The first three steps in recognition of revenue under the revised IFRS for SMEs standard require identification of a contract, unpacking its performance obligations, and determining the transaction price. The fourth step explores a critical question: how should that price be allocated?
At first glance, the answer may appear obvious. If a customer agrees to pay R2 million for a package of goods and services, surely each component simply receives a proportion of that amount.
In practice, Step 4 introduces a level of discipline that many SMEs have never previously applied. Once multiple performance obligations have been identified within a contract, the transaction price must be allocated to each performance obligation based on its relative stand-alone selling price.
This requirement represents a significant departure from traditional approaches where revenue was often recognised based on invoiced amounts or arbitrary internal allocations.
From Contract Value to Promise Value
The revised Standard, effective for annual periods beginning on or after 1 January 2027, requires entities to view contracts through the lens of individual promises made to customers.
The objective is straightforward: each performance obligation should receive an amount of consideration that reflects the value the customer places on that specific promise.
This ensures that revenue is recognised in a manner that faithfully depicts the transfer of goods and services to customers.
The allocation process becomes particularly important where contracts contain bundled offerings, discounts, incentives, or pricing structures that differ from the sum of individual selling prices.
The Foundation: Stand-Alone Selling Prices
The starting point for allocation is the stand-alone selling price of each distinct good or service.
A stand-alone selling price is the amount an entity would charge a customer if that good or service were sold separately.
Where observable prices exist, the exercise is relatively straightforward. However, many SMEs regularly bundle products and services together, meaning stand-alone prices may not always be readily available.
In such cases, management must estimate stand-alone selling prices using available market information, expected costs plus an appropriate margin, or other reasonable methods.
The emphasis is on achieving a reasonable allocation that reflects economic reality.
Example: Ubuntu Office Furnishings – Allocating a Package Deal
Assume Ubuntu Office Furnishings (Pty) Ltd enters into a contract to provide customised office furniture and installation services for a total contract price of R2 million.
If sold separately, the stand-alone selling prices would be:
- Furniture: R1.8 million
- Installation Services: R400,000
The total stand-alone selling prices equal R2.2 million.
Although the customer only pays R2 million, the transaction price must be allocated proportionately:
- Furniture: R1.8m ÷ R2.2m × R2m = R1.636 million
- Installation: R400k ÷ R2.2m × R2m = R364,000
Revenue is therefore recognised based on these allocated amounts rather than the nominal values management may have assigned internally.
This ensures that the contract discount is shared proportionately across all performance obligations.
When Discounts Require Judgement
One of the more challenging aspects of Step 4 arises when discounts do not relate equally to every promise within a contract.
The revised Standard recognises that, in some circumstances, a discount may clearly relate to one specific performance obligation rather than the contract as a whole.
Where sufficient evidence exists, the discount may be allocated entirely to the relevant performance obligation.
This requires careful analysis of pricing practices and customer purchasing behaviour.
Example: Jozi Solar Solutions – Targeted Discount
Jozi Solar Solutions (Pty) Ltd enters into a contract comprising:
- Solar system design
- Installation
- Ongoing monitoring services
The company routinely discounts installation services during promotional periods while charging standard rates for monitoring subscriptions.
If the bundled contract includes a discount that clearly relates only to installation services, management may allocate that discount entirely to the installation component rather than spreading it across all performance obligations.
This approach more accurately reflects how the transaction was priced commercially.
Variable Consideration and Allocation
Step 4 also interacts closely with Step 3.
Where the transaction price includes variable consideration such as performance bonuses or rebates, entities must determine whether the variable amount relates to:
- the contract as a whole, or
- a specific performance obligation.
If the variability relates specifically to one obligation, the amount may be allocated directly to that obligation provided doing so faithfully depicts the economics of the arrangement.
This prevents unrelated goods or services from being affected by performance measures that do not concern them.
Why Step 4 Changes Financial Reporting Behaviour
For many SMEs, allocating the transaction price may appear to be a technical exercise. In reality, it influences the timing and pattern of revenue recognition throughout the life of a contract.
The allocation determines:
- how much revenue is recognised for each performance obligation,
- when revenue is recognised,
- how discounts affect reported performance, and
- whether financial results accurately reflect commercial substance.
The process prevents entities from accelerating revenue recognition by assigning disproportionate value to obligations satisfied earlier in a contract.
Governance and Practical Implications
The introduction of Step 4 will require SMEs to develop a deeper understanding of their pricing models and sales practices.
Entities may need to:
- document stand-alone selling prices,
- analyse bundled offerings,
- review discount structures,
- align sales and finance teams on pricing decisions, and
- maintain evidence supporting allocation methodologies.
Auditors are expected to scrutinise these allocations carefully, particularly where significant judgement has been applied.
Ultimately, Step 4 reinforces one of the core principles of the revised IFRS for SMEs: revenue should reflect the value of promises made to customers and recognised as those promises are fulfilled.
In doing so, the Standard continues its progression away from invoice-based accounting and toward a model that faithfully depicts the economic substance of customer contracts.
