IFRS 15 Revenue from Contracts with Customers
On 28 May 2014, a new global standard on revenue recognition, IFRS 15 Revenue from Contracts with Customers, was published by the International Accounting Standards Board (IASB) and Financial Accounting Standards Board (FASB). This new standard will apply to almost all companies reporting under International Financial Reporting Standard (IFRS) and US Generally Accepted Accounting Principles (GAAP).
Single global standard, significant impact
IFRS 15 introduces a new revenue recognition model for contracts with customers. This will replace most of the current revenue recognition guidance under IFRS and US GAAP.

The new standard will be mandatorily effective for financial years beginning on or after 1 January 2017. In Singapore, the Accounting Standards Council (ASC) is expected to adopt the new standard without modification.

Companies will have to understand the new standard and analyze its application to their contracts as the new model has significant impact on how and when they recognise revenue. For example, while the existing stage-of-completion accounting for certain long-term contracts has been retained, there are new criteria for determining when revenue should be recognized over time. In some arrangements, the revenue may have to be recognized on contract completion while with others, the amount of revenue recognized under the new model may be different from the current model.

As such, all arrangements will need to be reviewed in detail before a conclusion can be reached. In some cases, companies may wish to re-draft certain contract terms and re-consider certain business practices in order to achieve or maintain a particular revenue profile.

What is important is that all companies must understand the extent of the impact and address the needed communications with investors and analysts. Any change to the revenue recognition profile will affect financial ratios and in turn impact share prices or access to capital. Changes to the timing of revenue recognition will also affect tax payments, dividends and staff bonuses and incentive plans. Budgets may have to be re-visited to take into account the proposed changes of the new standard. Directors responsible for the financial statements will need to ensure the companies they steer understand these revisions in order to avoid the risk of non-compliance.
One model, two approaches, five steps
The new standard contains a single model that applies to contracts with customers. There are two approaches to recognizing revenue – revenue at a point in time, when control of the good or service is transferred to the customer, or over time, in a manner that best reflects the company’s performance.

The model features a contract-based five-step analysis of transactions to determine whether, how much and when revenue is recognized. At a glance, this is how the five-step model is applied (Figure 1).

Industries affected
Globally, the impact of the new standard varies across industries (Table 1). All companies should conduct a detailed analysis to determine how IFRS 15 affects them as the standard completely overhauls the way revenue is recognized.

Singapore real estate developers
The new standard replaces existing guidance on revenue recognition including INT-FRS 115 Agreements for the Construction of Real Estate and the Accompanying Note.

It re-affirms the general consensus among developers in Singapore that progressive recognition of revenue faithfully reflects the financial performance of developers under certain circumstances. Progressive recognition of revenue is allowed if the following criteria, among others, are met:
  • It is probable that the consideration is collectible;
  • The developer cannot direct the same unit to another customer, and
  • Throughout the term of contract, the developer has an enforceable right to payment for performance completed to date.
Developers will need to demonstrate they have an enforceable right to receive payment for performance completed to date. They will require a detailed analysis of the contractual terms in the sale and purchase agreements with customers, and the legal framework and practices in the jurisdictions of their operations.

It is also likely that revenue for sales of certain overseas development projects will be recognized progressively under the new standard. In some cases, careful drafting of certain contract terms may be required to achieve the progressive recognition of revenue under the new standard.

Another positive change for the real estate industry is that sales commissions paid to marketing agents on the basis of successful outcomes can now be capitalized, subject to certain conditions.
Telecommunication companies
Telcos are likely to be significantly affected. New guidance on unbundling would require telcos to allocate revenue to various components such as handsets and ongoing telecom services in a bundled arrangement based on their relative standalone selling prices.

This would likely result in more revenue being allocated to the handset as compared to current practice in many cases. There will be a significant difference between when revenue is recorded and when actual cash is received from customers.
Marine builders
The new standard may allow marine builders in Singapore to continue with the current practice of recognizing revenue over time for some arrangements. In other arrangements, the accounting may need to be revisited.

For example, recognition of contract revenue may need to be deferred until delivery of the vessels if the customer is enjoying vendor financing arrangements and/or if the marine builder is building generic vessels that are largely interchangeable with other vessels constructed by the builder and the builder may be able to substitute the vessels across different customer contracts.

Marine builders who wish to continue with the progressive recognition of revenue under the new standard will have to re-draft certain contract terms and change certain existing business practices.

Other critical judgment to note include:
  • Marine builders may find it challenging to gather support that future revenue reversals are highly improbable for variations and claims. This may cause a delay in the recognition of revenue from variations and claims when the new standard is adopted.
  • If consideration is paid in advance, IFRS 15 requires the marine builder to determine whether the contract includes a significant financing component. If so, the builder needs to adjust for the time value of money unless the interval between the transfer of the promised goods and services and payment by the customer is expected to be less than 12 months at contract inception.
Extensive disclosure requirements
The new standard includes extensive disclosure requirements applicable to all companies. The new disclosures are onerous and may require disclosure of information that could be commercially sensitive. Examples of new disclosures include:
  • Reconciliation of contract asset and contract liability balances;
  • Transaction price and when revenue recognitions are allocated to performance obligations that are unsatisfied or partially satisfied (for example, future order books for which the company has signed contracts with customers for future deliveries including when the future order books are expected to be recognized as revenue);
  • Closing balances of assets recognized from the costs to obtain or fulfill a contract with a customer by category (for example, costs to obtain contracts, pre-contract costs and set-up costs).
Understanding the extent of disclosures in advance will enable companies to redesign existing systems to capture the additional information required for disclosure and to assess the impact on the business if the disclosures include commercially sensitive information.
What you need to do about IFRS 15
The new IFRS 15 takes effect on 1 January 2017, though earlier adoption is possible.

There are several transition options available to affected companies. Preparers can choose to apply IFRS 15 retrospectively, with certain optional practical expedients, and adjust each comparative period presented in the financial statements. Alternatively, preparers can recognise the cumulative effect of applying IFRS 15 at the date of initial application (that is, 1 January 2017 for calendar year-end companies) and make no adjustments to its comparative information.

Companies need to carefully consider the options as their choice can have a significant effect on revenue and cost trends.

If companies choose to adopt the full retrospective approach, one option is to implement the necessary system changes such that companies can account for their contracts on a real-time basis and provide the necessary disclosures under IFRS 15 from the beginning of the earliest comparative period presented (that is, 1 January 2016 for calendar year-end companies). With this option, they have just over a year to implement the system changes.

Companies wishing for early adoption of IFRS 15 by just a year using the full retrospective transition method may need to have their redesigned systems up and running by 1 January 2015, a date about four months away.

An early decision will allow companies to develop an efficient implementation plan and inform their key stakeholders in advance.
This article was contributed by Gerald Low, Audit Partner at KPMG in Singapore. The views expressed are his own.
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