One criticism of the current revenue standards is the limited guidance for certain transactions. For instance, there is no detailed guidance under International Financial Reporting Standards (IFRS) for multiple deliverable arrangements. To address this limited guidance and the differing guidance under IFRS and US Generally Accepted Accounting Principles (US GAAP), the International Accounting Standards Board (IASB) and the Financial Accounting Standards Board (FASB) jointly developed a common revenue standard that aims to: (1) remove inconsistencies and weaknesses in previous revenue requirements; (2) provide detailed guidance for addressing revenue issues; (3) improve comparability across entities and industries; (4) improve disclosure requirements; and (5) reduce the number of reference standards for revenue recognition. The new revenue recognition standard is known as IFRS 15, Revenue from Contracts Customers (ASU 2014-09 Topic 606 under US GAAP). It was released in May 2014 and will replace virtually all the current revenue standards under IFRS.
THE NEW REVENUE RECOGNITION MODEL
IFRS 15 is based on the core principle that “an entity recognizes revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled to.” To apply this principle, entities must go through the following five-step model in recognizing revenue:
• Step 1: Identify the contract with a customer. A contract (whether written, oral or implied by customary business practices) is an agreement between two or more parties that creates enforceable rights and obligations. In some cases, IFRS 15 requires an entity to combine contracts and account for them as one. IFRS 15 also provides guidance on accounting for contract modifications.
• Step 2: Identify the performance obligations in the contract. Performance obligations involve the transfer of goods or services to a customer. If there are multiple deliverables under a contract, IFRS 15 provides guidance on determining whether the goods or services are distinct and should, therefore, be accounted for separately.
• Step 3: Determine the transaction price. The transaction price is the amount of consideration to which an entity expects to be entitled in exchange for the promised goods or services. The transaction price can be a fixed amount, but may sometimes include variable or non-cash considerations. The transaction price also considers the time value of money.
• Step 4: Allocate the transaction price to the performance obligations in the contract. The transaction price is allocated to each distinct performance obligation on the basis of the relative stand-alone selling prices of each distinct good or service. Under certain criteria, the residual allocation method can be used.
• Step 5: Recognize revenue when or as the entity satisfies a performance obligation. A performance obligation may be satisfied at a point in time or over time.
MORE THAN AN ACCOUNTING CHANGE
Adoption of this new standard will result in major changes in the current way of accounting for revenue transactions. The following is an overview of some of these major changes:
• Oral and implied contracts, in addition to written contracts, are scoped in by IFRS 15. This would result in earlier recognition of revenue for some entities whose customary business practice is to start providing the goods or services even before a written contract has been signed.
• Unlike current revenue recognition standards, IFRS 15 provides more explicit requirements on how to account for contract modifications and when to combine contracts.
• For a single contract with multiple deliverables, applying the new standard may result in the identification of new or different performance obligations or deliverables compared to the deliverables identified under the current standards. IFRS 15 also has detailed guidance in assessing whether these deliverables are distinct from each other and, therefore, to be accounted for separately.
• Revenue is now measured based on the consideration that the entity expects to be entitled to. This is a significant change from the current measurement basis of fair value of the consideration received or receivable.
The new standard requires entities to consider in their transaction price elements other than the fixed contract price, such as variable considerations. Some examples of variable considerations are rebates, discounts, refunds and bonuses. Currently, entities may defer measurement of these variable considerations until the uncertainty is removed, which is usually when the final payment is received or these are granted. However, under IFRS 15, these variable considerations should be identified, estimated and constrained at contract inception date and reassessed moving forward. Thus, the transaction price or amount by which the revenue will be recorded may differ from the fixed contract price.
• The current standards provide limited requirements on multiple-element arrangements, particularly on the allocation of the contract price to these arrangements. IFRS 15 now prescribes the allocation methods and introduces the new concept of “relative stand-alone selling prices” in allocating transaction price. Thus, the amounts that will be allocated under the new standard may differ from the amounts allocated under the current standards.
• From the current revenue recognition trigger of transfer of risks and rewards, revenue is now recognized when control is transferred. Revenue can only be recognized over time when certain criteria are met. Otherwise, it is recognized at a specific point in time.
• IFRS 15 also provides explicit guidance on certain topics such as costs to obtain and fulfill a contract, warranties, right of return, breakage, and customer options for additional goods or services. One significant change is that costs to obtain a contract (e.g., commissions), if they are expected to be recovered in the future, will be capitalized under the new standard.
• Lastly, IFRS 15 requires expanded disclosures on contracts with customers.
With these new requirements, the impact of IFRS 15 may vary among industries and entities depending on how entities structure their revenue arrangements. Some entities may see significant changes on how and when they recognize revenue while others may not be impacted significantly. For those entities that fall in the second category, this does not mean that they are spared. They still need to validate this expectation by evaluating their existing revenue contracts vis-à-vis the requirements of IFRS 15. They also need to plan and take the needed steps to capture and to comply with the expanded disclosure requirements of the new standard.
TRANSITION
Once adopted by the Philippine Financial Reporting Standards Council (FRSC) and approved by the Board of Accountancy, the new standard is effective for calendar year 2018. Companies have the option to transition using the full retrospective or modified retrospective approach. Under the full retrospective approach, contracts outstanding as of the beginning of the earliest period presented (Jan. 1, 2016 for publicly listed companies) have to be assessed under IFRS 15 and any restatement should be recognized on the same date. In the modified retrospective approach, only contracts existing as of Jan. 1, 2018 are revisited, with any restatement reflected in the opening balance of retained earnings on the same date. Additional disclosures are required to compensate for non-comparative revenue figures.
The standard was originally intended to be effective in 2017 but the IASB eventually approved a one-year deferral. This deferral acknowledges the fact that applying IFRS 15 will not be an easy task and that companies need more time to implement this standard. The impact of IFRS 15 is not constrained to the financials; it has a wider business impact, affecting multiple business functions. The implementation effort should not only involve the finance or accounting departments, but should also involve other functions such as (among others) tax, legal, sales, human resources, marketing, investor relations, and Information Technology.
Even prior to the effectivity of the new standard, entities should already study the provisions and implications of IFRS 15 and make an early assessment of the standard’s impact on their revenue streams and systems and processes. With the magnitude of anticipated impact, education and early preparation are the keys to ensure a smooth transition to the new standard.
This article is for general information only and is not a substitute for professional advice where the facts and circumstances warrant. The views and opinion expressed above are those of the author and do not necessarily represent the views of SGV & Co.
Erwin A. Paigma is a Senior Director of SGV & Co.
source: Businessworld
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