Two aspects of IFRS 15 where the SEC has already expressed particular interest
By now we’ve spent no less than sixteen (!) previous articles discussing aspects of the new revenue recognition standard, IFRS 15, effective for financial years beginning on or after January 1, 2017. In general, it’s not really plausible to highlight some aspects of the standard as needing greater attention than others – entities have to meticulously work their way through the whole thing, attuned to their own circumstances. On the other hand though, regulators will likely focus on certain key areas that are relatively more susceptible to detectable error, and where they can perhaps make a difference without spending too much time on unproductive fishing expeditions. In a recent speech at the the 2014 AICPA National Conference on Current SEC and PCAOB Developments, Steve Mack, a Professional Accounting Fellow at the SEC’s Office of the Chief Accountant, gave some insight into a couple of these areas:
- “The increased use of estimates and management judgments in some areas of the new revenue standard may result in varying results in financial reporting amongst companies and, as such, require more detailed quantitative and qualitative disclosures. Furthermore, systems, processes, and controls will need to be either updated or implemented to support the increased use of management judgment. I would like to highlight a couple of areas of judgment in the new revenue standard that may differ from current accounting guidance.
- Variable Consideration – the new revenue standard will introduce a new model for evaluating uncertainties with respect to variable consideration. Keep in mind that variable consideration is more than the common performance bonus. Variable consideration may include price concessions, volume discounts, rebates, incentives, and royalties. Under the new standard, revenue will be recognized up to the amount that is probable of not being reversed, even in situations where the uncertainty is not yet resolved. Because the assessment of variable consideration is not meant to be a quantitative threshold, but more of a qualitative assessment subject to the constraint, judgment will be needed when selecting either a probability weighted or most likely outcome approach to best estimate the ultimate outcome. This may result in the need for new processes and controls supporting the estimate of variable amounts, and this would need to be revisited each reporting period.
- Disclosures – the new revenue standard also includes a number of disclosure requirements that allow financial statement users to understand judgments made with respect to revenue recognition and corresponding cash flows. The disclosures will include qualitative and quantitative information. The disclosure requirements can be quite involved. For example, companies will now need to disclose remaining performance obligations and provide a narrative discussion of potential additional revenue that is constrained. Companies will also have to disclose significant judgments describing the methods used to recognize performance obligations over time, and assumptions used to determine and allocate the transaction price.
- Overall, the new revenue standard allows for greater use of management judgment, but also results in more robust and transparent disclosure. Companies that are not used to making management estimates and providing the supplemental information in disclosures will need to evaluate systems, processes, and controls to support the application of the new revenue standard.”
Although Mack was talking as a US regulator, it’s likely his Canadian counterparts might have said something similar: the areas he highlights aren’t a great surprise. For obvious reasons, it’s always easier for regulators to assess the apparent adequacy of disclosure than of underlying practice. As we wrote here, entities for whom IFRS 15 causes significant changes in their recognition or measurement practices may be surprised by the potential volume of additional explanation; the standard takes four pages to set out all the disclosures that might be required. At the same time, it does acknowledge at the outset that an entity “consider(s) the level of detail necessary to satisfy the disclosure objective and how much emphasis to place on each of the various requirements,” and goes on: “An entity shall aggregate or disaggregate disclosures so that useful information is not obscured by either the inclusion of a large amount of insignificant detail or the aggregation of items that have substantially different characteristics.” This dovetails of course with the current focus on reducing disclosure overload, as embodied by the recent amendments to IAS 1 – regulators will be figuring out how best to probe the quality of IFRS 15 disclosures at around the same time as they’re trying to strike the right balance in supporting rather than hindering those broader efforts. This may be a somewhat subtle balancing act.
For the variable consideration issue: we discussed this here as a key element of the third step in the IFRS 15 framework – that of determining the transaction price. As we put it previously, entities reporting under IFRS are presumably already accustomed to reducing the amount of revenue they recognize from their transactions to reflect an estimate for price concessions or similar matters, but current standards don’t address how to implement this. Consequently, for some entities (such as those engaging in a high volume of transactions, subject to multiple ways in which the amount ultimately received from a customer might vary), this aspect of IFRS 15 might require establishing significant systems and procedures, creating an ongoing challenge in assessing the adequacy of estimation processes. This is an obvious area in which some issuers might be tempted by unacceptable short-cuts, whether by recognizing too much or too little revenue at the outset, or by some overly simplistic approach in between. Although it’s difficult to anticipate exactly how or to what degree regulators would intervene in this, it’s only wise for issuers to proceed on the assumption that they might…
The opinions expressed are solely those of the author