Let’s take a look at some other recent examples of changes resulting from the implementation of IFRS 15.
This is from Stantec Inc.:
When we looked several years ago at how the standard addresses the key step of determining the transaction price, we noted the following:
- Among other things, the new standard also requires adjusting the promised amount of consideration for the effects of the time value of money if the timing of payments agreed to by the parties to the contract contains a significant financing component (either explicitly or implicitly). This requirement is similar but not identical to a current requirement in IAS 18.
The passage was obviously hinting at greater complexities, but we never ended up getting into them, so let’s remedy that now. IFRS 15.61 specifies that the objective of such an adjustment is “is for an entity to recognize revenue at an amount that reflects the price that a customer would have paid for the promised goods or services if the customer had paid cash for those goods or services when (or as) they transfer to the customer (ie the cash selling price).” This doesn’t mean that any consideration amount to be transferred in the future is a deviation from the cash selling price. The standard sets out the following factors as not indicating a significant financing component:
- The customer paid for the goods or services in advance and the timing of the transfer of those goods or services is at the discretion of the customer.
- A substantial amount of the consideration promised by the customer is variable and the amount or timing of that consideration varies on the basis of the occurrence or non-occurrence of a future event that is not substantially within the control of the customer or the entity (for example, if the consideration is a sales-based royalty).
- The difference between the promised consideration and the cash selling price of the good or service…arises for reasons other than the provision of finance to either the customer or the entity, and the difference between those amounts is proportional to the reason for the difference. For example, the payment terms might provide the entity or the customer with protection from the other party failing to adequately complete some or all of its obligations under the contract.
Stantec seems to be referencing that last item. In contrast, IAS 18 expressed the issue rather more broadly:
- In most cases, the consideration is in the form of cash or cash equivalents and the amount of revenue is the amount of cash or cash equivalents received or receivable. However, when the inflow of cash or cash equivalents is deferred, the fair value of the consideration may be less than the nominal amount of cash received or receivable. For example, an entity may provide interest-free credit to the buyer or accept a note receivable bearing a below-market interest rate from the buyer as consideration for the sale of goods. When the arrangement effectively constitutes a financing transaction, the fair value of the consideration is determined by discounting all future receipts using an imputed rate of interest.
This might have been taken to indicate that any deferred inflow of consideration potentially constitutes a financing transaction by its nature, regardless of whether either of the parties to the transaction regards it as such. It’s to avoid this kind of implication that the IASB amended its original drafting of IFRS 15 to remove references to the “time value of money” – this, they concluded, “is a broader economic term that may suggest that it is necessary to adjust the promised amount of consideration in circumstances other than when the cash sales price may differ from the contractual payments.”
In the previous article, we did mention a practical expedient: an entity needn’t adjust the promised amount of consideration for the effects of a significant financing component if it expects, at contract inception, that the period between when it transfers a promised good or service to a customer and when the customer pays for that good or service will be one year or less. It likely speaks for itself how this simplifies the application of IFRS 15, presumably with usually only a limited effect on the pattern of profit recognition. The Board stopped short of accepting another suggestion, of exempting an entity from accounting for the effects of a significant financing component associated with advance payments from customers. It concluded that in some of these cases, such an exemption could substantially skew the amount and pattern of profit recognition – for example, “where an entity requires a customer to pay in advance for a long-term construction contract, because the entity requires financing to obtain materials for the contract.”
On the face of it, this seems like one aspect of IFRS 15 where a company like Stantec might have it a little easier than it did under the old standard. Unfortunately, that’s probably outweighed by several other issues for which that’s not the case. Oh well, at least they’re in good company…
The opinions expressed are solely those of the author.