The financial reporting landscape will witness significant changes in 2018 as the two major standards on Revenue and Financial instruments (IFRS 15 Revenue from contracts with customers and IFRS 9 Financial Instruments) become effective. For many reporting entities, the new revenue accounting principles is a paradigm shift that require care in implementation.
The investment community including auditors, regulators, financial analysts, financial reporters and the investing public at large need to be aware of the changes the new standard brings and its impact on the financial statements of reporting entities otherwise there may be a systemic wave of miscommunication, misinterpretation and analysis of company’s financial performance and position if the knowledge gap is not filled.
IFRS 15- Revenue from contracts with customers was issued on May 28, 2014 as a result of the joint effort of the International Accounting standard Board (IASB) and the Financial Accounting Standard Board (FASB)’s response to the concern in the investment community on the differences in accounting for similar revenue transactions using the different reporting framework. Before the convergence of the revenue accounting, a huge deal of reconciliation effort went into attempting to make a meaningful comparison of financial information for most multinational companies operating in different jurisdictions and applying different GAAPs. Revenue is a crucial metric in performance reporting and there was need to achieve a level of comparability and enhance the quality and consistency of how it is being measured.
Notwithstanding the convergence that has been achieved in reporting revenues by the new standard, all reporting entities have to deal with managing the changes that results from the adoption of the new standard. The changes have impacts on the nature of financial information that will be produced (in terms of disclosures, measurements, and presentations) and the processes, controls, systems that will generate the financial information.
One of the critical areas to highlight is the degree of managerial judgment that is required in complying with the standard. For instance, IFRS 15 requires companies to include in the measurement of revenue, variable considerations that it will be entitled to so far there will not be significant future reversals (constraining revenue). A significant degree of judgment is required in determining the timing, the amount, the estimation method in arriving at the revenue to be recognized.
The principle of unbundling transactions to determine the performance obligations within each contract is another area where judgement is required. Companies are now required to allocate the transaction price to each performance obligation provided on a relative standalone basis. There are a number of obligations within a contract that may not have a standalone transaction price or selling price or a comparable price for a similar transaction. The application of the standard will requires a degree of judgment in the allocation process and the determination of revenue to be recognized.
In addition to the degree of judgements required in the application of the standard, there is the introduction of some new and unique assets lines in the balance sheet that will require accounting policies and process set up. The nature of these assets have to be carefully understood and interpreted. IFRS 15: 91 requires the incremental costs of obtaining a contract with a customer to be recognized as an asset if the entity expects to recover those costs. The incremental costs are costs incurred to obtain a contract with a customer that would not have been incurred if the contract had not been obtained. For instance, sales commissions can be capitalized as assets. This new class of assets need to be carefully understood and interpreted as they are subject to specific principles on amortization and impairments.
For SEC regulated entities with December reporting period, the first time adoption of IFRS 15 will be reported in their first quarter financial statements in March, corporates have to brace up for the decisions that need to be made especially in term of measurement, presentation and disclosure requirements of revenue transactions. The new standard gives room for alternative approaches and options for transitioning and the impact of each transition approach has a huge impact on the financial information provided in those first set of accounts. For instance a company that chooses to apply the full retrospective approach and no practical expedients will be required to assess the impact of the adoption of the new standard on revenue contracts that dates back to as far as possible and to adjust the impact of the changes in principles to financial statements presented for the affected periods while companies that choose the modified approach will only be required to adjust the effect of the adoption on the opening balances of their current reporting period with no restatement of the comparatives. This invariably implies that the companies that choose to apply the retrospective approach without any practical expedient will present a minimum of three (3) statement of financial position on transition and will have more elaborate notes and disclosures than those who choose not to. Although the financial results of the companies that choose to adopt the retrospective approach will show less volatility in the revenue profile overtime and will have more comparable results than those who do not.
Although IFRS 15 gives room for judgments and subjectivity, the standard, however, requires companies to make more elaborate disclosures than the existing guidance. Companies will be required to provide both qualitative and quantitative information about its contracts with customers, the significant judgements, and changes in the judgements made in applying [IFRS 15] to those contracts and any assets recognized from the costs to obtain or fulfil a contract with a customer in accordance with [IFRS 15:91] in addition to other more elaborate requirements on disclosures that explain the impact that new accounting standards are expected to have on an entity’s financial statements . This will aid the understanding of the financial statement impact of the adoption of the new revenue standard.
The investment community needs to continue to re-orientate itself to understand the intricacies and peculiarities of the application of the new revenue standard; it is quite obvious that areas that will potentially require more attention will be the application of judgement and the use of significant model estimates, the peculiarities of the new assets lines created and for first time reporters, the impact of transition decisions on trend analysis.