Financial Reporting Brief - June 2014
This months article: Revenue – getting the top line right
Welcome to our financial reporting brief for June, our opportunity to update you on recent developments with our featured article which discusses "revenue – getting the top line right".
Revenue – getting the top line right
Six years after the International Accounting Standards Board (IASB) and the U.S. Financial Accounting Standards Board (FASB) published a joint Discussion Paper, which followed many years of development work, their efforts have come to fruition with the publication of a new standard on revenue recognition on May 28. This is a major step forward in financial reporting in one of the most important areas for entities. The U.S. currently has a plethora of largely industry-specific standards with considerable complexity while IFRS has had significant deficiencies in the guidance provided with much inconsistency in accounting for revenue. The new guidance standardises how companies should recognise revenue in financial statements under both IFRS and US GAAP.
For IFRS – adopters the Standard, IFRS 15, is effective for accounting periods beginning on or after 1 January 2017, with early adoption permitted. For US GAAP – adopters, the transition date is effectively the same for public entities but non-public entities have an additional year before transition. There are also decisions to be made regarding the manner of transition, with the option of either full retrospective application or a modified approach.
The core principle
The core principle underlying the framework of the new standard is that a company should recognise revenue to depict the transfer of promised goods or services to the customer in an amount that reflects the consideration to which the company expects to be entitled in exchange for those goods or services.
The standard outlines a recognition model based on the passing of control from supplier to customer with a process which involves five steps:
- Identify the contract(s) with the customer
- Identify the performance obligations (distinct promises) in the contract
- Determine the transaction price
- Allocate the transaction price
- Recognise revenue when a performance obligation is satisfied
The new model applies to all contracts with customers except those that are within the scope of other IFRSs, such as leases, insurance contracts and financial instruments. The recognition of interest and dividend income is not in scope and there are certain other exceptions.
Development of the standard
Progress to the final publication of the standard has been painstaking with a Discussion Paper in 2008 and Exposure Drafts in June 2010 and November 2011. With limited guidance available which was often difficult to apply to complex transactions, it has been quite common for IFRS – adopters to supplement the limited guidance in IFRS by selectively applying US GAAP guidance.
The limited guidance available has often led to revenue from contracts that are economically similar not being accounted for on a consistent basis. The new standard addresses deficiencies by specifying a comprehensive and robust framework for recognition, measurement and disclosure and reduces the need for interpretive guidance to be developed on a case-by-case basis to address emerging revenue recognition issues.
Some of the many aspects of revenue recognition for which IFRS 15 should provide improved guidance and help to ensure a consistent approach include:
- Timing of revenue recognition
- Estimates of variable consideration
- Non-observable selling prices of different components
- Incidental obligations and sales incentives
- Significant financing components
IFRS 15 includes a comprehensive set of disclosure requirements that require a company to disclose qualitative and quantitative information to help investors understand the nature, amount, timing and uncertainty of revenue.
The steps to recognising revenue have remained unchanged since the first ED in 2010 but there have been many changes to the detailed requirements in respect of their specific application. Therefore, a fresh read of the newly published standard is very much recommended. Since the 2011 ED some of the main areas under review include:
- Identifying performance obligations and how they are satisfied over time
- Collectability and customer credit risk
- Variable consideration and constraints
- Disclosure requirements
Change for some?
For many situations, such as relatively straightforward retail transactions, IFRS 15 will have little, if any, effect on the amount and timing of revenue recognition.
For other contracts, such as long-term service contracts and multiple-element arrangements, IFRS 15 could result in changes, sometimes significant, either to the amount or timing of the revenue recognised by a company. The new standard could especially affect businesses in such industries as telecommunications, software and real estate.
Even in instances where there is no change in accounting for a particular company, the new disclosure requirements are extensive, with, for example, greater disaggregation and considerably more required on significant judgements.
Deloitte has published on its IASPlus global website a number of IFRS Industry Insights on the application of IFRS 15 to a range of different industries (further information).
Readers in specific industries should find these of specific benefit in gaining an initial insight into how IFRS 15 will affect them. More detailed guidance will follow.
More than accounting
The profile of revenue and profit recognition may change for some entities, e.g. those with multiple element contracts, and the extent of disclosure will change for even more. IFRS 15 will impact on more than financial reporting and areas which companies should be particularly mindful of in planning for implementation of the new standard include:-
- Examination of existing contracts and identifiable performance obligations
- Analysis of existing accounting policies
- Tax changes caused by changing the timing and amount of revenue recognition may require adjustments to tax planning
- Systems and processes may need to be developed to capture data needed for any additional judgements, estimates and disclosures
- Staff bonus and incentive plans may need to be reconsidered
- Covenants and key conditions in funding arrangements may need to be examined
- Investors will need to understand the impact on the business and the results being reported
While the effective date of implementation of IFRS 15 may seem a long way off, it is important for companies to gain an early understanding of any changes in accounting and their broader implications so that action required in any of the above areas, or perhaps others, can be taken in an efficient manner. Planning early will yield benefits and avoid potential surprises, which may be more difficult to explain to the stakeholders at a later stage.
The new Standard has been through a lengthy and painstaking development process which should hopefully ensure that it will provide greater clarity and consistency to revenue accounting across industries and on a global basis. The IASB and FASB will be carefully monitoring the progress towards implementation and post-implementation and have formed a joint transition resource group which is intended to help the boards resolve any diversity in practice and address implementation issues as they arise.
Our Deloitte Global publication IFRS in Focus provides insight and observations on the new Standard (further information).
What’s new - monthly reporting pack
Irish GAAP / GAAS and related developments
- FRC comments on publication of the EU Audit Directive and Regulation
- FRC comments on publication of IMA Stewardship Code Survey
IFRS and related developments
- IASB and FASB issue new, converged revenue standards
- ESMA publishes IFRS enforcement report
- IASB clarifies depreciation and amortization
- IASB clarifies accounting for acquisitions of interests in joint operations
Regulatory and related developments
- First comprehensive review of the EU's financial regulation reform
- ODCE Annual Report 2013 published
- Central Bank publishes review of the credit union sector
- IFRS in focus — IASB issues new standard on revenue recognition
- IFRS project insights — Insurance contracts
- IFRS in focus — IASB amends IAS 16 and IAS 38 to clarify acceptable methods of depreciation and amortisation
- IFRS in focus — IASB issues amendments to IFRS 11 'Joint Arrangements' to address the accounting for acquisitions of interests in joint operations
Financial Reporting Brief
- May 2014: The quest for improved disclosure
- Quarterly Financial Report Brief: April 2014
- April 2014 - Sustainable investment – accounting a concern?
- Financial Reporting Brief special edition (March 2014): FRS 103 Insurance Contracts
- March 2014 - Annual reports – Achieving their goal?
- February 2014 - Pensions – more than an accounting challenge?
- January 2014 - Quarterly edition of financial reporting brief