The new revenue recognition rule affecting public companies comes into force on 1 January 2018, and there is already evidence that early-adopting firms have been affected.
IFRS 15 applies to publicly listed companies, and has been drawn up by the international accounting standards board (IASB) to prevent businesses from deliberately manipulating financial statements by delaying or accelerating revenue.
Over the years revenue recognition practices have resulted in misleading financial results, giving rise to a number of major accounting scandals, including Tesco’s recognition of promotional discount payments in its annual accounts.
According to Steve Collings, audit and technical partner at Leavitt Walmsley Associates, the old standards had become outdated and the IASB came across a variety of inconsistencies and weakness.
Standards already biting
Unless a public company has chosen to early-adopt, IFRS 15 is effective from 1 January 2018, and there have already been several cases where the standard has affected companies’ reporting:
- In November 2016, Rolls-Royce PLC shares fell following the company reporting that its profits would have been £900m lower if it had adopted IFRS 15, the accounting standard on Revenue Recognition.
- Google: the tech giant early-adopted the revenue recognition standard on 1 January 2017 and saw a $15m impact on its first quarter. The company reported revenue of $24bn during the first quarter.
- According to Bloomberg, Airbus hasn't completed its assessment of IFRS 15 and plans to update investors early next year. Credit Suisse estimates the order book will be revised down to about 500bn Euros (from 945bn Euros at the end of September).
The new standard forces entities to consider the timing of revenue recognition, and separate out different parts of a transaction.
An often-used example of this is around mobile phone companies: previously a phone contract could combine the handset and the airtime so the cost of the handset could be presented as free, but IFRS 15 forces firms to split the two out and accounted for them separately.
This ‘unbundling’ is predicted to have more of an impact on certain industries such as software, telecommunications and automobile sales.
Software retailers will also need to appropriately report revenue and expenses that correspond with the period of contracts. Generally, revenue from a one-time sale of software installed at a customer site would be recognised immediately. Similarly, revenue from a contract for access to software over a period would be recognised evenly over the period, regardless of how payments might be structured. Companies that provide a mix of services and software may need a more detailed review of specific performance obligations to determine when to recognise revenue.
When it comes to preparing for the new rules, Collings said there was no substitute for actually reading the standard.
Many publications and entities offer guidance on applying the detailed technical aspects, but Collings added that “care needs to be taken at entity level because every company is different so there isn't really a 'one-size-fits-all' where the new IFRS 15 is concerned.”
The steps involved are:
- Step 1: Identify the contract(s) with the customer
- Step 2: Identify the performance obligations in the contract
- Step 3: Determine the transaction price
- Step 4: Allocate the transaction price
- Step 5: Recognise revenue when a performance obligation is satisfied
‘Complicated but common sense’
“There will be a lot more disclosure and number crunching,” commented Collings, “it’s complicated but common sense”.
The standard also requires an assessment of how likely (or unlikely) it is the customer will pay – an assessed credit risk of each sale.
The standard is a joint collaboration between international and US standard setters. When it was first issued the standard came under criticism for its lack of clarity, and so was deferred for a year to iron out certain points.
According to Steve Collings the standard may also affect FRS 102 at some point, but certainly not in the near future.
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