IFRS 15 in action – part 3

Let’s take a look at some other recent examples of changes resulting from the implementation of IFRS 15.

This is from UGE International Ltd.:


I mentioned before that although the standard is called “Revenue from Contracts with Customers,” we may – who knows – identify some cases over time where the bottom-line impact flows as much from the impact on reported costs as from that on top-line revenue. The old standard, IAS 11, certainly addressed the area of costs, specifying that contract costs include costs relating directly to the specific contract; costs attributable to contract activity in general and capable of being allocated to the contract; and such other costs as are specifically chargeable to the customer under the terms of the contract. But this is less specific than the reference in IFRS 15 to costs that “generate or enhance resources of the entity that will be used in satisfying (or in continuing to satisfy) performance obligations in the future.” It’s clearer under IFRS 15 that, for instance, costs relating to performance obligations that have already been satisfied should be expensed as incurred rather than added into a general pool of contract costs.

One of IFRS 15’s illustrative examples (Example 37) helps to drive home the point, setting out a case where an entity “assigns two employees who are primarily responsible for providing the service to the customer.” It states: “Although the costs for these two employees are incurred as part of providing the service to the customer, the entity concludes that the costs do not generate or enhance resources of the entity (and therefore) cannot be recognized as an asset using IFRS 15.” It therefore recognizes the payroll expense for these employees when incurred. Presumably in the past, many entities would have viewed such directly-assigned employees as being well within the kind of costs that could be allocated to a particular contract. In case there’s any doubt, the basis for conclusions underlines that: “an entity is precluded from deferring costs merely to normalize profit margins throughout a contract by allocating revenue and costs evenly over the life of the contract.” A further blow, that is, to those who cling fondly to old-fashioned concepts of “matching.”

Conversely, that same illustrative example addresses a CU10,000 sales commission paid to an employee by the entity, when the customer signs the contract, clarifying the principle that “an entity shall recognize as an asset the incremental costs of obtaining a contract with a customer if the entity expects to recover those costs.” Under IAS 11, such items might have been regarded as part of “selling costs” and excluded from the determination of contract costs. Espial Group Inc. provides an example of such a difference:


Espial illustrates a different kind of impact as well:


A quick search of financial statements doesn’t suggest that the term “lag-based” was in particularly common use, but I expect many of us have come across this kind of approach here and there. It’s not entirely clear that it would have been generally appropriate under IAS 18 though. Perhaps some entities saw it as an application of the IAS 18 notion that royalties “accrue in accordance with the terms of the relevant agreement and are usually recognized on that basis unless, having regard to the substance of the agreement, it is more appropriate to recognize revenue on some other systematic and rational basis.” Others may have analogized with how IAS 28 allows the financial statements of an equity-accounted investee to be prepared at a different date from those of the reporting entity, subject to a maximum difference of three months (even in this circumstance though, IAS 28 requires making adjustments for the effects of significant transactions or events occurring in the gap period).

Anyway, IFRS 15 specifies that an entity recognizes revenue for a sales-based or usage-based royalty only when (or as) the subsequent sale or usage occurs or (if later) the performance obligation to which the royalty has been allocated is satisfied or partially satisfied. It doesn’t envisage that an entity might ever defer recognizing that revenue based on essentially administrative considerations. Of course, the general notion of estimating variable consideration and of reassessing that estimate from one period to the next is one of the standard’s most prominent aspects.

I wouldn’t necessarily say though that any form of “lag-based” accounting needs to go out of the window now. In practice, companies may use all sorts of methodological short-cuts in preparing their financial statements, and it shouldn’t be necessary to tell the world about them as long as any resulting imprecision is immaterial (which of course requires that there’s a system in place capable of determining whether it is or not). An exception might arise in some jurisdictions when relying on such short-cuts raises questions about the effectiveness of internal controls over financial reporting. But that’s a bit of a different issue…

The opinions expressed are solely those of the author


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