Income recognition on commercial contracts Updated FRS 102 and Charity SORP (2026)

The new requirements (See Chapter 23)

The updated FRS 102 introduces, for the first time, an overarching methodology for the recognition of commercial income (income from contracts with customers) and brings FRS 102 into line with IFRS 15. It is effective for accounting periods commencing on or after 1 January 2026.

The existing FRS 102 approach to revenue recognition is to set out the general principles, supported by a range of examples on how to apply these principles. By contrast, the updated FRS 102 provides a detailed methodology with which all contracts must comply. For most commercial contracts there will be no change to the recognition of income. However, there are a number of detailed changes in approach which will affect some contracts.

Type of contracts affected by the new regime

1. Contracts where there are more than one distinct deliverable which are delivered at different times. In this case, the total contract price would need to be allocated to each distinct deliverable and income recognition criteria would need to be considered separately for each distinct deliverable. (See detailed example below).
2. Construction and other similar long term contracts. Although the general methodology for accounting for construction and other similar long term contracts has not changed, changes in detail to the methodology may result in changes to the recognition of profit between financial periods. (See separate section below on construction contracts).
3. Contracts where there are material upfront costs associated with obtaining or preparing for the contract (See separate section below on contract costs)

Transitional Arrangements (See paragraphs 1.61 to 1.67)

There two options available:

1. A full prior year adjustment, with amendment of comparatives.
2. An adjustment only in respect of contracts which are still in progress at the start of the first financial year, the adjustment being made against opening reserves. In this case, no amendment to the comparatives is necessary.

The new 5 step methodology

The methodology comprises the following 5 steps:

• Identify the contract with a customer.
  1. This involves, initially, determining that there is a commercial contract in place with a customer which meets the definition of a contract as set out in the standard. It also involves assessing whether two or more related contracts should be combined and considered together for the purpose of income recognition.
  2. Where, during the course of the delivery of a contract, significant modifications to the contract deliverables are agreed, the standard sets out criteria which determine whether this constitutes a new contract with potentially different recognition criteria.

 Identify the performance obligations in the contract. This step involves determining whether:

• 1. there is a single supply of distinct goods or services
  2. there is a supply of a bundle of distinct goods and services where the performance obligation of each element of the bundle may be met at different times
  3. there are a series of the same goods or services (usually services) which are being provided over a period of time. This could range from a long term construction contract to a membership.

• Determine the Transaction Price. Where the contract price is potentially variable (because of features such as discounts, rebates, refunds, penalties or performance bonuses). the standard offers two options for calculating the price. These are:
  1. The expected price (which is the sum of probability-weighted amounts)
  2. The most likely amount (which is the most likely outcome in a range of expected outcomes)

Variable consideration should only be recognised when it is highly probable that it will be received.

The standard also sets out when the time value of money must be taken into account

• Allocate the transaction price to the promises in the contract.
  1. This will usually only be necessary where there is a supply of a bundle of distinct goods and services where the performance obligation of each element of the bundle will be met at different times.  A common example included in technical releases is a mobile phone company providing a phone and a mobile telecoms service under a two year contract for a monthly fee. In this case, the total fee receivable from the customer has to be divided between the phone (where the performance obligation is satisfied at the point the phone is delivered) and the telecoms service (which is being provided over two years). The example below shows how this is done in practice.
  2. The methodology which must be used when allocating the contract price is the stand-alone price of each element of the bundle. Where there is no readily available stand-alone price, an estimate must be made. The example below explains how this works in practice.

• Recognise revenue when the entity satisfies a promise.
  1. A significant part of the standard deals with the methodology to be applied where goods or services (usually services) are being provided over a period of time. (The standard sets out the criteria for determining when goods and services are being delivered over time as distinct from a single point in time). Whether the entity is carrying out a construction contract or providing ongoing services, or providing facilities to members, it will be required to measure the percentage of the performance obligations which have been delivered as the contract progresses.
  2. The options available to measure the performance obligations completed to date are not too dissimilar from the existing standard and are categorised as either an outputs method (the percentage value provided to the client to date) or an inputs method (the costs or efforts put into delivering the contract to date).
  3. Outputs methods include:
     1. Surveys of work completed (common for construction contracts)
     2. Units delivered

• Time elapsed (where performance is delivered over time such as a subscription or a telecoms service)

1. Inputs methods include:
   1. Costs incurred to date where the costs reflect the performance delivered (this is a common alternative method in the construction industry)
   2. Labour hours where these reflect the performance delivered

• Time elapsed (where an entity’s efforts are delivered evenly over time)

Example

The following example has been extracted from ICAEW guidance on the updated FRS 102:

Contract Costs

Under the amended standard, the initial costs of obtaining the contract cannot be added to contract costs as they do not relate directly to the delivery of the goods or services under the contract. This is a significant change from the existing FRS. Instead, the costs of obtaining or preparing for (fulfilling) the contract may be capitalised as an asset provided the costs meet certain criteria. (The decision to capitalise these costs is an accounting policy choice). To meet the criteria for capitalisation, it would need to be demonstrated that the costs would not have been incurred if the contract was not secured and that they are expected to be recovered. Once capitalised, the asset would be depreciated over the contract term.

Other matters

The updated standard covers a number of specific performance obligations and payment options which are not covered in the existing FRS. For example:

1. Non-refundable upfront fees. These are required to be treated as advance payments for goods or services to be provided and are therefore not recognised on receipt.
2. Licence revenue. A distinction is made between a ‘grant of use’ (which should be accounted for at a point in time), and a ‘grant of access’ (which should be recognised over the term of the contract).
3. The nature of the warranty determines whether this is treated as a separate supply from the supply of goods.

Effect of the new requirements on Construction Contracts

As noted above, there is a potential impact on construction contracts as set out in the table below. Although the effect on construction contracts has been highlighted by commentators on the updated FRS 102, there would be the same effect on any long term service contract.

Effect of the new requirements on Charities

The Charities SORP module on income recognition is now divided into two sections with commercial income (exchange transactions) dealt with separately from voluntary income such as donations and legacies (non-exchange transactions). The SORP recognises that grant income can potentially fall into either category and it sets out the criteria which determine how grants should be classified. Essentially, if there is a formal contract with a third party and that third party receives goods or services from the charity of equivalent value to the grant, the grant should be classified as an exchange transaction. In practice, it may be difficult to determine whether a grant is an exchange or a non-exchange transaction, particularly where the third party is a government agency or local authority and where there are performance conditions attached to the grant.

The section dealing with exchange transactions provides some examples of how the new five step income recognition model would apply. They include:

1. Subscription income which entitles members to specific goods and services. In this case, the value of each of the goods and services provided would need to be valued and the income recognised as the goods and services are provided to the member
2. Subscription income which entitles the member to free access to the charity’s heritage buildings or gardens. Where the member is entitled to free entry at any time and the charity simply commits to keeping the building/garden open, the income would normally be recognised evenly over the subscription period.
3. Education services. Where the contract requires a course to be provided to beneficiaries over a period of time, the income would be recognised by reference to the course sessions provided.
4. Welfare services such as a helpline. Where a grant is funding a service such as a helpline, the income would be recognised evenly over the contract period.

The section dealing with non-exchange transactions has not amended the existing income recognition criteria in practical terms. Although the recognition principles have been redrafted so that there is no longer any reference to ‘entitlement’, the entitlement requirement is still implicit throughout the section. There is also no change to the recognition criteria where grant income is received with performance related conditions. As before, the income must not be recognised until the conditions have been met. The SORP notes that some grants with performance related conditions requiring a level of output or service may be non-exchange transactions. However, unlike for exchange transactions, there is no guidance on how to recognise the income where the conditions are met at different points in time or gradually over time.

About the Author

Kevin Lally

Senior Partner

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