IFRS 15 takes a holistic view of recognising revenue. If you have clients in three particular areas of business, or you work for companies in those industries, it’s likely that you’re going to be affected.
So what is the new standard, have you or your company already transitioned, and if not – what should you do?
“The idea behind IFRS 15 is to provide a single principle-based approach to recognising revenue,” says Steve Collings, Director at Leavitt Walmsley and a widely published author on financial standards. “It replaces IAS 11 and IAS 18 as well as a host of smaller standards including IFRIC 13, 15 and 18. The idea is to provide a single principle-based approach to recognising revenue – we now have one standard to outline all the guidance involved in doing so,” Collings says.
Exposing the weaknesses of the previous standards
IFRS 15 is also designed to be more prescriptive than before. “It’s no secret that some companies have been in the headlines for all the wrong reasons – the Tesco accounting scandal is a notable example of this,” Collings says. “In effect, revenue was made to appear better than it was. Shareholders thought their shares were performing better than they were. The IASB has recognised that the existing standards were not outdated, as such, but developments in business have meant that weaknesses and inconsistencies in the standards were exposed.”
Who will be affected by the new standard? “Principally three industries: telecoms, specifically mobile phone providers; construction; and software companies.” The new standard brings in a five-step model to recognising revenue. “The idea is that you have to go through each step before you can recognise revenue.”
IFRS 15 in detail
It’s best described by example. “Say I’m a mobile phone provider. For each phone, I sell the handset to the customer and sign a two-year contract with the provider. The provider now has to separate it into two components – the good and the services component.” This new distinction between the product and the service is step 1: “identifying the contract exists. Then you identify performance obligations in the contract – i.e., the good and the contract; that’s step 2.”
Next, you have to determine the transaction price. “That might be so much a month for so much download time – that’s step 3. Step 4 is to take the transaction price and allocate it to the performance obligations; it has to split the total contract price over the obligations. And step 5 is to recognise revenue when (or as) the entity is satisfied of the performance obligation.” For example if you pay £25 a month, the entity takes £600 over 24 months.”
It sounds straightforward: does IFRS 15 make things more complex than they need to be?
“No; it’s simply trying to make entities go through the strict 5-step model so you recognise revenue at the appropriate time. An entity will need professional judgement, but there are boundaries to where that professional judgement lies.” There is more disclosure involved than there used to be in IAS 18 and 11, Collings adds – so areas of judgement become important.
The new standard brings in a five-step model to recognising revenue
So – what do AAT members need to do?
“First, be aware of the 5-step model. Then, have a sound understanding of how IFRS 15 works, because it’s very different to what we had before. Bear in mind that it won’t affect every single company that reports in a physical way, but will affect the three particular industries in significant ways.” They are likely to be affected far more than retailing, for example. “If you have clients in those particular three areas, or if you are in the accountancy team in a company in those industries, make sure you gain a clear understanding of the kind of contracts your clients get involved in.” As with all changes in reporting standards, preparation is key.
In addition to the 5-step approach, consider variable consideration (VC). “Let’s look at construction for our example this time. In a construction contract, the customer might say – if the project is built by a certain deadline, you’ll get a bonus. Here, management has to determine whether or not it’s likely they will hit that target, and recognise the appropriate amount of revenue. Where it’s unlikely that the customer might pay, that can give rise to VC.”
Are there penalties for non-compliance to IFRS 15?
“If you report, you’re likely to be a listed company – very few private companies will be doing so. So if you don’t comply, your financial statement won’t give a fair and true view. Your auditors won’t be happy about it; and questions might be asked about why you’re not complying.” There are some cases where a company might reasonably choose not to comply with a particular reporting standard, Collings says, and they would then make disclosures as to why they’ve done that; “but to depart from an entire provision is unheard of.”
This, ultimately, is why we need the new standard. “A company might be desperate to raise finance and the future might hinge on that. To do so, they will want to report as good a balance sheet as possible – and that’s where the temptation to manipulate revenue can come in. The problem is that you recognise sales that don’t exist – you bring sales forwards and the profits aren’t there.” In the long run, this catches up with you. “It’s pointless, because the problem will still be there – if shareholders see great results this year, they’ll want to see the same next year. That’s where it snowballs.”
Don’t panic – but do act
Finally, if you haven’t transitioned already – is it too late? “No. IFRS 15 is mandatory for annual reporting periods that start on or after 1 January 2018, so the first companies affected will be applying it at year’s end on 31 December 2018 onwards.” With just over six months to be ready, the key is to make sure you understand the changes. “Don’t fall into the trap of thinking, ‘my software will sort this out,’ ” Collings urges. “It won’t – review your accounting systems and make sure they are geared up now.”
Find out more information, and an expansion of the five-point plan.
Mark Blayney Stuart is Business Journalist of the Year, Wales Media Awards 2017 and Former Head of Research at the Chartered Institute of Marketing.