There are challenges associated with the latest financial reporting changes, in particular the new accounting standard on revenue recognition, IFRS 15.
It is more than just an accounting exercise; these reporting changes could impact your business’ operations too.
Managing expectations around likely impacts
Revenue is one of the most commonly used key performance indicators (KPIs). Any changes to accounting standards that could alter the timing of revenue recognition or the measurement of revenue, may have implications for future investment in your business.
After Rolls Royce issued a statement on the impact IFRS 15 was expected to have on their financial results, a commentator on Bloomsberg.com reported the effect on the share price:
“After declining only 2 per cent on Wednesday, when Rolls-Royce first revealed the full extent of its accounting change at a capital markets day, the stock tumbled a further 5.4 percent on Thursday as investors digested the news.”
Markets clearly care about the impact this new standard will have on business because revenue is such a key measure of performance.
Companies are required to report how they expect the new accounting standards will impact their financial statements as soon as they’ve assessed that impact.
Your finance team will need to have undertaken a thorough analysis to say something meaningful about how significantly IFRS 15 might change your business’s revenues.
Some businesses are still saying very little about the impact, in my experience this is often because those businesses have not yet performed any detailed analysis. The FRC1 and ESMA2 have placed a lot of emphasis on the importance of providing investors with this information. The FRC will watch closely to ensure businesses keep their investors informed, and will act if they believe that companies are not doing all that they should.
Companies should disclose:
- a detailed description and explanation on how key IFRS 15 concepts will be implemented along the different revenue streams; where relevant, highlighting the differences to the current approaches
- an explanation of the timeline for implementing IFRS 15, including expected use of any of the transition practical expedients
- if known or reasonably estimable, quantification of the possible impact of the application of IFRS 15
- additional qualitative information enabling users to understand the expected impact on the financial statements of the issuer, when the quantitative information is not disclosed because it is unknown or not reasonably estimable
Investors could draw unfavourable conclusions about the governance and management of those businesses that do not follow this guidance and continue to provide boilerplate commentary on the impacts.
How can you continue to tell your story?
When you first publish financial statements using IFRS 15 you will want to discuss your business’ performance in the strategic report in the context of the changes. Normally, you are required to restate your comparatives at the introduction of a new accounting standard.
IFRS 15 has specific provisions enabling businesses not to restate their comparatives, and given the complexity of the alternative approach, I am expecting many will take these simplifications. The question remains, how will you tell the story of the development and performance of your business in your narrative reports when your income statement has comparatives for revenue that are not truly comparable? The notes will also need to set out the effect of applying IFRS 15 in the current year by providing additional disclosures based on IASs 11 and 18.
There are two approaches taken by finance teams that are preparing for the implementation of IFRS 15:
- provide information for the current year based on the old standard
- provide information for the comparative period based on the new standard
Both approaches involve the finance team keeping two sets of books and records. Whichever approach the board chooses, the decision cannot wait too long as there may be system changes needed to enable dual reporting.
The key challenge for the board is assessing what the investors will want to see. Do they want comparative information restated in accordance with the new standard? Alternatively, will they want the current year reported under the old rules?
Either approach involves producing information not necessarily included in the audited income statement; at least in the way that management want.
As a result, I have heard boards discuss the level of assurance needed on the front end reporting, and this is another question boards should ask their investors. If investors do want the non-GAAP figures assured or audited then the next question is what level of assurance, quickly followed by whether the auditors should provide that additional assurance and at what price.
All of these considerations have implications for the year-end timetable. Again, it is important to consider market sentiment about elongating your timeframe. If you do not intend to delay reporting, early planning is needed to ensure all the extra work is completed, and that your auditors are aware of your intentions and are bought into this timetable.
Is there a real cash impact?
Like many accounting changes the new standard will not change the actual cash you will recover from your customers but it might change other cash flows. Tax, at least in the UK, is based on the accounting profit for the year. Over an entire agreement the accounting profit will not change, however, the timing of revenue recognition could have an impact on tax cash flows.
IFRS 15 could result in either the acceleration or deceleration of revenue. If revenue recognition is not aligned to cash flows then this can result in needing to fund tax cash flows, which in turn could result in higher interest payments where loan funding is used to bridge the gap.
If this is a significant problem, then it might be appropriate to look to renegotiate contract terms with your customers to align the cash flows with the revenue profile. One business I have spoken to has gone a step further, to match the revenue profile and cash flows; they have redesigned the actual hardware they sell. As a result, they believe that the revenue recognition will now match the cash flows.
In the current decreasing corporation tax environment, the later you recognise revenue, the lower your corporation tax payments on that revenue. This is obviously subject to political uncertainty given the unknown (at the time of writing) consequences that the recent general election will have on the government's tax reduction programme.
There will be other cash effects where other payments depend on your profits, for example:
- employee bonus arrangements
- acquisition contingent consideration
- distributable profits.
One of the biggest cash flows could be the cost of implementing the systems and processes that are needed to ensure compliance with the new standard, and the cost of auditing the transition. Many businesses have sought to implement systems solutions to ensure compliance with the new standard and some have incurred significant costs as a result.
There are opportunities
Implementing IFRS does come with opportunities. For example, businesses that have started analysing the impacts have found that they often have legacy terms of business. The implementation of IFRS 15 is providing some of the affected businesses with an opportunity to review those contract terms and introduce more standardised terms and conditions.
If you are making system changes this is also an opportunity to ensure that your finance systems are providing you with the information you need to run your business. If you haven’t thought about making any system changes then now is a good opportunity to start.
IFRS 15 will have a wide range of impacts for many businesses, and these need to be taken seriously by the finance director and the board. If you haven’t started your implementation planning yet, your first step is to appoint someone to lead the project. Without ownership, nothing will happen and your shareholders could find themselves out of pocket and asking you some difficult questions.
IFRS 15 Revenue from Contracts with Customers is applicable to all businesses that apply IFRS or FRS 101 for accounting periods beginning on or after 1 January 2018.