AASB 15 which becomes effective for reporting periods after 1 January 2018, will impact most sectors revenue recognition, but perhaps one of the hardest hit will be the construction sector.
If you have remuneration models that are include a measure based on revenue, revenue growth, net profit, EBIT or EBITDA, it is time to understand the impact of AASB 15.
The construction industry has transaction types that will;
- Bring revenue forwards
- Delay revenue recognition
- Increase gross revenue
- Decrease gross revenue
- Decrease gross margin
A major issue arises on transition where;
- Revenue may be " lost " forever and never recorded in a company's financial report; or
- May be double counted, allowing companies to ‘double dip’ and the same revenue to be recorded in the 2017 financial report and the 2018 financial report.
Bring revenue forward
There are a number of ways AASB 15 may result in revenue being recognised earlier than under AASB 118 or AASB 111, these include:
- Where a constructor of condominiums, which sells units off the plan, is required under the current requirements of Interpretation 15 to only recognise revenue when the customer takes possession of the unit, adoption of AASB 15 may allow revenue to be recognised using the percentage of completion method.
- Where the construction contract includes an award bonus, under AASB 118 / 111 the recognition of revenue in respect of this bonus may be recognised when the bonus is actually achieved, under AASB 115, revenue will include the bonus award from the point that it is highly probable that the constructor will not fail to achieve the requirements to receive the award/bonus. This could lead to the bonus being factored into the contract from the outset and result in accelerated revenue recognition compared with AASB 118 or AASB 111.
There are numerous instances where AASB 15 will result in revenue being delayed these include:
- Having to link design services with construction services;
- Having to recognise "free " goods and services given to the customer after the construction; is completed as separate performance obligations, for example " free" landscaping, access to clubhouses, golf courses, shared facilities, extended warranties;
- Having to be very conservative when accounting for penalties or awards
Increase gross revenue
Application of AASB 15 may result in certain types of transaction showing greater levels of absolute revenue than under AASB 111 or 118. If employees are set targets on absolute levels of sales or growth in sales, this is likely to have a major impact.
In certain situations a constructor may be paid well in advance of performing the construction service. This may represent a financing arrangement under AASB 15, which will require the constructor to account for the prepayment as if it had borrowed from its customer, recognising a borrowing cost and a corresponding increase in revenue.
AASB 15 requires non cash consideration or a non cash contribution by the customer to be recorded at fair value. There are a number of situations where a developer takes land in part consideration for providing the construction service, in these cases the land received must be recorded at fair value, this is likely to increase revenue.
Decrease gross revenue
There are a number of situations where a constructor may pay money to its customer, these include rental guarantees, support on bridging loans, and guaranteed minimum sales price on the customer disposing of existing property.
These payments MUST be offset against revenue, not treated as a cost of sale or a marketing expense.
Decrease gross margin
Many construction projects involve installing equipment not manufactured by the constructor, lifts, turbines, boilers etc. AASB 15 expressly requires no margin to be recognised on supplying these types of equipment, when it has not been installed.
Linking contacts and contract modification
AASB 15 contains very specific rules as to when separate contracts with a customer must be linked and when a new contract with a customer should be accounted for as a modification of an existing customer. These new rules are again likely to change the pattern of revenue recognition compared with the current practice.
AASB 15 centres around identifying the overall promise made to the customer and if that promise requires goods to be integrated and installed, simply putting the supply of goods in one contract and the provision of services in another in another, does not mean revenue can be recognised separately based on the individual contracts.
Similarly it may well be that a constructor, enters into numerous contracts with a customer to build different buildings, construct bridges, roads etc. Depending on the nature of the negotiated package, AASB 15 may require these contracts to be linked rather than revenue being determined on a contract by contract basis.
AASB 15 introduces complex rules when determining if a new sales contract is in fact a modification of an existing contract. If it is determined that the new contract does result in the customer receiving additional goods or services then the accounting requires the existing contract to be modified/merged with the new contract, resulting in "catch up" accounting, again this needs to be considered when drafting remuneration contracts.
If a new contract does provide the customer with additional goods or services, but is not ‘distinct’ from an existing contract because the price of the goods and services in the new contract does not represent the standalone selling price of those goods or services, then this requires the application of these new ‘modification’ rules. This requires the closing down of the existing contract and then the creation of a new merged contract, involving the new contract and the uncompleted amount of the existing contract. Again this will very likely change the pattern of revenue recognition.
An entity with a December year end will report its 2017 results under AASB 18 and AASB 111, it will then prepare its 2018 financial report applying AASB 15. It will have the choice to restate the 2017 results in the 2018 report. If AASB 15 results in an earlier recognition than existing standards, revenue will be ‘lost for ever’.
This could arise for example where an entity moves to a percentage of completion basis for revenue on transactions currently recorded at a point in time under Interpretation 15.
An entity with a December year end will report its 2017 results under AASB 18, and AASB 111, it will then prepare its 2018 financial report applying AASB 15. It will have the choice to restate the 2017 results in the 2018 report. If AASB 15 results in latter recognition than existing standards, revenue will be double counted, having been recorded in 2017 or earlier and then reported again in 2018 or later.
This could arise for example where a developer provides “free “access to a golf course for three years after the customer moves into their new fairway property.
The above discussion is in no way meant to be a comprehensive list of those transaction types that will be impacted by the adoption of AASB 15, we strongly urge entities in the construction sector to commence an initial impact assessment as the start of their adoption process. The challenges in respect of changes to processes and system should not be underestimated and this process should be started sooner rather than later.