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New revenue recognition standard issued

08 Dec 2014

Monique ArcherA new revenue recognition standard that clarifies the principles of revenue recognition was issued earlier this year. Its potential impact on some businesses in the construction, real estate, telecommunication, retail, technology and software industries may be significant.

IFRS 15 Revenue from Contracts with Customers was issued jointly by the International Accounting Standards Board (IASB) and the Financial Accounting Standards Board (FASB) on 28 May 2014. Implementation thereof is required for annual periods beginning on or after 1 January 2017, but early adoption will be permitted.

The new standard, which will replace all existing IFRS revenue requirements, will:

  • remove inconsistencies and weaknesses in previous revenue requirements;
  • provide a more robust framework for addressing revenue issues;
  • improve comparability of revenue recognition practices across entities, industries, jurisdictions and capital markets;
  • provide users of financial statements with more useful information through improved disclosure requirements; and
  • simplify the preparation of financial statements by reducing the number of requirements an entity has to refer to.

The core principle of IFRS 15 is that an entity recognises revenue to depict the transfer of goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services.  

The revenue standard applies to all contracts with customers, but excludes contracts that are regulated by other standards, e.g. leases, insurance and financial instruments. In addition, some revenue items that arise from an entity’s ordinary activities may also fall outside the scope of the revenue standard, e.g. interest and dividends.

Entities will need to exercise judgement when considering the terms of contracts as well as all relevant facts and circumstances, and will have to apply the requirements consistently to contracts with similar characteristics and in similar circumstances.

A five-step model is used to apply the principles of the standard:

Step 1:    Identify the contract(s) with the customer.
Step 2:    Identify the separate performance obligations in the contract.
Step 3:    Determine the transaction price.
Step 4:    Allocate the transaction price to separate performance obligations.
Step 5:    Recognise revenue when (or as) the entity satisfies a performance obligation.

The effect on entities may vary depending on industry and current accounting practices. However, almost all entities will be affected to some extent by the significant increase in required disclosures. The objective of these is to disclose sufficient information to enable users of financial statements to understand the nature, timing and uncertainty of revenue and cash flows from contracts with customers. Entities therefore will have to disclose qualitative and quantitative information about the following:

  • disaggregation of revenue,
  • reconciliation of contract balances,
  • performance obligations,
  • remaining performance obligations,
  • costs to obtain or fulfil contracts,
  • the significant judgements – and changes in judgements –  in applying the standard to those contracts.

As the potential changes to revenue recognition may be significant for some, entities should assess its impact without delay. Early preparation will ensure the successful implementation of the new standard.

For more information please contact Monique Archer at Tenk Loubser Inc on tel 021 915 6666 or e-mail monique@exceed.co.za

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