract with a Customer

A contract exists when all parties approve it, rights and obligations are clear, payment terms are defined, and the agreement has commercial substance. Businesses must also assess collectability, whether it is probable that consideration will be received.

2. Identify Performance Obligations

Each distinct good or service promised in the contract is a performance obligation. Determining whether obligations are separate or combined requires judgment, especially for bundled offerings such as products with installation or ongoing support.

3. Determine the Transaction Price

The transaction price is the amount the entity expects to receive, excluding third-party amounts like sales taxes. Variable consideration, such as discounts, rebates, or contingent payments, must be estimated using either the expected value or most likely amount approach.

4. Allocate the Transaction Price

When a contract contains multiple performance obligations, the total transaction price must be apportioned to each obligation based on its standalone selling price. Where these prices are not readily available, businesses will need to estimate them, which can be challenging for SMEs and mid-market entities.

5. Recognise Revenue When (or as) Performance Obligations Are Satisfied

Revenue is recognised when control of goods or services transfers to the customer, either over time or at a point in time. This may differ significantly from previous practice, particularly for service contracts or long-term projects.

What Does This Mean for Businesses?

For simple transactions, the impact may be minimal. However, for businesses with complex arrangements, such as construction, software, or professional services, the changes could alter the timing and profile of revenue recognition. For example:

Bundled Contracts: Companies offering products with installation or after-sales support must assess whether these are separate obligations.
Variable Consideration: Estimating rebates or performance bonuses introduces judgment and potential volatility.
Financing Components: Where payment terms differ significantly from delivery, adjustments for the time value of money may be required.

These changes will also affect KPIs, tax calculations, and potentially covenant compliance. Stakeholders, including lenders and investors, should be informed early to manage expectations.

Transition and Practical Challenges

The FRC offers two transition options: full retrospective or modified retrospective, the latter allowing adjustments to be recorded directly in equity without restating comparatives. While this eases implementation, businesses still face challenges:

Reviewing all customer contracts to identify performance obligations
Updating accounting systems and chart of accounts
Training finance and commercial teams on the new requirements
Preparing revised disclosures, which are more extensive under the new model

How to prepare

Businesses should start by:

Impact Assessment: Quantify how the new model affects revenue timing and financial metrics.
Contract Review: Identify complex arrangements and consider renegotiating terms for clarity.
System Readiness: Ensure accounting systems can handle the new requirements.
Stakeholder Communication: Engage auditors, lenders, and investors early to manage covenant implications

The introduction of the five-step model under FRS 102 marks a significant shift in revenue accounting for UK and Irish companies. While the changes enhance transparency and comparability, they also demand careful planning and robust processes. Preparation will be key to ensuring compliance and turning this challenge into an opportunity for improved financial reporting.