www.pwc.com IFRS Workshop
Objective of today s session At the end of the session, you should: - be able to discuss the potential impact of the new standard; and - understand some of the implications on current practice. We will: - discuss the key principles of the standard; - discuss the implications and practical examples; and - discuss the transition rules. 2
Scope Revenue is income from ordinary activities IAS 18 IAS 11 Performance Sale of services obligations Sale satisfied of goods over time Royalties Performance Construction obligations satisfied at contracts a point in time IFRS 15 Dividends Revenue from contracts with customers IAS 17: leasing income Interest IAS 39 IAS 39 Other income: government grants, investment property, agriculture and so on. 3
IAS 18 - Core Principle Revenue should be measured at the fair value of the consideration received or receivable. It is measured when the following criteria has been met it is probable that any future economic benefit associated with the item of revenue will flow to the entity, and the amount of revenue can be measured with reliability IAS 11 - Core Principle If the outcome of a construction contract can be estimated reliably, revenue and costs should be recognized in proportion to the stage of completion of contract activity. This is known as the percentage of completion method of accounting. [IAS 11.22] 4
IFRS 15 - Core Principle An entity recognises 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. Revenue is recognised in accordance with the core principle by applying a 5 step model. 5
Agenda 1) 5-Step model 2) Deep dive: performance obligations, including material rights 6
The 5-step model Core principle Revenue recognised to depict transfer of goods or services Step 1 - Identify the contract with the customer Step 2 - Identify the performance obligations in the contract Step 3 - Determine the transaction price Step 4 - Allocate the transaction price Step 5 - Recognise revenue when (or as) a performance obligation is satisfied 7
Revenue recognition model A simple example. Contract: Entity A sells products X, Y and Z to Customer B Transaction price: Kshs 18m, 50% upfront, 50% when all three delivered Stand alone price: Each sold separately for Kshs 8m each Nature of products: - Product X: Good, control transferred at a point in time - Product Y: Good, control transferred at a point in time - Service Z: Service transferred over one year 8
Revenue recognition model a simple example Step 1 - Identify Signed contract the contract exists with the customer Step 2 - Identify the performance obligations in the contract Step 3 - Determine the transaction price Contract An agreement between two or more parties that creates enforceable rights and obligations (not necessarily written) Step 4 - Allocate the transaction price Approved Rights of each party identified Payment terms identified Commercial substance Collectibility Step 5 - Recognise revenue when (or as) a performance obligation is satisfied 9
Revenue recognition model a simple example Step 1 Signed contract exists Step 2 Customer B can benefit from X, Y and Z separately as they are sold separately three separate performance obligations Step 2 - Identify the performance obligations in the contract Performance obligation: Step 3 - Determine the transaction price A promise in a contract with a customer to transfer a good or service to the customer AND Step 4 - Allocate the transaction price Distinct Implicit Explicit Written Verbal Step 5 - Recognise revenue when (or as) a performance obligation is satisfied 10
Revenue recognition model a simple example Step 13 Signed The transaction contract exists price is fixed at Kshs 18m. Step Transaction 2 Customer price B = can Amount benefit from to which X, Y and entity Z separately expects as to they be entitled are sold separately in three exchange separate for performance transferring obligations goods or services Step 3 - Determine the transaction price Highly probable? Subject to significant reversal? Step 4 - Allocate the transaction price Step 5 - Recognise revenue when (or as) a performance obligation is satisfied 11
Revenue recognition model a simple example Step 41 25% Signed discount contract is allocated exists evenly Total stand alone price = Kshs 24m across X, Y, Z Total transaction price = Kshs 18m Total discount = 25% Step 2 Customer B can benefit from Discount X, Y and * Z stand-alone separately = as they are Kshs sold 6m separately - three separate performance obligations Step 3 The Observable transaction price of is fixed good at or Kshs service 18m. that is sold separately 1 Estimate selling prices if not observable Relative Step 4 - Allocate Adjusted the transaction market assessment price approach or expected cost plus margin 2 approach stand-alone selling price Residual approach Only when selling price is highly variable or uncertain (different to Step 35 - Recognise current revenue residual when method) (or as) a performance obligation is satisfied 12
Over time Revenue recognition model a simple example Step 1 Signed contract exists Step 5 Kshs 6m each = recognise when control of X / Y transfers Step 2 Customer B can benefit from X, Y and Z separately as they are sold separately Yes - three separate performance obligations Step 3 The transaction price is fixed at Kshs 18m. No Step 4 25% discount is allocated Total transaction price = Kshs evenly across Yes X, Y, ZCreate/enhance an asset 18mcustomer controls e.g. house on customer s Total discount land = 25% Discount * stand-alone = Kshs Total stand alone price = Kshs 6mNo 24m Yes No Step 5 - Recognise revenue when (or as) a performance obligation is satisfied Ksh 6m = recognise over the period that Z is provided Customer receives benefits as performed/another entity would not need to re-perform e.g. cleaning service, shipping Does not create asset w/alternative use AND Right to payment for work to date e.g. manufacturing service Point in time 13
Revenue recognition model a simple example If not over time, then point in time. Recognise revenue when control transfers Indicators that customer has obtained control of a good or service: Customer has significant risk and rewards Customer has accepted the asset Legal title to asset Physical possession of asset Right to payment for asset 14
Revenue recognition model a simple example 15
Exercise - Temperature test Scenario 1 Entity C sells land to Customer D. Customer D uses the land to construct a housing development. Customer D makes a non-refundable upfront payment of Kshs 10,000 when legal title is transferred and Kshs 990,000 in five years, which is when Customer D expects to have completed the development. Entity C has no history with this customer and the land is in an area currently not zoned for housing development. Thus, Entity C is not able to conclude that Customer D will pay more than the upfront payment. If Customer D fails to pay in five years, Entity C re-takes legal title to the land and any assets on the land. 16
Exercise - Temperature test Scenario 1 (continued) How much revenue is recognised when Entity C transfers legal title of the land? A. Recognise revenue Kshs 1,000,000 as the control of the land has been transferred. There is a long-term receivable of Kshs 990,000. B. Recognise revenue of Kshs 10,000 as this is a non-refundable payment and control of the land has transferred to the customer. C. Recognise no revenue as there is no contract with the customer due to the significant doubt about the customer s ability and intention to pay. 17
Temperature test: Exercise Debrief Step 1: Identify the contract Scenario 1 Entity C Initial payment: Kshs 10,000 Deferred payment: Kshs 990,000 How much revenue is recognised when Entity C transfers legal title of the land? A. Kshs 1,000,000, full contract amount B. Kshs 10,000, non-refundable amount C. Nil, there is no contract with the customer 18
Temperature test: Exercise Debrief Step 1: Identify the contract Step 1 Collectibility criterion to determine if contract exists Record deposit liabilities initially and continue to re-assess whether a contract with a customer is established subsequently Recognise revenue only if the Approved consideration received is nonrefundable of each and party when: Rights identified Contract Payment o either terms there identified is no remaining obligations to transfer goods or services to the customer; o or the contract has been terminated Commercial substance Collectibility What is the appropriate treatment then? 19
Exercise - Temperature test Scenario 2 Entity E enters into a contract with Customer F to construct a brand new high-end power station. Control of the power station is expected to transfer at the end of five years. It is the first power station of this particular design and Entity E agreed to provide support to Customer F in connection with the general maintenance of the plant for the first year of operation free of charge. Entity E also provides similar maintenance services to other power stations. 20
Exercise - Temperature test Scenario 2 (continued) How many performance obligations exist in this agreement? A. One. The maintenance service is not a distinct performance obligation. It is a marketing expense and costs should be expensed as incurred. B. Two. The construction of the plant and maintenance represent two distinct performance obligations. They can be sold separately to the customer. C. Many. Each component of the power station that can be sold separately (for example, the generator) is a distinct performance obligation 21
Temperature test: Exercise Debrief Step 2: Identify the performance obligations Scenario 2 Entity E Customer F $ How many performance obligations exist in this agreement? A. One B. Two C. Many 22
Temperature test: Exercise Debrief Step 2: Identify the performance obligations Step 2 Distinct considered from the perspective of the customer Can the customer benefit from the goods or services transferred on their own? Distinct Performance Obligations Is the promise separately identifiable from other promises? 23
Exercise - Temperature test Scenario 3 Assume the same facts as Scenario 2. The contract price is Kshs 1,000,000 plus a 5% bonus if the plant meets specific operating thresholds in the first two years. Entity E projects a 50% chance that it will receive the bonus (50% that it will not receive a bonus). The plant is a new design and Entity E has limited historical evidence on the plant s operations. Customer F finances the project by making a Kshs 1,000,000 prepayment before construction begins. The lending rate between the customer and the entity is 10%. 24
Exercise - Temperature test Scenario 3 (continued) What is the transaction price? A. Kshs 1,000,000, the fixed contract sum B. Kshs 1,025,000, the fixed contract sum plus estimated bonus of Kshs25,000 (5% * 50% likelihood) C. Kshs 1,610,510, the fixed contract sum considering time value of money D. Kshs 1,635,500, the fixed contract sum plus estimated bonus of Kshs 25,000 (5% * 50% likelihood) plus effect of time value of money (TVM on the contingent payment assumed immaterial) 25
Temperature test: Exercise Debrief Step 3: Calculate the transaction price Scenario 3 Contract Expected construction period... 5 years Full payment Kshs 1 million What is the transaction price? A. Kshs 1,000,000 B. Kshs 1,025,000 C. Kshs 1,610,510 D. Kshs 1,635,500 5% bonus based on operating target 26
Temperature test: Exercise Debrief Step 3: Calculate the transaction price Step 3 New model for variable consideration and financing Variable consideration IAS 11 / 18 Measured reliably? Sufficiently advanced that performance is probable to meet [IAS 11]? IFRS 15 Highly probable? Not subject to significant reversal? Financing IAS 11 / 18 Prepayment is non-financial liability Time value of money only considered for deferred payments IFRS 15 Need to determine if significant financing component exists 27
Exercise - Temperature test Scenario 4 Entity G sells mobile phones, tablets and airtime plans to its customers. Entity G offers a new promotion package where customers can purchase a phone, subscribe for a 12-month airtime plan and receive a free tablet for a total price of Kshs 80,000. This reflects a 20% discount from the standalone selling prices of the items which are as follows: Phone: Kshs 30,000 Airtime: Kshs 30,000 Tablet: Kshs 40,000 Total: Kshs 100,000 The entity regularly offers bundled packages for the phone and a 12-month airtime plan for Kshs 40,000. 28
Exercise - Temperature test Scenario 4 (continued) How should the transaction price of Kshs 80,000 be allocated to the phone, airtime and tablet? A. Phone: Kshs 24,000, Airtime: Kshs 24,000, Tablet: Kshs 32,000, based on 20% discount applied proportionally to all three performance obligations B. Phone: Kshs 20,000, Airtime: Kshs 20,000, Tablet: Kshs 40,000, based on the entire discount being allocated to the phone and airtime because there is objective evidence that the discount relates to those two performance obligations 29
Temperature test: Debrief Step 4: Allocate the transaction price Scenario 4 Phone Kshs 30k Kshs 1,000 Airtime Kshs 30k Tablet Kshs 40k 20% Discount Kshs 80k How should the transaction price of Kshs 800 be allocated? A. Phone: Kshs 24k, Airtime: Kshs 24k, Tablet: Kshs 32k B. Phone: Kshs 20k, Airtime: Kshs 20k, Tablet: Kshs 40k 30
Temperature test: Exercise Debrief Step 4: Allocate the transaction price Step 4 Based on relative standalone selling price but more guidance provided Phone Kshs 30k Airtime Kshs 30k Kshs 1,000 Tablet Kshs 40k 20% Discount Kshs 80k Phone/airtime Kshs 40k Tablet Kshs 40k Phone and airtime regularly sold together for Kshs 40k 31
Exercise - Temperature test Scenario 5 Entity H agrees to produce 10,000 car frames for Customer I for a transaction price of KShs 10,000,000. Entity H has the right to payment for work performed including a reasonable margin if Customer I cancels while production is partially completed. There is no alternative use for the frames as they reflect a particular car model designed by the customer. 32
Exercise - Temperature test Scenario 5 (continued) Entity H has completed 50% of the production and delivered 2,000 car frames to Customer I. How much revenue should Entity H recognise for the work performed to date? A. Kshs 2,000,000 B. Kshs 5,000,000 33
Temperature test: Exercise Debrief Step 5: Recognise revenue Scenario 5 Entity H Customer I Kshs 10 million How much revenue should Entity H recognise for the work performed to date? A. Kshs 2,000,000 B. Kshs 5,000,000 34
Temperature test: Exercise Debrief Step 5: Recognise revenue Step 5 Single model for all performance obligations criteria to determine over time IFRS IAS 18 15 Exclusive Point in time Over time 35
Temperature test: Exercise Debrief Step 5: Recognise revenue Good or service transfers over time if one of the follow criteria met: Customer receive benefits as performed/another would not need to reperform Create/enhance an asset customer controls Does not create asset w/alternative use AND right to payment for work to date If criteria not met, transfers at a point in time based on following indicators Right to payment for asset Legal title to asset Customer has accepted the asset Physical possession of asset Customer has significant risk and rewards 36
Deep dive: performance obligations Recap: definition Performance obligation if: Distinct good or service: o customer benefits from good/service on its own or with other resources; and o separable from other promises Series of goods/services, if consistent pattern of transfer to customer over time 37
Transition 23
Cumulative catch-up Cumulative catch-up Transition, effective date and earlier application 2016 2017 2018 2017 footnotes Retrospective (optional practical expedients) Contracts under new standard Contracts restated Cumulative effect at date of application Contracts not restated Existing* and new contracts under new standard Existing and new contracts presented under legacy IFRS *contracts not completed in prior years as determined under legacy revenue guidance Effective date: annual periods beginning on or after 01/01/2018 Early application permitted
Method of adoption Retrospective Entity may use one or more of the following practical expedients: No restatement of contracts that begin and end within the same annual reporting period No disclosure of the amount of the transaction price allocated to remaining performance obligations and expected delivery for pre adoption year deferred revenue Hindsight may be used Practical expedient As of effective date, apply to existing and new contracts Recognize the cumulative effect to existing contracts in the opening balance of retained earnings on effective date For existing and new contracts disclose adoption impact on all affected financial statement line items in the adoption period 25
Industry Impacts 23
Industry Impacts Retail and Consumer Industry Amount and timing of revenue recognised on customer incentives such as rebates and free products is likely to be impacted. Accounting for customer loyalty programs or warranties will be impacted and is likely to result to revenue being recognised much later Accounting for licences and franchise agreements may be different. Engineering and Construction Industry Greater complexities pertaining to performance obligations and transfer of control to a customer. This is different from the %ge of completion method currently in use under IAS 11. Greater complexities pertaining to time value of money and the allocation of consideration. Reassess all revenue contracts. More disclosure. 44
Industry Impacts Communication industry Important to determine performance obligations especially with respect to bundled products. Accounting for activations fees and upfront fees may change Variable consideration will need to be incorporated in the transaction pricing. Insurance Intermediary Industry Determination of Principal agent relationship based on control may lead to insurance intermediaries being principals in some transactions. Greater complexities pertaining to time value of money and the allocation of variable consideration. Reassess all revenue contracts. 45
Recap What do customers buy? What benefits do customers obtain from goods / services transferred? Separable from other goods / services? Similar in nature and recognition pattern? Material rights? 46
More challenges are coming Uh oh.this is not going to be easy 47
A change in mind set Reassessment of contracts will be time consuming Transaction price allocated on a relative selling price basis Change to model for variable consideration Transition may require running dual systems and gathering of historic data More extensive disclosure requirements Potential impact on compensation arrangements Awareness is essential! 48
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