Revenue recognition is crucial in preparing the financial statement and in making assessment about the performance and the prospect of the company. More companies are moving towards globalization, difference in the reporting and revenue recognition makes it difficult for the investors to make a comparison and in understanding about the actual performance of the company (Silvia, n.d.). This demand for more changes in the revenue recognition that resulted in the formation of IFRS 15 (Deloitte, n.d.). The main aim is in reducing the gap between the revenue recognition as per US GAAP and IFRS (Silvia, n.d.). This paper narrates about the main objective, scope, accounting requirements, implementation guidance and disclosure.
The core objective of developing IFRS 15 is to establish such principles that will be implemented by the entire organization and enhances the quality of the financial statement (Deloitte, n.d.). It adds more value to the statement with regard to the nature, the amount, reporting time and details about cash flow generated from the contract and uncertainty in the revenue and cash flow from contracts (Deloitte, n.d.). This standard will be in effect from January 1, 2017 (Deloitte, n.d.). IFRS 15 replaces the following standards (Silvia, n.d.):
- IAS 11 Construction contracts
- IAS 18 Revenue
- IFRIC 13 Customer Loyalty Programmes
- IFRIC 15 Agreements for the Construction of Real Estate
- IFRIC 18 Transfers of Assets from Customers
- SIC-31 Revenue – Barter Transactions Involving Advertising Services
This standard will be applicable to all the customer contracts except for the following (Deloitte, n.d.):
- Leases that fall under the scope of IAS 17 leases.
- Those financial instruments and the contractual obligation and rights that fall within the scope of IFRS 9 Financial instrument (Deloitte, 2014, p. 3).
- Similarly, it will not be applicable to IAS 27 Separate Financial Statements, IAS 28 Investments in Associates and Joint Ventures, IFRS 10 Consolidated Financial Statements, IFRS 11 Joint Arrangements and IFRS 4 Insurance Contracts and any non-monetary exchange that took place between the entities within the same business line.
There are some situations where applicability of IFRS15 may be partial, and another standard has to be taken into consideration (Deloitte, n.d.).
- If in case other standard provides for details about segregating them and one or more portion of the contract then in this case, those standards will be applicable first, prior to IFRS 15. In this case, there will be a reduction in the transaction amount that was measured at the initial stage (Deloitte, n.d.).
- If in case there are no standards about segregation is available then IFRS 15 will be completely applicable (Deloitte, n.d.).
Five-step model (Deloitte, n.d.):
The primary principle of IFRS15 is being segregated into five steps (Deloitte, n.d.). The primary principle is in depicting the transfer of goods and services to the customers for the amount that will reflect about the consideration to which a firm is expected to be entitled to in exchange of goods and services (Deloitte, n.d.).
Step 1: It deals in identifying the customer contract (Deloitte, n.d.):
IFRS 15 defined contract as an agreement that is being made between two or more person which creates rights and obligations that are enforceable and must exert those criteria which meet the entire requirement (Silvia, n.d.). Contracts must be approved by the involved parties, all rights, product or services transferred must be identified, transfer in the payment terms and conditions must be identified, contract must consist of commercial content, and there must be a probability to collect the entitled product and services (Deloitte, n.d.). This standard provides clear narration about the requirements in case of modification in the contract. There are certain situations which may even lead to the consideration of any modification as a separate contract (EY, 2014, p. 2).
Step 2: Identify the performance obligations in the contract (Deloitte, n.d.):
At this step, it clearly narrates that at the time of inception of the contract, firm must make assessment about the goods or services which have been promised to be delivered to the customer and this must be recognized as a performance obligation as per IFRS 15.22 (Deloitte, n.d.). The core determinant lies in determining the series of services or goods which are distinct in nature.
Any product or service can be unique only if the customer gets different benefit that can be distinctively identified from the contract’s promise. Each distinct product or services will be considered as the separate obligation to be performed (EY, 2014, p. 2).
Similarly, there are cases where the company can provide a similar pattern of transfers to the customers; it provides more details about all the consideration factors which are essential.
Step 3: Determine the transaction price (Deloitte, n.d.):
Transaction price is the amount that will be received by the company in exchange for the transfer of goods or services, while making such estimation entity will consider the customary business practices as per IFRS 15:47 (Deloitte, n.d.). An estimation of any consideration is essential which can be using either probability weighted value expected or can the amount that makes a better prediction about the amount of consideration. It must consider the time value of money; fair value has to be determined in case of non-monetary transaction and the effects of consideration payable (EY, 2014, p. 3).
Incase of variable consideration estimation of value will be made only for those contracts that fall under the contract [IFRS 15:50]. There are more restrictive approach being applied with regard to sales or any usage based on the revenue arising from the intellectual property licensing. But these revenues will be recognized only when these underlying sales occurs [IFRS 15:B63] (Deloitte, n.d.).
Step 4: Allocate the transaction price to the performance obligations in the contracts (Deloitte, n.d.):
The transaction price has to be allocated to individual performance that is based on the relative stand-alone sales price with the limited exception (Deloitte, n.d.). If in case the standalone sales price is directly observable then this has to be estimated using different methods like (Deloitte, n.d.):
- Expected cost plus the margin.
- Residual approach.
- Adjusted market assessment approach.
If in case, any consideration is being paid in advance or there are arrears then company must consider the contract which includes some significant financial arrangement, which must consider the time value of money [IFRS 15:60] (Deloitte, n.d.).
Step 5: Recognize revenue when (or as) the entity satisfies a performance obligation:
Revenue will be recognized only if the control is being transferred it can be either over a period or at any point of time [IFRS 15:32] (Deloitte, n.d.). First one has to understand the meaning of control of an asset, it is the ability to direct the usage and in obtaining the sustainability over the remaining life of the asset. Benefits that are related to these assets are the cash flow generated directly or indirectly (Deloitte, n.d.).
There are more specific criteria being mentioned in detail by this standard like:
- Customer must receive and consume simultaneously the benefits provided by the firm (Deloitte, n.d.).
- The performance of the company will create or enhance the asset which customer controls as the asset is being created (Deloitte, 2014, p. 7).
- Performance of the entity does not create any asset with alternative and firm has an enforceable payment right for performance completed (Deloitte, n.d.).
There are different factors that have to be considered when passing the control.
Analyzing the contract cost (Deloitte, n.d.):
The incremental cost that is incurred in obtaining the contract will be considered as an asset if they are expected to be recovered (Deloitte, n.d.). Similarly, costs that are incurred for fulfilling the contract is being looked as the asset only if the meet with the following criteria:
- The incurred cost is directly related to the contract.
- The incurred cost will enhance or generate the entity’s resources for satisfying the performance obligation during the future period.
- Finally, such costs are expected to be recovered.
Those assets which are recognized with respect to the cost for obtaining or in fulfilling the contract will be amortized on a systematic basis which will be consistent with the transfer of service or goods that are related to the asset [IFRS 15:99] (Deloitte, n.d.).
Impact of IFRS 15 on the financial statement (Deloitte, n.d.):
Contract with the customers will be presented in the financial statement as the contract asset or contract liability or as receivables that depends upon the performance of entity and customer payment relationship (Deloitte, n.d.). If incase customer makes a payment in advance that is prior to the delivery of goods or service will be considered as contract liability [IFRS 15:106] (Deloitte, n.d.).
In contrast, entity delivered service but did not receive any consideration from the customer will be presented as the contract asset. It will be recognized provided there is a conditional right for consideration except for the time (Deloitte, n.d.). There will be recognition of receivables only when the right to consideration of the entity is being unconditional except for the passage of time. IFRS 9 will be implemented in case of receivables and contract assets. There must be a clear disclosure about any impairment in the asset that includes details like measurement and presentation (Deloitte, n.d.). Difference between the initial recognition of the receivables and the amount of revenue recognized must be disclosed as the expenses. [IFRS 15:107-108] (Deloitte, n.d.).
IFRS 15 Disclosure requirement (Deloitte, n.d.):
According to the IFRS 15, an entity must disclose all sufficient information in enabling the user of the financial statement for understanding about the nature, timing, amount and the uncertainty of cash flow and revenue arising from the customer contract (Deloitte, n.d.).
Both quantitative and qualitative information related to the contract has to be disclosed about all the information like (Deloitte, n.d.):
- Contract with the customers.
- Those assets that are recognized from costs or for fulfilling the customer contract.
- Any significant judgment, changes in these judgment that is being made while applying for the guidance that are related to contract (Deloitte, 2014, p. 10).
All entity must meet the desired level and expectation for satisfying the objective of disclosure and must also emphasis in placing such requirement. It is the responsibility of the entity for not obscuring the required details [IFRS 15:111] (Deloitte, n.d.). Further new disclosure requirements will be introduced to enhance the quality of financial statement by the board that can be obtained from IFRS 15:113-129 (Deloitte, n.d.).
More concentration is required by the company while implementing the guidance of this standard. This includes careful consideration of the following topics (Deloitte, n.d.).
- Agent versus Principal considerations (Deloitte, 2014, p. 9)
- Sale with a right of return
- Unexercised rights of the customer
- Satisfaction of the performance obligation over a period
- Additional goods or service options to the customers.
- Repurchase arrangements
- Bill-and-hold arrangements
- Non-refundable upfront fees
- Acceptance of customers.
- Arrangement of consignments.
- Methods related to measuring the progress in order to obtain complete satisfaction
- Disaggregation of revenue must be disclosed.
IFRS 15 will bring in more detail and qualitative financial statement presentation which is essential. It will reduce the gap between US GAAP and IFRS (Deloitte, n.d.). It will implement more standards as mentioned above and will be a consolidated standard which will meet the requirement of all related standards. It will make a financial statement more standardized and reduces the chances of fraud (Deloitte, n.d.). It will enhance the clarity of the report and the revenue recognition of the company. It will be beneficial for the investors of the company.