Long-term contractual arrangements entered now may be affected by new accounting standards approaching in 2018. Here’s what you need to know…
Understanding the key requirements of new or changing accounting standards, and making an early evaluation of the potential impacts on your business, will help to reduce the risk of surprises and help you plan when entering into long-term arrangements.
With a plethora of changes on the horizon – from wholesale changes like IFRS 9 (financial instruments), IFRS 15 (revenue) and IFRS 16 (leasing) for IFRS preparers, or regular updates and changes such as the tri-annual review of FRS 102 planned by the Financial Reporting Council (FRC) – you need to be alert to them all. Those who are ahead of the game and have thought about the wider implications of any changes will be in a stronger position to manage the transition.
Will the changes really have a commercial impact?
While new accounting standards can sometimes be seen as a compliance exercise, their implementation can have much wider implications on your business and a real commercial impact when it comes to decision-making. Some examples include the following…
Changes to metrics and impact on covenants
IFRS 16 (leasing) will generally result in higher EBITDA numbers due to the expenses charges moving from operating expenditure to depreciation and finance charges. Will this mean higher performance measures under existing employee bonus schemes or contingent consideration arrangements resulting in higher cash payments?
IFRS 16 will also result in almost all leases being recognised on the balance sheet as an asset with a corresponding liability for the payments resulting in higher gearing. Will this result in a problem with bank covenants?
Impact of changes in timing of profit recognition
IFRS 15 (revenue) will result in 'distinct' performance obligations in a contact being accounted for separately, which may see the acceleration or deferral of revenue compared to existing practice.
The timing of impairment losses on financial assets, including trade receivables, may also be front-loaded as a result of changes to the impairment model under IFRS 9 (financial instruments), which will typically see a day-one loss being recognised immediately on the recognition of financial assets.
Other commercial implications include the impact on realised profits (and, therefore, ability to pay dividends); the consequential impact on tax charge and timing of tax payments; and a potential need for additional data capture and integrity.
What type of arrangements do I need to think about?
Any contractual arrangement entered into today which extends into a future period covered by new accounting standard. This includes:
- sales contracts
- financing arrangements
- derivative contracts
- arrangements where payments are linked to profits or other performance measures, such as employee bonus schemes and earn-out schemes in purchase agreements
- lease contracts
- service contracts, which may, for example, include leased assets.
Long-term arrangements that extend into the comparative period will also need to be considered.
What questions should I be asking now?
- Can the risk be managed by incorporating 'frozen' GAAP measures into the long-term arrangements?
- Can contracts be negotiated or standard terms be amended to minimise the impact of upcoming accounting changes?
- When should stakeholder engagement take place?
- What underlying data will need to be captured from long-term contracts to ensure the appropriate information is available, and do any IT systems need amending as a result of additional data requirements?
While the major accounting changes will primarily effect IFRS preparers with the implementation of IFRS 9, IFRS 15 and IFRS 16, UK GAAP preparers also need to consider any future changes as a result of the FRC's planned tri-annual review of FRS 102.
It will be important for businesses to think widely about the impact of changes to accounting standards on new long-term contracts and other long-term arrangements being entered into.
If you would like any further assistance on the changes arising as a result of any new standards, please contact your usual Grant Thornton adviser or Jake Green.