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Future Of Revenue Recognition

Published on Tue, Oct 14,2014 | 08:11, Updated at Tue, Oct 14 at 08:11Source : 

By: Pankaj Chadha, Partner In A Member Firm Of Ernst & Young Global

To align with the proposed roadmap announced earlier and the budget announcements thereafter by the Finance minister, The Institute of Chartered Accountants of India (ICAI) has initiated the process of obtaining comments on modifications it has made in the Ind AS. For some of the Ind AS currently exposed, ICAI would receive comments up to 15 October, 2014.

Whilst most of the Ind AS would require revision to come to speed with changes in IFRS, new IND AS would be required to be prepared in relation to IFRS 9 and IFRS 15.

This note is on IFRS 15, a standard that has been under preparation since over 10 years and is the first FASB/IASB converged standard announced on 28 May, 2014. It will be applicable in all countries currently reporting under IFRS or USGAAP (equivalent standard is ASC 606). For countries which are yet to adopt IFRS, like India, adoption/convergence would be necessary.

IFRS 15 includes a cohesive set of disclosure requirements that would result in an entity providing users of financial statements with comprehensive information about the nature, amount, timing and uncertainty of revenue and cash flows arising from the entity’s contracts with customers. Specifically, IFRS 15 requires an entity to provide information about:

a. revenue recognised from contracts with customers, including the  disaggregation of revenue into appropriate categories;

b. contract balances, including the opening and closing balances of receivables, contract assets and contract liabilities;

c. performance obligations, including when the entity typically satisfies its performance obligations and the transaction price that is allocated to the remaining performance obligations in a contract;

d. significant judgements, and changes in judgements, made in applying the requirements to those contracts; and

e. assets recognised from the costs to obtain or fulfill a contract with a customer

IAS 11 (Ind AS 11) and IAS 18 (Ind AS 18) are current standards in relation to accounting for Construction Contracts and Revenue respectively. IFRS 15 replaces these standards as well as other guidance available on revenue under IFRIC 13 (Customer loyalty programs), 15 (Agreements for the Construction of Real Estate), 18 (Transfer of Assets from Customers) and SIC 31 (Revenue- Barter transactions involving advertisement services) providing guidance on a broader definition of revenue. Similarly, in the US, ASC 606 replaces the revenue guidance available in existing standards including the industry specific and other guidance.

Though IFRS 15 is applicable effective periods starting 1 January, 2017 or after, retrospective application is required. In the US early adoption is allowed to non-public companies for up to the date it becomes public, whereas IFRS permits early adoption. Corporates have already started evaluating the impact the application of new standard would have, not only on financial reporting but also on customer contracts, people and processes. To understand the impact and its rigorousness, brief overview would assist.  The standard prescribes a five step approach to revenue recognition and also adds significant disclosures in relation to revenue model of the enterprise.

Step 1: Identify the contract with the customer (Oral, implicit, written)- typically all contracts having commercial substance would require careful evaluation.
Step 2: Identify the performance obligations in the contract (explicit or implicit; contractual terms or customary business practices)
Step 3: Determine the transaction price (giving consideration to fixed v/s variable; financing; transaction costs with customers; any non-cash consideration)
Step 4: Allocate the transaction price to performance obligations (relative to “standalone selling price” of these obligations)
Step 5: Recognize revenue as performance obligations are satisfied (concept of recognition moved from “risk & rewards” to “transfer of control”) 

In addition, presentation in financial statements would be at “contract” level resulting in recognition of “contract assets” and “contract liabilities”.  As the related IndAS is announced, not only the current IFRS or USGAAP reporting entities from India but also the companies reporting in India would need to assess the impact of this new standard. Whilst this standard would impact companies in all industries, it is likely to have more significant impact in those industries which usually deal in bundled contracts like software, technology, media & entertainment etc. Some of the key areas to focus for corporates would include

Understand the new Disclosures requirements properly: Many new and potentially complex disclosures, such as more disaggregation of revenue, remaining performance obligations (i.e., deliverables) and contract balances, will be necessary.

Review and carefully evaluate the accounting for Contract Modifications: Significant judgments in the accounting for change orders and claims will increase over the existing prescriptive accounting guidance.

Training on the new standard as well as process changes emerging from it: The amount of training and time required to embed the new standard in every facet of the business will be significant, especially for project managers and other non-financial personnel who know GAAP as “how the system works.”

Transition to the new standard: transition could be costly as would entail activities starting from determining opening balances and dual tracking for retrospective adoption, to system changes and key stakeholder education. 

Systems Modifications requirements: Significant system modifications will be needed to capture the additional information required under the new standard, including disclosures, tracking performance obligations and contract balances.

Specific policies review and redevelopment: Most companies have well established and documented accounting policies under current GAAP; those policies will have to be revisited and changed based on the new guidance.

Key Performance Metrics: Changes will likely be made to financial KPIs. Compensation, benefit arrangements, pre-qualification requirements and bonding/surety capacity may be affected.

Tax Accounting: New differences between book accounting and tax accounting are likely to result from implementation of the new standard, as corresponding changes to the tax laws are unlikely.

Uncertainty: Since this standard affects a wide array of stakeholders like regulators for indirect taxes, changes are likely in such other regulatory provisions impact where would require careful evaluation.


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