United Kingdom
Revenue recognition

Revenue recognition - a new global standard - Brian O'Donovan:

BD Thank you Sarah, and hello everyone. So, Sarah’s been talking about UK GAAP. I'm going to move us on to IFRS.


My name is Brian O’Donovan. One of my key roles in the team here is that I track the major IASB projects, and I have to say I've noticed a shift in what people want to talk about over the last six months or so. Six months ago pretty much every time my phone went somebody wanted to shout and swear, and let off steam about leases. Maybe a few people in this room were swearing at me six months ago, but these days, these days when my phone goes, increasingly people want to talk about revenue.


Number one question I'm getting at the moment, where is the revenue standard? Where is it? I can tell you where it is right now; the revenue standard is at the printers. That's where it is. In board language, the technical staff have handed the final words over to the production staff, and it's all been reformatted and got ready for publication.


In the US that's quite a complicated process. They have about 600-700 pages of text, and they're chopping it up into codification format, and working through the consequential amendments, but they're pretty much there, and just last week we got an alert from the IASB saying that the revenue standard is now expected in the second half of this month, so maybe June, maybe June.


The point is, it's not years any more, it's not months, it's weeks. So it’s been quite a long time, but I suspect that each and every one of you in this room is soon going to be called on to answer three key questions. Firstly, what's the impact of this standard on your business? Secondly, when are you going to adopt the new standard? And thirdly, something maybe you're not thinking about, but how are you going to adopt the new standard? I'll explain why that's important later.



Now, most of you will have time to develop progressively more detailed answers to those questions, but I think most of you, within a matter of months, perhaps in time for your next audit committee meeting, perhaps in time for an analysts’ presentation on your June interims, by then I think you're going to need high level elevator pitch type answers to those three questions: what's the impact, when are we going to adopt, and how are we going to adopt. In this session I want to give you a few pointers as to how you might begin to answer those questions.


So what is the new revenue standard? Well, it's the fruit of the big convergence efforts. It's one of the big four convergence projects. Hans Hoogervorst, who’s the Chair of the IASB, has described revenue as the jewel in the crown of convergence. I love that phrase. Have you heard this before? The jewel in the crown of convergence.


Now, maybe convergence is quite a small crown, with only one jewel in it, but I do think that having a new revenue standard is still quite a big deal. It's a single standard that applies under US GAAP, under IFRS, and it applies whichever industry you're in, so it’s quite a big deal.



At a high level you can kind of fit the standard on a slide. It sets out a five-step model, a framework to be used to analyse pretty much all of your transactions with your customers, and this five-step model is pretty familiar from both the ED’s. This is the framework; it's the language we'll all get used to using between now and the effective date of the standard.


Yes, so we've got it on one slide. 600-700 pages in the FASB version, we've got it on this one slide, but just knowing the five steps probably isn't enough to help you begin to assess the impact on your business. You're going to have to get to grips with this framework, with this language, but maybe the way to start to develop that high level, elevator pitch type answer to the what's the impact question is going to be to look at a few directional pointers.


Now, I'm not going to talk to all of these, but just to pick out a few of them, when you transact with your customers are you selling multiple goods and services in a single contract? You know, are you selling an iPhone and a two-year data plan? Very, very common.


Under the new standard there will be very specific guidance telling you when you have to account separately for the different elements in a contract, and you might find that the elements you have to account for separately, the basic building blocks of your revenue recognition, are going to be different.


There's also very specific guidance on how you allocate the total contract price to those different elements. At the moment it's very common that if you have two elements in the same contract you measure the second element, the undelivered element, at fair value, and measure the up front thing as a residual. That's what most of the telcos do. They take a lot of revenue over the period of the data plan, and they take next to no revenue when they deliver the handset. Under the new standard you'll be required to allocate consideration according to relative standalone selling values.



So, these multiple component arrangements, they're very common, and it's going to be very common, under the new standard, to pull forward revenue, compared to current practice. Thinking about Sarah’s points on distributable reserves, well, it's good news for distributable reserves. Maybe it's slightly less good news for your tax bill, so that's something to look at.

If I go down two lines, variable consideration, again, very common, variable consideration could be a success fee, a performance bonus. Maybe your remuneration depends on assets under management exceeding a target rate of return at the end of the year. So variable consideration, very common, quite a lot of diversity at the moment, as to whether or not people hold off recognising variable consideration until it's certain, or make some kind of estimate, and put that in revenue.

The new standard will be very, very specific. It tells you that you have to arrive at your best estimate of the variable amount, right, so best estimate, and then you include in revenue only the proportion of your best estimate that you believe you can put in revenue, whilst it being highly probable that if things change you're not going to have to make a downwards revision to your revenue number.


So, I'm not sure what you, individually, do with variable consideration at the moment, but I bet you don’t articulate it in precisely that way. If you're currently deferring variable amounts until they become certain, maybe you're going to be accelerating some revenue. What I've just described is probably going to give you a number that's lower than fair value, so if your current policy is to recognise variable amounts at fair value, maybe you're going to be pushing back revenue.


One more, before I move on, cost to obtain a contract: do you capitalise the cost of obtaining the contract? I suspect if we handed out a questionnaire there’d be a mix of answers. Some people do, some people don’t. The people who do, sometimes recognise different costs within the contract acquisition assets.


This isn't a revenue question; this is a cost question, and it flows through to the bottom line. The new standard is going to be very specific. It’s going to tell you that you must capitalise certain identified, incremental costs of obtaining a contract, unless it's a fairly short-term contract. So if you're recognising different costs you might have an adjustment, or if you're not capturing those costs at the moment you might have to make systems changes, so you can identify the cost that you are now required to put in the balance sheet.


There's a lot going on in the new standard, and I'm not going to talk about all of these questions, but next door we have a nice little handout that talks through each of them, in a bit more detail, and I would encourage you to take that with you, because that will help you answer the first question, the ‘what's the impact’ question.



My second question is, when? When is this standard going to affect you? Well, the mandatory effective date we expect will be 2017, so accounting periods beginning on or after 1st January 2017, and it's because there's a bit of a gap that I think you'll have time to develop a progressively more detailed answer to the impact question.


There are just two points to note. Firstly, early adoption will be permitted. Maybe there's not going to be a huge appetite for early adoption in the UK, and it’ll be subject to endorsement in any case.


If you're a first time adopter, you know, maybe you're listing a new entity for the first time, maybe you're spinning something off, perhaps you'd want to go straight to the new standard, rather than convert from UK GAAP to IFRS and then make these revenue changes a year or two later.


Another possibility is that you're doing group reporting to a part of the world that is more likely to early adopt. I understand there's quite a lot of interest in Japan in early adopting, in Singapore. A lot of those AsPac regions could well move before Europe or the US does, so think about possible group reporting implications that could bring forward the date of the impact.



That's my second question. My third question, which maybe was the question you weren't expecting, was the how to adopt the new standard. Now, I think this is important, because there are a lot of different ways in which you can adopt it. I'm going to explain the two extreme ways.


In the top line, what we have here is a slide assuming 2017 adoption with an entity that's presenting one year of comparatives, so one thing that entity can do, which is what the top line is showing, is it can adopt the new requirements fully retrospectively, so it can go back all the way into ancient history, restate all of its contracts, and present 2017 and the 2016 comparatives under the new standard, equity adjustment, 1st January 2016, full retrospective.


If I come down to the bottom line, the other extreme is, in a sense, you can wait. You can wait until 2017 and adopt the new standard with effect from that date, so no restatement of 2016 comparatives. When you put forward your financial statements, your 2016 and 2017 revenue numbers will be different, because they’ll be prepared under the two different sets of revenue standards, and there are hybrid variations between those two extremes.


Remember, I said, multiple component arrangements, there's a good chance you're going to be pulling forward revenue? Think about these transition options. Where does the revenue you're pulling forward go? It goes to equity. If you're a growing business, and you're pulling all that revenue forward, you might think, well, you know, kind of waiting until 2017 is quite attractive, but what's happening there? Yes, you're losing revenue through the equity adjustment.



Yes, so quite a lot to think about when you're deciding which of these transition methods to choose, and your decision here, I think, could well be a function of those first two questions: are you in a relatively high impact business? When is this going to affect you, and how long do you have to plan and prepare for the change?


As I say, revenue, it's been a long time, but it's not years; it's not months; it's weeks until we have the new standard, and frankly, I suspect within a month or two many of you are going to need those high-level, elevated-pitch answers around what's the impact, when are you going to adopt, and the odd one, how are you going to adopt?


A brief introduction. Pick up one of these on the way out.

Now, I've been talking about an international development that's going to affect us in the UK, and Mike Metcalf is going to [break] something that's going to be happening in the UK that could set a few international precedents. Mike.

Revenue recognition - a new global standard - Brian O'Donovan 

Revenue recognition – a new global standard – Brian O'Donovan