The new revenue recognition standard IFRS 15
The year 1993 marked the issue of IFRS 11 “Construction Contracts” and IFRS 18 “Revenue”, and it was a time when some of us were still attending the school. Since then, a number of amendments have been made to the above-mentioned standards as a result of the issuance of new International Financial Reporting Standards (IFRS). In addition, IFRS and a number of Interpretations related to income have been issued. For example, IFRIC 13 “Customer Loyalty Programs”, IFRIC 15 “Agreements for the Construction of Real Estate”, and IFRIC 18 “Transfers of Assets from Customers”.
The new revenue recognition standard IFRS 15 “Revenue from Contracts with Customers” is effective for accounting periods beginning January 2018.
The main difference is that revenue will be based on the changes in assets and contract liabilities. All contracts will be analyzed as contract assets and contract liabilities. Revenue would only be recognized when either the net contract liability is reduced or the net contract asset has increased as a result of the performance of the entity’s contractual liabilities. The transfer of control evidences the fulfilment of obligations.
IFRS 15 includes a five-step model framework. Changes under each of them were as follows:
Identify of contracts with a customer. In some cases, the distinction between whether the parties act as an agent in a contract or as a customer has changed. House builders were obliged to separate the sales of new buildings from the contracts to sell old ones taken on partial exchange basis, for example. This problem also affects companies in software, transportation, and property management. As a result, what was a commission cost may become a discount and so a reduction in revenue, and vice versa. The impact of such changes was less on the bottom-line profit than on gross revenue or the reporting margins of different business directions, but in some companies, the impact can be equally significant on both.
Identify separate performance obligations in the contract. As it was expected, this change had the biggest impact. The greater unbundling required by IFRS 15 changes the timing of revenue recognition and profit, and this means that retained earnings will be restated. For example, the separation of the sale of equipment and software from the provision of services, maintenance, and installation accelerated the recognition of revenue/profit for mobile phone contracts; for others, the recognition of income for previous periods has been derecognized and deferred. In case of property developers, revenue should be allocated to five-year warranties provided as part of the “package” and cannot be merely allocated as a provision for the estimated cost of claims.
Determine of the transaction price. Companies do not distinguish major changes in the treatment of variable consideration. This indicates that volume discounts or bonuses on milestones, for example, have already been accounted for cautiously. IFRS 15 mainly changes treatments to a greater extent on contract acquisition costs. It was not covered by the previous standard, but now such costs must be allocated in advance in line with revenue. Apparently, some engineers involved in large equipment sales, mobile phones companies, house builders had previously written off substantial commissions to intermediaries as they incurred.
Allocate the transaction price to the different performance obligations. The option to disregard the financing element when the time difference between receipt of cash and performance under contract is less than 12 months, is widely used where there are substantial customer down-payments. The requirement to identify standalone selling prices for separate performance obligations was considered by many entities to be difficult to apply and it was a requirement where a certain degree of judgement was necessary.
Recognize revenue when the performance obligations are fulfilled. The key criterion for fulfillment under IFRS 15 is that control passes to the customer, either at a point in time or over time. It is difficult to determine the consequences from this from the separate performance obligations of equipment delivery and service.
There are also more important detailed effects – for example, the transition from percentage of completion method to proportion of costs incurred method for the measurement of milestones achieved. In real estate projects, the point in time for sale changes from the exchange of contracts and actual completion of construction to legal termination of the contract.
It may seem unclear that, even under IFRS 15, all housing projects will have the same revenue recognition model, but some may be recognizing over time, while others at a point in time.
Transition and restatement
Companies seem to be divided equally between companies with full retrospective restatement and those who choose the modified approach. Large number of companies did not make the final choice at the end of 2017, even for the interim reports in 2018, for many the choice of transition remains still not clear. Thus, users may not be aware of whether the previous year’s numbers are comparable or not.
Restatements can be an increase or decrease, although the telecoms companies have seen steady increase as a result of prior recognition of the sale of equipment.
Much about adoption of the new standard in 2018 remains to be disclosed and evaluated. The absence of full retrospective restatements means that the real impact on profit will not fully emerge until the publication of the reports for the fiscal year 2019.
Today, the impact of IFRS 15 is variable – what has changed varies (and may be in the details of the standard), as does the degree of impact from one entity to another, and some sectors (e.g. retail and property investments) have hardly been affected.
In general, the impact of IFRS 15 on profit or net assets may be insignificant, although the effort required to implement it may be significant as companies try to understand fully many types of contracts with customers.
So has it all been worth it? The benefits of improved reporting – greater clarity and consistency, and better disclosure – will probably only become evident only in future periods when the new accounting standard becomes fully embedded into corporate reporting.
Overview of ACCA articles under the new IFRS 15
Y. V. Staroverova, FCCA