How to make the transition to the IASB’s new accounting requirements

As we summarized here, the IASB has issued IFRS 15, Revenue from Contracts with Customers, effective for annual reporting periods beginning on or after January 1, 2017 (NB this was subsequently amended to January 1, 2018). An entity for which the standard causes a change from existing accounting practices will have to choose from the two following transition methods:

• (a) apply IFRS 15 retrospectively to each prior reporting period presented in accordance with IAS 8 Accounting Policies, Changes in Accounting Estimates and Errors, subject to the practical expedients described below; or
• (b) apply IFRS 15 retrospectively, recognizing the cumulative effect of initially applying the standard as an adjustment to the opening balance of retained earnings (or other component of equity, as appropriate) of the annual reporting period that includes the date of initial application (to illustrate, for calendar year entities adopting the standard no earlier than they have to, this means a cumulative adjustment  to retained earnings as at January 1, 2017). An entity choosing this method applies the Standard retrospectively only to contracts that aren’t completed at the date of initial application.

The first of the practical expedients attaching to full retrospective adoption allows that for completed contracts, an entity needn’t restate contracts that begin and end within the same annual reporting period. In the basis for conclusions document, the Board notes: “A consequence of this relief is that revenue reported in interim periods before and after the effective date would not necessarily be accounted for on a comparable basis. The boards expect that an entity would not elect to use this relief if it operates in an industry in which comparability across interim reporting periods is particularly important to users of financial statements.”

The second practical expedient allows that for completed contracts that have variable consideration (discussed here), an entity may use the transaction price at the date the contract was completed rather than estimating variable consideration amounts in the comparative reporting periods. The third and final expedient allows that for all reporting periods presented before the date of initial application, an entity can omit the disclosures usually required about the amount of the transaction price allocated to the remaining performance obligations and when it expects to recognize that amount as revenue. An entity using any of the practical expedients must apply it consistently to all contracts within all reporting periods presented; it must disclose the expedients that it’s used and, to the extent reasonably possible, a qualitative assessment of the estimated effect of applying them.

Readers can likely intuitively grasp the kind of balancing act that underlies these transition provisions. Naturally, “retrospective application ensures that all contracts with customers are recognized and measured consistently both in the current period and in the comparative periods presented, regardless of whether those contracts were entered into before or after the requirements became effective” and “provides users of financial statements with useful trend information across the current period and comparative periods.” On the other hand, the work of applying the standard retrospectively may entail costs in excess of the benefits (at least from some perspectives) or may require information that no longer exists, or making estimates that would almost certainly be influenced by hindsight. The second allowable method set out above reflects the IASB’’s conclusion that even given the help provided by its practical expedients, retrospective application would still be a major burden for many entities. When an entity uses this second method, to help users understand the effect on trend information (because, in the above example, revenue amounts for 2016 and 2017 won’t be reported on a consistent basis), it discloses the amount by which each financial statement line item is affected in the current reporting period by applying the standard, and an explanation of the reasons for such changes, if they’re significant.

For most entities, revenue constitutes a key performance measure, presumably increasing the argument for working towards retrospective adoption unless this is truly impracticable. Like anything else in the financial statements, the concepts of IFRS 15 are subject to materiality considerations, and perhaps in some situations (for example, where an entity’s multi-element contracts all involve similar combinations of performance obligations with similar relative values) can be approached partly through estimation techniques. On the other hand, where every contract is different and individually significant, there may be no way to achieve retrospective treatment without going back and crunching the numbers.

Although, all things being equal, investors would likely prefer such treatment, this may be more significant in some cases than others. For example, investors may be more concerned about an absence of retrospective information in a situation where the pattern of organic sales growth is partly obscured by the impact of acquisitions. An entity may be able to provide other information in its MD&A (on transaction volumes, numbers of customers or suchlike) that mitigate any lack of comparability in its reported revenue numbers; its operating cash flow numbers (which would presumably be unaffected by applying IFRS 15) may also be important to how it communicates with investors on this. In any event, for any entity where the mechanics of transition aren’t straightforward, it makes sense to consider all aspects of this area sooner rather than later.

The opinions expressed are solely those of the author