Will your Data Architecture change due to IFRS 15?
Examples of Data challenges in implementing the new revenue recognition standard
The objective of the new IFRS 15 standard is to implement a more consistent approach to recognize revenue and associated contract costs. In our previous article we concluded IFRS 15 can have significant impact on the Data Architecture of an entity. This article describes specific examples of potential changes in the Data Architecture due to IFRS 15.
Organizations implementing IFRS 15 will be faced with a number of key challenges in each of the 5 steps to recognize revenue and mandatory disclosure requirements. In our previous article we concluded IFRS 15 can have a significant impact on the Data Architecture of an entity. This article provides specific examples of the potential impact of the new revenue recognition standard. The IFRS 15 standard however is complex and this article does not intend to provide an exhaustive list of examples.
Step 1: Identify the contract with a customer
- Modifications to contracts, such as changes to price or scope, should be assessed if the added performance obligations can be considered distinct and priced at stand-alone selling price. Business rules should be implemented to automatically determine if contract modifications are considered a new contract or part of the original contract. Furthermore, if the modification is part of the original contract the revenue should be accounted retrospectively which requires specific calculation logic.
- Contracts should be accounted on an individual basis but similar contracts and performance obligations should be processed consistently. Therefore entities in some cases are required to combine contracts in a portfolio approach. From a contract management perspective, contract data and conditions need to be recorded separately to accurately recognize revenue in the following steps. Appropriate data points should be defined to be able to assess the similarity of performance obligations and substantiate the portfolio approach.
- Identifying incremental costs of obtaining a contract. These incremental costs must satisfy specific requirements and should be recorded in an operational system or database providing sufficient evidence that these costs satisfy the requirements. These costs are capitalized over time (or a point in time) in step 5 as the performance obligation stated in the contract is fulfilled.
Step 2: Identify performance obligations in the contract
- IFRS 15 has specific requirements for bundling or unbundling of performance obligations to identify distinct performance obligations. To appropriately account for performance obligations the Order to Cash process must be able to record different types of orders and distinguish between bundled or unbundled sales. Another option is to define business rules in the revenue recognition logic based on product type and / or product ID.
Step 3: Determine the transaction price
- When a contract contains variable considerations such as discounts, performance bonuses, rebates, right of return, penalties, the revenue recognized should either the expected value or the most likely amount. To determine this amount the revenue recognition logic needs to take into account historic transaction data or be able to approximate the total amount of consideration.
Step 4: Allocate the transaction price to the performance obligations in the contract
- The transaction price of goods or services underlying the performance obligations should represent the amount of consideration the entity expects to be entitled in the exchange. The transaction price, however, might differ due to market conditions or the specific class of customers the goods or services are sold to. Data should be available of the stand-alone selling prices of each performance obligation.
Step 5: Recognize revenue when the entity satisfies a performance obligation
- Revenue recognition and capitalization of contract costs should be based on the transfer of control. Either control is transferred over time or instantly at a point in time. The entity is required to record per performance obligation the type of transfer. When revenue is recognized over time the entity needs to have sufficient data to track the transfer of control, such as percentage of distance covered by goods in transit, time elapsed, milestones reached, units produced or delivered, labor hours, costs incurred or a combination of these data points.
- To process transactions with regard to gift cards, coupons and vouchers the entity needs historic data to properly allocate the revenue for the initial sale and subsequent transactions. For warranties and gift cards the entity needs to determine an appropriate return rate, which can develop over time and differ per product and / or client category.
- The IFRS 15 standard requires that revenue should be disaggregated into meaningful categories. The General Ledger might not contain all relevant data points to disaggregate revenue into these meaningful categories. As such this information needs to be extracted from other source systems or databases where this data is available.
- Availability of aggregated and granular data regarding changes in balances of rights and obligations during the period under review. Accounting system do not always contain the necessary data points for analysis of these changes.
Determining your impact for IFRS 15
Entities will need to assess the impact of IFRS 15 from a controlling and accounting perspective as well as a Data Architecture perspective. This assessment will help to determine the most (cost) effective method of implementing IFRS 15. For some entities the impact of IFRS 15 is limited, while other entities might need to make significant changes to their Data Architecture to capture more data points and / or data processing capabilities to properly calculate the revenue recognized and / or contract costs to be capitalized.
In less complex situations such as ‘simple’ consumer retail business the impact of IFRS 15 is limited, while in environments with more sophisticated contracts the impact can be extensive if the performance obligations are material to the financial statement. Analysis of the examples in table 1 clearly shows the complexity of IFRS 15 is primarily a result of these contracts with customers.
The introduction of IFRS 15 requires revenue recognition to become more data-driven if the entity has complex contracts with customers. The new standard requires robust contract & order management to record the required data points, implementation of business rules to recognize revenue and availability of historical data to properly recognize revenue and capitalization of contract costs according to IFRS 15 guidelines.
Would you like more information on IFRS 15? Please contact Frank Boerkamp via +31 (0)88 288 7285.
Note to the reader
This article contains a high level analysis regarding the implementation of IFRS 15 from a data architecture and data processing perspective. IFRS 15 is a complex subject which can have various consequences depending on specific considerations applicable to the entity. An assessment is required to determine the impact of IFRS 15 on individual entities.