IFRS 9 and IFRS 15 Business Case with SAP Revenue Accounting and Bank Analyzer.

Dear,

Since January the 1^st 2018, Banks and Corporates should be compliant to the new Accounting Standards IFRS 9 and IFRS 15.

In my opinion, most of Banks and Corporates are far from being ready to be compliant to these legal requirements and we will see some examples in the oncoming months.

On the other hand, there is some confusion about the implications of IFRS 9 and IFRS 15, so I’ll try to make a short description with a practical example.

IFRS 15 is relevant for Contracts with customers with particularly visible implications in contracts combining the delivery of Services and Goods.

For instance, a Telecommunications company confirms a contract with a customer committing to deliver Internet access for 12 months for 35 EUR/month and a subsidized Wifi Router for 50 EUR.

Before the IFRS 15 Accounting Principle was implemented, the above contract would produce a revenue in the Telecommunications company of 35 EUR every month, and a one-time revenue of 50 EUR (for selling the Router).

With the implementation of IFRS 15 the company is required to adjust the revenue recognition to a Fair Price of the two sold elements (Router and Internet Access) and the completion of the commitment with the client (deliver the Router and provide the Internet Access). For instance, the Router has been sold to a lower price (subsidized) because the client has committed with a 12 months contract of Internet Access, so it seems logical that a portion of the revenue for selling the router is distributed during the 12 months of the Internet Access.

The International Accounting Standard Board proposes a 5 steps process for fulfilling the IFRS 15 requirements.

Step 1.- Identify the contract with the customer.- This first step has been run just above, identify the contract with the client, in which the company commits to deliver a bundle of services and goods.

Step 2.- Identify Separate Performance Obligations.- Performance Obligations are the promises to the client to transfer Goods or Services. In the above example, the two Performance Obligations are, delivering the Internet service and the Router. At the same time, the company must identify the Stand Alone Selling Price of each Performance Obligation, which is a “Fair Price” that the company would charge for the goods or services if they were sold separately.

The current version (1.3), SAP Revenue Accounting and Reporting does not have the capacity of determining the Stand Alone Selling Prices, but the company can use average historical prices for determining the Stand Alone Selling Price of each Performance Obligation.

In this example we would assume that the Stand Alone Selling Price of the Internet Access is 40 EUR/month and the Stand Alone Selling Price of the Router is 55 EUR.

Step 3.- Determining the Transaction Price which is the actual price that the company is charging to the client for each Performance Obligation. In this case the Transaction Prices are 35 EUR/month for the Internet Access and 45 EUR for the Router.

Step 4.- Allocating the Transaction Price to each Performance Obligation in an amount that depicts the revenue that the company can recognize for delivering the Goods/Services to the client. In our example, they are the following.

Performance Obligation	Transaction Price	Standalone Selling Price	Allocated Amount	Calculation of the Allocated Amount
Router	50 EUR	55 EUR	48 EUR	470*55/535
12 month Internet Service	35*12=420 EUR	40*12=480 EUR	422 EUR	470*480/535
	470 EUR	535 EUR	470 EUR

Step 5 .- Recognize revenue when each performance obligation is satisfied.

Month 1.- Performance Obligation 1 is fully satisfied and Performance Obligation 2 is satisfied in 8.33%. Revenue Recognition is 48 EUR + 35.17 EUR

Month 2.- Performance Obligation 2 is satisfied in 8.33%. Revenue Recognition is 35.17 EUR

Month 3.- Performance Obligation 2 is satisfied in 8.33%. Revenue Recognition is 35.17 EUR

Month 4.- Performance Obligation 2 is satisfied in 8.33%. Revenue Recognition is 35.17 EUR

….

Month 10.- Performance Obligation 2 is satisfied in 8.33%. Revenue Recognition is 35.17 EUR

Month 11.- Performance Obligation 2 is satisfied in 8.33%. Revenue Recognition is 35.16 EUR

Month 12.- Performance Obligation 2 is satisfied in 8.33%. Revenue Recognition is 35.16 EUR

On the other hand, when the company issues the invoices to the client, the company assumes a Credit Risk that the client is not paying the due amount.

IFRS 9 describes the process for measuring the Expected Loss, which starts by determining the Probability of Default of the Client, based in a Credit Risk model which classifies the Client according to the payment behavior of the clients belonging to the same Risk segment. This process is called Historization and is supported by the SAP Bank Analyzer System.

The second step is determining a Fair Value provision that will reduce the recognized revenue until the client makes the payment. The provision amount is determined by the Key Date Valuation of the AFI-Bank Analyzer module, by discounting the Cash-Flow (due amount) with a Yield Curve with the same maturity of the Cash-Flow and the correspondent Spread of the client’s Probability of Default.

Obviously the provision will increase if the client does not make the payment on time, and the Account Receivable becomes impaired.

SAP offers a complete business suite for fulfilling the requirements of the new Accounting Standards. Unfortunately, technical and functional skills for implementing them are scarce, making the implementation projects very challenging.

Looking forward to read your opinions.

K. Regards,

Ferran.

www.capitency.com

Join the SAP Banking Group at: https://www.linkedin.com/group

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Ferran.frances@capitency.com

Financial Instruments Product Costing Planning with SAP Bank Analyzer.

Dear,
Capital Optimization requires efficient planning, providing management with the necessary information for having resources when they are requested, and taking corrective actions in case of deviations.

Planning relies in accurate Product Costing, assuring that profit and margin objectives are fulfilled in every financial period.

Product Costing for Financial Products has three dimensions; Risk driven Capital Costs, Funding Costs and Process Costs.

1) Risk driven Capital Cost.- IFRS 9 and Basel III require that every bank develops a Risk Model which supports the estimation of the Expected Loss of every Financial Asset. The Expected Loss represent the values of the potential losses in a Financial Asset, multiplied by the probability of that loss occurring, and it is the basis for determining the Fair Value Provisions and Capital Requirements of the Bank. The Fair Value Provisions and Capital Requirements represent a cost for the bank, which must be included in the Product Costing estimations of the bank.

Bank Analyzer -AFI supports the determination of the Fair Value Provisions (IFRS 9) and Bank Analyzer – Credit Risk supports the determination of the Credit Risk Capital Requirements (Basel III), according to the Expected Loss of the Financial Asset. Credit Risk Capital Requirements can be included in the Financial Asset Statement (AFI sub-ledger) as Off-Balance Postings, representing the Capital Cost of the Financial Asset, assuring that the sales price will cover the Risk Driven Capital Costs.

Assuming that the bank has a consistent common risk model per Financial Asset, it means that we can assume a direct relationship between the Expected Loss for Capital Requirements (Basel III) and Fair Value (IFRS 9), to the extent that gives the bank an opportunity to reduce Fair Value provisions in case of excess of Capital Requirements determination.

This double approach of the Expected Loss (Solvency and Accounting) per Financial Asset is a very interesting Value Proposition of the Integrated Financial and Risk Architecture.
Bank Analyzer stores the Expected Loss in the Credit Risk Result Type, and the Fair Value Provisions on the Accounting Result Type of the Results Data Layer. In both cases the results are stored individually per every Financial Asset which opens the gate for representing the Capital Requirements as Accounting Provisions per Financial Asset.

Capital Requirements must be determined under base and stressed scenarios, for this reason, in practical terms, Product Cost Planning requires the bank use Standard Costs, that must be reconcilable with the Expected Loss of the banks risk model, and Capital requirements estimations. This reconciliation is also supported by the Integrated Financial and Risk Architecture of Bank Analyzer.

2) Funding Costs.- The bank has to get liquidity from the market, compensating the liquidity consumed in Lending and Investing. Bank Clients and Capital Markets provide this liquidity at an interest rate, which represents a cost, that the bank must include in the cost estimations of its products.

Liquidity requirements fulfillment are a shared responsibility by all the bank branches and Treasury department. Some branches get liquidity that others consume, with the Treasury department compensating liquidity requirements or excess in the Capital Markets. In exchange for covering the liquidity requirements of other branches, liquidity providers receive internal transfer of the funding cost value (transfer price for liquidity). We’ll talk about this in more detail in a future blog.

3) Process Costs.- In order of getting clients and managing investing and contracts with them, the bank needs resources; staff, information systems, branches, etc. Every contract has to support a fair distribution of its related banks costs, assuring that the selling price is higher enough for assuring a positive margin. The fair distribution of the banks process costs is achieved with the cost analysis model of the bank, using Management Accounting techniques for services like Activity Base Costing, Internal Cost Orders, Cost Center Accounting, etc.

As you can see above, the first two families of costs are financial services driven, while the third is general services driven. Integrating all in the same Financial Statement requires a seamless integration between the Analytical Banking and the ERP System. This is the main advantage of combining SAP Bank Analyzer and S4 HANA Universal Journal, combining in the a unified Financial Statement, all the revenues and cost of a Financial Instrument, so the bank will have the profits and losses of every business segment, and the allocated capital.

We looked at the concept briefly in a previous blog.

https://www.linkedin.com/pulse/why-bank-analyzer-afi-sub-ledger-anymore-chapter-ii-ferran-frances/

And we will come back to this topic, in more detail, in a future one.

Looking forward to read your opinions.
K. Regards,
Ferran.