aasb issues new revenue recognition standard

AASB Issues New Revenue Recognition Standard

The Australian Accounting Standards Board (AASB) has published AASB 15: Revenue from Contracts with Customers. Except for some limited exceptions, AASB 15 will provide a single source of accounting requirements for all contracts with customers. The new Standard will impact the reported results of clients that:

• provide customers with bundled products and/or services;

• provide customers with significant warranties and/or rebates;

• experience significant variability in revenue collectability from contract to contract;

• have contracts for which the amount of consideration can vary; and/or

• renegotiate the scope and/or consideration with customers.

The types of industries that are most likely to be impacted by the adoption of AASB 15 include construction, manufacturing, telecommunications, software development and licensing, and real estate.

The economic implications of AASB 15 for clients will vary, depending upon their particular circumstances, but clients with bank covenants and/or compensation arrangements tied to revenues or profits or public reporting obligations are likely to be affected by the new Standard.

AASB 15 will become effective for annual reporting periods beginning on or after 1 January 2017. For many clients, the new Standard will necessitate changes in some information systems and processes to capture previously uncollected information. Accordingly, preparation will be the key to a successful adoption of the new Standard.

Snapshot

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The Australian Accounting Standards Board (AASB) has published AASB 15: Revenue from Contracts with Customers, the Australian equivalent of its international namesake, IFRS 15. The purpose of the new Standard is to provide (except in relation to some specific exceptions, such as lease contracts and insurance contracts) a single source of accounting requirements for all contracts with customers, thereby replacing all current accounting pronouncements on revenue, including:

• AASB 111: Construction Contracts;

• AASB 118: Revenue;

• AASB Interpretation 13: Customer Loyalty Programmes;

• AASB Interpretation 15: Agreements for the Construction of Real Estate;

• AASB Interpretation 18: Transfers of Assets from Customers;

• AASB Interpretation 131: Revenue – Barter Transactions Involving Advertising Services; and

• AASB Interpretation 1042: Subscriber Acquisition Costs in the Telecommunications Industry.

During its deliberations on AASB 15, the AASB has also reconsidered the current requirements for government grants and other types of contributions contained in AASB 1004: Contributions that apply only to not-for-profit entities. In light of the changes to be introduced by AASB 15, the AASB has decided to replace AASB 1004. An Exposure Draft outlining the proposed replacement requirements for AASB 1004 is expected to be issued by the AASB in early 2015.

Background

2AASB Issues New Revenue Recognition Standard


Recognising Revenue Under AASB 15

The core principle underpinning the requirements in AASB 15 is that revenue should be recognised in a manner that depicts the transfer of promised goods or services to customers in an amount that reflects the consideration to which the provider of the goods or services expects to be entitled. To this end, AASB 15 requires the adoption a 5-step model for recognising revenue.

To apply the 5-step model, an entity may need to exercise significant judgement when considering the terms of the contract(s) and all of the facts and circumstances in relation to the contract(s), including implied contractual terms. AASB 15 also contains requirements applicable to items that are not normally considered to be revenue, including some costs associated with obtaining and fulfilling a contract and the sale of some non-financial assets.

Step 1: Identify the contract(s) with the customerA customer is a party that has contracted with an entity (provider) to obtain goods and/or services that are an output of the entity’s ordinary activities in exchange for consideration. While a contract with a customer may be in a written or verbal form, the agreement is only recognised as a customer contract by the provider when it meets a number of specified criteria, including:

• each party’s rights regarding the goods and/or services can be identified;

• the risk, timing and/or amount of an provider’s cash flows are expected to change as a consequence of the contract (i.e., the contract has commercial substance); and

• it is probable that the consideration for the goods and/or services will be collected.

Moreover, a contract is not recognised if it is wholly unperformed and each party to the contract has the unilateral enforceable right to terminate without providing compensation.

A provider may be required to account for two or more contracts as a single contract if:

• the contracts are all negotiated as one package with a single commercial objective;

• the amount of consideration paid in one contract depends on the price or performance of one or more other contracts; and

• the goods and/or services promised are a single performance obligation.

When the parties to a contract approve a change in the scope and/or price of the goods and/or services under the contract, such changes may need to be accounted for as a modification of the original contract (an adjustment to the accounting for the pre-existing contract) or as a separate contract (in addition to the pre-existing contract), subject to the specific facts and circumstances.


Step 2: Identify the distinct performance obligationsHaving identified the contract(s) with a customer, it’s necessary to assess the terms of the contract, including any promises implied by a provider’s customary business practices, published policies or specific statements, and identify as separate performance obligations each promise to transfer to the customer either:

• a good or service (or a bundle of goods or services) that is distinct; or

• a series of distinct goods or services that are substantially the same and that have the same pattern of transfer.

A promised good or service is considered distinct if:

• the customer can benefit from the good or service either on its own or together with other resources that are readily available to the customer; and

• the provider’s promise to transfer the good or service to the customer is separately identifiable from other promises in the contract.

Factors that may indicate a promised good or service is distinct include:

• the provider does not integrate the good or service with other goods and/or services promised under the contract into a combined output for which the customer has contracted;

• the good or service does not significantly modify or customise another good or service promised under the contract; or

• the good or service is not highly dependent on, or highly integrated with, another good and/or service promised under the contract.

Step 3: Determine the transaction price cfhdThe transaction price is the amount of consideration to which a provider of goods and/or services expects to be entitled (which may or may not be the same as what they are legally entitled to) in exchange for transferring the promised goods and/or services to the customer. The transaction price includes, when applicable:

• variable consideration reflecting the impact of discounts, rebates, refunds, credits, concessions, incentives, bonuses and penalties, but only to the extent that a significant and subsequent reversal in the amount of the consideration recognised is not highly probable;

• any significant financing component arising from deferred payment arrangements;

• non-cash consideration; and

• the impact of consideration payable to the customer (e.g., cash back, coupons or vouchers), except for consideration paid by the provider for a distinct good and/or service.

The expected amount of consideration may be determined based on the expected amount (sum of the probability-weighted amounts from the range of possible outcomes) or the most likely amount (single most likely outcome), depending on which method better predicts the amount of consideration the provider will be entitled to.


Step 4: Allocate the transaction price to the performance obligationsHaving determined the transaction price, the provider allocates the transaction price to each distinct performance obligation in an amount that depicts the amount of consideration to which the provider expects to be entitled in exchange for transferring the promised good or service to the customer. Except in limited circumstances, the transaction price is allocated on a relative stand-alone selling price (observable if available, otherwise estimated) basis at inception of the contract. In addition:

• the allocation is not subsequently adjusted to reflect changes in the stand-alone selling prices of the promised goods or services; and

• any changes in the transaction price after contract inception other than changes arising from modifications must be allocated to the performance obligations on the same basis as at the contract inception.

Step 5: Recognise revenue when (or as) a performance obligation is satisfiedRevenue from a contract with a customer is recognised when (or as) the provider satisfies a performance obligation by transferring a good or service to the customer. To this end, the provider establishes at the inception of the contract whether under the contract performance obligations are satisfied:

• over time, which means that (from the customer’s perspective):

• the customer simultaneously receives and consumes the benefits provided; or

• the provider’s performance creates or enhances an asset that the customer controls; or

• the provider’s performance does not create an asset with an alternative use to the provider and the provider has an enforceable right to payment for the performance completed to date; or

• at a point in time, in which case the point in time is when the customer controls the transferred asset (including any asset embodied in a service provided to the customer).

The method applied for measuring progress towards achieving a performance obligation over time must be:

• appropriate for the performance obligation;

• for which the provider has reliable information; and

• applied consistently over time and in similar circumstances.



Potential Implications of AASB 15Most entities will be impacted to some extent by the introduction of AASB 15, but those entities that provide bundled products and/or services under individual customer contracts or are involved in long-term service contracts are likely to be particularly affected. The magnitude of this impact is likely to vary between entities, depending on the nature of their customer contracts, the accounting policies they currently apply to such contracts and the level of sophistication embodied in their accounting systems. Entities operating in the following industries will need to closely examine all of these factors to determine the actions they will need to take in transitioning to AASB 15.

• construction

• manufacturing

• telecommunications

• software development

• real estate

The following outlines some of the more significant changes we anticipate as a consequence of entities adopting AASB 15.

Identifying customer contractsIn applying AASB 15, entities will need to consider past and current business practices in order to determine what arrangements should be accounted for as customer contracts. As noted above, a customer contract may be written or verbal. It may also be construed from the circumstances if the parties are acting in a manner consistent with a contractual arrangement. Accordingly, those entities that have previously only recognised written contracts should review their business practices to determine if they have any previously unrecognised customer contracts.

Identifying contracts outside of AASB 15Arrangements that are not ‘contracts’ involving the provider’s ‘customers’ are accounted for differently under AASB 15 as compared to customer contracts. For instance, if an entity provides goods and/or services that are not outputs of its ordinary activities, the entity would defer recognising revenue from the arrangement until:

• the related performance obligations have been fully satisfied and consideration is fully received and non-refundable; or

• the arrangement is terminated and consideration is fully received and non-refundable.

Potential Implications of AASB 15


Collectability of considerationTo meet the definition of a contract with a customer, an arrangement must exhibit a number of features, including collectability of consideration. Collectability refers to the customer’s ability and intention to pay the consideration (credit risk).

Under AASB 15, if partial payment of consideration for the goods and/or services promised under a contract is considered probable, this is sufficient for recognition of some revenue when (or as) the promised good or service is transferred. Subject to how customer contracts with uncertain variable consideration are being accounted for under AASB 111: Construction Contracts and AASB 118: Revenue, the adoption of AASB 15 may cause some entities to recognise revenue relatively earlier than is currently the case.

The ‘reliable measurement’ recognition criteria in both AASB 111 and AASB 118 are generally interpreted to mean that revenue from a customer contract is only recognised when the total amount attributable to the contract can be measured reliably. Under AASB 15, however, some entities may be required to recognise at least a minimum amount of the total estimated revenue earlier, notwithstanding that their contracts with customers contain the same provisions regarding, for instance, price concessions, incentives, rebates and performance fees.

To mitigate the risks associated with entities recognising revenue before it is expected to be realised, AASB 15 requires variable consideration to only be recognised to the extent that it is highly probable that a significant revenue reversal will not occur in the future. Consequently, some entities might conclude that, consistent with their current reported outcomes, no revenue is recognisable until the uncertainty associated with the variable consideration is completely resolved. This determination, however, will require entities to consider both the likelihood and magnitude of a revenue reversal. In addition, entities will need to demonstrate that the magnitude of the revenue reversal will be significant relative to the total revenue (not just the variable consideration) under the contract.

Combining contracts with customersWhilst entities should currently be accounting for multiple customer contracts that are, in substance, a single contract in a manner consistent with AASB 15, the introduction of specific criteria in AASB 15 may impact the basis on which entities combine contracts going forward, particularly if their current policy differs from the criteria in AASB 15.

Accounting for performance obligations Consistent with the criteria for identifying customer contracts, performance obligations comprise written, verbal and implied contractual terms. Under AASB 15, valid expectations of a customer may be sufficient to establish a performance obligation, notwithstanding that the obligation is not explicitly stated in the customer contract.

Under AASB 15, the pattern and timing of revenue recognition will be primarily driven by the performance obligations identified and the transaction price amounts allocated to each of the obligations. Identifying and quantifying individual performance obligations and tracking progress against these obligations, however, is likely to pose significant challenges for many entities. Such challenges will include:

• identifying the distinct goods and/or services (individual or groups) being provided;

• determining a stand-alone price for each individual or group of distinct goods/services;

• determining an appropriate basis for measuring progress towards the performance obligation (particularly if revenue was previously recognised based on the provision of one of the bundled goods/services and the other goods/services have significantly different patterns of transfer); and

• determining when performance with respect to the obligation commences and finishes.



Allocating the transaction price to performance obligationsCurrent Australian Accounting Standards do not explicitly address how multiple-element contracts (i.e., more than one good and one service provided under a single contract) should be accounted for. To deal with this some entities have applied guidance in other pronouncements dealing with related matters and/or the requirements applicable in other jurisdictions, such as US GAAP. Accordingly, some entities currently apply a ‘residual’ approach for allocating the transaction price of multiple-element contracts, whereby the amount of the transaction price allocated to the main products and services is equal to their respective fair values, and any unallocated (residual) amount is allocated to the remaining goods and/or services.

Under AASB 15, the residual approach is only permitted where the entity:

• regularly sells on a stand-alone basis goods and/or services (individual or groups) at a discount to the stand-alone selling prices of the goods and/or services; and

• the stand-alone discount is substantially the same as the discount provided under the contract.

Consequently, entities should anticipate that under AASB 15 they will be required to allocate any discount within a customer contract proportionately across all of its performance obligations.

Accounting for licences of intellectual propertyExcept in some specific circumstances, AASB 15 requires the provision of a licence to intellectual property (IP), including software, patents and copyrights, to be accounted for by the provider as a performance obligation based on whether the promise to provide the IP is distinct from other goods and services promised under the contract.

In some circumstances, the assessment of whether the IP is distinct will be relatively straightforward, such as when the licence is the only item transferred under the contract. In other circumstances, however, the assessment may involve more judgement, such as when a licence is transferred with other goods and/or services. To assist preparers and auditors, AASB 15 provides some examples of licences that are not distinct elements of multi-element contracts. Promises to provide IP that are not distinct are combined with promises to provide other (related) goods and/or services until a distinct bundle is identified, in which case revenue from the provision of the IP will only be recognised when the entity satisfies the combined performance obligation.

For IP found to be distinct from other goods and services, the pattern of revenue recognition will be largely determined by whether the customer has a right to access the IP as it exists throughout the licence period (and thereby benefit from any upgrades or improvements in the IP during the course of the contract) or as the IP exists at a point in time (normally at inception). We note that some contracts explicitly establish the customer’s rights to upgrades and improvements during the course of the contract. We also note, however, that some contracts are silent on this matter, which will necessitate entities reviewing any promises implied by its customary business practices, published policies or specific statements.

With respect to sales- or usage-based royalties on licences of IP, AASB 15 requires that such royalties not be included in the transaction price until the customer’s sales or usage occurs.



Accounting for modifications of customer contractsThe lack of specific guidance in AASB 118 in respect of accounting for contract modifications may also necessitate changes in some entities’ accounting policies with the introduction of AASB 15. As noted above, AASB 15 requires an entity to assess changes in the scope and/or price of a contract to determine whether to treat the modified contract as a separate contract (in addition to the pre-existing contract).

Accounting for non-refundable upfront feesThe accounting for non-refundable upfront fees arising from customer contracts has been a challenge for preparers and auditors for some time. Unfortunately, AASB 15 does not entirely resolve this situation. Under AASB 15, entities will need to determine whether a non-refundable upfront fee relates to the transfer of a promised good or service. If the fee gives rise to a separate performance obligation, the provider would recognise the fee as revenue when the good or service is provided to the customer.

Where to From Here? dfhhhhhhhhhhhhhhEntities that expect to be impacted by the introduction of AASB 15 should not wait till 2017 to start the transition process. Given the significance of revenue as a reported figure, entities should now be contemplating the system changes necessary to facilitate their transition to AASB 15. As with all significant changes, preparation will be the key to a successful adoption of AASB 15.



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aasb issues new revenue recognition standard

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