In less than a year, in January 2018, the old requirements (IAS 18 Revenue, IAS 11 Construction Contracts and numerous additional interpretations) will be replaced by a single comprehensive IFRS 15 Revenue from Contracts with Customers. One year later, on January 1, 2019, IFRS 16 Leases will enter into force. Accounting departments and financial directors face a number of challenges related to the new standards.
Revenues are one of the basic measures used in company assessment. This standard introduces a new revenue recognition model and new, more complex requirements for additional disclosures in financial statements.
So far, many companies have not conducted an in-depth analysis of the impact of the new revenue recognition standard, assuming that the impact will be small. For some industries and simple sales systems this may be true, but for many businesses the impact can be enormous.
For instance, the telecommunications industry should carefully analyse steps 2 and 4. The analysis will assess whether a particular telecommunications company provides a customer with a single comprehensive service (one contractual obligation) or several separate services (two contractual obligations, such as telephone and data transmission). Analysis will also specify how to assign a transaction price for particular contractual obligations.
Another interesting example may be the housing development industry which should focus on step 5 and determine whether the official sale occurs at the time of the delivery of a completed apartment to a purchaser, or (if certain specific conditions stated in the standard are met) a sale should be recognised proportionally, during the course of the construction.
In order to recognise revenue in accordance with the new IFRS 15 standard, at a correct amount and at the right time, 5 areas, so called 'steps', should be analysed. Each of them has precise guidelines and advice set forth in the IFRS 15, allowing for the preparation of an appropriate assessment.
We present a brief overview of each step below:
STEP 1 – contract identification – does the contract exist?
STEP 2 – defining contractual obligations – does the customer receive one or several separate services?
STEP 3 – fixing the transaction price – taking into account the expected rebates, bonuses, returns, and value of money over time.
STEP 4 – allocation of the transaction price (specified in step 3) of the individual contractual obligations (specified in step 2) – preferably on the basis of observable and readily available market prices.
STEP 5 – Revenue recognition – over time or at a given moment, depending on how the control over a product / service has been turned over to a customer.
Leases will be put in the lessee's balance sheet so that the share of liabilities will increase, while the proportion of lease payments in the income statement will change, as hitherto it featured the regular operating lease payments as costs of third parties services. According to the new standard, depreciation and interest expenses will become a part of the income statement, which will directly affect the growth of the frequently used and analysed EBITDA measure.
It is important to emphasise that the new standard involves potential changes not only regarding the moment or the value of recognised revenues and additional disclosures in the financial statements, but can also affect business areas, such as: operational processes, IT systems, customer agreements, product offer, budgeting and training. Because of this, comprehensive analysis the new standard's impact may require the involvement, in addition to the accounting, of the following departments: legal, asset management, internal audit, tax IT, control, contract management and budgeting.
Implementation of IFRS 15 is not the end of the challenges awaiting accountants and those preparing the implementation as the following year IFRS 16 Leases will enter into force.
Evaluating the standard's impact on the company's financial statements or the key indicators by which its investors, loan providers or other stakeholders evaluate the company, should start as soon as possible. Almost every business entity uses leasing or renting to a smaller or larger extent. Up to this point, a significant portion of these contracts were not recognised as a part of the balance sheet, but as operating leasing costs.
Instead of the current division into operational and financial leasing, IFRS 16 introduces a new division: a leasing and service provision. All contracts that meet the definition of leasing will be recorded in the lessee's balance sheet. The most important criterion to be taken into account when deciding whether a given contract is a lease is whether the lessee has control over part of the assets which are the subject of the contract.
Under the new definition, leasing is an arrangement whereby the lessee exercises control over and has the right to use a particular asset for a specified period of time in exchange for a remuneration paid to the lessor.
In the face of these new challenges, accounting departments and financial directors should undertake an in-depth analysis of their accounting policies, customer contracts, or credit agreements that include financial measures often based on EBITDA or net debt, as well as adjust their accounting systems to an increased scope of disclosure. This all shapes up to be a really busy period, and time is short before the new standards come into force.
Director, General Audit Department at KPMG in Poland
Director, General Audit Department at KPMG in Poland