The technology, media, and telecom (TMT) industry includes a wide variety of companies that provide a large range of goods and services to customers. This variability and complexity found in the types of contracts and arrangements within the TMT industry will likely cause accountants applying IFRS 15 considerable difficulty.
The new principle
The core principle in IFRS 15 is to recognise revenue in a way that reflects how the goods or services are provided to the customer. It contains a lot more specific and detailed guidance than the current IAS 18 Revenue standard.
IFRS 15 focuses on the ‘promises’ made to the customer and requires greater separation of the components or ‘promises’ made in the contract. Revenue needs to be allocated to each ‘distinct’ component in proportion to the standalone selling prices of each ‘promise’.
When is it effective?
The standard is effective for accounting periods commencing on or after 1 January 2018 with early adoption permitted. For many entities in the TMT sector there will be significant need for changes to processes and systems, including far greater liaison between those drafting sales contracts and the accountants that will need to ensure compliance with IFRS 15.
Implications for the TMT industry
Many contracts within these industries contain a number of separate ‘performance obligations’ which under the new revenue standard, IFRS 15, will each have to be accounted for separately. This will introduce significant complexity to the accounting processes whereby a standalone selling price will need to be determined for each separate performance obligation, together with a separate profit margin for each.
If the separate ‘performance’ is consumed by the customer at a later date than the goods the customer has purchased, e.g. maintenance contracts, access to upgrades and extended warranty periods, then revenue on these performance obligations will be deferred. This deferral of revenue will move both revenue and profit into later periods and this could have serious implications on paying executive and staff bonuses, paying dividends and meeting bank covenants.
This complexity should not be underestimated. Processes and systems will need changing, for example to:
- Identify all performance obligations that need to be accounted for as a separate sale
- Assign a value and a profit margin to each separate performance obligation
- Determine when revenue should be recognised on each performance obligation
- Modify systems so that each separate performance obligation is ‘captured’ at date of sale
- Modify systems to recognise revenue on each separate performance obligation at the appropriate time.
IFRS 15 sets out more detailed guidance on variable consideration than IAS 18, with revenue being recognised at the amount expected from the customer which may not necessarily be the same as the invoiced amount. IFRS 15 also contains more specific guidance on principal and agency relationships that can affect revenue recognition when on-costs are charged to the customer and this may be particularly challenging for online retailers.
In this series of articles, we will discuss the following areas likely to significantly impact entities operating within the TMT industry under IFRS 15:
- ‘Point in time’ vs. ‘over time’ revenue recognition, and if ‘over time’, how progress towards completion can be measured and recognised
- Recognising revenue for licensing arrangements
- ‘Bunding’ and ‘unbundling’ performance obligations
- Accounting for variable amounts of consideration
- Contract modifications
- Rights of return
- Accounting for tender costs
- Adjustments for the effects of the time value of money (‘financing components’), and
- Whether an entity is acting as principal or an agent.
The commercial effects
The adoption of IFRS 15 may lead to significant changes in the pattern of revenue and profit recognition. Careful consideration and planning will be needed for a wide range of issues, including the effect on:
- Compliance with bank covenants
- Performance-based compensation (including share-based payments)
- Internal budgeting processes
- Corporate tax obligations
- Market and investor communications, including compliance with regulatory requirements (which might arise from significant expected future changes to an entity’s reported financial position or performance).
A review of the terms and conditions of existing contracts will be needed (in particular long-term contracts which extend into periods covered by financial statements affected by the adoption of IFRS 15) as well as those which are to be entered into in future. In some cases, entities may wish to consider whether changes should be made to contracts.
The TMT industry needs to pay attention to the new revenue standard now. We predict that the new standard will be extremely difficult to apply for the TMT industry due to the fact that many entities will provide multiple goods and services to customers under one contract. IFRS 15 is far more complex than the current accounting standard (IAS 18) and can significant alter the pattern of revenue recognition and pattern of profit for companies applying the standard. It will not just be a mere accounting change but will have wide spread implications to other businesses areas, e.g. significant IT systems changes will be required, sales contracts/terms may need to be modified, and marketing campaigns will need to be reconsidered. The impact on revenue will also have a flow on effect to bonuses, bank convents, dividend payments, and corporate taxes.