What is IFRS 15 in simple terms & how does it affect my business?

IFRS 15 can look daunting if you are a business, but with a helping hand it can be demystified and ultimately help your business. IFRS 15 is a bit like a box of jigsaw pieces. Just like putting together a puzzle, IFRS 15 provides the framework that helps businesses piece together their revenue recognition process. It provides a clear set of rules and guidelines for recognising revenue from customer contracts, ensuring consistency and transparency in financial reporting.

This is a guest post first published by our friends and clients at Finomatic Consulting, which helps software companies maximise value. The original article can be found here: Navigating IFRS 15

Introduction to IFRS 15

Complying with International Financial Reporting Standard 15 (IFRS 15)* presents unique challenges for software companies. This article highlights some of the essential considerations which must be addressed in order to facilitate successful compliance and ensure accurate financial reporting.

These factors include:

• Identifying distinct services

• Determining the transaction price

• Allocating revenue

• Recognising revenue

• Modifying contracts

• Considering variables

• Implementing internal controls

*Note: The issuance of IFRS 15 was a joint project with the US standard setters – the Financial Accounting Standards Board (FASB). The FASB equivalent of IFRS 15 is ASC 606 Revenue from Contracts with Customers.

Key aspect of IFRS to consider

Identifying distinct services

IFRS 15 requires software companies to identify each contract’s distinct services. This can be a complex process as software contracts often include a number of different components.

Determining the transaction price

This is the amount to be received by the company in exchange for their services. The contract may not explicitly state the transaction price if there are multiple elements such as:

• Upfront fees

• Milestone payments

• Variable payments

• Discounts

Software companies should use reasonable and supportable estimates where the transaction price is not defined. Any significant changes or modifications to the transaction price should be reassessed and updated accordingly throughout the contract period.

Allocating revenue

As software contracts often include multiple elements, it is important that the fair value of services is correctly allocated to the appropriate revenue lines.

Recognising revenue

Once a customer obtains control of the services, the company can begin to recognise the revenue. Control is deemed to be passed if the customer can obtain benefits from the services.

For example, perpetual licences should be recognised upfront once the customer has control. However, for a licence with a specific term, the revenue should be spread over the length of the contract.

Additional complexities tend to arise as the contract value increases. Sophisticated enterprise software introduces complexities in revenue recognition because, despite granting customers access to the software, deriving significant benefits from the installation often requires a lengthy implementation phase.

Billing such licences immediately would be advantageous for revenue (at least initially). However, this may be perceived as unfair from the customers’ perspective because they would be charged for a licence which cannot be fully utilised due to an ongoing implementation process. An immediate recognition policy could therefore damage customer relationships and create hurdles during the service renewal phase. The resulting knock-on effect might lead to lower retention rates in the future, which would be detrimental to the company’s valuation.

Modifying contracts

Companies must account for contract changes in accordance with IFRS 15. Typical examples in businesses we have worked with are changes in:

• The number of seats for a licence

• Subscription price

• Cost which are not proportional to extensions in the service (e.g. changing a licence term from 4 to 5 years without adjusting the price)

Considering variable payments

Companies should appropriately estimate and allocate the variable consideration (such as discounts, rebates, or performance bonuses) based on expected outcomes.

Implementing internal controls

It is critical that there are robust procedures in place to ensure that revenue is being recognised correctly. Common pitfalls for software companies are:

• Not capturing changes to customer contracts

• Incorrectly recognising implementation revenue for both time and materials (T&M) and fixed price engagements

Apportioning discounts

Where companies have applied a discount to a bundle package which includes multiple revenue lines (e.g. support and licence fees), companies should allocate these discounts proportionally to the performance obligations in a contract.

Recommendations for implementing IFRS 15

Seeking expert help

IFRS 15 is a complex standard, and it can be difficult to comply with without professional help. You should have a qualified accountant explain the standard and review your internal procedures to ensure that you are complying with IFRS 15 on an ongoing basis.

Documenting your processes

Processes around identifying, allocating, and recognising revenue should be clearly documented. This documentation will all staff understand the complete revenue recognition process to ensure you comply with IFRS 15.

Reviewing your contracts regularly

It is important to review your contracts regularly as they change over time. You want to make sure that any changes are compliant with IFRS 15.

Making necessary changes to accounting processes

Compliance with IFRS 15 may require you to make changes to your business processes to ensure that you consistently apply the standard.

Key takeaways for IFRS in conclusion

By following these tips, software companies can comply with IFRS 15 and ensure that their financial statements are accurate and reliable. This will help maintain investor confidence and avoid any awkward conversations around the board table after the year end audit.