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David Holland
Director IFRS & Accounting BDO
IFRS 15
• Introduction
• Potential issues in practice
• Other issues
• Transition
Page 3 Title
• Contents
Introduction
INTRODUCTION
• Issued 28 May 2014
• Joint revenue project - IFRS and US GAAP
• Effective 1 January 2017
• Early application permitted
Page 5 Title
• IFRS 15 Revenue from Contracts with Customers
INTRODUCTION
• It is difficult!
• Needs attention now!!!!
• Changes pattern of revenue recognition
• Changes pattern of profit
Page 6 Title
IFRS 15 Revenue from Contracts with Customers
INTRODUCTION
• Bonus schemes
• Earn outs
• Deferred payments
• Bank covenants
• Dividends payments
Page 7 Title
Impact of change in pattern of revenue
INTRODUCTION
• Determine impact
• Educate staff
• Change processes
• Change systems
• Modify contracts
Is three years enough time?
Page 8 Title
Actions required before 2017
INTRODUCTION
• Software companies
• Construction companies
• Residential real estate
• Manufacturers
• Professional services
• Licensors
• Retailers and consumer industries
• Media companies
• Telecommunication companies
• Everyone else?
Page 9 Title
• Who will be impacted
INTRODUCTION
Supersedes previous IASs, SICs and IFRICs related to revenue
Page 10 Title
• Superseded standards
IAS 18 Revenue
IAS 11 Construction Contracts
IFRIC 13 Customer Loyalty Programmes
IFRIC 15 Agreements for the Construction of Real Estate
IFRIC 18 Transfers of Assets from Customers
IFRS 15
Revenue from Contracts with Customers
SIC-31 Revenue – Barter Transactions Involving Advertising Services
INTRODUCTION • Size of IFRS 15
IFRS 15 (pages)
IAS 18 (pages)
IAS 11 (pages)
Standard 39 10 11
Application guidance 17 n/a n/a
Transition guidance 2 n/a n/a
Amendments to other standards
26 n/a n/a
Illustrative Examples 82 8 4
Basis for conclusions 173 n/a n/a
Total pages 339 18 15
INTRODUCTION
• Does not apply to
• Lease income (IAS 17 Leases)
• Insurance income (IFRS 4 Insurance Contracts)
• Contractual rights & obligations under IFRS 9 Financial Instruments
• Non-monetary exchanges
• Income that is not derived from ‘contracts’ with customers (IFRS 15)
Page 12 Title
• Scope
INTRODUCTION
• Far more complex
• Far more disclosure
• Clear set of principles for recognition of all types of revenue
• Pattern of revenue recognition will change
• Will require systems changes
• Will impact earnings per share (EPS)
• Possibly bonuses, share-based payments and bank covenants
Page 13 Title
• Impacts of IFRS 15
KEY POINTS TO NOTE
• Based on the principle of transferring control of an asset (even for services)
• Not focused solely on risks and rewards (now one indicator of a transfer of control)
Page 14 Title
• Transfer of control
KEY POINTS TO NOTE
• Consideration recognised is the ‘expected’ consideration that the vendor is entitled to (not fair value)
• Revenue can only be recognised if it is highly probable that consideration will be collected
Page 15 Title
• Recognising consideration
KEY POINTS TO NOTE
• Centres on ‘promises made in the contract’
• Requires identification of ‘performance obligations’
• Requires key judgement as to whether performance obligations are ‘distinct’
• Do goods or services need to be ‘integrated’ in order to provide benefits to the customer ?
Page 16 Title
• Performance obligations
KEY POINTS TO NOTE
• Are the performance obligations dependent upon other ‘promises’ made to the customer ?
• Are performance obligations satisfied over time or, at a point in time?
• Stand-alone selling price will need to be determined for performance obligations that are never sold separately
Page 17 Title
• Performance obligations
KEY POINTS TO NOTE
• Much greater guidance on agent vs. principle
• Greater guidance on sale or return / refunds
• Assurance warranty vs. service warranty
• Contract assets
- Sets out guidance on what should not be capitalised
- Capitalise costs (incremental and those to fulfil the contract) that relate to contracts within the scope of IFRS 15
Page 18 Title
• Other
KEY POINTS TO NOTE
• Complexity on linking contracts and modifying contracts
• Significantly more disclosure
• Specific guidance on recognising revenue at a ‘point in time’ vs ‘over time’
• Significant guidance on accounting for variable consideration
Page 19 Title
• Other
VARIABLE CONSIDERATION
Page 20 Title
An entity shall include in the transaction price some, or all, of an amount of variable consideration, only to the extent that it is highly probable that a significant reversal in the amount of cumulative revenue recognised will not occur when the uncertainty associated with the variable consideration is subsequently resolved.’
KEY POINTS TO NOTE
• Importance of having a customer
– IFRS 15 applies only to contracts with customers, therefore excludes collaboration agreements, farm in etc
• Customer must receive a benefit for revenue to be recognised
– Mobilisation activities, recruitment activities etc. do not benefit the customer (i.e. there is no transfer of goods or services) so no revenue can be recognised
Page 21 Title
• Other
KEY POINTS TO NOTE
• Financing arrangements
– Entities need to consider financing both in terms of deferred consideration and prepaid revenue ... prepaid revenue could mean you are borrowing from the customer
• Determining margin on contracts
– Where equipment delivered procured with low margin (e.g. elevators) adjust profile of profit recognition
Page 22 Title
• Other (cont)
CORE PRINCIPLE
Page 23 Title
Recognise revenue to depict the transfer of goods or services to customers in an amount that reflects the consideration to which the entity expects to be
entitled in exchange for those goods or services
FIVE STEP MODEL
Page 24 Title
Potential issues in practice
POTENTIAL ISSUES IN PRACTICE
• IFRS 15: Specific guidance regarding ‘over time’ or ‘point in time’ (mutually exclusive)
• Currently: Lack of clear guidance, diversity in practice
• Impact
- Some current ‘point in time’ revenue recognition may switch to ‘over time’
- Some current ‘% of completion’ revenue recognition may switch to ‘point in time’
Page 26 Title
• Timing of revenue recognition – Point in time vs over time
POTENTIAL ISSUES IN PRACTICE
• From ‘point in time’ to ‘over time’
• Most likely result in earlier revenue recognition
– Residential real estate
• Most likely result in delayed revenue
– Sign on/activation fees
– Design and build
– License fees
Page 27 Title
• Timing of revenue recognition - Point in time vs over time
POTENTIAL ISSUES IN PRACTICE
• From ‘% of completion’ to ‘point in time’
• Most likely result in delayed revenue
– Constructing an asset e.g. ships or oil rigs at the constructor’s premises
– Audit fees
– Consulting fees
– Linked contracts
Page 28 Title
• Timing of revenue recognition - Point in time vs over time (cont)
POTENTIAL ISSUES IN PRACTICE
• IFRS 15: Specific guidance on
– Bundling (linking) performance obligations
– Debundling (separating out) performance obligations
• Currently: Lack of clear guidance, diversity in practice
Page 29 Title
• Timing of revenue recognition – Bundling vs debundling
POTENTIAL ISSUES IN PRACTICE
Bundling or linking performance obligation
• Changes revenue recognition from ‘point in time’ to ‘over time’
• Most likely result in delayed revenue recognition
– Software license fees
– Gym membership
Page 30 Title
• Timing of revenue recognition – Bundling vs debundling (cont)
POTENTIAL ISSUES IN PRACTICE
Debundling or separating out performance obligations
• Most likely result in earlier revenue recognition
- Free watch with magazine subscription
- Mobile phone with a phone plan
• Most likely result in delayed revenue recognition
- Free repair maintenance services
- Extended warranties
Page 31 Title
• Timing of revenue recognition – Bundling vs debundling (cont)
POTENTIAL ISSUES IN PRACTICE
• IFRS 15: Requires separate revenue recognition for each separate performance obligation
• Currently: Such items may not be separately accounted for
• Examples
- Subsequent maintenance services
- Discount vouchers
• Potential impact
– Could result in delayed revenue recognition
Page 32 Title
• Timing of revenue recognition - Incidental obligations and sales incentives
POTENTIAL ISSUES IN PRACTICE
• IFRS 15: Specific guidance regarding the methods of measuring and constraining variable consideration (high probability of no future revenue reversal)
• Currently: Lack of clear guidance, diversity in practice
• Examples
- Contract penalties
- Volume rebates
- Performance bonuses
- Rental guarantees
- Contingent consideration
- Retentions
Page 33 Title
• Estimates of variable consideration
POTENTIAL ISSUES IN PRACTICE
• IFRS 15: Specific requirement to consider significant financing components
• Currently: May not be being considered when customers pay in advance/arrears
• Examples
– Contracts with extended payment terms
– Contracts with advanced payment terms
• Potential impact
– Increases revenue
– Increase interest charge
– Creates a loss in the earlier periods and more profit in later periods
Page 34 Title
• Significant financing components
POTENTIAL ISSUES IN PRACTICE
• IFRS 15: More specific guidance on principal and agent relationships
• Currently: Diversity in practice
• Potential impact
– Decreases revenue if now acting as agent
Page 35 Title
• Principal and agent
POTENTIAL ISSUES IN PRACTICE
• Currently: Disclosures are inadequate and lack cohesion
• IFRS 15: Comprehensive disclosure and presentation requirements have been introduced
• Example
– Disclosure of unfulfilled obligations that has not yet been recognised revenue in time bands
Page 36 Title
• Disclosure
Other issues
TOPICS
• Licenses
• Principal and agent
• Contract costs
Page 38 Title
Page 39 Title
Licenses
LICENSES
• Technology - software and patents
• Entertainment and medial – films, music, copyrights
• Pharmaceutical – patents and trademarks
• Retail– trade name and franchises
Page 40 Title
• Industries affected
LICENSES
Page 41 Title
• Is the license distinct?
Is the promise to provide license separate from other promises?
One performance
obligation (bundle)
Yes
Separate performance
obligation
No
LICENSES
Page 42 Title
Customer has right to access the item throughout the license period as the conditions of that item changes over time
Customer has right to use
the item in its condition
at a point in time
Recognise revenue at a
point in time Recognise revenue
over time
Future sales or usage based royalties
Recognise revenue when
the sale or usage occurs
LICENSES
• Pharma Ltd Licenses patent for Drug X to XYZ Ltd
• Pharma Ltd will also manufacture Drug X for XYZ Ltd for next 10 years (manufacturing process is highly specialised)
• Pharma Ltd does not need to do anything else to support the drug (mature product)
Page 43 Title
• Example: Licenses – Distinct vs non distinct
LICENSES
• Questions: (a) Is the license distinct if no one else other than Pharma Ltd are able to manufacture
the product?
(b) Is the license distinct if other entities can manufacture the drug?
(c) How is revenue recognised if other entities can manufacture the drug and Pharma receives 5% royalty for sales?
Page 44 Title
• Example: Licenses – Distinct vs non distinct
LICENSES
Question (a): Is the license distinct if no one else other than Pharma Ltd are able to manufacture the product?
• Answer (a): • Not distinct
• XYZ cannot benefit from license on its own – has to take License and manufacturing
service
• One performance obligation – recognised the revenue over time (10 years)
Page 45 Title
• Example: Licenses – Distinct vs non distinct
LICENSES
Question (b): Is the license distinct if other entities can manufacture the drug?
• Answer (b): • Yes
• Can benefit from License on its own
• XYZ will benefit from date License granted as no further update work
• Recognise License revenue at ‘point in time’ – Day 1
Page 46 Title
• Example: Licenses – Distinct vs non distinct
LICENSES
Question (c): How is revenue recognised if other entities can manufacture the drug and Pharma receives 5% royalty for sales?
• Answer (c): • License revenue recognised over time as and when the future sales occur
Page 47 Title
• Example: Licenses – Distinct vs non distinct
Page 48 Title
Principal vs agent
PRINCIPAL VS AGENT
• The party responsible for providing the goods or services promised
• Recognise revenue on a gross basis
Page 49 Title
• Principal
PRINCIPAL VS AGENT
• Another party is responsible for fulfilling the contract • No inventory risk • No discretion in setting prices • Consideration is in the form of commission • Not exposed to credit risk
Agents recognise revenue on a net basis
Page 50 Title
• Indicators of agent
PRINCIPAL VS AGENT
• Mr A purchased 5 shirts from ShirtCo an online retail store CU60 each, a total of CU300 (CU60x5)
• Standard delivery is free for any customers with orders above CU250 • For orders less than CU250, a standard delivery fee of CU20 is charged • The delivery fee is set by the delivery company • Customers can enquire on the status of their delivery by contacting the delivery
company • All online purchases are paid by credit card
Question: How much revenue should ShirtCo recognise?
Page 51 Title
• Example: Principal versus agent – Online retailer
PRINCIPAL AND AGENT
Question: How much revenue should ShirtCo recognise? Answer: • ShirtCo should only recognise revenue of CU280 (CU300 – CU20)
• ShirtCo is only an agent for the delivery company
- Does not control the shipping services - Delivery company is responsible for the shipping services - ShirtCo has no inventory risk during shipping - ShirtCo has no discretion in setting shipping prices - ShirtCo has no credit risk as the price is fully paid by credit card
Page 52 Title
• Example: Principal versus agent – Online retailer
PRINCIPAL VS AGENT
• E-buy is an online website that allows customers to buy different goods from a range of suppliers
• The goods are delivered directly to the customers • When a customer buys a good E-buy is entitled to 10% commission of the sales price • Prices are set by the suppliers • E-buy requires payments from customers before the orders are processed and all
orders are non-refundable • Customer A buys CU100 worth of goods Question: How much revenue should E-buy recognise?
Page 53 Title
• Example: Principal versus agent
PRINCIPAL VS AGENT
Question: How much revenue should E-buy recognise? Answer: • E-buy should only recognise revenue of CU10 (CU100X10%)
• E-buy is only an agent
– Supplier is responsible for fulfilling the contract i.e. shipping the goods to the customer
– E-buy has no inventory risk – goods are directly shipped to the customer – E-buy has no discretion in setting prices of the goods – E-buy has no credit risk as the price is fully paid in advance
Page 54 Title
• Example: Principal versus agent
Page 55 Title
Contract costs
CONTRACT COSTS
• Capitalise contract costs if they are incremental • Unless the contract <1 year then can expense
• Incremental costs • Costs that would not have incurred if the contract had not been signed e.g. sales
commissions - Sales commission for contracts less than a year can be expensed - Example: an agent is paid a 5% commission when a customer signs up for a 24
month magazine subscription. The commission paid is amortised over 24 months
Page 56 Title
• Capitalise incremental contract costs
CONTRACT COSTS
• Bid costs
• Proposal costs
• Selling costs
• Marketing costs
• Advertising costs
• Fixed salaries
Page 57 Title
• Examples of non incremental costs
CONTRACT COSTS
Fulfillment costs can be capitalised if all three criteria are met (if not addressed by other standards) • The costs relate directly to a specific contract
• The costs generate/enhance the resources the entity will use to complete the contract
• The costs are expected to be recovered
Page 58 Title
• Capitalise fulfillment costs
CONTRACT COSTS
• Telco sells mobile phones and provides mobile phone services • 100 customers signed up for two year service contract • Sales staff are paid a commission on top of their salaries • Telco incurs the following expenses for the month
• Question: • Can Telco capitalise any of the above costs?
Page 59 Title
• Example: Selling costs
Salaries CU10,000
Commissions CU2,500
Advertising CU5,000
Total CU17,500
CONTRACT COSTS
• Question: • Can Telco capitalise any of the above costs?
• Answer:
Page 60 Title
• Example: Selling costs
Costs Capitalise? Explanation
Salaries X Would have been incurred whether or not contracts are signed
Commissions √ Would not have been incurred if contracts were not signed
Advertising X Would have been incurred whether or not contracts are signed
Transition
TRANSITION
Choice of three methods
1. Full restatement of comparative figures (IAS 8)
2. Full restatement with any of the following practical expedients:
– Need to restate any completed contracts that begin and end within the same annual period
– For completed contract with variable consideration, may use the transaction price at the end of the contract rather than estimating the variable consideration in the comparative periods
– No need to disclose information on unfulfilled performance obligations for comparatives
3. Cumulative effect of initial application recognised as a single entry in opening retained earnings at date of initial application, with additional disclosures
Early application permitted
Page 62 Title
• Retrospective application
Questions