IFRS News - Grant Thornton Northern Ireland

liaec on ueSp iti enEd evRonIFRS NewsRevised October 2016IASB and FASB release major new standard on revenue recognition“IFRS 15 ‘Revenue from Contracts with Customers’ represents theculmination of more than five years of cooperation between theIASB and FASB, and will affect almost every revenue-generatingbusiness that applies IFRSs. While achieving convergence hasbeen challenging and sometimes controversial, we believe thenew Standard will provide a major boost for investors looking tocompare company performance across borders.IFRS 15 will apply to most revenue arrangements, includingconstructions contracts. Among other things, it changes thecriteria for determining whether revenue is recognised at a point intime or over time. IFRS 15 also has more guidance in areas wherecurrent IFRSs are lacking – such as multiple element arrangements,variable pricing, rights of return, warranties and licensing.The actual impact on each company’s top line will dependon their specific customer contracts and how they have appliedexisting Standards. For some it will be a significant shift, andsystems changes will be required, while others may see onlyminor changes. With IFRS 15 taking effect in 2018, managementshould begin their impact assessment now.”Global IFRS TeamGrant Thornton International Ltd.A shift in the top line – the newglobal revenue standard is hereat lastThe IASB has published IFRS 15 ‘Revenuefrom Contracts with Customers’. IFRS 15: replaces IAS 18 ‘Revenue’, IAS 11‘Construction Contracts’ and somerevenue-related Interpretations establishes a new control-based revenuerecognition model changes the basis for deciding whether revenueis recognised at a point in time or over time provides new and more detailed guidanceon specific topics expands and improves disclosures aboutrevenue.This special edition of IFRS News explains thekey features of the new Standard and providespractical insights into its application and impact.

A single model for revenue recognitionIFRS 15 is based on a core principle that requires an entity to recognise revenue: in a manner that depicts the transfer of goods or services to customers at an amount that reflects the consideration the entity expects to be entitledto in exchange for those goods or services.A “customer” is defined as “a party that has contracted with an entity to obtaingoods or services that are an output of the entity’s ordinary activities.” Applyingthis core principle involves the following five steps:Five steps for revenue recognition1. Identify the contract(s) with a customer2. Identify the performance obligations3. Determine the transaction price4. Allocate the transaction price to theperformance obligations5. Recognise revenue when or as an entitysatisfies performance obligationsIFRS 15 at a glanceSituationDetailsWho’s affected? all entities that enter into contracts with customers with fewexceptions.What is the impact? entities affected will need to reassess their revenue recognition policiesand may need to revise them the timing and amount of revenue recognised may not change for simplecontracts for a single deliverable but most complex arrangements will beaffected to some extent IFRS 15 requires more and different disclosures.When are the changes annual periods beginning on or after 1 January 2018effective? early application is permitted.2 IFRS News Special Edition Revised October 2016

Practical insight – some industries will be affected more than othersSome of the industries that will be most affected by revenue recognitionchanges include: telecoms and IT – where multiple deliverables are commonplace and currentpractice is mixed. Cell-phone businesses that account for a “free” handset asa marketing cost will need to change this policy and instead allocate revenuebased on relative standalone selling prices real estate – when to take revenue for “off plan” apartment sales has been adifficult issue and the new model will shift the boundary between percentageof-completion and on-completion revenue recognition asset management, legal and professional services and other sectorswhere performance-based or contingent fees are commonplace –under the new model variable payments are accounted for on a best estimatebasis subject to a constraint retail – accounting for rights of return, customer loyalty schemes andwarranties could all be affected.Other areas that could be affected include deferred and advanced payments,licensing arrangements, breakage and non-refundable upfront fees.ScopeIFRS 15 applies to contracts with customers to provide goods or services. It does notapply to certain contracts within the scope of other IFRSs such as lease contracts,insurance contracts, financing arrangements, financial instruments, guarantees otherthan product warranties, and non-monetary exchanges between entities in the sameline of business to facilitate sales to third-party customers. In scopeScope of IFRS 15 revenue from contracts with customers (subject to specificexceptions), including contracts for – sales of goods – rendering of services, including construction services– licensing of intellectual property exchanges of non-monetary assets other than scoped-out exchanges(see below). non-contractual income eg fair value of agricultural producerecognised under IAS 41 ‘Agriculture’ contracts within the scope of: – IAS 17 ‘Leases’ – IFRS 4 ‘Insurance Contracts’ – IAS 39 ‘Financial Instruments: Recognition and Measurement’(or IFRS 9 ‘Financial Instruments’) contracts that are not with customers (eg some risk-sharing contracts) non-monetary exchanges between entities in the same line of businessto facilitate sales to customers.Not in scopePractical insight – scopeAlthough the scope of IFRS 15 isdescribed differently, for practicalpurposes we expect it will be verysimilar to the scope of IAS 18 andIAS 11 taken together.IFRS 15 also coversarrangements currently in the scopeof IFRIC 13 ‘Customer LoyaltyProgrammes’, IFRIC 15 ‘Agreementsfor the Construction of Real Estate’and IFRIC 18 ‘Transfers of Assetsfrom Customers’.IFRS News Special Edition Revised October 2016 3

The five stepsStep 1: Identify the contract(s) with a customerThe first step in IFRS 15 is to identifythe “contract,” which IFRS 15 definesas “an agreement between two or moreparties that creates enforceable rightsand obligations.” A contract can bewritten, oral, or implied by an entity’scustomary business practices.In addition the general IFRS 15model applies only when or if: the contract has commercialsubstance the parties have approvedthe contract the entity can identify each party’s rights the payment terms for thegoods and services to betransferred it is probable the entity willcollect the consideration.If a customer contract does not meetthese criteria, revenue is recognisedonly when either: the entity’s performance iscomplete and substantially allof the consideration in thearrangement has been collectedand is non-refundable the contract has been terminatedand the consideration received isnon-refundable.4 IFRS News Special Edition Revised October 2016For purposes of IFRS 15, a contractdoes not exist if each party has anenforceable right to terminate awholly unperformed contract withoutcompensating the other party. Combining contractsAn entity is required to combine two ormore contracts and account for themas a single contract if they are enteredinto at or near the same time and meetone of the following criteria: the contracts were negotiated asa package with one commercialobjectivethe amount paid under onecontract is dependent on theprice or performance underanother contractthe goods or services to betransferred under the contractsconstitute a single performanceobligation.Criteria for combining two or more contractsWere contracts negotiated as a packagewith a single commercial objective?YesNoDoes consideration in one contract depend onthe price or performance of another contract?YesNoAre contracts for a singleperformance obligation?NoTreat as separate contractsYesTreat as a singlecontract

Step 2: Identify the performance obligationsHaving identified a contract, theentity next identifies the performanceobligations within that contract. Aperformance obligation is a promise ina contract with a customer to transfereither (1) a good or service, or a bundleof goods or services, that is ‘distinct’(see below); or (2) a series of distinctgoods or services that are substantiallythe same and meet certain criteria.Performance obligations arenormally specified in the contract butcould also include promises impliedby an entity’s customary businesspractices, published policies or specificstatements that create a valid customerexpectation that goods or services willbe transferred under the contract.Performance obligations do notinclude administrative-type tasks thatdo not result in a transfer of a goodor service to a customer (eg someset-up activities).A promised good or service is‘distinct’ if both of the following criteriaare met: the customer can benefit from thegood or service either on its ownor with other resources readilyavailable to them. A readily availableresource is a good or service that issold separately (by the entity or byanother entity) or that the customerhas already obtained it is separately identifiable fromother promises in the contract(ie the good or service is distinctwithin the context of the contract).Indicators that an entity’s promisesto transfer goods or services are notseparately identifiable include: significant integration services areprovided (ie the entity is using thegoods or services merely as inputsto produce the specific outputcalled for in the contract) the goods or services significantlymodify or customise other promisedgoods or services in the contract(or are modified by them)Meaning of ‘distinct’DistinctCustomer canbenefit eitheralone or with otherreadily availableresourcesReadily availableresource Soldseparately orcustomer hasalready obtainedSeparately identifiableSignificantintegrationservices notprovidedNo significantcustomisationormodificationNot highlydependent orinterrelatedPractical insight – performance obligationsThe concept of performance obligations is a cornerstone of the IFRS 15 model.The timing of revenue recognition is based on satisfaction of performanceobligations rather than the contract as a whole. This area is sometimesreferred to as ‘multiple element arrangements’ – a topic on which IAS 18 andIAS 11 are lacking in guidance. Practice has therefore been somewhat mixedunder current IFRSs and in some industries, such as software, many entitieshave turned to much more detailed US GAAP for guidance.Entities applying IFRSs will need to analyse all but the simplest customercontracts to identify whether they include more than one performanceobligation, based on the ‘distinct’ principle described above. That said,we expect that many long-term construction and service contracts willbe identified as single performance obligations because they ofteninclude a significant integration service. By contrast, the calculation ofrevenue attributable to free or discounted mobile phones delivered bytelecommunications companies as part of an airtime or data package willchange if those companies previously applied a ‘cash limit’ by analogy to USGAAP when assessing the probability of receipt.IFRS 15 also includes specific guidance on some contract elements suchas warranties and customer loyalty schemes. the goods or services are highlydependent on, or interrelated with,other promised goods or servicesin the contract.IFRS News Special Edition Revised October 2016 5