At a glance
By David Hardidge and Ram Subramanian
When it comes into force, International Financial Reporting Standard IFRS 15, Revenue from Contracts with Customers (Australian Accounting Standards Board AASB 15) will introduce a completely new approach to revenue recognition.
The new standard introduces a five-step model based on “transfer of control” and is accompanied by substantial application guidance and examples to assist with implementation.
A recent LinkedIn webinar enabled participants to discuss the new requirements with technical experts. The following is an edited version of that discussion.
When will the new standard commence?
IFRS 15/AASB 15 is applicable for accounting periods commencing on or after 1 January 2018. In practice, because of transition methods and comparatives, preparers should ideally have been ready a year earlier.
For companies with a December year end, this was 1 January 2017. In Australia, not-for-profits are required to apply the requirements from 1 January 2019 so these entities should be ready by 1 January 2018.
What are the transitional provisions on first application?
IFRS 15 includes the common transitional provision of retrospectively applying the standard to current and previous financial years.
For a 30 June 2019 year end, the 30 June 2018 comparative period must be restated, using the new requirements. The restated period would therefore commence on 1 July 2017.
The standard also allows for a modified retrospective approach, meaning companies that choose this option will not have to restate prior year comparatives. However, while it sounds good, from a user’s perspective it will be akin to comparing apples and oranges.
Since revenue is significant accounting measure, the International Accounting Standards Board (IASB) requires those who opt for this provision to include revenue for the first financial year (e.g. year ended 30 June 2019) to be calculated under the old system and disclosed in the notes.
So, while the new system applies from 1 July 2018, the old system must continue to be applied for another year to determine the disclosures.
Also, the transition method may not always be up to a company. Financial statement users, including analysts, may want the first year of transition and comparative year presented under the new standard. There could also be implicit pressure from what others in the same industry are doing.
There have been amendments to the standard since it was issued. What are the main changes?
There have been two amendments – the first extending the start date by 12 months to financial years beginning 1 January 2018. Imagine if the extension was not made – we would already be applying the new standard.
The second was termed “clarifications” by the IASB to emphasise that the fundamental model was not changed. The clarifications mainly concentrate on principal versus agent considerations, performance obligations, licences and some transitional expedients.
How long can preparers of financial statements leave things?
Those with December year ends should already be well advanced in preparation for the standard, which was published more than two-and-a-half years ago.
In theory, those with June year ends have a slightly longer lead time. However, it is strongly recommended that regardless of when the year end of the entity falls, preparers pay close attention to the requirements of the new standard and the modifications needed to accounting and other systems to capture relevant data.
Focus areas for learning
The primary focus should be on the new five-step revenue recognition model. An understanding of the new terminology, including “performance obligation”, “variable consideration” and the “recognition constraint” is essential. It is also important to understand the breadth of issues the standard covers.
The new model has five steps, each with important considerations:
|1||Identify the contract(s) with a customer.||Contract modifications; principal versus agent.|
|2||Identify performance obligations in the contract.||What are distinct goods/services? What is the “unit of account”?|
|3||Determine transaction price.||What is variable consideration and how to apply the “recognition constraint”.|
|4||Allocate transaction price to performance obligations.||Dealing with “bundles” of goods and/or services.|
|5||Recognise revenue when (or as) the entity satisfies each performance obligation.||Revenue recognition at a point in time or over time.|
Unfortunately, some issues may not be immediately apparent. For example, a joining fee for membership of a club or similar organisation. Joining a club will often not in itself involve transferring any goods or services to the member. The transfer happens when the club member uses, or has the opportunity to use the club’s services.
In such cases, the joining fee will often not be permitted to be recognised when the cash is received on the member joining, but will need to be recognised over the life of the membership.
Key areas for entities preparing for change
Affected entities will first need to assess the extent of changes under the new standard to current revenue recognition practices.
For many, there may not be much of a change, except for disclosures, which are likely to affect almost everyone. Clearly, entities should concentrate on the issues that specifically affect them.
How will disclosures be impacted?
IFRS 15 includes a long list of disclosures. These need to be tailored to the individual circumstances of each entity to meet the disclosure objective of IFRS 15.
A recent change to accounting standards was to clarify that a checklist approach should not be used when meeting the disclosure requirements of any accounting standard.
How are not-for-profits affected by IFRS 15/AASB 15?
IFRS 15/AASB 15 was developed for for-profit companies. The AASB has issued guidance on how to apply for-profit terminology in AASB 15 in a not-for-profit environment.
It has also issued a significantly revised standard (AASB 1058) to address contributions and other “non-exchange transactions”.
The effective date of AASB 15 has been delayed by one year to 1 January 2019 for not-for-profits. However, early application is permitted.
It is expected that the new requirements will allow more revenue transactions to be “matched” against expenses. Even so, there are likely to be circumstances where the standard’s requirement around “enforceability” of a contract cannot be clearly established, which may result in up-front revenue recognition.
Similar issues can arise with the identification of the timing and nature of “performance” under a contract.
What should auditors be doing to get ready for the new standard?
Auditors should already be familiar with the new requirements. Many audit firms have already undertaken staff training in anticipation of the changes.
Auditors are likely to have a good understanding of their clients’ business environment and related issues. Once entities have identified specific issues likely to affect them, they should discuss them with their auditors to gain a better understanding of the best way forward.
Concurrently, auditors should proactively engage with clients about how accounting systems and procedures are being changed and what these mean for audit planning.
Auditors should also be reminding clients of the disclosure requirements in IAS 1/AASB 101 about the effect of forthcoming accounting standards.
What considerations are there when determining performance obligations?
The unit of account is the performance obligation. It is the accounting for performance obligation which determines when, and how much, revenue can be recognised.
Central to this fundamental concept is the delivery of distinct goods or services. If there is interdependence between goods and/or services – such as significant integration of services – they should be grouped into a distinct bundle.
Then it would be the bundle that is accounted for as a unit, rather than the individual goods and services that makes up that bundle. Revenue would be recognised when the bundle is delivered to the customer.
This may not occur until the whole bundle is complete, even though some components were delivered earlier.
Standard-setters have tried to balance the situation; on one hand, having the unit of account so small that every brick or nail could be individually identified and accounted for (a ridiculous situation), and on the other having the unit of account so large that everything in a contract could be recognised as a unit (not suitable if goods and services in the contract have different characteristics).
The standard has specific guidance on licenses. When should revenue be recognised – upfront or over time?
The broad distinction is whether it is the sale of the right to use the license (fundamentally as it is when sold), or whether it is a sale of the right to access the licence (which may be updated or modified) over time.
This can give rise to different revenue recognition patterns – the former at a point in time (normally up front), and the latter over an extended period.
How will special purpose financial reports (SPFR) be affected by the standard?
Companies lodging under the Corporations Act will need to consider the new rules in light of Australian Securities and Investments Commission (ASIC) guidance that states measurement and recognition requirements of all Australian accounting standards are applicable in the preparation of SPFR.
The merits of picking and choosing accounting standards for other entities preparing SPFR are the subject of ongoing debate.
It has to be remembered that revenue is a fundamental performance measure, and for many entities it can change under the new requirements.
Revenue recognition requires significant estimation and judgment, and entities preparing a SPFR should reflect on whether or not they have implemented the new standard in the note on accounting policies, and within the disclosure on estimates and judgements.
Of course, some entities preparing SPFR may be reluctant to apply the new requirements, particularly if they believe requirements under the old standard meet their individual and user needs.
However, as the new requirements become the norm, SPFR entities may need to explain what – if any – the differences are between their own revenue recognition practices and those generally accepted as accounting practice.
Need to learn more about the standard?
In anticipation of IFRS 15 / AASB 15 coming into effect, CPA Australia has been engaged in resources development to assist stakeholders prepare for its new requirements.
This includes a podcast that provides an overview of the standard, as well as a half-day workshop that was held in Melbourne and Sydney late last year.
More information on these and other resources can be found at the CPA Australia website.
Because revenue is so fundamental, preparers should study the standard and accompanying material to gain a full understanding of impending requirements.
David Hardidge is the Director – Technical and Treasury Products at Queensland Audit Office. Ram Subramanian is Policy Adviser – Reporting at CPA Australia