Accounting standards that deal with how revenue is recognised by different entities around the world have now been harmonised.
The convergence process that began in 2002 will this year impact financial reporting for businesses worldwide, through changes to standards such as the IFRS and US GAAP.
Ceri-Ann Ross, Reporting Leader at Chartered Accountants Australia and New Zealand explains that IFRS 15 Revenue from Contracts with Customers changes the way revenue is recognised in financial statements.
“It was born out of a desire to achieve global consistency. The previous international accounting standards offered very little guidance on this topic, which led to substantial divergence in how revenue was being recognised in financial accounts in practice," Ross explains.
“Under US GAAP, a lot of industry-specific guidance was developed, but it was inconsistent and confusing. We now have a single, comprehensive framework for determining how much revenue to recognise and when. The international and US standards are substantially converged, which is great news for companies that do business globally," she adds.
IFRS 15 is applicable for financial years beginning on or after 1 January 2018, so the first annual reports in which this applies will be for the year ended 31 December 2018.
Revenue timing will change
IFRS 15 introduces a five-step model for recognising revenue:
1. Identify the contract
2. Identify your deliverables
3. Work out the contract price
4. Allocate the contract price to each deliverable
5. Recognise revenue as each deliverable is satisfied
“Five steps sounds simple enough, but there are more than 250 pages in the standard, including nearly 70 pages of illustrative examples, so the model is only the tip of the revenue recognition iceberg. Any finance team that has gone beyond the high-level principles will tell you the same thing – it's not as easy as it looks. The devil is definitely in the detail with this standard," Ross advises.
“The main impact this standard has, is it changes the timing of when revenue is recognised. Again, on the face of it that doesn't sound like too big a deal. It's only when you look below the surface you see the full picture," she adds.
According to Ross, every company will be impacted in some way by this standard. “The extent of the impact will vary depending on the industry and complexity of underlying customer contracts, but you'd be hard pushed to find a company that can genuinely say this standard has no impact on their business," she says.
Additionally, Ross explains the implications could be pervasive and that under the new standard, revenue is more than just a number. This is particularly important as there could be knock-on effects on reported EBITDA, sales and management bonuses, employee share schemes, covenant calculations, contract negotiations, systems and processes, business forecasts and tax.
Ross believes that each step has many complex elements that could possibly be a challenge. These include identifying individual performance obligations, dealing with contract modifications and accounting for variable consideration.
“Many finance teams have been surprised to learn the broad range of contract terms their companies offer customers. This needs to be worked through at the same time as working out which of the various transition options in the standard to apply, preparing comparative information and assessing the impact of an at-first seemingly simple change on internal processes, policies, technology and data requirements," she says.
Take time for a detailed transition plan
Many companies may not already have a transition plan and it could take a considerable amount of time for CFOs to properly assess, develop and implement a strategy to address the new revenue standard.
“That's pretty scary when the calendar has already ticked over into 2018. Revenue is the most important, most influential and most highly scrutinised number in the financial report. IFRS 15 transition planning and the management of risks and opportunities should be at the top of every CFO's priority list," Ross says.
Ceri-Ann Ross's top tips for CFOs applying IFRS 15 for the first time:
1. Get a transition strategy, timeline and budget in place as soon as possible and resource-up. Having adequate resources to deal with the transition could help to avoid over-work, stress and expensive last-minute consultancy bills. Consider combining the revenue project with transition planning for the other two big new standards on financial instruments and leases, and tackle the 'triple-threat' in one go.
2. Get buy-in across the business, including from the board. Work with the commercial/sales team, because understanding how contracts work in practice is fundamental to success. This is about more than just the debits and credits.
3. Seek early engagement with auditors and advisers. There's little point investing time and resources into planning and implementation if the results don't comply with the standard.
4. Communication is key to managing the expectations of investors and regulators. Companies should already be making qualitative and quantitative disclosures of the expected effect of the new standard. For example, a quick read of the standard may suggest no material impact will emerge. However, when it comes down to the detail the implications of compliance could be significant.
5. Benchmark against industry competitors. Investigate what they are doing about this and what disclosures have they made about possible impact and transition approach. Have they changed the way they structure their contracts? Is there an opportunity for you to gain a competitive advantage?
- IFRS 15 changes the timing of revenue recognition in financial statements.
- It has the potential to also affect EBITDA (earnings before interest, tax, depreciation and amortisation), bonuses, employee share schemes, covenants, contracts and systems and processes.
- CFOs who take a measured, thorough approach to the new accounting standard, can assess how best to apply it across the business and how the firm will be affected as a result.