Businesses are beginning to ask scenario-specific questions about how they should be applying the new revenue recognition standard, as Adam Deller reports
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This article was first published in the January 2020 UK edition of Accounting and Business magazine.
IFRS 15, Revenue from Contracts with Customers, became effective for accounting periods beginning on or after 1 January 2018, which means we are now reaching the point where entities are raising specific queries based on real-world situations.
As part of this process, questions are often brought to the IFRS Interpretations Committee (IFRIC), which is the interpretive body of the International Accounting Standards Board (IASB). IFRIC is responsible for responding to questions about the application of IFRS Standards. As questions are raised, IFRIC makes a series of ‘agenda decisions’ to help clarify the application of standards in specific scenarios. If it is decided that these decisions highlight a widespread or material issue, it may make a narrow scope amendment to a published standard.
This article will look at some of the agenda decisions made in relation to IFRS 15 to date as a way to understand how entities can apply them. It will also consider a tentative agenda decision about training costs incurred as part of a contract, which is still open for comment.
The five-step model
To begin, it is important to recall the key principles underpinning IFRS 15. The standard replaced the more ‘risks and rewards’ approach in IAS 18, Revenue, and IAS 11, Construction Contracts, with a five-step method for recognising revenue from contracts with customers. While IFRS 15 still allows room for judgment, the five steps offer more detail and guidance for users, with the aim of reducing ambiguity around the timing and amounts relating to the recognition of revenue.
The five steps are key to IFRIC’s decisions, so those decisions will be examined with reference to them:
- Identify the contract.
- Identify the performance obligations in the contract.
- Determine the contract price.
- Allocate the transaction price.
- Recognise revenue when a performance obligation is satisfied.
The first of the IFRIC agenda decisions relates to real estate contracts, where an entity constructs property for sale to third parties. There is sufficient scope for judgment in the IFRS 15 standard to decide whether the conditions are met to record revenue over time or at a point in time.
If an entity decides to recognise revenue over time, then the asset created cannot have an alternative use to the entity, which must also have an enforceable right to payment for performance completed to date. If this is the case, the entity recognises revenue as the buildings are constructed, increasing revenue further as construction progresses.
This raised further questions about the costs of fulfilling such a contract. As a real estate contract progresses, the potential assets relating to it will depend on the situation, as follows:
- If an item of property has been pre-sold to a customer, there will be a receivable if the right to issue an invoice has been established.
- If the contract has not yet reached that stage, then there will be a contract asset.
- If an item of property has not been pre-sold, then the property will represent inventory until a sale is agreed with a customer.
In a real estate project, it is likely that the construction entity will need some element of financing in the initial phase. There are likely to be significant costs incurred upfront before any right to invoice is established. In this case, the question was raised as to whether borrowing costs could be capitalised in relation to the assets under the contract.
The decision IFRIC arrived at is that the borrowing costs cannot be capitalised, regardless of whether the item created was a contract asset, receivable or inventory. If the asset being created is a receivable, this will be built up to the full sales value based on progress towards completion, so no interest can be added. Similarly, if this is a contract asset it will result in the same situation. In both cases, the amount charged to the customer will be set in the sales price, so interest cannot be capitalised onto this.
If the item has not been pre-sold, then the borrowing costs can still not be capitalised. The reasoning here is that at any moment a customer could agree to purchase the goods, which would mean that progress towards completion could immediately be recorded as revenue. It is unlikely that the sales price would include an increase due to the interest incurred, so this would not be included in the asset.
A specific question was raised in the context of a stock exchange, which charges companies fees to list. As part of the listing, the stock exchange charges both an upfront fee and an ongoing fee. The upfront fee is charged to cover the costs of due diligence work and other views, and is non-refundable. The question was whether the upfront and ongoing fees could be regarded as being for two separate services, and whether the upfront fee could initially be recognised as revenue.
IFRIC decided that no revenue could be recognised. Its assessment was there was only one performance obligation under the contract – the provision of a stock exchange listing. It decided that as nothing else was promised for the upfront fee, the accounting treatment should be similar to that of a membership agreement with an upfront fee. When assessing the query, the committee went back to the general principles of revenue – revenue cannot be recognised in the accounts unless something is given to the customer.
Payments to a customer
The specific query relates to the airline industry, which can be required by law to provide customers with compensation in the case of delay or cancellation. The query was whether this should be recognised as a provision under IAS 37, Provisions, Contingent Liabilities and Contingent Assets, or as part of the contract under IFRS 15. This is important to entities, as it results in either the recognition of expenses or a deduction in revenue, even if the overall profit figure is the same either way.
The decision made was that the compensation is embedded as part of the contract, as a form of variable consideration. Under the contract price determine step of the IFRS 15 model, the treatment for variable consideration states that if an entity makes a payment to a customer and receives nothing in exchange, this is a debit to revenue.
This raises the interesting question as to what happens if the reimbursement is above the initial revenue, which can sometimes be the case with flight compensation. This could result in negative revenue, which conceptually seems wrong. The committee did not specifically address this issue, deciding it wasn’t a widespread occurrence. It is likely that entities could take the revenue to zero and record the excess as an expense. They would also be able to deduct the whole amount from revenue. Either way, as long as the entity explains its treatment, is likely to be an acceptable application of IFRS 15.
Costs to fulfil a contract
The final question we will look at is the tentative decision, yet to be finalised, which relates to training costs incurred as part of a contract. The example raised was one where an entity providing a support service on behalf of a customer would need to be trained in the specific details of that customer’s product, which would then be charged to that customer. As these costs could be recharged to the customer, the question was whether the costs would have to be expensed as incurred, or could be matched to the revenue earned on the contract.
To deal with this situation, the committee took a step outside of IFRS 15. The standard states that a first consideration is to look at whether costs are covered by another standard. In this case, the committee ruled that training costs are already covered by IAS 38, Intangible Assets, which states they must be expensed as incurred. The committee therefore decided that this would be the correct treatment.
In each of these cases, the decisions clearly relate to specific industries, but these are key in helping users to understand the application of accounting standards. The decisions made in these cases provide greater clarification of upfront fees, training costs, payments to customers and borrowing costs. These agenda decisions are a vital tool in the development and refining of new standards, and will provide valuable information to preparers as they grapple with the specific reporting requirements of new standards.
Adam Deller is a financial reporting specialist and lecturer.
CPD technical article
"Revenue cannot be recognised in the accounts unless something is given to the customer"