Issue 1 (19 March 2015) FRS 115 Tax Alert FRS 115 Revenue Recognition Are you prepared for the tax challenges of the new revenue recognition standard? Overview The accounting requirements for recognising revenue are changing. On 19 November 2014, the Accounting Standards Council issued Singapore Financial Reporting Standard (FRS) 115, Revenue from Contracts with Customers. This new revenue recognition standard is based on International Financial Reporting Standards (IFRS) 15 Revenue from Contracts with Customers, a jointly issued converged standard on revenue recognition by the International Accounting Standards Board and the Financial Accounting Standards Board. FRS 115 is effective for annual periods beginning on or after 1 January 2017. Early adoption of the new revenue standard is permitted. Accordingly, FRS 115 aims, amongst several objectives, to clarify the principles for recognising revenue that would remove inconsistencies and weaknesses in current revenue requirements and provide a more robust framework for addressing revenue issues. The core principle of FRS 115 is for entities to recognise revenue to depict the transfer of goods or services to customers in amounts that reflect the consideration which the entity expects to be entitled to in exchange for those promised goods or services. Virtually all industries will be affected by the new revenue standard which applies to all contracts that an entity has with its customers that will give rise to revenue in the entity (with limited exceptions). Depending on the industry and current accounting requirements applicable to the industry, the impact of FRS 115 can be more significant for some entities.
The five-step model for revenue recognition The key difference between FRS 115 and the existing revenue recognition standard, FRS 18 Revenue is the introduction of the five-step model when an entity recognises revenue from a contract with a customer, namely: Step 1 Identify the contract(s) with a customer 2 Identify the separate performance obligations in the contract 3 Determine the transaction price 4 Allocate the transaction price to the separate performance obligations 5 Recognise revenue when (or as) the entity satisfies a performance obligation See Annex for details. Costs of obtaining contracts In addition, the new revenue standard also specifies how entities are to account for incremental costs of obtaining a contract and the costs directly related to fulfilling a contract. Generally, if these costs are expected to be recovered, they can be capitalised and subsequently amortised and tested for impairment. Transition All entities will be required to apply FRS 115 retrospectively using either a full retrospective approach or a modified retrospective approach. Entities that elect the full retrospective approach will have to apply the new standard to all the periods presented in the financial statements in accordance with the existing accounting standards. This will normally result in the entity making cumulative catch-up adjustments (retrospective adjustments) to the comparative periods presented in the financial statements. Practical expedients are available in FRS 115 to provide relief to ease the burden for entities who may wish to apply the full retrospective approach. Alternatively, entities may adopt the modified retrospective approach to reflect the impact of the new standard. Under this approach, the standard will only be applied to the most current period presented in the financial statements. Entities will continue to present comparative periods in accordance with existing revenue standards and recognise a retrospective adjustment to the opening balance of retained earnings at the effective date for existing contracts that still require performance by the entity in the year of adoption. However, this approach requires entities to disclose additional information in their financial statements. Key tax considerations With the adoption of the new revenue standard, what are the tax challenges that companies should be aware of and what can you do now? (1) Revenue recognition for tax purposes may not be the same Companies should not assume that the timing and amount of revenue recognised under the new revenue standard will be the same for tax purposes. This assumption should be validated. Where the revenue recognised under FRS 115 differs from the revenue assessable for tax purposes, new significant temporary differences may arise or existing temporary differences may need to be accounted for differently. It will also affect the income tax return filings of the company. For example, if the arrangement with the customer involves variable consideration, the new revenue standard requires the company to determine the variable consideration to be included in the transaction price at contract inception using a permitted approach. As a result, the company may recognise an amount of such revenue sooner. If the variable consideration is only regarded as taxable in the future, this would result in a deferred tax impact in the financial statements. Companies may also need to revise their processes and documentation to capture the new temporary differences for tax reporting purposes in order to substantiate the tax adjustments upon request by the Inland Revenue Authority of Singapore (IRAS). (2) Companies may miss out on opportunities of claiming a tax deduction on contract costs earlier Contract costs under FRS 115 may differ from what they are today as the new revenue standard requires capitalisation in certain circumstances. In this scenario, companies should determine whether this will result in a different pattern of expense recognition for financial and tax reporting purposes. For example, the capitalised contract costs may be tax deductible to the company in full when the costs are incurred instead of the amortised amount for accounting purposes. All Rights Reserved [Insert local EY firm Name] FRS 115 Tax Alert (March 2015) 1
(3) Uncertainty in income tax implications of retrospective adjustment Adoption of FRS 115 under the full retrospective or modified retrospective approach will likely result in a retrospective adjustment for accounting purposes. As there can be a significant upward or downward retrospective adjustment, companies should gain a thorough understanding of the income tax implications of this adjustment. The questions that companies should consider are: Would the IRAS permit the Retrospective Adjustment for tax purposes? In which financial period would the Retrospective Adjustment be allowed for tax purposes the financial year(s) to which the adjustment relates to or the financial year of adoption of FRS 115? What would be the overall income tax impact to the company due to the revisions of income tax computations? What are the current and deferred tax consequences of the Retrospective Adjustment? What supporting details should be maintained by the company on the Retrospective Adjustment that may be provided to the IRAS upon request? To-date, the IRAS has not issued any clarifications on FRS 115 for tax purposes. Therefore companies should take a proactive role in understanding the extent of the income tax impact of the new revenue standard including having an early dialogue with their in-house tax director or external tax advisor. (4) Transfer pricing The IRAS issued revised transfer pricing (TP) guidelines in Singapore on 6 January 2015. Notably, the 2015 Singapore TP guidelines include a requirement for taxpayers to prepare contemporaneous TP documentation. Although not explicitly stated by the IRAS, the first year covered by the 2015 guidelines would logically be the financial year 2014. This means that the Year of Assessment (YA) 2015 may be the first YA affected, with a filing deadline of 30 November 2015. With the adoption of FRS 115, companies should assess the impact of the changes on revenue recognition on their TP policies and related documentation, especially where the company s TP documentation is based on revenue or profit measures in financial accounts. (5) Tax incentives of the changes to revenue recognition for accounting purposes. For example, as a result of adoption of FRS 115, a significant portion of qualifying revenue enjoying concessionary tax rate may be deferred and only recognised at a later stage. In this scenario, this may impact the extent of tax benefits that can be enjoyed by the company. (6) Impact on foreign subsidiaries Singapore companies with significant foreign subsidiaries in jurisdictions adopting FRS 115 should also evaluate the tax effects of changes in revenue recognition for accounting purposes. A jurisdiction-by-jurisdiction analysis may be necessary to assess the income tax accounting impact and other local tax implications due to differences in timing and amount of revenue or contract costs recognised for accounting purposes and tax purposes. Conclusion Revenue is very often an entity s most critical financial performance indicator. How it is recognised for accounting purposes may also have an impact on tax. It is therefore imperative that companies obtain a full understanding of the tax effects of the new revenue standard on a timely basis. While it is possible that for some companies, there may not be significant changes to the existing revenue recognition process and hence any tax effect may be minimal, this assumption should always be validated. An early assessment of the income tax challenges and implications is critical for managing the implementation process. This provides the opportunity for companies to address the relevant tax considerations arising from the adoption of the new revenue standard. Contact us Ronald Wong Financial & Accounting Advisory Services Partner Tel: +65 6309 6155 Email: ronald.wong@sg.ey.com Chai Wai Fook Tax Accounting & Risk Advisory Services Partner Tel: +65 6309 8775 Email: wai-fook.chai@sg.ey.com Companies enjoying tax incentives may need to assess how the revenue qualifying for concessionary tax rate for the relevant reporting periods may be impacted as a result All Rights Reserved [Insert local EY firm Name] FRS 115 Tax Alert (March 2015) 2
Annex: Five-step model under FRS 115 1. Identify the contract(s) with a customer To identify the contract(s), entities will have to exercise judgment when considering the terms of the contracts. The new standard contains specific criteria on when to combine contracts compared to existing guidance. Entities may need to evaluate and consider if they should combine two or more contracts that are entered into at or near the same time with the same customer and account for them as a single contract, even though these contracts may not have been combined under current rules. Where there are modifications to existing contracts, the new standard provides guidance on whether such modifications may be regarded as separate and distinct contracts or part of existing contracts. Contract modification may lead to adjustment to revenue as a result of the changes to transaction price, and the entity s measure of progress towards complete satisfaction of the performance obligation. 2. Identify the separate performance obligations in the contract An entity is then required to identify the performance obligations in the contract which are the different goods and/or services. Step 2 requires the entity to evaluate the terms of the contracts as well as its customary business practices to assess if the various performance obligations are distinct from each other and therefore be accounted for as separate performance obligations. If they are not distinct or the performance obligations are so closely inter-related to one another, the new standard will require the entity to group the performance obligations together and account for them as one bundled performance obligation. Comparing this to existing revenue standards which contain limited requirements for transactions with multiple deliverables, entities may end up identifying different performance obligations compared to deliverables identified under current standards. 3. Determine the transaction price If there is any variable component in the transaction price, the entity is required to estimate the amount of variable consideration to be included in the transaction price at contract inception, using either the expected value approach or the most likely amount approach, subject to the extent that the entity does not expect the inclusion of such amount in the transaction price to result in a significant revenue reversal in the future. This is a significant change from existing revenue standards which require entities to measure revenue at the fair value of the transaction price. Further, due to the lack of specific requirements, entities currently may be deferring the measurement of variable consideration until the uncertainty surrounding the outcome associated with the variable consideration is removed, which typically coincide with the receipt of the consideration. 4. Allocate the transaction price to the separate performance obligations After having identified the performance obligations and determined the transaction price, Step 4 requires the entity to allocate the transaction price to each performance obligation. In this respect, the new standard introduces a new concept known as the stand-alone selling price which it defines as the price at which an entity would sell a promised good or service separately to a customer. Entities are required to allocate the transaction price to the performance obligations in portion to reach each performance obligation s stand-alone selling price. As a result, any discount within the contract generally is allocated proportionally to all the separate performance obligations in the contract, unless exception applies if specified criteria are met. 5. Recognise revenue when (or as) the entity satisfies a performance obligation Under Step 5, the entity will recognise revenue when it has satisfied an identified performance obligation by transferring a promised good or service to a customer. A good or service is considered to be transferred when the customer obtains control of the good or service. Further, the new standard also indicates that an entity must determine at contract inception whether it will transfer control of the promised good or service to the customer over time or at a point in time. Step 3 requires entities to determine the transaction price of the contract. The new standard explains that the transaction price is the amount of consideration that an entity expects to be entitled in exchange for transferring a promised good or service to a customer. All Rights Reserved [Insert local EY firm Name] FRS 115 Tax Alert (March 2015) 3
An entity will conclude that it transfers control of the good or service to the customer over time, and therefore satisfies a performance obligation and recognises revenue over time, if it can demonstrate that one of the three criteria specified in the standard is met. If the entity is unable to demonstrate that control transfers over time, then the presumption is that control transfers at a point in time and therefore the entity can only recognise revenue at this point in time. Recognising revenue upon a transfer of control is a different approach from the risks and rewards model that currently exists in the current standards. All Rights Reserved [Insert local EY firm Name] FRS 115 Tax Alert (March 2015) 4
EY Assurance Tax Transactions Advisory About EY EY is a global leader in assurance, tax, transaction and advisory services. The insights and quality services we deliver help build trust and confidence in the capital markets and in economies the world over. We develop outstanding leaders who team to deliver on our promises to all of our stakeholders. In so doing, we play a critical role in building a better working world for our people, for our clients and for our communities. EY refers to the global organization, and may refer to one or more, of the member firms of Ernst & Young Global Limited, each of which is a separate legal entity. Ernst & Young Global Limited, a UK company limited by guarantee, does not provide services to clients. For more information about our organization, please visit ey.com. 2015 Ernst & Young Solutions LLP. All Rights Reserved. APAC no. 12000425 ED 0315 Ernst & Young Solutions LLP (UEN T08LL0784H) is a limited liability partnership registered in Singapore under the Limited Liability Partnerships Act (Chapter 163A). This material has been prepared for general informational purposes only and is not intended to be relied upon as accounting, tax, or other professional advice. Please refer to your advisors for specific advice. www.ey.com All Rights Reserved [Insert local EY firm Name] FRS 115 Tax Alert (March 2015) 5