AASB 15 Revenue from Contracts with Customers is coming for 31 December 2018 year-ends onward. Have you fully considered all the implementation issues? As part of your implementation project you need to consider a range of different issues around revenue recognition and measurement, capitalisation of costs, disclosures, transition and flow on impacts to other standards. This article considers one of those flow-on issues – the impact of the new standard on inventory recognition.
How and when revenue is recognised, has been under much discussion with the issuance of the new revenue standard. But, have you thought about the impact on your inventory recognition? There may be significant impacts for you in practice due to subtle changes in the standard.
AASB 102 Inventories has no specific guidance on the timing of purchased inventory recognition and we have typically referred to the revenue recognition requirements in AASB 118 Revenue to determine that point in time. The logic being that if the seller is recognising the revenue because they’ve sold the inventory then that must be the point when the customer should recognise that inventory. The old revenue standard was a ‘risks and rewards’ based model to revenue recognition. Applying this approach, purchased inventory is recognised when the buyer obtains the significant risks and rewards of ownership of inventory.
In contrast, under AASB 15, sellers will recognise revenue when they ‘transfer of control’ of the inventory to their customers. It is possible that as a buyer of inventory, you obtain control at a different time to when you obtain the significant risks and rewards of inventory, and as such the timing of inventory recognition could change.
Differences in the timing of inventory recognition could impact key inventory management metrics and working capital ratios.
The concept of control is discussed in a number of different standards, unfortunately all with their own slightly different take. From the AASB 15 perspective, control is ‘the ability to direct the use of and obtain the remaining benefits from an asset.’ More helpfully there are 5 indicators of control the standard suggests we consider. It says to consider when the customer has:
Whilst risks and rewards of ownership is still important, they are only one of a number of factors to consider, it may be that other indicators of control are more persuasive and you may need to reconsider the timing of when you recognise your inventory. It is possible the indicators you consider most persuasive align to those of your supplier.
For example, your supplier may end up recognising revenue as they manufacture the inventory (over-time), likewise you may end up recognising this inventory as it is manufactured rather than on receipt into your warehouse. While an evaluation of the timing of “transfer of control” is less subjective than the timing of transfer of “risks and rewards”, given the level of judgment required, it is also possible for there to be differences between when your supplier recognises revenue and you recognise inventory.
Have you thought about the impact freight terms may have on your inventory recognition? While not definitive, freight terms could mean you obtain control when it leaves your supplier’s facility, not when it is delivered into your facility.
Another thing to think about is safety stock. Do you require your suppliers to keep safety stock on hand for you? Have you considered whether you might actually control that safety stock even though it is at your suppliers premise?
If you haven’t already contemplated the impact on AASB 15 on the timing of your inventory recognition, it is one more thing that you will need to add to your implementation to do list. There are a whole host of different scenarios that may result in different timing of inventory recognition. If you are lucky, you may end up being able to conclude that there is no change, or you may have more work to do. It is also a timely reminder to ensure you consider all flow on impacts of the new standard and not just the impact on revenue recognition.
If you would like to discuss the implementations of the new standard on your organisation contact your usual KPMG contract or the contacts on this page.