Understanding FRS 102: revenue recognition
FRS 102, the financial reporting standard applicable in the UK and Republic of Ireland, has recently undergone significant changes, particularly in how revenue is recognised. These amendments aim to enhance transparency and comparability in financial reporting and are mandatory for accounting periods beginning on or after 1 January 2026. They also bring FRS 102 more in line with the requirements of IFRS for recognition of revenue.
The changes will have a material impact on the financial statements of many professional firms. They will also be time-consuming because firms will need to take a considerable amount of time to analyse the substance of their contracts with clients to assess how significant the impact will be. Firms should therefore act now.
Five-step model for revenue recognition
The revised FRS 102 introduces a five-step model for revenue recognition, which requires firms to evaluate their revenue streams carefully. Firms will need to work through all five steps for each of their revenue streams to identify when and how much revenue should be recognised.
The five steps are:
1. Identify the contract
Revenue can only be recognised if there is a contract with enforceable rights and obligations and, whilst a contract does not have to be in writing to be enforceable, the terms of a verbal contract would be very hard to demonstrate – not least to a firm’s auditors. Most professional firms have robust procedures to prevent work from being performed without a letter of engagement (LOE) being in place. However, if any work is performed without a contract, the revised standard may prevent recognition of revenue that could have been recognised under the existing standard.
Example:
Work is performed on a significant assignment before a LOE has been signed, on the understanding that time spent will be included in the amount billed for the matter. In the following accounting period, an LOE is signed and the work is billed and paid for by the client in full. Currently some firms’ accounting policies would allow recognition of revenue for time worked in the first accounting period in that period; under the revised standard they cannot.
Consider:
- What is the explicit control that prevents time from being worked without an LOE?
- Are any contracts subject to modifications (additional services and/or fees that are agreed after the initial engagement letter)? Or is more than one engagement letter issued for related services? If so, this can give rise to complications.
2. Identify performance obligations
Firms must identify the distinct services being provided. This step is straightforward for simple time and material or fixed fee engagements but may require more thought for contracts involving multiple interdependent services.
Principal vs agent:
In some professions, such as the law, it is currently common to recognise revenue net of disbursements that are recharged to clients at cost. This will no longer be permissible in some cases. The revised standard requires a firm to consider whether or not it “controls” the good or service purchased before it is delivered to the customer. Firms should also consider whether the disbursement is combined with other goods and services to provide the contracted services to the customer.
Example:
A firm incurs airfares and accommodation costs to attend a client meeting. Although the expenses are charged to the client at cost, the firm books the flights and hotel and is responsible for paying for them, regardless of whether the client pays. The airfares and accommodation are part of the cost of advising at the meeting, which is the service provided to the client. In this situation, we expect the costs to be recognised as incurred as principal and shown gross in revenue and costs of sales.
Consider:
- What are the services in each type of contract?
- Can a contract cover more than one service? If so, this can give rise to complications, depending on whether the services are interdependent or distinct.
- Do client disbursements incurred meet the characteristics of expenditure as principal or agent? This may vary by type of disbursement (e.g. counsel fees vs travel expenses).
3. Determine the transaction price
The transaction price is likely to be clear for time and materials contracts. For variable consideration, firms should use the expected value where there is a large number of similar contracts. Where the outcome is binary, they should recognise the most likely amount but only when it is highly probable that it will become due.
Time value of money:
Allowance should be made for the time value of money if the period between providing services and being paid is more than 12 months and “beyond normal business terms”. Firms who do not require settlement of fees until the occurrence of an event, such as the settlement of an insurance claim, should assess whether this applies to them.
4. Allocate the transaction price
This step applies when there is more than one performance obligation in the contract. The transaction price should be allocated based on the stand-alone price of each obligation.
Consider:
- Where there is more than one performance obligation, is the allocation of the price in the contract a fair reflection of the relative stand-alone prices of the services?
- Are there any changes in estimated transaction price? Are there any changes to transaction price due to contract modifications? If either of these apply, the revised FRS 102 gives guidance on how to allocate these.
5. Recognise revenue when (or as) performance obligations are satisfied
Revenue is recognised either over time or at a point in time, depending on the nature of the performance obligations. For most time and materials and fixed fee arrangements, revenue will be recognised over time as hours are worked. Contingent fees are likely to be recognised at the point at which the contingency is met because until that point the performance obligation is unlikely to have been satisfied.
Consider:
- Do the services reflect any of the three criteria in the revised FRS102 that would cause them to be recognised over time? If not, they should be recognised at a point in time.
- What is the appropriate way to measure revenue recognised over time? For fixed fee agreements, how will variations between budgeted and actual costs be identified and recognised?
Other key points
In addition to the five-step model, firms should consider the following:
- Section 13 “Inventories” will no longer be disapplied from work in progress arising on service contracts. This will impact contracts for revenue recognised at a point in time. Recoverable costs should be deferred as an asset and matched to future revenue; under the current standard, revenue is accrued to match recoverable costs incurred.
- There are explicit rules for the treatment of non-refundable upfront payments. These must be deferred as a contract asset until the client exercises their right to services or the likelihood of the client exercising their remaining rights becomes remote.
- The new standard requires extensive additional disclosures. Some of these may require information that is not readily available. Firms should familiarise themselves with the requirements and make plans to capture the necessary data.
If you would like to discuss these changes to FRS 102, or any other matter affecting your firm, please get in touch with our professional firms experts.