This article was first published in the November 2018 UK edition of Accounting and Business magazine.

The new standard for revenue recognition, IFRS 15, Revenue from Contracts with Customers, came into effect for accounting periods beginning January 2018. There can be few more fundamental areas to change than the top-line number.

We looked at the disclosures in 18 companies’ final annual reports before the adoption of the new standard, and at their interim reports from 2018. Some interesting changes emerged.

IFRS 15 includes a five-step approach. The reported changes under each of these were as follows.

  • Identify the contracts with the customer. In some cases the distinction between whether parties are acting as an agent in a contract or as a customer has changed. House builders have had to separate the sales of new houses from the contracts to sell older houses taken in part-exchange, for example. This issue also affects companies in software, property management and transportation sectors. The result is that what was a commission cost may become a discount and so a reduction in revenue, and vice versa. The effect of such changes has been less on the bottom line profit than on gross revenue or the reported margins of different business lines, but in some companies the impact can be just as significant on both.
  • Identify separate performance obligations in the contract. As predicted, this change has delivered the biggest impact. The greater unbundling required by IFRS 15 changes the timing of revenue recognition and profit, and this has meant restating retained earnings. Separating the sale of equipment and software upfront from the provision of services, maintenance and installation has speeded up revenue/profit recognition for mobile phone contracts, for example; for others, past profits have been derecognised and deferred. For residential property developers, revenue has to be allocated to the five-year warranties given as part of the ‘package’ and cannot just be set aside as a provision for the estimated cost of claims.
  • Determine the contract price. Companies are not highlighting major changes in the treatment of variable consideration. This indicates that volume discounts to customers or bonuses on milestones, for example, were already being accounted for cautiously. Where IFRS 15 seems to be changing treatments to a greater extent is on contract acquisition costs. This was not covered by the previous standard, but now such costs should be spread forward in line with revenue. Some engineers making major equipment sales, house builders and mobile phone companies seem previously to have been expensing substantial commissions to intermediaries as incurred.
  • Allocate the contract price to the different performance obligations. The option to disregard a financing element when the time difference between the receipt of cash and the performance under the contract is less than 12 months has been widely taken up where there are substantial customer down-payments. The requirement to identify standalone selling prices for separate performance obligations was one that many companies found difficult to apply and where a degree of judgment was required.
  • Recognise revenue when the performance obligations are fulfilled. The key criterion for fulfilment under IFRS 15 is that control passes to the customer, either at a point in time or over time. It is difficult to disentangle any effects from this from the separate performance obligations of equipment delivery and service.

More detailed effects have been important – for example, the switch away from ‘percentage of completion’ method to ‘proportion of costs incurred’ method for measuring the milestones achieved. In property development, for some the point in time for the sale is changing from exchange of contracts and practical completion to legal completion.

It does not seem entirely clear that, even under IFRS 15, all housing developments will be on the same model for revenue recognition; some may be recognising over time and others at a point in time.

Transition and restatement

Companies seem evenly split between those with a full retrospective restatement and those opting for the modified approach. Among a surprising number of companies, no final choice had been made at the end of 2017; even for interim reports in 2018, for many the choice on transition is still not clear. Users might therefore be unaware of whether the previous year’s numbers are truly comparable or not.

The restatement of retained earnings on either transition method appears to have been relatively modest overall, but for some, such as Rolls-Royce, it has been substantial.

Restatements can be an increase or decrease, although the telecoms companies have seen consistent increases as a consequence of the upfront recognition of the sale of equipment.

Much about companies’ application of the new standard in 2018 remains to be disclosed and evaluated. The absence of full retrospective restatements means that the real impact on earnings will not fully emerge until 2019.

What can be seen so far, however, would indicate that the impact of IFRS 15 is variable – what has changed varies (and may be in the detail of the standard), as does the extent of the impact from one business to another, and some sectors (retail and property investment, for example) have scarcely been affected at all.

Overall, the effect of IFRS 15 on profits or net assets may not be extensive, although the effort required to implement it may have been significant, with companies trying to understand fully the many different sorts of contracts with customers.

So has it all been worth it? The benefits in improved reporting – greater clarity and consistency, and better disclosure – will probably only become evident in the next periods as the new accounting standard becomes fully embedded into corporate reporting.

Richard Martin, head of corporate reporting, ACCA