The following article was originally published by Wiley.
“The detail required for revenue under contracts with customers that have not yet been recognised poses a practical issue in that for many entities this information is likely to be outside of the accounting system. There is therefore a need to assemble the required disclosure which for many entities is likely to add to the Excel collage supporting the financial reporting, with all the inherent risks over completeness and manual errors.”
- Which types of transactions will the new standard have the greatest impact on and which industry sectors will be most affected?
The previous revenue standard used a risk and reward model for recognition, such that revenue was recorded if the significant risks and rewards of ownership had transferred to the customer. The new standard applies a control based model, such that revenue is recognised when control over the good or service passes to the customer. While the actual effect on reported revenues may not be substantial for many sales transactions because risks and rewards pass at the same time as control there will be a need for many entities to rigorously apply the new model to their revenue streams to ensure proper reporting.
Under IFRIC 15 the percentage of completion method was allowed for construction projects where the criteria in IAS 18.14 (the first of which is the transfer of the significant risks and rewards of ownership) were continuously met as construction progressed. With the change from a risk and rewards model to a control model, there may be changes required in the timing of recognising revenues from construction contracts.
IAS 18 included very limited guidance for recognising revenues where a contract comprises separately identifiable components. The guidance in IFRS 15 is significantly more detailed, and includes guidance for identifying the performance obligations in a contract and for allocating the transaction price between them. The circumstances in which the residual approach can be used to allocate the transaction price have been narrowly defined.
Any industry in which entities typically enter into contracts with multiple deliverables will be affected. Such arrangements are common in the telecommunications and software industries but also arise, for example, where any tangible product is sold along with either installation services or a maintenance contract.
- Do you anticipate that preparers will have difficulty identifying individual performance obligations and allocating the transaction price across them? If so, are there particular types of transactions where you believe this will be particularly problematic?
A performance obligation is a promise in a contract with a customer to transfer to the customer either: a good or service (or a bundle of goods and services) that is distinct, or a series of distinct goods or services that are substantially the same and have the same pattern of transfer.
Determining whether identified goods and services are distinct will often require a degree of judgement given the criteria that must be met: the customer must be able to benefit from the good or service either on its own or together with the customer’s existing resources and the good or service must be distinct within the context of the contract.
Software entities are again a good example of such transactions because a licence to software is often sold along with services to integrate the software with the customer’s existing systems. Determining whether a licence to software is distinct from the integration services may be a fine line, which is ultimately determined from the customer’s perspective despite the additional guidance provided in paragraph 28.
The transaction price is allocated to each performance obligation on a relative stand-alone selling price basis. The best evidence of a stand-alone selling price is an observable price when the entity sells the good or service in similar circumstances and to similar customers. When a stand-alone selling price is not available the amount that the entity expects to receive in exchange for each performance obligation must be estimated considering all information that is reasonably available.
The difficulty in such estimation will be exercising judgements consistently across contracts and across group entities.
- Do you anticipate that preparers will have difficulty determining whether a promised good or service is a performance obligation satisfied over time if it is unclear that the customer obtains control of the good or service over time? If so, are there particular types of transactions where you expect this may arise?
A good or service is a performance obligation satisfied over time if one of the following criteria is met:
(a) The customer simultaneously receives and consumes the benefits provided by the entity’s performance as the entity performs;
(b) The entity’s performance creates or enhances an asset that the customer controls; or
(c) The entity’s performance does not create an asset with an alternative use to the entity and the entity has an enforceable right to payment for performance completed to date.
This may arise in the software industry where a customer contracts to purchase both a license for the entity’s own software and also integration services. If the software licensed to the customer can be used on a stand-alone basis prior to it being integrated with the customer’s other hardware and software systems then a conflict exists as to when the customer takes control of the license: either on signing and delivery for the stand-alone use (because the customer obtains control of the asset), or as a bundle with the integration services (which could satisfy either b or c above, depending on the circumstances).
- Do you anticipate that an entity will encounter practical difficulties in preparing some of the required additional disclosures? If so, which disclosures and why?
The level of detail required to be disclosed is significantly increased from the prior revenue standards. There are two areas that may be problematic: first, revenue under contracts with customers that have not yet been recognised because the performance obligation has not been discharged (paragraphs120-122), and second the level of qualitative disclosure required.
The detail required for revenue under contracts with customers that have not yet been recognised poses a practical issue in that for many entities this information is likely to be outside of the accounting system. There is therefore a need to assemble the required disclosure which for many entities is likely to add to the Excel collage supporting the financial reporting, with all the inherent risks over completeness and manual errors.
Qualitative explanations and descriptions are required throughout the disclosure section of the standard. Examples include: an explanation of the timing of satisfying performance obligations and the timing of payments; detailed descriptive information about performance obligations; and a description of when future revenue will be recognised.
In applying the standard, the qualitative disclosures required are not defined. Therefore entities will have to rely on the general principle regarding the objective of disclosures: to disclose sufficient information to allow users of financial statements to understand the nature, amount, timing and uncertainty of revenue and cash flows arising from contracts with customers.
The standard includes concessions for disclosures during the transition period: for example entities need not present qualitative information required by paragraph 28 of IAS 8 for the prior period.
- What are some of the key issues an entity should consider when planning to transition to the new standard?
Issues to be considered in the run up to adoption of the new standard include:
- As with any new accounting standard that has an effect on financial performance, entities must consider the effect on the timing of revenue recognition and whether loan covenants will still be satisfied. If the changes in recognising revenue will mean covenants are breached the terms of loan agreements should be raised early with lenders.
- Similarly, early communication with investors would be desirable once the effect on operating results is determined to set expectations and avoid surprises.
- The transition method to be adopted is a decision that should be considered and concluded early.
- Entities should consider desirable system and process changes in order to generate the required information for both accounting and disclosures.
- For consolidated groups the consistency of exercising judgements and making estimates should be determined by the parent and disseminated to group entities.
- In Canada the measure of income used for income tax purposes starts with income determined under GAAP unless the tax legislation requires some other measure or adjustment. Since the effect of the new standard on accounting income may be substantial for some entities, the tax consequences should be considered early in the process.
- A joint International Accounting Standards Board (the Board) & FASB resource group has been set up to discuss implementation issues. What type of implementation issues do you see this group addressing in the future?
With the new standard the additional guidance will be more useful in accounting for complex transactions. While it is difficult to speculate about the issues that will be considered by the resource group, the one issue likely to be addressed is the consistency of accounting for similar transactions.