IFRS 15 – meeting the quality threshold? (often, no)

The UK’s Financial Reporting Council recently issued a report on its “follow-up thematic review” of IFRS 15 Revenue from Contracts with Customers.

Here’s how the news release summed it up:

  • This is the third review on the application of IFRS 15 and focusses on those areas that have previously provided the greatest cause for concern. Although there has been some progress, the FRC continues to identify disclosures by many companies that do not meet the FRC’s quality threshold. Companies should critically review their revenue-related disclosures to ensure they provide a clear understanding of how they have applied the requirements of the standard to their own particular circumstances. 
    In particular, the FRC expects companies to:
  • provide clear descriptions of performance obligations, the timing of revenue recognition and explanations of any significant judgements made by management;
  • identify, and explain significant movements in, contract balances;
  • ensure there is consistency between revenue-related information in the strategic report and information in the financial statements, including, for example, details about significant contracts and disclosures of disaggregated revenue; and
  • specify the types of any variable consideration that exist within contracts and how they are both estimated and constrained.

This was based on a detailed review of the financial statements of 22 entities, backed up by a “quick review” of the disclosures of 50 others. It doesn’t appear that the review has to this point identified any material problems with recognition or measurement, but the report states “We are writing letters to 8 companies included in our sample where there is a substantive question relating to their revenue reporting and/or accounting, and to a further 3 companies drawing their attention to aspects of their revenue disclosures which could be improved.”

The FRC’s reports on such matters are impressive feats of design, issued in Powerpoint form with summaries of the issues identified for each key area, making frequent use of charts and graphs, with copious examples of inadequate and better disclosures, in many cases specifying in bullet-point form what’s good or bad about them, and providing various interesting observations along the way, for instance:

  • One company thoughtfully presented in its Chief Executive’s review the proportion of revenue by size of order, explaining that smaller orders (<£100.000) generated three quarters of total revenue, while the largest orders (<£100,000) generated three quarters of total revenue, while the largest orders (>£1m) just 5% of revenue. This was important as it demonstrated that revenue was largely dependent on customers’ operational, rather than capital, budgets. Changes in revenue composition could then be linked to underlying economic conditions. Another company implied in its business review that revenue was impacted by the sector of its end customers. However, neither company disaggregated revenue on these bases in their respective financial statements.

The report can sometimes be a little eye-hurting and perhaps overdone (is it necessary to have a pie chart to summarize the breakdown between the 72% who provided an accounting policy for contract costs and the 28% who didn’t?) but it amounts to an impressive and presumably useful amount of information. Of course, it’s sometimes subject to the kind of neurosis that characterizes most such regulatory endeavours. For example, the report laments that “just one of eight Construction & Materials companies in our Quick Review sample disclosed a policy for contract costs. That company explained that costs were incurred to secure contracts, i.e. commissions. The apparent absence of contract costs in the other seven companies was surprising given costs to fulfil a contract (e.g. set-up costs) may be relevant to these companies, such as labour, transportation and other overheads, before contracts commence. Similar set-up costs might also arise in other industries, such as Support Services and Software & Computer Services.” It goes on to note that it might be helpful to disclose, among other things, “that contract costs eligible for capitalization are not a material consideration to the company if contract costs are common in a particular industry.” But I’ve always thought it’s a little onerous to expect companies to anticipate all of the possible things that some readers (especially specialized ones) might conceivably expect to be material in their financial statements and then to specify for them that those things aren’t actually material.

Anyway, the report makes a couple of mentions of Covid-19, which I’ll end by listing here:

  • Estimates of variable consideration should reflect uncertainties arising from the Covid-19 pandemic. Disclosures should help users understand changes to the transaction price arising from Covid-19 including changes to the assessment of whether an estimate of variable consideration should be constrained.
  • Companies should clearly explain the significant judgements and sources of estimation uncertainty affected by or arising from Covid-19. For example, risks associated with estimating the transaction price and/or contract costs may be heightened as a result of the virus. Furthermore, users want to understand not only how historical financial performance has been impacted by Covid-19, but also what it means for the company’s future prospects. Disclosure of sensitivities or range of possible outcomes should provide users with that information in relation to estimation uncertainties.

Hard to argue with that…

The opinions expressed are solely those of the author

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