It's been a while now since January 1, 2018, when IFRS 9 and IFRS 15 became mandatory accounting standards for banks and corporations. In my experience, a surprising number of organizations are still far from ready to fully comply with these critical legal requirements. We're going to see the consequences of this unpreparedness unfold over the coming months.
There's also a good deal of confusion surrounding what IFRS 9 and IFRS 15 actually mean for businesses. Let's break it down with a practical example to make it clearer.
Understanding IFRS 15: Revenue from Customer Contracts
IFRS 15 focuses on revenue from contracts with customers, with a particularly noticeable impact on agreements that bundle both services and goods.
Let's imagine a telecommunications company. They sign a contract with a customer for 12 months of internet access at €35/month and a subsidized Wi-Fi router for €50.
Before IFRS 15, the accounting for this was straightforward: the company would recognize €35 in revenue each month for the internet service and a one-time €50 revenue for the router sale. Simple, right?
With IFRS 15, things get more nuanced. Companies now must adjust revenue recognition based on the fair price of each sold component (router and internet access) and the completion of their commitment to the client (delivering the router and providing internet access). Since the router was subsidized because the customer committed to a 12-month internet contract, it makes sense that a portion of the router's revenue should be distributed over those 12 months of internet service.
The International Accounting Standards Board (IASB) provides a five-step process to meet IFRS 15 requirements:
- Identify the contract with the customer: This is about clearly defining the agreement where the company promises to deliver a bundle of services and goods, like our telecom example.
- Identify separate performance obligations: These are the distinct promises made to the client to transfer goods or services. In our example, the two performance obligations are providing the internet service and delivering the router. Crucially, the company must also determine the "Stand-Alone Selling Price" for each obligation – this is the fair price if each was sold separately.
- A note on technology: While SAP Revenue Accounting and Reporting (current version 1.3) doesn't automatically determine Stand-Alone Selling Prices, companies can use historical average prices to figure them out.
- For our example, let's assume the Stand-Alone Selling Price for internet access is €40/month and for the router is €55.
- Determine the transaction price: This is the actual price the company is charging the client for each performance obligation. In our case, it's €35/month for internet and €50 for the router.
- Allocate the transaction price to each performance obligation: This step ensures the revenue recognized reflects the value delivered for each good/service. Here's how it breaks down for our example:
| Performance Obligation | Transaction Price | Standalone Selling Price | Allocated Amount | Calculation of the Allocated Amount |
| Router | €50 | €55 | €48 | (€470 total transaction price) * (€55 router Standalone Price) / (€535 total Standalone Price) |
| 12-month Internet Service | €420 (€35*12) | €480 (€40*12) | €422 | (€470 total transaction price) * (€480 internet Standalone Price) / (€535 total Standalone Price) |
| Total | €470 | €535 | €470 |
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Recognize revenue when each performance obligation is satisfied: This is where the actual accounting takes place over time.
- Month 1: The router (Performance Obligation 1) is fully delivered, and 8.33% of the internet service (Performance Obligation 2) is provided. Revenue recognized: €48 (router) + €35.17 (internet) = €83.17.
- Months 2-10: 8.33% of the internet service is provided each month. Revenue recognized: €35.17.
- Months 11-12: 8.33% of the internet service is provided each month. Revenue recognized: €35.16.
Understanding IFRS 9: Expected Credit Loss
Now, let's switch gears to IFRS 9. When a company issues invoices, it takes on credit risk – the risk that the customer won't pay. IFRS 9 outlines the process for measuring the Expected Loss from this credit risk.
This process begins by determining the Probability of Default (PD) for the client. This is typically based on a credit risk model that categorizes clients according to the payment behavior of similar risk segments. This "historization" process is often supported by systems like SAP Bank Analyzer.
The second step involves determining a Fair Value provision. This provision will reduce the recognized revenue until the client actually makes the payment. The amount of this provision is calculated through a Key Date Valuation within modules like AFI-Bank Analyzer. It involves discounting the cash flow (the amount due) using a yield curve with the same maturity as the cash flow, along with the corresponding spread for the client's Probability of Default.
Naturally, if the client fails to pay on time and the account receivable becomes impaired, this provision will increase.
The Implementation Challenge
SAP offers a comprehensive business suite designed to help companies meet these new accounting standards. However, there's a significant bottleneck: scarce technical and functional skills needed to implement them. This scarcity makes these implementation projects incredibly challenging.
What are your thoughts on these new standards and the challenges they pose? I'm eager to read your opinions.
Kindest Regards,
Ferran.
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