Revenue recognition post-implementation observations.
From the IFRS Institute – August 30, 2019
IFRS 15 and ASC 606, Revenue from Contracts with Customers, went live for all IFRS preparers and most US public business entities in 2018. The standards go live for other US GAAP reporters in 2019. Interpretive questions persist: the IFRS Interpretations Committee has been issuing Agenda Decisions, the SEC is active in issuing comments and pre-clearance advice, and standard-setting activities continue under IFRS Standards and US GAAP.
IFRS preparers seek clarity on Steps 2 and 5 and interactions of IFRS 15 with other standards
The IFRS Interpretations Committee (IFRS IC) has addressed several questions related to the application of the 5-Step model that are particularly relevant for real estate developers, airlines, stock exchanges and contractors, but that may impact other sectors as well. Specifically, Step 2 (identify performance obligations) and Step 5 (recognize revenue at a point in time or over time) are common topics of interest. There are also questions about how the revenue recognition model interacts with other standards, such as IFRS 11 (joint operations), IFRS 10 (sale of single-asset real estate entities), and IAS 23 (capitalization of borrowing costs in long-term customer contracts; see our related article). See the complete list of topics considered by the IFRS IC at the end of this article.
US GAAP preparers and the SEC focus on Steps 2 and 5, disclosures and the agent / principal analysis
SEC registrants frequently consult with the Office of the Chief Accountant (OCA) of the SEC through the pre-clearance process regarding identifying single versus multiple performance obligations. Another common issue on which OCA is consulted relates to determining whether a company is a principal or agent in a transaction, including evaluating the application of the overall control principle under US GAAP.
Comment letters by the SEC’s Division of Corporation Finance have focused on companies’ Step 2 and Step 5 analyses, including the identification of multiple performance obligations; the timing of when performance obligations are satisfied; how this timing affects contract assets and liabilities; the rationale for recognizing revenue over time versus at a point in time; and support for the selected measure of progress under the over-time model. The Division has also questioned the completeness of disclosures, and has required some companies to provide more disclosures explaining the basis for their accounting conclusions to better inform investors of their significant judgments in applying the new standard.
Standard-setting that may be relevant to customer contracts
In January 2019, the International Accounting Standards Board (the Board) proposed amendments to IAS 371 to clarify how to determine if a contract, including a customer contract, is onerous. IAS 37 specifies that a contract is onerous when the unavoidable costs of fulfilling it outweigh its economic benefits. The Board proposed a full cost approach and clarified that the unavoidable costs of fulfilling a contract comprise those costs that relate directly to the contract. The proposed amendments included examples of costs that are identical to the examples of fulfilment costs in IFRS 15.
The period to comment on the exposure draft closed in April 2019, and the Board is expected to discuss the project’s direction at its September 2019 meeting. Read KPMG’s comment letter to learn about KPMG’s views. In addition, see KPMG’s article on differences between IFRS 15 and ASC 606 where we discuss onerous contracts under the two standards.
The FASB recently issued proposed guidance on two topics relating to revenue recognition.
The first proposal2 addresses the acquirer’s accounting for contract liabilities from the target’s revenue contracts in a business combination. It would align the recognition criteria for revenue contract liabilities in a business combination with the definition of a performance obligation in ASC 606.
The second proposal3 relates to accounting for modifications of licenses of intellectual property, specifically those under which:
No similar amendments are being considered for IFRS 15. If the FASB proposals are approved, this could create further accounting differences between US GAAP and IFRS Standards. The eventual outcome could be additional guidance that IFRS preparers need to consider under the hierarchy requirements of IAS 84 as they continue to evaluate their revenue accounting policies.
IFRS IC Agenda Decisions
The IFRS IC supports the consistent application of IFRS Standards and helps the Board improve financial reporting through the timely identification and resolution of financial reporting issues within the framework. Agenda Decisions provide key interpretive guidance for companies to use as they apply IFRS Standards; see our recent article on the importance of Agenda Decisions. The following table summarizes the main revenue-related issues that the IFRS IC has considered.
|Sale of real estate entities||Under discussion – June 2019||Scope||
As part of its ordinary activities, an entity enters into a contract with a customer to sell real estate by selling its equity interest in a single asset entity that is a subsidiary. Should the entity account for the contract under IFRS 105 or IFRS 15?
The IFRS IC did not make any decisions in its June 2019 meeting and will continue discussions in a future meeting.
|Compensation for delays or cancellations||Tentative – June 2019||3||
Should an airline account for its obligation to compensate customers for delayed or canceled flights as variable consideration under IFRS 15 or as an obligation under IAS 37?
Based on the fact pattern in the request, the IFRS IC tentatively concluded that compensation for delays or cancellations is variable consideration. Therefore, the variable consideration guidance in IFRS 15 applies.
|Costs to fulfil a contract||Final – June 2019||5||
How should an entity recognize costs incurred to fulfill a contract when the entity satisfies its performance obligation in the contract over time?
Costs of construction, as described in the request, relate to a partially satisfied performance obligation and do not generate or enhance resources of the entity that will be used in continuing to satisfy the performance obligation. Therefore, the IFRS IC concluded that those costs should be recognized as expenses when incurred.
|Sale of output by a joint operator||Final – March 2019||5||
How should a joint operator recognize revenue when the output the joint operator receives from a joint operation and sells to its third-party customers in a reporting period is different from the output to which it is entitled?
Based on the fact pattern in the request, the IFRS IC concluded that the joint operator should recognize revenue that relates to the transfer of output to its customers, and it should not recognize revenue for the output to which it is entitled but has not yet received from the joint operation and sold.
|Over time transfer of constructed goods||Final – March 2019||5||
May a real estate developer capitalize borrowing costs incurred in relation to the construction of a residential multi-unit real estate development?
An entity assesses whether it recognizes a qualifying asset under IAS 23 – i.e. an asset that takes a substantial period of time to get ready for its intended use. Whether a real estate developer recognizes a receivable, a contract asset and/or inventory (work-in-progress) depends on the facts and circumstances.
In the fact pattern, the developer intends to sell partially-constructed units as it finds suitable customers. Control of the units transfers to the customers over time. The IFRS IC concluded that the developer’s receivable, contract asset and inventory (work-in-progress) are not qualifying assets.
|Assessment of promised goods and services||Final – January 2019||2||
How should a stock exchange that charges a non-refundable up-front fee on initial listing in addition to an ongoing listing fee recognize revenue?
An entity assesses the services promised in the contract with the customer and identifies performance obligations. When an entity charges a customer a nonrefundable up-front fee, the entity considers whether it transfers a promised good or service to the customer at or near contract inception. The outcome of the assessment depends on the entity’s facts and circumstances.
Based on the fact pattern in the request, the IFRS IC concluded that the up-front fee does not transfer any good or service to the customer other than the service of being listed on the exchange. Therefore, the up-front fee should be recognized over the estimated performance period rather than at the time of the initial listing.
|Revenue recognition in a real estate contract||Final – March 2018||5||
Should a real estate developer recognize revenue over time or at a point in time for the sale of a unit in a residential multi-unit complex?
Based on the fact pattern in the request, the IFRS IC concluded that none of the over-time criteria in paragraph 35 of IFRS 15 were met.
|Revenue recognition in a real estate contract that includes the transfer of land||Final – March 2018||2, 5||
Should an entity identify a promise to transfer land in a contract as a separate performance obligation from the promise to build on that land, and then recognize revenue over time for each performance obligation identified?
Based on the fact pattern in the request, the IFRS IC concluded that the transfer of the land and the construction of the building were separate performance obligations. In making that determination, the entity considers whether its performance obligations would be any different if it did not also transfer the land (and vice versa) and whether it would be able to fulfil its promise to transfer the land if the customer used another party to construct the building (and vice versa).
The IFRS IC also concluded that in this fact pattern, the promise to transfer the land did not meet any of the criteria in paragraph 35 of IFRS 15 to recognize revenue over time, while the construction of the building did.
|Right to payment for performance completed to date||Final – March 2018||5
Should a real estate developer recognize revenue over time or at a point in time for the sale of a unit in a residential multi-unit complex based on whether the real estate developer has the enforceable right to payment for performance completed to date when applying the criteria in paragraph 35(c) of IFRS 15?
In the fact pattern, the developer was under contract to construct a real estate unit as follows.
The IFRS IC concluded that the developer does not have an enforceable right to payment for performance completed to date and should recognize revenue at a point in time. This is because its right to payment under the first contract is limited to the shortfall in resale price.
While IFRS 15 and ASC 606 have been effective for over a year, companies still encounter implementation issues regardless of which framework they are applying. Dual reporters should closely follow the implementation and interpretive guidance as well as proposed amendments that affect revenue recognition under both accounting frameworks. Companies also following trends in SEC comment letters may benefit from ensuring that their conclusions are in line with the issues already addressed by the regulatory body.
Understanding the guidance in IFRS 16 on accounting for lease modifications by both lessees and lessors.
Differences on the capitalization of borrowing costs under IAS 23 and interest costs under US GAAP.
Lessons we’ve learned.