Contract Revenue
The Financial Reporting Council has amended Financial Reporting Standards 102 (‘FRS102’) and 105 (‘FRS105’) to incorporate updated requirements when accounting for contract revenue. This article considers the changes, with the key objective being to introduce you to the new requirements which are effective for accounting periods commencing on or after 1 January 2026. Early adoption is permitted.
The updated standards require your business to adopt a new five-step model (the ‘Model’) when accounting for contract revenue, the purpose being to ensure revenue from all contracts with your customers is recorded by identifying the distinct goods or services your business provides its customers during the life of an individual contract, and by matching those deliveries to the appropriate proportion of the contract’s total revenue.
The Model’s Five Steps
The revised standards contain detailed guidance on the application of the Model, and whilst the majority of principals applied are similar to the current rules, step two below may require closer examination during the preparation of your financial statements in order to establish each contract’s individual performance obligations.
The five steps are as follows:
1. Identify the contract with your customer,
2. Identify the performance obligations in the contract (terms and conditions must be carefully reviewed),
3. Determine the transaction price (may result in a varied revenue profile and require estimation of subcomponents within the contract),
4. Allocate the transaction price to the performance obligations (may require estimation of standalone selling prices), and
5. Recognise revenue when (or as) your business satisfies a performance obligation (one of three criteria must be met, and progress must be reliably measured).
Initial Adoption
Although the changes will apply from 1 January 2026, they may be applied earlier. On initial adoption, the changes must be applied retrospectively, either by amending the comparatives, including the opening balance of retained earnings in the comparative period (“full retrospective application”) or by showing the cumulative effect through retained reserves at the initial date of application (“catch-up”).
Full retrospective application will not require the restatement of contracts that begin and end in the same accounting period or those completed before the beginning of the comparative period. Catch-up application requires the rules to be applied retrospectively to contracts that are not completed at the date the new requirements are applied.
There are no prescribed criteria as to which transition approach should be used. However, you should consider the needs and expectations of the users of your financial statements, bearing in mind the qualitative characteristics of useful financial information.
In Summary
These changes may have broad implications on your customer contracts, so assessing the new requirements and their potential impact upon your business and its financial statements is key, not least because of the need to consider comparative information in the first accounting period in which the changes are applied. This can affect taxable profits and consequently the corporation tax computation.
You should assess the appropriateness of your current revenue recognition accounting policy, and review all active and new customer contracts. It may be necessary to update your internal controls and systems, to provide training to your staff and to assess the impact on your financial statements.
Assessing and understanding the impact of the changes will be essential for those businesses subject to covenants connected to third party debt.
PK Group’s Professional Services team are here to support you when assessing, preparing for and implementing these changes.
For more information, please don’t hesitate to contact us via welcome@pkgroup.co.uk or by phone on +44 (0)20 8334 9953.
