The UK’s Financial Reporting Council has published a report on its “IFRS 15 Thematic Review: Review of Disclosures in the First Year of Application.”
The overall finding was that “most of the companies sampled provided sufficient information to enable users to understand the impact of adopting IFRS 15. Generally, companies included helpful company-specific explanations and disclosures covering various aspects of their accounts affected by IFRS 15.” The FRC was “particularly pleased that all five companies identified from (an earlier) review of interim reports as having specific areas for improvement provided enhanced revenue disclosures in their year-end accounts.”
So, good, that’s it for this time! No wait, there’s still room for improvement. Here are the main items highlighted, along with my own (possibly deliberately devil’s-advocate-like) italicized comments:
There is scope to improve explanations of accounting policies for revenue recognition such as the specific nature of performance obligations and when they are satisfied, including whether a company is acting as agent in providing any goods and services. The link between policies and information in the segmental reporting note and strategic report was sometimes not clear. It’s not uncommon at all to come across cases where the business description in the annual report, MD&A or elsewhere doesn’t seem to align with various aspects of what’s in the statements. It’s certainly understandable if the underlying perspectives are different, but the financial reporting process should surely include a higher-level review to ensure the overall coherence of the disclosure. It seems on too many occasions that even chief financial officers and audit committees fail this kind of “forest for the trees” test. It seems to me that the most effective policy disclosures in this area would serve as fully to explain the business as to explain the accounting – for example, if a portion of the revenue on a particular contract is recognized later because of the nature of the performance obligations, or if a portion of the anticipated revenue is identified as variable consideration, then that should serve to illuminate the kinds of customer relationships entered into, and the associated demands and risks.
Information about significant judgements relating to revenue was variable. Some disclosures appeared to list all judgements involved in accounting for revenue rather than those having a significant effect on the amount and timing of revenue recognition. Descriptions often lacked clarity about the specific judgements made. Quantitative disclosure, such as sensitivities or ranges of potential outcomes, were often not provided for judgements involving estimation uncertainty. This aspect of disclosure is an evergreen source of dissatisfaction. We’ve noted before that 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 of course, preparers are supposed to be focusing more rigorously on materiality and avoiding disclosure overload. It’s not surprising that the balancing act is often susceptible to being questioned.
We observed more comprehensive disclosures about the balance sheet impact of adopting IFRS 15 in the year end accounts compared to our review of interim accounts. However, some accounts we reviewed made no reference to costs to obtain or fulfil a contract which, in some instances, was surprising given the companies’ activities. I did write some time back 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.” I don’t know whether that transpired, but it does seem that a healthy chunk of the ongoing interpretation challenges arise on the cost side (see for instance here and here). Where gross profit is a key performance measure, it certainly seems appropriate to provide equal transparency for both sides of the ledger, but by its title and overall emphasis, some practitioners may not entirely glean that from the standard.
As an aside, the report gives the following example (from Melrose Industries PLC) of useful specificity:
- “Design and build….Due to the nature of design and build contracts, there can be significant ‘learning curves’ while the group optimises its production processes. During the early phase of these contracts, all costs including any start-up losses are taken directly to the income statement, as they do not meet the criteria for fulfilment costs.”
Many companies disaggregated the transition adjustment by category of impact, explaining the changes by referring to changes in the accounting policies or methods arising from implementing the new standard. However, it was disappointing that some companies sampled did not provide a quantitative breakdown of the transition adjustment. On the other hand, it’s all history, and further breakdown wouldn’t often be likely to assist a prospective analysis, especially given that…
In general, companies adopting the modified retrospective approach sufficiently addressed the lack of comparability between the current year revenue prepared under IFRS 15 and prior year revenue prepared under the previous standard. Many companies put in particular effort to ensure that meaningful ‘like for like’ comparisons were clearly made. Good, so no big problem there then!
The opinions expressed are solely those of the author