IFRS 15: Revenue recognition from contracts with customers - Major changes in the offing for some industries
A new Standard, laying down revised guidance for recognising revenue from contracts with customers has been introduced by International Accounting Standards Board (IASB) of the IFRS Foundation and USA’s Financial Accounting Standards Board (FASB) which governs US GAAP. The new Standard is the outcome of a joint project carried out by IASB & FASB. While it has been collectively formulated and embodies identical principles & guidance, the two agencies have issued individual standards – IFRS15 by IASB and ASC606 by FASB.
Why the need for a new Standard:
Variance in accounting practices: The principles, practices & guidelines governing accounting for revenue from contracts with customers as per US GAAP were at variance with those as per IFRS. It was felt that IFRS provided only limited guidance for recognising revenue due to which diverse accounting treatments were carried out by different entities even for similar nature of transactions. On the other hand, the US GAAP provided too many guidelines/requirements, which were industry specific or transaction specific resulting in similar transactions being treated differently from industry to industry and from entity to entity.
Complex contracts with multiple considerations: Standards issued by both FASB under USGAAP & IASB under IFRS did not contain adequate guidance for complex contracts with customers with multiple elements of performance obligations or multiple sales considerations.
Inadequate disclosure: The GAAPs did not lay down adequate disclosure requirements which could enable an outsider to fully understand the basis, principles, judgements & estimates based on which an entity recognises revenue.
A single set of comprehensive & uniform recognition and disclosure guidance was therefore considered necessary.
Effective date of the New Standard (IFRS 15) & transition:
The new Standard will be mandatory for accounting periods beginning on or after 1.1.2017. IASB permits entities to make an early adoption provided they disclose this fact in their relevant financial statements. When adopting for the first time, entities are required to apply the standard in full for the current period. Retrospective applications has to be made for all contracts that were not yet complete at the beginning of first time adoption period. In respect of prior periods, entities are allowed to either apply IFRS 15 in full to prior periods or retain prior period figures as reported under the previous standards.
The standard will cover all contracts with customers for providing goods and/or services in the ordinary course of an entity’s business, except:
IAS 17 Lease contracts, IFRS 4 Insurance contracts, IFRS 9/IAS 39 Financial instruments, IFRS10 Consolidation of financial statements, Joint Arrangements IFRS 11, IAS 27 Separate Financial Statements, and IAS 28 Investments in Associates and Joint Ventures
IFRS 15 will supersede and replace the following existing standards/interpretations:
IAS 11 Construction contracts, IAS 18 Revenue, IFRIC 13 Customer Loyalty Programmes, IFRIC 15 Agreements for the Construction of Real Estate, IFRIC 18 Transfers of Assets from Customers and SIC-31 Revenue - Barter Transactions Involving Advertising Services
The new standard IFRS 15 is a principle based single source of frame work for all accounting & disclosure matters related to revenue recognition from all types of contracts with customers except for those specifically excluded. It is expected to provide a robust mechanism for measuring and disclosing revenue for all contracts with customers, irrespective of industry and entity. The underlying principle is that an entity will recognise revenue to depict the transfer of promised goods or services to customers in an amount that adequately reflects the consideration for such goods or services and at that point of time or over time when the performance obligations are met.
Changes in recognition-A Five step approach:
The standard lays down a five step approach for determining the amount of revenue to be and the time at which such revenue should be recognised:
Identify & analyse contracts with customers to see if all of the laid down conditions are met,
Identify the performance obligations in the contract - the entity should assess the goods or services that have been promised to the customer and identify each distinct performance obligation under the contract separately.
Determine the transaction price which an entity expects to be entitled in exchange for the transfer of goods and services. When making this determination, an entity will consider past customary business practices also. Where a contract contains elements of variable consideration, the entity will estimate the amount of variable consideration to which it will be entitled under the contract by estimating the expected value or the most likely amount.
Allocate the transaction price to the performance obligations. Where a contract has multiple performance obligations and individual price is not available in the contract, an entity will allocate the transaction price to the performance obligations by reference to their relative standalone selling prices. If a standalone selling price is not directly observable, the entity will need to estimate it as per the methods suggested in IFRS 15.
Recognise revenue as & when each performance obligation is satisfied.
What is going to change?
Uniform principles: Revenue will be measured for amount & time of recognition on identical basis & principles, improving comparability across industries.
Collectability of the amount or unstated but implicit price concessions or discounts will have to be taken into account while determining the transaction price. This will involve significant judgement and adequate disclosure of the same.
Financing component: Payment consideration shall be adjusted for effects of the time value of money if the timing of payments agreed to by the parties to the contract (either explicitly or implicitly) provides the customer or the entity with a significant benefit of financing the transfer of goods or services to the customer provided that such time difference exceeds a period of one year.
In Automobile industry a Car manufacturer may offer post sales free maintenance service to customers. IFRS15 requires that in case of any Incidental obligations or obligations in the nature of incentives, which are not separately priced, part of transaction price will have to be recognised at the time when such goods or services are transferred or rendered to customers. In such cases, part of Revenue out of the transaction price will be recognised towards such maintenance services as & when they are rendered.
In case of Telecom industry, companies may offer bundled contracts for sale of a mobile phone with network services for a specified period for an inclusive transaction price. Revenue will have to be bifurcated between the sale of phone at the point of time when the contract is taken and for the network services as & when the network is utilised.
In Software industry, contracts for licencing & use of Software, free upgrades & technical support are usually offered along with software at “no cost” which can be observed from the contract. Now, the revenue will have to be recognised the basis of standalone price of such services at the time when these are rendered.
In Real Estate industry- for example construction & sale of Houses, construction services take place over a period of time, contracts provide for payment of consideration in stages over construction period and therefore presently revenue is recognised “over such period”. With the introduction of IFRS15, revenue can be recognised “over” the period only if specific conditions laid down in the Standard are met. In other cases, revenue will be recognised only at the “point of time” when houses are constructed and ownership is passed on to customers.
Long Term contracts under which performance under contract and payment for the same takes place over a generally long period of time will have to be analysed for timing as well as any financing component involved and treated as per the Standard.
Preparing for transition to IFRS15:
Recognising revenue under this guidance will depend on the facts and circumstances of each contract with customers and may require exercise of considerable judgment in the context of provisions of IFRS15. Such recognition will be governed by the nature, amount, timing, and cash flows arising from the contracts with a customer, as supplemented by collectability & certainty of realisation. Considering the transition time available before the Standard becomes mandatory, following actions initiated right will facilitate a smooth transition:
a. Understanding requirements of the new Standard,
b. Taking care of the training needs,
c. Modifications in the systems to capture additional information required for performance obligations, transaction prices under each contract and to facilitate relevant disclosure.
d. Review all major contracts and analyse performance obligations co-relating them to provisions of IFRS15,
e. Analyse any major tax & financial implications, and
f. Review of Policies, if required.