Changes to the way the headline indicator of company performance is identified will have a significant impact on business. Liz Loxton looks at the work being done to prepare the ground
I FRS 15 has had one of the longest incubation periods in the International Accounting Standard Board’s (IASB) immense standard setting endeavour. First flagged around 2004, the issue of how and when to recognise revenue in financial reporting has been passed back and forth many times before this year’s release of the standard in its final form.
While the standard arguably will change little for many companies, it will have significant impact on a few. IASB board member Jan Engstrom says: “For 95% of companies, there is likely to be no change in the way they recognise revenue, which is a good outcome.”
For listed companies, the first reporting period in which they will need to reflect the standard begins 1 January 2017 – providing a comfortable lead time, assuming companies put impact assessments and sensible preparations in train.
PRIVATE AND SMALLER COMPANIES
Entities within the private company and SME sector will be drawn in if they have voluntarily adopted IFRS, perhaps because they are a subsidiary of a larger group.
In cases like these, says Nigel Sleigh-Johnson, head of ICAEW’s Financial Reporting Faculty, preparers are likely to be able to avail themselves of the examples and resources of their parent companies.
The trickle down to UK GAAP will be some way off as 1 January 2018 seems the earliest possible date, and so far the IASB says it has no plans to incorporate the principles of the new standard into IFRS for SMEs.
“This is currently not a big issue for private companies, but eventually these requirements may become a feature of UK GAAP,” says Sleigh-Johnson. “Ultimately, this might become the basis of revenue recognition in UK GAAP for private companies, but there may be an element of simplification.”
In the meantime, the issues for smaller, non-listed entities that need to apply the standard are broadly the same as for listed companies, says Engstrom. IFRS should not present more of a problem here. “Smaller companies are generally more focused businesses. And we have tried to be as pragmatic as possible,” he says.
So advisers and preparers within SMEs and the private company sector would do well to see how the impacts play out for listed companies and take note of the preparatory work that goes into assessing contracts, particularly those within the telecoms and IT sectors.
Tessa Park, technical and training partner at Kingston Smith, says the long lead time for the standard gives plenty of scope for firms to get to grips with the main differences between the new standard and current requirements.
The most significant issues that firms and their clients will need to consider will be determining whether a contract has different elements and when revenue should be recognised for each element. “The new standard focuses on when the customer obtains control of the goods or services supplied to determine when revenue is recognised,” she says.
Here again, there will be many cases where preparers won’t need to change things. “For simple sales of goods this will probably achieve the same result as the current requirements, but it may well not where contracts have multiple elements or are performed over a longer period of time,” Parks says.
“These are the areas of the new standard on which firms will therefore need to focus their training because, as is so often the case, the devil is in the detail.”
The telecoms industry has become something of a poster child for IFRS 15, but any organisation that offers complex bundles of goods and services may need to unpick its usual approach.
“Companies that bundle together goods and services will need to unbundle them for the purposes of accounting and apportion revenue to the elements,” says Sleigh-Johnson.
While contracts and approaches differ widely from company to company, where a phone company offers a free phone along with a contract lasting two years at £25 pcm, typically, it will book simply the £25 pcm as revenue and ignore the cost of the phone.
“Under the new standard, you would ask ‘what is the standalone value of the phone?’ and allocate an appropriate proportion of the total revenue to it. You’re going to reflect the economic reality rather than the cash flow,” he says.
Approaches to this issue just within the telecom sector have varied widely, says Engstrom. “Where companies offer a phone without charge along with a service contract, they have considered the phone as an expense, without value to the customer. We have said that there are two elements with value.”
That upfront revenue recognition may be more significant where companies offer a discounted high-end phone, and clearly these kinds of instances also occur within the IT sector where contracts commonly include hardware, implementation, upgrades and maintenance, and companies in this sector may also see significant changes in their revenue recognition profiles.
What’s more, the standard is broadly retrospective, so companies will need to restate the prior years. “If you have many thousands of contracts, particularly if they are not standard contracts, that is challenging, which is why we have a long lead time,” says Sleigh-Johnson.
Within the debate around the standard as it evolved, there have been operational concerns around just how straightforward identifying and valuing those performance obligations within contracts will be in practice. And since the final version favours the IASB’s principle-led approach over US GAAP’s heavily detailed and granular version, this remains an area where account preparers will need help.
The IASB says the final principle-based version makes sense in the face of the huge variance of styles of contract across different industries. “This is a standard that will hopefully cover a wider range of transactions.
“It doesn’t rely on the different applications of revenue accounting for users in the US or others affected by US GAAP; there will be a lot of situations where good judgement will prevail,” says Engstrom.
“The standard includes basic principles; you divide delivery into separate performance obligations. If you are looking at a building contract, of course, you can see the border between the different elements,” he says.
The IASB will be assembling a discussion group to build guidance and best practice and to address questions as the profession begins to grapple with this particular issue.
PROCESSES AND SYSTEMS
“There will be some significant training issues,” says Sleigh-Johnson. “There will be a need to educate not just financial people, but people right across the organisation.”
And training is far from the only impact when considering what, for most accounts users, is the first port of call when assessing a company’s performance. The practical issues that cascade down from changes to what is, for many, the headline indicator of company performance are legion.
Organisational and systems issues such as the need to invest or modify IT systems should be high up the operational agenda. Changes to accounting systems will also need to reflect changing forecasts around revenue, sales forecasts and tax payments. The new requirements may force real changes in business practices, including a reassessment of sales forecasts and KPIs. The need to communicate those changes and their knock-on effects will have to be acknowledged up front.
“Where you are talking about an impact on net profit, that translates into something that may affect bonus calculations, for example,” says Sleigh-Johnson. “And there is no doubt that there will be tax implications when recognising a lot of possible revenue upfront for the first time. The new standard may throw new light on business practices. All that will take a good deal of time to evaluate and discussion will have to go up to board level.”
One aspect of the new standard that has drawn concern is the level of disclosures it involves. An IASB spokesman says that, after extensive consultation, the board has tried to reduce the burden on preparers without diminishing the usefulness of the information in the financial statements.
But it is an area that firms and preparers should not overlook, says Sleigh-Johnson. “It’s interesting that, at a time when we have debate on whether the current level of disclosures is helpful or not, here we have a standard that increases disclosure. Challenges of actually implementing the disclosures for IFRS 15 should not be underestimated.”
He adds, “It really is one to start looking at sooner rather than later.”
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