Proposed changes to IFRS 15 – making the transition

The IASB has issued its exposure draft of clarifications to IFRS 15, with comments to be received by October 28, 2015.

As we discussed here, any entity for which the standard causes a change in its existing accounting practices will have to make a specific choice about how to make the transition from its old to its new IFRS 15-compliant policies, between the two following 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 defined practical expedients; 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. An entity choosing this method applies the Standard retrospectively only to contracts that aren’t completed contracts at the date of initial application.

The new exposure draft proposes two additional practical expedients. The standard already allowed that for completed contracts, an entity needn’t restate contracts that begin and end within the same annual reporting period. The Board noted: “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.” It now proposes adding that an entity also needn’t restate contracts that are completed contracts at the beginning of the earliest period presented. For purposes of this expedient, a completed contract is “a contract for which the entity has transferred all of the goods or services identified in accordance with IAS 11 Construction Contracts, IAS 18 Revenue and related Interpretations.”

The IASB notes that reducing the population of contracts to which IFRS 15 applies could significantly reduce the effort and cost of initial application, and that paragraph D35 of IFRS 1 allows a similar concession for first-time adopters. However, the FASB isn’t proposing such a change to its corresponding standard, concluding that it’s one concession too many. For example, an entity adopting the standard retrospectively in its calendar-year 2018 financial statements might consider a particular contract to be completed at December 31, 2016 with reference to IAS 18, and might apply the newly-proposed short-cut to avoid rethinking that contract on adopting IFRS 15. However, if the entity had analyzed the contract under IFRS 15, it might have concluded that certain performance obligations extended past January 1, 2017, allocating a portion of the transaction price accordingly. In this example, applying the new proposed short-cut would reduce revenue in 2017 compared to what might have been reported, possibly providing an incentive to crunch all the numbers regardless (or possibly not, if revenue growth in 2018 is artificially increased as a result). Anyway, this will provide a further factor for entities to consider, when they decide on their approach to transition.

The second proposed addition to the transition provisions is as follows:

  • “for contracts that were modified before the beginning of the earliest period presented, an entity need not retrospectively restate the contract for those contract modifications in accordance with paragraphs 20–21. Instead, an entity shall reflect the aggregate effect of all of the modifications that occur before the beginning of the earliest period presented when: (i) identifying the satisfied and unsatisfied performance obligations; and (ii) determining the transaction price.”

This means, in effect, that an entity can apply some hindsight in addressing contracts that remain open at (in the example I used above) January 1, 2017. The IASB thinks this “would provide some cost relief and yet would result in financial information that closely aligns with the financial information that would be available under IFRS 15 without the expedient,” and on this occasion the FASB agrees. As I wrote here, the IASB’s avoidance of hindsight can sometimes seem like something of a fetish, at least in situations where applying that quality wouldn’t seem to consistently confer an unwarranted advantage on anyone. That certainly seems like the case here, so the proposed modest concession doesn’t seem too controversial to me.

Neither of these amendments affects the big picture as I laid it out before. For many 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, it 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 an acquisition. 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.

More to come on the other elements of the new exposure draft…

The opinions expressed are solely those of the author.

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