New accounting standard set to change way in which companies account for revenue
A new accounting standard is expected to result in significant change in the way in which companies record revenue, says PwC. The International Accounting Standards Board (IASB) will issue IFRS 15 Revenue from Contracts with Customers, on Wednesday this week, which will represent a fundamental change in the way in which revenue is recognised for some companies.
Gary Berchowitz, an Associate Director at PwC and who was a member of the project staff at the IASB when the standard was finalised, says: “ This is probably the biggest thing the IASB has issued in the last three years. Just about every entity that generates revenue will be affected in some way – for some, this will represent a fundamental change in the way in which revenue is recognised. For others, this may only require an increase to the current disclosure requirements.”
“A common example of an industry in which we’re expecting big changes is the telecommunications industry,” adds Berchowitz.
Another industry that should be on the look out for the new requirements is the construction and engineering industry. IFRS 15 will replace all previous revenue guidance so construction contracts that previously fell under the scope of IAS 11, Construction contracts, will no longer be subject to different revenue recognition requirements. There are also some “tricky requirements” for dealing with revenue from licencing agreements, so companies in the pharmaceutical and media and entertainment industries might also need to pay close attention to the new requirements, warns Berchowitz. Some industries will be spared the tumultuous change that IFRS 15 will bring. Most banks, insurance and leasing companies will continue to account for their ’revenue’ in accordance with banking, insurance and leasing accounting requirements respectively (although change is on the horizon for those industries too).
“It’s important to remember that this isn’t just a change to the accounting rules. Because revenue is such a pervasive and critical number for most entities, there will be other areas of the business that will need to be considered.” For example:
- Compensation and bonus plans. Revenue is often a figure to which bonuses or other remuneration is linked. To the extent that the new requirements change the timing or amount of revenue, this may have a knock on effect to employee remuneration schemes.
- Contracts. Changes in revenue might affect ratios used in debt covenant agreements. In addition, some customer contracts might need to be renegotiated to ensure that the original intent is maintained in the accounting when the new requirements are applied.
- Technology. Revenue is often integrated into the core enterprise resource planning (ERP) systems of a company. Any change that is required as a result of IFRS 15 will require a corresponding IT change. There may also be new data requirements that need to be captured to comply with the requirements.
- Tax implications. The timing of cash tax payments could be affected if, for example, a company recognises revenue sooner than in the past and the tax authority deems the amount as taxable income. Similarly, if revenue is deferred as a result of applying the new requirements, there might be a benefit from a cash tax perspective.
- Controls and processes. The standard’s requirements are vastly different in some aspects to the requirements today. Consequently, companies will need to develop new internal controls and policies to demonstrate compliance with the new requirements.
- Investor relations. Stakeholders will want to know how and why the revenue numbers will change. Explaining this change may in some cases require a long lead time to ensure that the new revenue figures tell the company’s story correctly.
The new guidance is based on a simple core principle, that is, a company should recognise revenue when it transfers a good or service to the customer. The measurement of revenue under the new guidance bucks the current trend of fair value – revenue will be measured at an amount based on reality, that is, what the entity thinks it will actually be entitled to for the goods or services that are provided to the customer.
Berchowitz says: “I think this is a great step forward in helping to drive consistency and transparency in how companies report their most important metric. Some may see this as a compliance challenge, while for others this may represent the opportunity to recognise revenue in a manner that more closely aligns with the economics of the business.”
The mandatory effective date of IFRS 15 will be for years beginning on or after 1 January 2017. While the 2017 effective date may seem far off, proper preparation is essential. Revenue recognition is a critical accounting area, and companies can't afford to get it wrong.
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