Hailed as a significant milestone in financial reporting, IFRS 15 Revenue from Contracts with Customers is less than a year away from implementation.
Having taken up to 15 years to come to fruition, IFRS 15
Revenue from Contracts with Customers can be held up as a truly aligned Standard between the US and international standard developers. Not only will it lead to better alignment between a company’s revenue and performance in the vast majority of situations, it will also in large measure provide a one-stop-shop for revenue accounting for companies that use IFRS and US GAAP, regardless of the sector or capital market they operate in. This will in turn help investors in their analysis and comparison of companies and their accounting for revenues.
The challenge is now whether companies are ready for implementation.
The final countdown
With little over six months to go, companies need to be sure that the correct foundations are in place. The European Securities and Markets Authority (ESMA) called for consistent and high quality implementation of IFRS 15 and the need for transparency regarding its impact on financial statements. ESMA also called on issuers to ensure appropriate disclosure of both the qualitative and quantitative considerations involved in introducing the new Standard, and the manner in which accounting policies may change.
With many companies about to enter interim reporting season, it will be their last opportunity to ensure investors and other stakeholders are fully informed about the implementation of IFRS 15. Investors and others will have a realistic expectation that the full picture will be made clear before the transition to the new Standard.
What will change?
IFRS 15 contains a new set of principles on when and how to recognise and measure revenue, based on the principle of ‘control’ rather than the ‘risk and rewards’ approach in current standards. While in some circumstances the impact of the implementation may be limited (e.g. straightforward retail transactions), for other transactions such as long-term contracts and multiple element arrangements, the impact on the amount and/or timing for recognising revenue may differ significantly from current practice. Even with what appear to be straightforward retail transactions, one needs to be alert to any additional features such as financing of transactions, possible rebates, sales support, extended warranty and so on.
The core principle underlying the new model is that an entity should recognise revenue in a manner that depicts the pattern of the transfer of goods and services to customers. The amount recognised should reflect the amount to which the entity expects to be entitled in exchange for those goods and services.
As the Standard requires issuers to allocate the transaction price to all identified performance obligations included in a contract and to recognise revenue when (or as) the performance obligations are satisfied, issuers may need to, for example...
- Change the methodology in place to identify the performance obligations included in a contract and, also, to assess whether there is a significant financing component;
- Adjust their internal procedures to assess the progress towards satisfaction of performance obligations, and to recognise revenue over time;
- Determine variable considerations; and
- Assess the impact on the recognition of revenue derived from licences.
IFRS 15 makes available to entities a number of options on transition. The options chosen may have a significant impact in such areas as accounting for contracts, which pre-date transition.
Judgements and estimates
Under IFRS, IAS 1 deals with distinct requirements relating to disclosure of the judgements and estimates made by management that have the most significant effect on the amounts recognised in the financial statements with regard to:
- Disclosure of the judgements that management has made in the process of applying the entity’s accounting policies; and
- Disclosure of information about the assumptions the entity makes about the future and other major sources of estimation uncertainty.
Examples of potential areas where judgement may arise that require disclosure include revenue recognition, for example, (1) in complex cases such as those involving multiple element arrangements; (2) assumptions regarding the value and recoverability of assets under customer contracts; (3) the impact of variable consideration; and (4) recognition of revenue for warranties, and many other matters.
Whereas IFRSs previously allowed significant room for judgement in devising and applying revenue recognition policies and practices, IFRS 15 is more prescriptive in many areas. Applying the new standard may result in significant changes to the profile of revenue and, in some cases, cost recognition.
Practical matters for consideration
In addition to preparing the market and educating analysts on the impact of the new standard, entities will need to consider wider implications. These may include:
- Changes to key performance indicators and other key metrics;
- Changes to the profile of tax cash payments;
- Availability of profits for distribution;
- Impact on employee compensation and bonus plans; and
- Potential non-compliance with loan covenants.
Other issues that could arise in implementing the new Standard may include:
- Contracts may not be as ‘standard’ as expected – the terms and conditions of the customer contract are critical to applying the IFRS 15 accounting model. Many companies are finding that their contracts are less than straightforward and they may, inter alia, need legal interpretation;
- The volume of data can be very challenging, with possible shortcomings of legacy systems compounding the difficulties;
- The Standard deals with both revenue and the incremental costs of obtaining a contract; and
- Education is needed throughout the company on new systems and processes.
Final steps on the road
Some companies may still need to make significant progress to get to the finish line in time and may be lagging behind in their preparations. It is important that all companies keep stakeholders informed and provide informative disclosures about the status of their efforts. Matters that may need to be considered include:
- Careful evaluation of detailed information regarding the nature, design and economic substance of the contract with the customer;
- While in some cases the presentation of revenue may remain the same as under today’s revenue guidance, the evaluation will need to be based on the new standard and its new concepts;
- Companies may need to exercise more judgment under the new standard than they do currently with potential consequences for internal control processes over financial reporting; and
- Companies should provide useful disclosures to investors about the impact of adopting the new standard.
Even if the extent of change for a particular company is slight, the related disclosures to describe revenue streams may not be. IFRS 15 addresses comprehensive disclosures about contracts with customers, including the significant judgements made.
Conclusion
IFRS 15 is a major change for companies, the full extent of which will depend on the class of business, nature of activity and the complexities involved. Time and resources must be invested by companies to ensure their readiness for implementation of the standard and to avoid any unwelcome surprises.
Brendan Sheridan FCA is Director, Audit & Assurance at Deloitte.