Kinaxis Inc. provides a recent example of a company simultaneously applying both IFRS 15 and (voluntarily in advance of the effective date) IFRS 16.
The company “is a leading provider of cloud-based subscription software that enables its customers to improve and accelerate analysis and decision-making across their supply chain operations.” Here’s how it presented the effect of both standards:
Am I the only one who might more naturally have presented these columns the other way around, to illustrate IFRS 15 and 16 as additions to what would otherwise have been? Anyway, as the table shows, these twin adoptions affected most of the lines on the balance sheet, creating several new categories of non-current asset, and causing a significant shift within working capital. Of course, materiality is always a matter of context, and in this particular case, the company’s substantial holding of cash may overshadow everything else. Still, this certainly provides a thematic illustration of how the combined impacts of the two standards may be pervasive.
In the past, I quoted IASB member Stephen Cooper as follows:
- “A user of financial statements might reasonably expect that the amount of lease liabilities appearing on the balance sheet when IFRS 16 is first applied will be broadly similar to previously reported operating lease commitments, adjusted for the effect of discounting. If the amount of lease commitments on the balance sheet in 2019 is likely to differ from investor expectations, communicating early is the best approach. We know some companies are thinking about this already.
- Differences could arise because judgements about whether to include particular amounts in lease liabilities become more critical when IFRS 16 is applied…
Kinaxis provides an example of such a difference. It previously disclosed its operating lease commitments at December 31, 2017 as $11,847; on applying the incremental borrowing rate, it discounts this to $10,515. However, this differs from the amount of $10,822 recognized as a lease obligation at January 1, 2018, primarily because of extension options assessed as reasonably certain to be exercised. You’ll recall that under IFRS 17, the lease term is:
- the non-cancellable period of a lease, together with both:
- (a) periods covered by an option to extend the lease if the lessee is reasonably certain to exercise that option; and
- (b) periods covered by an option to terminate the lease if the lessee is reasonably certain not to exercise that option.
These and other matters might in some cases generate a different analysis of the lease term from the current definition in IAS 17: “the non-cancellable period for which the lessee has contracted to lease the asset together with any further terms for which the lessee has the option to continue to lease the asset, with or without further payment, when at the inception of the lease it is reasonably certain that the lessee will exercise the option.” The term “reasonably certain” is the same between the new and the old standards, but the greater supporting guidance in IFRS 16 might generate a different analysis in some cases.
Differences arising from IFRS 15 include:
- Prior to adopting IFRS 15, subscription fees for licenses and coterminous maintenance and support and hosting services were combined and recognized ratably over the term of the subscription contract. Under IFRS 15, the fees for on-premise and hybrid subscriptions are separately allocated to each distinct performance obligation. Revenue attributable to the distinct software license component is recognized upfront upon term commencement and revenue allocated to maintenance and support and hosting components is recognized ratably over the term. This results in earlier recognition of revenue for these subscription arrangements.
This might be regarded as a fairly “classic” illustration of the standard’s five-step approach, as examined here in many previous posts. The largest single line-item effect though comes from contract acquisition costs. Under IAS 18, such costs, “including commissions paid to employees and referral fees to third parties, were expensed upon commencement of the related contract revenue.” Under the new policy:
- The Company recognizes an asset for the incremental costs of obtaining a contract with a customer if it expect the costs to be recoverable, and has determined that certain sales incentive programs meet the requirements to be capitalized. Capitalized contract acquisition costs are amortized consistent with the pattern of transfer to the customer for the goods and services to which the asset relates. The amortization period includes specifically identifiable contract renewals where there is no substantive renewal commission.
We discussed that aspect of the standard here. For further background, the IASB records in its basis for conclusions that the IASB considered requiring an entity to recognize all such costs as expenses when incurred. The thinking there would have been that under the principle in IFRS 15, an entity recognizes revenue and creates a contract asset as a result of satisfying a performance obligation: incurring expenses doesn’t amount to satisfying such an obligation. But it’s also possible to argue that such up-front expensing might be misleading – if, for example, it resulted in expensing an up-front sales commission that’s reflected in the pricing of the contract and is expected to be recovered. These latter considerations won the day.
The opinions expressed are solely those of the author.