Non-refundable upfront fees – we’ll recognize them later….

Another example of how IFRS 15 may require re-examining existing practices in a common area

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). The new standard is built around a five-step framework, including the key step of identifying the performance obligations contained in a contract with a customer: that is, the separate promises contained in the contract to transfer to a customer goods or services that are distinct. The standard’s approach to non-refundable up-front fees (received for example at the initiation of a membership into a health club or similar organization) provides a good example of how this concept might cause differences from existing practices.

Some issuers already made changes in this regard on adopting IFRS. For example, in its IFRS transition disclosures, the TMX Group Inc. reported that it would recognize certain initial and additional listing fees in full under IFRS in the period in which the listings occur; previously, under old Canadian GAAP, it initially recorded these fees as deferred revenue and then recognized them on a straight-line basis over an estimated period of ten years. The change flowed from the guidance in IAS 18 that “if the fee permits only membership, and all other services or products are paid for separately, or if there is a separate annual subscription, the fee is recognized as revenue when no significant uncertainty as to its collectibility exists.” In contrast, old Canadian GAAP put less weight on the flow of cash, and more on the customer’s motivation for paying the fee in the first place: “the up-front fee is not received in exchange for services provided to the customer that represent the culmination of the earnings process and the up-front fee does not have a stand-alone value to the customer because ongoing use of the (club) is dependent on payment of an additional usage fee each month.”

Unfortunately or not, many of those entities that made changes in the recent past will likely soon find themselves switching back to something similar if not identical to what they did before, because the approach in IFRS 15 is more reminiscent of old Canadian GAAP. This is how the new standard puts it: “To identify performance obligations in such contracts, an entity shall assess whether the fee relates to the transfer of a promised good or service. In many cases, even though a non-refundable upfront fee relates to an activity that the entity is required to undertake at or near contract inception to fulfil the contract, that activity does not result in the transfer of a promised good or service to the customer. Instead, the upfront fee is an advance payment for future goods or services and, therefore, would be recognized as revenue when those future goods or services are provided.”

That is, the non-refundable fee may notionally relate to initial administrative work or suchlike, but the customer doesn’t get anything out of that. In some cases where such a fee is paid (other examples in the standard include activation fees in telecommunication contracts, setup fees in some services contracts and initial fees in some supply contracts), the non-refundable fee may at least in part relate to a good or service, in that the customer does receive something at the outset of the contract. In this case, the entity evaluates whether the good or service constitutes a separate performance obligation: if so, then it recognizes a portion of the total contract revenue – although not necessarily the entire amount of the up-front fee, if that doesn’t represent a reasonable estimate of the stand-alone selling price for the good or service –  at that point.

As noted, an entity may charge the non-refundable fee in part as compensation for costs incurred in setting up a contract, or other initial administrative tasks, which don’t constitute satisfying a performance obligation. In this case, those activities and costs aren’t taken into account in subsequently measuring the progress under the contract: that is, if the contract is of a kind where progress is best measured by comparing costs incurred to date to total expected costs (rather than, say, with reference to the passage of time) then these initial costs don’t affect that calculation.

However, as addressed here, such costs might still be recognized as an asset if they relate directly to a contract or to an anticipated contract that the entity can specifically identify, they generate or enhance resources of the entity that’ll be used in satisfying (or in continuing to satisfy) performance obligations in the future; and they’re expected to be recovered. The asset is subsequently amortized on a systematic basis consistent with the transfer to the customer of the goods or services to which the asset relates. Other kinds of expenses incurred at the outset of the contract are expensed as incurred.

It’s not hard to sum up the main point of all this in plain language terms: no one gets something for nothing. Even if you’ve put the money in the bank and you’re not giving it back, it won’t ultimately get you far unless you maintain the customer as an ongoing revenue source: recognizing the revenue up-front, before giving anything back to the customer, allows the flow of cash to overshadow the substance of the business arrangement. Even so, it’s regrettable that some companies may have to change their approach to such matters for the second time in less than a decade, but this will presumably be the last time…

The opinions expressed are solely those of the author

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