FINANCIAL REPORTING STANDARDS IMPLEMENTATION COMMITTEE

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1 FINANCIAL REPORTING STANDARDS IMPLEMENTATION COMMITTEE FRSIC Consensus 29 Revenue recognition in bancassurance arrangement under MFRS 15 Revenue from Contracts with Customers Preamble FRSIC Consensus 29 Revenue recognition in bancassurance arrangement under MFRS 15 Revenue from Contracts with Customers was developed by the Financial Reporting Standards Implementation Committee ( FRSIC ) and issued by the Malaysian Institute of Accountants ( MIA or Institute ) on 27 December The Consensus contained herein is issued as part of the Institute s initiatives to promote best practices in compliance with the highest standards in financial accounting. Malaysian Institute of Accountants

2 FRSIC CONSENSUS 29 REVENUE RECOGNITION IN BANCASSURANCE ARRANGEMENT UNDER MFRS 15 REVENUE FROM CONTRACTS WITH CUSTOMERS FRSIC Consensus is a guidance issued by MIA and shall be regarded as best practice. It should be read in conjunction with the respective applicable accounting standards. Members of MIA are expected to observe compliance with the consensus issued. In exceptional circumstances where departure is necessary, members shall be prepared to justify the departure. FRSIC Consensus needs not be applied to immaterial items. Nothing in the FRSIC Consensus is to be construed as amending or overriding the accounting standards or other statements adopted or issued by the Malaysian Accounting Standards Board ( MASB ) and other relevant laws. Background 1 Bancassurance refers to an arrangement for the marketing or distribution of general and life insurance or general and family takaful products at the premises of banking institutions or by using the banking institutions distribution channels, which include the banking institutions call centres, internet, branches, marketing booths as well as third parties providing such sales support services. 2 In Malaysia, there are currently three observable predominant bancassurance models which are as follows: (a) Referral arrangement this model refers to an arrangement whereby an insurer or a takaful operator is placed on the panel of a banking institution for the provision of certain insurance covers or takaful benefits (credit-related) to the banking institution s customers. The banking institution has minimal degree of involvement as the insurance or takaful arrangement is consequential and closely tied to the financing arrangement; (b) Distribution agreement this model refers to an agreement between a banking institution and an insurer or a takaful operator whereby the banking institution agrees to actively promote the insurance or takaful products of its bancassurance partner to its customers. The banking institution s involvement ranges from a relatively low involvement to high involvement, including providing after-sales service to customers; and (c) Integrated services this model refers to integrated front and back-end operations between a banking institution and an insurer or a takaful operator to deliver banking and insurance or 2 of 12

3 takaful products to customers in a seamless manner. This model could also refer to equity relationship between the banking institution and insurer or takaful operator. Under this model, the banking institution has a high degree of involvement, ranging from prospecting of potential clients or customers to claims servicing. 3 In any bancassurance arrangement, banking institutions are normally entitled to various fees in accordance with the roles assumed such as commitment fee, facilitation fee, marketing campaign fee, commissions and others. Some of these fees may be paid upfront, for example, upon signing of agreement and may not be refundable, while others could be paid at a later stage including those that are due and collectible or payable when the relevant insurance or takaful products are sold to the customers. Scope 4 This Consensus applies to upfront fees in such a bancassurance arrangement described above. The upfront fees are paid by the insurance company or takaful operator to the banking institution when the bancassurance agreement is executed. The upfront fees are normally non-refundable. The Issue 5 Some are of the view that the upfront fees should be recognised immediately when they are received (i.e., at a point-in-time) because the banking institution does not need to return the consideration received from the insurance company or takaful operator regardless of the performance of the banking institution under the bancassurance agreement (i.e. non-refundable). 6 Others are of the view that the upfront fees received should be recognised as revenue over time as and when the banking institution satisfies its performance obligations towards the insurance company or takaful operator under the bancassurance agreement. This is because in the event that the banking institution failed to perform its obligations under the contract, legal actions can be taken by the insurance company or takaful operator against the banking institution, for example, by requesting for specific performance on the part of the banking institution although the upfront fees are not refundable. Consensus and Basis of Consensus 7 MFRS 15 outlines the recognition of revenue from contracts with customers, which may also include upfront fee received from bancassurance agreement between the banking institution and 3 of 12

4 the insurance company or takaful operator. Paragraph 2 of MFRS 15 states that the core principle of MFRS 15 is that an entity shall recognise revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. 8 To achieve this core principle, MFRS 15 requires an entity to apply the following five steps to recognise revenue: Step 1: Identity the contract(s) with a customer; Step 2: Identify the performance obligations in the contract; Step 3: Determine the transaction price; Step 4: Allocate the transaction price to the performance obligations in the contract; and Step 5: Recognise revenue when (or as) the entity satisfies a performance obligation. 9 As a bancassurance arrangement may be structured differently from a contract to another as explained in paragraph 2 above, all relevant terms and conditions in the bancassurance agreement should be considered to determine the performance obligations and hence, as the basis for recognition of the upfront fees received. Step 1: Identify the contract(s) with a customer 10 Paragraph 9 of MFRS 15 states that an entity shall account for a contract with a customer that is within the scope of this Standard only when all of the following criteria are met: (a) the parties to the contract have approved the contract (in writing, orally or in accordance with other customary business practices) and are committed to perform their respective obligations; (b) the entity can identify each party s rights regarding the goods or services to be transferred; (c) the entity can identify the payment terms for the goods or services to be transferred; (d) the contract has commercial substance (i.e., the risk, timing or amount of the entity s future cash flows is expected to change as a result of the contract); and (e) it is probable that the entity will collect the consideration to which it will be entitled in exchange for the goods or services that will be transferred to the customer. In evaluating whether collectability of an amount of consideration is probable, an entity shall consider only the customer s ability and intention to pay that amount of consideration when it is due. The amount of consideration to which the entity will be entitled may be less than the price stated in the contract if the consideration is variable because the entity may offer the customer a price concession. 4 of 12

5 FRSIC is of the view that the bancassurance arrangement entered into between a banking institution and an insurance company or a takaful operator, as evidenced by the executed bancassurance agreement, meets the criteria in paragraph 9 of MFRS 15 above. As such, the banking institution and the insurance company or takaful operator are the parties to the bancassurance arrangement whereby the insurance company or takaful operator receives services from the banking institution. Step 2: Identifying performance obligations 11 Paragraph B49 of MFRS 15 requires that in order to identify performance obligations in such a bancassurance arrangement, the banking institution shall assess whether the fees relate to the transfer of any promised good(s) or service(s). 12 Depending on the specific circumstances and provisions of a bancassurance arrangement, a banking institution may have promised to deliver various goods and services to the insurance company or takaful operator (i.e., performance obligations) such as: i. commitment to provide exclusivity to the insurance company or takaful operator throughout the contract period; ii. commitment to facilitate and provide assistance to the insurance company or takaful operator in order to get regulatory approval for execution of the bancassurance arrangement; iii. commitment to make its customer database, branch network and/or distribution channels available for introduction and/or promotion of products of the insurance company or takaful operator; iv. commitment relating to development and/or enhancement of IT system and digital platform that would be used under the bancassurance arrangement; v. assistance during and/or after the selling process of insurance or takaful products, for example, to collect information for, conclude and/or deliver insurance policy or takaful certificate; and vi. others. 13 The banking institution shall identify its performance obligations with regard to the bancassurance arrangement as required in paragraph 22 of MFRS 15 whereby at contract inception, an entity shall assess the goods or services promised in a contract with a customer and shall identify as a performance obligation each promise to transfer to the customer either: 5 of 12

6 (a) a good or service (or a bundle of goods or services) that is distinct; or (b) a series of distinct goods or services that are substantially the same and that have the same pattern of transfer to the customer. 14 Paragraph 27 of MFRS 15 explains that a good or service that is promised to a customer is distinct if both of the following criteria are met: (a) 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 (i.e., the good or service is capable of being distinct); and (b) the entity s promise to transfer the good or service to the customer is separately identifiable from other promises in the contract (i.e., the promise to transfer the good or service is distinct within the context of the contract). 15 Paragraph 30 of MFRS 15 further states that if a promised good or service is not distinct, an entity shall combine that good or service with other promised goods or services until it identifies a bundle of goods or services that is distinct. In some cases, that would result in the entity accounting for all the goods or services promised in a contract as a single performance obligation. 16 Furthermore, paragraph B50 of MFRS 15 states that if the non-refundable upfront fee relates to a good or service, the entity shall evaluate whether to account for the good or service as a separate performance obligation in accordance with paragraphs FRSIC is of the view that in relation to a bancassurance arrangement, the banking institution shall assess whether each of the performance obligation is distinct or a series of distinct goods and services are substantially the same and have the same pattern of transfer to the customer, i.e. the insurance company or takaful operator. This is important as it will affect how the banking institution allocates the transaction price or the upfront fees to various distinct goods or services identified in accordance with the principles explained above. 18 Accordingly, the bank shall assess whether the upfront fees received constitute a distinct performance obligation in the bancassurance arrangement in accordance with the principles explained in the previous paragraphs. 6 of 12

7 Step 3: Determine the transaction price 19 Paragraph 47 of MFRS 15 states that an entity shall consider the terms of the contract and its customary business practices to determine the transaction price. The transaction price is the amount of consideration to which an entity expects to be entitled in exchange for transferring promised goods or services to a customer, excluding amounts collected on behalf of third parties (for example, some sales taxes). The consideration promised in a contract with a customer may include fixed amounts, variable amounts, or both. 20 For the purpose of this Consensus, the transaction price is the upfront fees paid to the banking institution when the bancassurance agreement is executed. Step 4: Allocate the transaction price to the performance obligations in the contract 21 Paragraph 73 of MFRS 15 states that the objective when allocating the transaction price is for an entity to allocate the transaction price to each performance obligation (or distinct good or service) in an amount that depicts the amount of consideration to which the entity expects to be entitled in exchange for transferring the promised goods or services to the customer. 22 For the purpose of this Consensus, the upfront fees are known and fixed at the inception of the bancassurance arrangement when the agreement is executed. The total amount of the upfront fees should be allocated to various distinct services identified as each of them may be recognised at different times and/or over different periods of times during the contract period when those services are delivered. 23 Paragraph 74 of MFRS 15 requires an entity to allocate the transaction price to each performance obligation identified in the contract on a relative stand-alone selling price basis, except for allocating discounts and allocating consideration that includes variable amounts. If a stand-alone selling price is not directly observable, paragraph 78 of MFRS 15 states that an entity shall estimate the stand-alone selling price at an amount that would result in the allocation of the transaction price meeting the allocation objective in paragraph 73. Step 5: Recognise revenue when (or as) the entity satisfies a performance obligation 24 Paragraph 31 of MFRS 15 states that an entity shall recognise revenue when (or as) the entity satisfies a performance obligation by transferring a promised good or service (i.e., an asset) to a customer. An asset is transferred when (or as) the customer obtains control of that asset. This requirement is further explained in paragraphs 35 to 38 of MFRS 15 whereby: 7 of 12

8 i. An entity transfers control of a good or service over time and, therefore, satisfies a performance obligation and recognises revenue over time, if one of the following criteria is met: (a) the customer simultaneously receives and consumes the benefits provided by the entity s performance as the entity performs; (b) the entity s performance creates or enhances an asset that the customer controls as the asset is created or enhanced; or (c) the entity s performance does not create an asset with an alternative use to the entity and the entity has an enforceable right to payment for performance completed to date. ii. If a performance obligation is not satisfied over time, an entity satisfies the performance obligation at a point in time. Accordingly, FRSIC is of the view that revenue recognition in relation to the upfront fees should be recognised when (or as) the banking institution has performed the promised services to the insurance company or takaful operator and hence, the insurance company or takaful operator obtains benefit from the services rendered. The banking institution shall not follow the cash flow stream of consideration received or to be received for its revenue recognition without considering the performance obligations of the promised services. 25 For each performance obligation satisfied over time, paragraph 39 of MFRS 15 requires an entity to recognise revenue over time by measuring the progress towards complete satisfaction of that performance obligation. In determining the appropriate method for measuring progress, an entity shall consider the nature of the good or service that the entity promised to transfer to the customer. Paragraph 40 of MFRS 15 further elaborates that the entity shall apply a single method of measuring progress for each performance obligation satisfied over time and that method shall be applied consistently to similar performance obligations and in similar circumstances. Depending on specific circumstances and provisions in the bancassurance agreement, the straight-line basis may be one of the possible methods to recognise the upfront fees as revenue over time. 26 The fact that the upfront fees are not refundable in itself does not justify the upfront recognition, as it does not indicate that the banking institution does not have an obligation to the insurance company or takaful operator. For this purpose, the banking institution shall also assess the default and termination clauses in the bancassurance agreement to confirm its obligations to the 8 of 12

9 insurance company or takaful operator when the promised services were not delivered or not delivered to the satisfaction of the other party. 27 In situations when the upfront fees do not result in transfer of distinct goods or services to the customer, they are advance payments for future goods or services, and therefore should be recognised when the future goods or services are provided. These upfront fees are therefore recognsied as revenue over the contractual period along with other performance obligations identified in the bancassurance arrangement. 28 Where banks have previously recognised the upfront fee from bancassurance arrangement as revenue when it was received, an assessment should be made on the transition impact that this Consensus has on the existing contracts when MFRS 15 becomes effective. Issuance date of this Consensus 29 This Consensus is issued on 27 December Effective date of this Consensus 30 This Consensus is effective for the period beginning on or after 1 January References MFRS 15 Revenue from Contracts with Customers 9 of 12

10 Illustrative Example This Illustrative Example accompanies the Consensus, but it is not an integral part of the Consensus. The example intends to illustrate the application of the 5-step approach of MFRS 15 Revenue from Contracts with Customers in relation to non-refundable upfront fees received in a bancassurance arrangement. Bank A enters into a bancassurance arrangement with Insurance Company B. Under the arrangement, Insurance Company B will pay Bank A a total upfront facilitation fee of RM50 million and Bank A shall commit to assist and facilitate Insurance Company B in bancassurance relationship pursuant to the terms of the agreement. This fee is payable upon receipt of regulatory approval and is non-refundable even if the agreement is subsequently terminated. The bancassurance agreement states that Bank A will provide Insurance Company B the right to access its customer database for a period of 10 years. Bank A and Insurance Company B also agreed to the following conditions, among others: (a) Bank A will, during the period covered by the agreement, make available resources sufficient to distribute Insurance Company B s products determined in the agreement, including sufficient numbers of personnel and training, distribution of promotional materials, as well as the use of the Bank s marketing channels and websites; (b) exclusivity is provided by both parties to each other on the insurance products to be distributed, except for situations when the banks need to distribute products of other insurance companies if required under regulatory requirements or by the regulators, if requested by the banks customers to use other insurance companies, or if the insurance contracts applied by the banks customers are rejected by the insurance companies in the agreements; and (c) joint committee is set up or other mechanism is used to monitor performances of both parties, including if sufficient support is provided by each party to promote and distribute the insurance products, and if effect of insurance products needed to be distributed by the banks other than from the insurance companies in the agreements is material, and to determine appropriate courses of actions in carrying out the requirements in the agreements or to rectify any non-compliances. Step 1: Identify the contract(s) with a customer Provided the criteria in paragraph 9 of MFRS 15 are satisfied, a bancassurance arrangement is a contract between Bank A and Insurance Company B whereby Insurance Company B is the customer in the bancassurance arrangement. 10 of 12

11 Step 2: Identify the performance obligations in the contract Step 2 requires Bank A to establish: (1) whether the fee relates to the transfer of a promised good or service; and (2) if the fee relates to a good or service, whether to account for the good or service as a separate performance obligation. Based on the bancassurance arrangement above, the upfront facilitation fee is paid for Bank A to assist and facilitate Insurance Company B in the bancassurance arrangement. For instance, such fee includes satisfaction of the following services (i.e., performance obligations) to Insurance Company B: i. Right to access to customer database; ii. Make available resources to distribute Insurance Company B s products (including sufficient number of personnel, marketing channels and website); iii. Provide training to a number of personnel on Insurance Company B s products; iv. Exclusivity of Insurance Company B s product; and v. Participation of Bank A in joint committee to monitor performance of both parties. As such, Bank A shall not recognise the fee received as revenue upfront as it is not a separate performance obligation. Rather, it is an advance payment for future goods or services to be satisfied throughout the contract period as stated above. In the event of default, legal action can be taken against Bank A for its incomplete performance obligations. Subsequent to that, Bank A shall assess whether each of the performance obligation is distinct from one another using the criteria stated in paragraphs 27 to 29 of MFRS 15. For instance, the right to access to customer database, to provide training to a number of personnel on Insurance Company B s products and make available resources to distribute Insurance Company B s products may be a distinct performance obligation as Insurance Company B can benefit on its own, is readily available and can be separately identifiable from other promises in the contract. Step 3: Determine the transaction price The amount of transaction price i.e. the upfront facilitation fee that Bank A is entitled in exchange for transferring the promised services above is RM50 million. Step 4: Allocate the transaction price to the performance obligations in the contract Bank A shall allocate the transaction price of RM50 million to the performance obligations in the contract as identified in Step 2 above based on stand-alone selling price. However, if the stand-alone selling price is unavailable or not directly observable, Bank A is required to estimate the stand-alone selling price using a suitable method such as adjusted market assessment approach, expected cost plus a margin approach or residual approach. 11 of 12

12 Step 5: Recognise revenue when (or as) the entity satisfies a performance obligation Bank A shall then recognise revenue when (or as) it satisfies a performance obligation. For example, say, Bank A allocates: (a) RM30 million to the rights to access customer data base over the period of 10 years, (b) RM3 million to provide training to a number of personnel over a period of 3 years; (c) RM10 million to distribution channels for 10 years; and (d) remaining RM7 million for one-year product exclusivity. As such, Bank A may amortise: (a) RM40 million for the rights to access customer data base and distribution channels over the period of 10 years; (b) RM3 million for the training over the period of 3 years; and (c) RM7 million for product exclusivity over the period of 1 year. 12 of 12