Financial Reporting Brief
Our featured article for May is 'Revenue Standard - Moving Towards Implementation' with Brendan Sheridan commenting on the challenges to be dealt with in the implementation of IFRS 15 and the recent amendments made to the Standard.
Revenue Standard - Moving Towards Implementation
Up to forty implementation issues in less than two years!
The International Accounting Standards Board (IASB) and the US Financial Accounting Standards Board (FASB) have had a busy nigh-on two years examining potential implementation issues in relation to IFRS 15 ‘Revenue from Contracts with Customers’ since its publication in May 2014, working through their Transition Resource Group (TRG).
The IASB has recently concluded its participation in the TRG and has crystallised its conclusions into targeted amendments in three areas of IFRS 15 as well as some transition relief.
These recent amendments and clarifications should help entities with their consideration of the implementation process. Surveys in various jurisdictions would indicate that many of those that will potentially be impacted by IFRS 15 are still in the early stages of assessing the effects of the new standard or have not yet begun the process.
Many companies are engaged in business activities which by their nature have arrangements or contracts in place on an ongoing basis which will carry through the transition period and into implementation. Entities need to determine whether the particular arrangement or contract is within the scope of IFRS 15 and how to measure and account for revenue. This may not always be clear cut.
Approach to Recognition
IFRS 15 introduces a five-step model for revenue recognition that focuses on the ‘Transfer of control’ rather than the ‘Transfer of risks and rewards’. The five-step model is as follows:-
Step 1: Identify the contract with a customer
Step 2: Identify the performance obligations in the contract
Step 3: Determine the transaction price
Step 4: Allocate the transaction price to the performance obligation
Step 5: Recognise revenue when (or as) the entity satisfies a performance obligation
It is not likely that IFRS 15 will have any significant impact on a number of different classes of business activity, which include ‘single-stage’ and ‘over the counter’ transactions of a ‘plain vanilla’ nature. Industries which are likely to have arrangements and transactions of a nature which will be significantly impacted by IFRS 15 include those where transactions have multiple elements or extend over a period of time. Such companies are likely to have relatively detailed and complex accounting policies in relation to revenue which will require full consideration in light of the changing and additional requirements.
Deloitte has published seventeen industry guides on the implications of IFRS 15. These are all available on www.iasplus.com
Questions to be addressed?
Particular questions which the industry guides address include:-
- The impact of the new standard on allocating revenue to all goods and services in a contract
- Whether an entity is able to apply the portfolio approach to groups of contracts
- How to account for contract modifications
- Whether revenue must be adjusted for the effects of the time value of money
- Whether revenue should be recognised over time or at a point in time
- How to account for pricing mechanisms which will include variable amounts
- Whether particular costs relating to obtaining a contract must be accounted for separately
The above list is not exhaustive but highlights that the profile of revenue and profit recognition will change for many entities.
Although determining whether the contract is, in fact, with a customer may seem simple conceptually, in practice it may be challenging for different types of contracts e.g. collaborative arrangements, production-sharing contracts, concession agreements and other similar risk-sharing contracts.
The New Amendments
The three areas of IFRS 15 where the IASB has considered it appropriate to amend IFRS 15 are:-
- Identifying performance obligations – to clarify the concept of ‘distinct’, an entity needs to determine whether the nature of the promise, within the context of the contract, is to transfer each of these goods or services individually or, instead, to transfer a combined item or items to which the promised goods or services are input.
- Principal versus agent considerations – to clarify how to assess control and determine whether an entity is acting as a principal or agent, the IASB has amended and extended the application guidance on the issue.
- Licensing – the amendments address circumstances where the contract requires the entity to undertake activities that significantly affect intellectual property to which the customer has rights. To clarify when an entity’s activities significantly affect the intellectual property, the IASB has amended the application guidance.
Deloitte has published IFRS in Focus ‘IASB clarifications to IFRS 15’ with our comments and observations.
The volume of implementation considerations undertaken by the TRG led to a change in the effective date of IFRS 15 with a deferral of one year to accounting periods commencing on or after 1 January 2018, with earlier application permitted.
In respect of comparative periods, entities have the option of using either retrospective application or a modified approach under which comparative periods are not restated. Instead, an entity recognises the cumulative effect of initially applying the Standard as an adjustment to the opening balance of retained earnings on the effective date. If an entity elects to use the modified approach it must disclose the impact of the change on the financial statement line items and include a description of significant changes.
The recent amendments to IFRS 15 provide two additional practical expedients with regard to transition relief, avoiding the need to restate contracts in certain circumstances.
To comply with the new accounting and disclosure requirements, many entities will have to meet the challenges of (1) documenting new or different judgements, and (2) gathering and tracking information that they may not have previously monitored. The systems and processes associated with such information may need to be modified to support the capture of additional data elements that may not currently be supported by legacy systems. To ensure the effectiveness of internal controls over financial reporting, management are likely to need to assess whether there is a need to revise existing controls or implement additional controls.
In assessing the effect of applying the new standard on systems, processes and internal controls, entities on which IFRS 15 impact will need to determine how to deal with such matters as (a) identifying all goods and services in a contract, (b) estimating stand-alone selling prices for individual performance obligations, (c) dealing with variable consideration, and many other implementation challenges.
The implementation of the new standard is a major challenge for many entities. While 2018 may for some seem a distance way, time will pass quickly and in many cases transactions are already in progress or in the pipeline which will be directly impacted by the new standard. Entities may be at differing stages of planning and implementation and a change-management project plan to include assessing the effects of the new standard and developing policies and systems to facilitate its implementation would be of significant value in managing to avoid any unwelcome challenges or surprises further down the line.
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