Impact of Accounting Standard Changes in Recognition of Revenue

Significant changes to accounting standards in 2018 and upcoming changes to lease accounting have the potential for a substantial amount of adjustment by not-for-profit organisations, writes Christopher Edwards, manager of Corporate and Audit Services at HLB Mann Judd.

In what has been described by many as the most significant change in accounting standards since the adoption of International Financial Reporting Standards in 2005, the way in which revenue is accounted for will significantly change for most entities, including not for profit organisations, next year.

AASB 15 Revenue from Contracts with Customers (which is based on the international standard, IFRS 15) was announced by the Australian Accounting Standards Board (AASB) in May 2015 and, after many years of waiting and several delays, is now within its transitional period. AASB 15 replaces both AASB 118 Revenue and AASB 111 Construction Contracts.

Furthermore, the AASB has released AASB 1058 Income of Not-for-Profit Entities, which contains significant changes to the way that NFP’s will account for grants and other forms of income.

Timing of the new standards

Through an amending standard, AASB 2016-7, the AASB 15 officially comes into effect for annual reporting periods commencing 1 January 2019, being one year later than for-profit entities, so entities with a 31 December balance date will be impacted first (i.e. 31 December 2019 year ends).  

Entities with a 30 June balance date will be first affected for 30 June 2020 year ends. However, as AASB 15 requires preparers to estimate the likely outcome at the commencement of a contract, the comparative information period will commence for those entities with December year ends at 1 January 2018, and will commence on 1 July 2018 for those with June year ends. A table with a more detailed timeline is shown below.

Of course, entities may elect to early-adopt, but must early-adopt both AASB 15 and AASB 1058 concurrently.

The most significant changes

In essence, the most significant changes are within AASB 15, which requires that preparers of financial information allocate revenue in accordance with the satisfaction of the performance obligations of a contract.

This has been split out into five steps:

–        Identify the contract with the customer

–        Determine the performance obligations under the contract

–        Calculate the full transaction price

–        Allocate the transaction price to each of the performance obligations

–        Recognise revenue as each performance obligation has been met

Whilst each step will require a thorough examination, Step 1 is especially important to determine if a transaction is captured under AASB 15. It is important to note that a contract under this standard can be written, verbal or implied.

The most significant change, if you are affected, is derived from the requirement to record revenue upon the satisfaction of performance conditions. Previously, those applying AASB 111 Construction Contracts would recognise revenue in line with an estimated percentage of completion method.  While this often worked well, and ‘matched’ as costs were incurred, there existed concerns that the method applied did not accurately match the level of effort required by an entity to generate revenue.

The new standard will require an entity to assess what their performance obligations under a specific contract are, determine what value to apply to each performance obligation and then record the revenue as each is met. This may result in a significant increase in the volatility of revenue recognition.

If a transaction is not captured within AASB 15 for a not-for-profit entity, it is likely captured within AASB 1058, which will require entities to recognise the revenue on receipt.

Bundling and ‘un-bundling’

AASB 15 requires an entity to combine similar contracts with the same customer and assess them as one for the analysis of revenue recognition. This ‘bundling’, may result in grants being grouped together and the performance conditions being assessed overall, against the total funds received.

Another impact of the new AASB 15 is the requirement to break down contracts into their individual components, or ‘un-bundling’. This arises due to the need to assess performance conditions of a contract separately. A great example of this, albeit with regards to a for-profit entity, would be with a mobile phone contract, where the sale of the handset and the provision of the service must now be analysed and recognised separately. Un-bundling is paramount when entities sell the bundled products separately, as well as part of a discounted bundle.

Peppercorn leases and other discounted purchases

Another interesting change encapsulated within AASB 1058 is the impact of the wording “enters into other transactions where the consideration to acquire an asset is significantly less than the fair value of the asset”. Therefore, any transaction entered into in which the amount paid is approximately 85 per cent or less than the fair value of the asset, you should consider the implications of this standard.

Most affected will be those with peppercorn leases, where the fair value of the asset provided must now be recognised, and any difference against the consideration paid is recognised as revenue.

Volunteer services

A requirement exists under AASB 1058 to recognise the fair value of volunteer services as revenue in the period the service occurs, however the requirement is limited to the government sector. Other entities may elect to adopt this requirement on a class-by-class basis, which we believe may occur when boards of NFPs wish to highlight the benefits being provided to the entity.

In order to recognise volunteer services, the fair value must be reliably measured and the services must have been required to be purchased if they were not otherwise donated.

Conclusion

The AASB has deferred adoption of AASB 15 for an additional year for NFP entities, which both aligns with the effective date of AASB 1058 and has allowed some reprieve. However, with these significant changes and the upcoming changes to lease accounting, there is the potential for a substantial amount of adjustment required for NFPs.

It is important to note that the combination of AASB 15 and 1058 as they apply to NFPs may result in recognising grant income in your results earlier than initially expected, which may impact future grant or expenditure conditions.

We recommend discussing with an HLB Mann Judd representative as to whether your entity is likely to be impacted and, if so, to what extent. We are here to assist your organisation prepare for these changes.