Australian Accounting Standards rarely figure top of mind when you enter into a commercial contract. But with the introduction of the new standard AASB15 - and its impact on revenue from contracts with customers - all of that is set to change.
The standard has the scope to significantly change the timing of revenue recognition under a contract for accounting purposes. This will necessitate changes to accounting processes. But it also leads to the question: what impact will there be on how contracts are drafted to deal with the changes to when revenue is recognised? If you are negotiating or drafting a contract you will now need to bear in mind that the way you draft clauses may have a material impact upon year-end accounts.
What is AASB15?
AASB15 is a 76 page long standard for the accounting treatment of revenue from contracts with customers. It comes into effect for annual reporting periods beginning on or after 1 January 2018.
The objective of AASB15 is stated as establishing "the principles that an entity shall apply to report useful information to users of financial statements about the nature, amount, timing and uncertainty of revenue and cash flows arising from a contract with a customer."
Under this standard an entity is required to "recognise revenue to depict the transfer of promised 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. An entity shall consider the terms of the contract and all relevant facts and circumstances when applying this Standard. An entity shall apply this Standard, including the use of any practical expedients, consistently to contracts with similar characteristics and in similar circumstances."
Does AASB15 apply to you?
This Standard applies to each entity that is required to prepare financial reports in accordance with Part 2M.3 of the Corporations Act and that is a reporting entity; general purpose financial statements of each other reporting entity; and financial statements that are, or are held out to be, general purpose financial statements. So if you are a publicly listed company, a company with special purpose accounts which are required to be prepared in accordance with the Australian Accounting standards or most public sector entities, you will probably feel the effect of AASB15. That covers a huge portion of the entities that operate commercial businesses in Australia.
There are detailed provisions in the standard explaining what it applies to. Importantly, it is worth noting some of the major areas that will now be caught by the new standard. This standard will eventually supersede the standards that relate to Construction Contracts, Customer Loyalty Programmes, 15 Agreements for the Construction of Real Estate, Transfers of Assets from Customers, Barter Transactions Involving Advertising Services; and Subscriber Acquisition Costs in the Telecommunications Industry. However, the standard will not apply to many lease contracts, insurance contracts, financial instruments, investments in joint ventures; and non-monetary exchanges between entities in the same line of business to facilitate sales to customers or potential customers.
What is the accounting impact of the standard?
The standard creates a five-step model requiring companies to consider:
- does a contract exist
- the promises in the contract to deliver goods and/or services to a customer
- the transaction price payable by the customer
- how to allocate the transaction price to the goods and services
- when to recognise revenue based on when 'control' over the good or service transfers to a customer.
AASB15 recognises revenue based on the satisfaction of performance obligations, with consideration allocated to each distinct performance obligation, based on the relative selling price of each one of these obligations.
A performance obligation is defined in the standard as follows:
"A promise in a contract with a customer to transfer to the customer either: (a) a good or service (or a bundle of goods or services) that is distinct; or (b) a series of distinct goods or services that are substantially the same and that have the same pattern of transfer to the customer."
If a contract is drafted such that the performance obligations do not specifically match when revenue is received then there could be a necessity to recognise revenue at different times to when a product or service is provided, in order to meet the requirements of AASB15.
So, for example, imagine that you have a contract for the provision of services that has a lifetime spanning two financial years. The services under this contract are delivered on a monthly basis and the customer pays you at the end of each month for the services to be received in the next month. You have been recognising revenue as the service is delivered. But it is possible that under the new standard that all revenue could be recognised at the start date of the contract. Why – because the drafting of the contract may not be specific enough to enable the five step process outlined above to be undertaken, so as to recognise the revenue on a monthly basis. Practically, this could mean that you move significant revenue recognition into one financial year and significant expense recognition into another. That may be good or bad for your business – the commercial impact is really a matter for you. But it is important to understand that this can happen rather than just letting it happen and being told of the impact by your auditor at audit time.
There may in fact be cause for celebration due to these changes. Clever companies will be able to change their contracts to make sure that they record revenue when it suits them. This can have all sorts of advantages, from tax to management of business relationships.
Specific areas for concern
The following contractual provisions are specifically called out for attention under the standard:
- performance obligations satisfied over time
- methods for measuring progress towards complete satisfaction of a performance obligation
- sale with a right of return
- warranties
- principal versus agent considerations
- customer options for additional goods or services
- customers' unexercised rights
- non-refundable upfront fees (and some related costs) Examples include joining fees in health club membership contracts, activation fees in telecommunication contracts, setup fees in some services contracts and initial fees in some supply contracts
- licensing including intellectual property licences and specifically sales based or usage based royalties
- repurchase agreements such as a put option or a call option
- consignment arrangements
- bill-and-hold arrangements
- customer acceptance which affects passing of title
- disclosure of disaggregated revenue into categories. That is how a company will that depict the nature, amount, timing and uncertainty of revenue and cash flows are affected by economic factors.
There is guidance given in the standard as to what impact the drafting of these clauses will have upon how revenue is recognised for the purposes of compliance with the standard.
What you should be doing now
The impact of AASB15 is not an issue for just a business's accountants or lawyers alone to deal with. It requires managers to approach the problem in a multi-faceted way. Advice will obviously be needed about the accounting impact. But that advice should then be discussed with those who are responsible for how contracts are drafted. A collaborative approach is best.
This publication does not deal with every important topic or change in law and is not intended to be relied upon as a substitute for legal or other advice that may be relevant to the reader's specific circumstances. If you have found this publication of interest and would like to know more or wish to obtain legal advice relevant to your circumstances please contact one of the named individuals listed.
