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IFRS NEWSLETTER 

REVENUEIssue 6, January 2013

The Boards confirmed how the revenue recognition model would apply to common scenarios in different industries.

Phil Dowad, KPMG’s global IFRS revenue recognition leader

Application issuesThis edition of IFRS Newsletter: Revenue examines the current

thinking on the revenue project, and what the proposals could mean for you.

In their first meeting of 2013, the Boards focused on how to apply the proposed general requirements to specific scenarios such as asset manager performance fees, financial sector

transactions, repurchase agreements and sales of non-current assets. The Boards reaffirmed the ED’s proposals in these areas, despite the counterintuitive outcomes that may arise in

some common situations. Remaining topics for discussion at future meetings include applying the model to credit card transactions, disclosures, effective date and transition.

Highlights

l   Asset managers – applying the revenue constraint to performance-based incentive fees could defer a significant portion of revenue to later periods.

l   Scope – no revenue would be attributed to services in some common financial sector transactions.

l   Repurchase agreements – different accounting would apply for what some view as economically similar arrangements common in the automotive industry.

l   Sales of non-current assets – applying the revenue constraint to the disposal of an asset that is used in the business may impact the gain or loss recognised on the date of disposal.

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CURRENT STATUS OF THE PROPOSALS

In January, the IASB and the FASB continued their redeliberations on the proposals included in the November 2011 exposure draft Revenue from Contracts with Customers.

The story so far ...The IASB and the FASB (the Boards) are working towards a converged standard that would supersede most existing IFRS and US GAAP guidance on revenue recognition.

ED/2011/6 Revenue from Contracts with Customers (the ED) proposes that a single revenue recognition model would apply to all contracts with customers, and features two approaches to recognising revenue: over time or at a point in time. The model includes a contract-based five-step analysis of transactions to determine whether and how much revenue is recognised. The five steps are as follows.

The Boards redeliberated the proposals during the second half of 2012. Significant decisions made in this period included:

• removing guidance on the identification and measurement of onerous obligations from the revenue project;

• rejecting a proposed practical expedient that would have allowed contract manufacturers to automatically apply the units-of-delivery or units-produced method to measure progress;

• setting out a new approach for licences, under which they would be analysed into two categories with different revenue profiles (at a point in time and over time); and

• rejecting certain exceptions that might have permitted current practice to continue in certain sectors.

In December, the Boards concluded substantive redeliberations of the core recognition and measurement principles in the proposed revenue recognition model. This left specific application issues, transition and disclosures open for discussion in 2013, along with a number of sweep issues. The Boards’ current project plan calls for a final standard to be issued in the first half of 2013.

What happened in January?The Boards discussed four topics in January 2013:

1. Asset managers – applying the general recognition and measurement principles

2. Scope – collaborative arrangements and financial services contracts

3. Repurchase agreements – accounting arrangements that some would view as economically similar

4. Sales of non-current assets – applying the revenue constraint to the disposal of a non-current asset.

These topics are discussed in detail in the remainder of this newsletter. The remaining topics currently scheduled for discussion include applying the model to credit card transactions, disclosures, effective date and transition.

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ASSET MANAGERS

Applying the revenue constraint to performance-based incentive fees could defer a significant portion of revenue to later periods.

What’s the issue?How should an asset manager account for performance-based incentive fees and up-front commission costs?

The ED includes an illustrative example in which an asset manager receives a performance-based incentive fee if a fund’s return exceeds the return on an observable index at the end of the year. In this example, the asset manager concludes that it is not reasonably assured to be entitled to the fee before the end of the year and so does not recognise the fee as revenue until then – i.e. operating the proposed revenue constraint defers revenue recognition until the uncertainty over whether the fee will be receivable is resolved.

Many respondents from the asset management industry did not support the proposals. They argued that deferring revenue recognition until all contingencies are resolved would:

• not reflect the economics of the transaction; and

• not faithfully represent the manager’s performance under the contract.

A number of respondents also questioned whether up-front commission costs incurred by an asset manager for distribution services are contract fulfilment costs or acquisition costs.

Additional outreach performed by the Boards suggested that analysts of the asset management industry had mixed views. Some believed that the ED’s proposals were appropriate and would limit revenue reversals in future periods; others disagreed with the proposals and instead provided comments consistent with those above.

What’s new in January 2013?Retain the revenue constraint proposals in the ED

The Boards reaffirmed that the objective of the revenue constraint is for an entity to recognise revenue only up to an amount that the entity is confident would not be subject to subsequent reversals. Asset managers should consider the revenue constraint when accounting for performance-based incentive fees.

The Boards also agreed that no changes should be made to the ED’s proposals on contract costs. Asset managers would assess all of the facts and circumstances in each asset management arrangement when accounting for up-front commission costs.

What are the implications?A change in practice for some asset managers

• The Boards observed that, at present, many asset managers recognise revenue either:

– progressively over time by estimating the fair value of the consideration at the end of each reporting period; or

– at the end of the performance period when all contingencies are resolved.

• By contrast, the proposed guidance would require all entities to exercise judgement and recognise revenue when and as they become confident that there will not be a significant revenue reversal. This will be a new test – and a new threshold – in IFRS. In some cases, this may result in revenue being deferred towards the latter portion of the performance period, when and as the asset manager becomes confident of the outcome. It may also affect margins when the related compensation expense is recognised throughout the period.

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SCOPE

No revenue would be attributed to services in some common financial sector transactions.

What’s the issue?

How should the revenue requirements be applied to collaborative arrangements and financial services contracts?

The ED applies to all contracts with customers, other than those within the scope of IFRS 4 Insurance Contracts, IFRS 9 Financial Instruments and IAS 17 Leases, and certain non-monetary exchanges. The ED also proposes that if the counterparty to the contract is a collaborator or a partner that shares with the entity the risks and benefits of developing a product to be marketed, then the contract is not within the scope of the ED.

If a contract is partially within the scope of the ED and partially within the scope of another IFRS, then an entity would first apply the guidance in the other IFRS on how to separate the contract. If the other IFRS does not provide guidance on separation, then the entity would apply the separation guidance in the ED.

Some respondents raised questions and requested clarifications on the description of a collaborator, including the following.

• Could a transaction with a collaborator or partner ever be within the scope of the ED?

• Did the Boards intend to narrow the definition of a customer or revenue in collaborative arrangements to those that resulted in a marketable product?

• How should preparers distinguish between a customer and a collaborator or a partner?

Some respondents from the financial services industry requested further clarification as to:

• how the transaction price would be allocated between the financial instrument component and the services component of hybrid financial services contracts; and

• how other aspects of the model would be applied to such contracts.

What’s new in January 2013?

Scope confirmed

The Boards unanimously reaffirmed the overall scope of the ED. They also decided to clarify that collaborative arrangements other than those that develop a marketable product can be within the scope of the model, if the counterparty meets the definition of a customer.

Boards to provide separation guidance

The Boards decided to improve the application guidance for financial services contracts by including an example. The Boards also clarified that if a contract includes both a financial instrument and services, then the financial instrument requirements would be applied first in allocating the transaction price; the revenue proposals would be applied to the residual, which may be measured as having no attributed value.

What are the implications?

Detailed analysis needed for transactions with collaborators

Entities should closely review their transactions with partners or collaborators to assess whether the counterparty meets the definition of a customer for any of the transactions within the collaborative arrangement.

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Change in practice for some financial services contracts

Financial services contracts that are partially within the scope of the ED’s proposals would first have to be separated and measured under the guidance for financial instruments. For example, if an entity provides a loan (or accepts a deposit) and also agrees to deliver services, then the loan (or deposit) would be measured in accordance with the financial instruments standards. Only the residual customer consideration, if any, after subtracting the amount attributed to the financial instrument component would be applied to services within the scope of the revenue model. In such cases, there may be little or no revenue to match the costs incurred as those services are delivered.

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REPURCHASE AGREEMENTS

Different accounting would apply for what some view as economically similar arrangements common in the automotive industry.

What’s the issue?

How should an entity account for repurchase agreements?

The ED defines a repurchase agreement as an arrangement in which an entity sells an asset and also has an option to, or can be required to, repurchase the asset at a future date. The ED identifies three forms of repurchase arrangements:

• calls – the entity has discretion to repurchase the asset;

• puts – the customer has discretion to require the entity to repurchase the asset; and

• forwards – there is no discretion over repurchase.

The ED proposes that an entity would not recognise revenue for sales that include unconditional forwards or calls, because the customer does not obtain control of the asset transferred. Instead, such arrangements are accounted for as leases or financing arrangements.

For sales that include put options, the ED proposes that the entity would assess whether the customer has a significant economic incentive to exercise the put option. If this is the case, then the entity would account for the arrangement as a lease; otherwise, it would account for the arrangement as a sale with a right of return.

Respondents requested clarification of various aspects of the proposals, including:

• whether processing costs should be included in determining the repurchase price when an entity sells a product to a contract manufacturer and repurchases it as part of a larger product;

• how the guidance would be applied to a contract that includes a guaranteed minimum resale value; and

• how to account for equipment that is sold and subsequently repurchased subject to an operating lease.

What’s new in January 2013?

Boards reaffirm repurchase agreement guidance with some clarifications

The Boards reaffirmed the implementation guidance in the ED on repurchase agreements with minor clarifications. Specifically, the Boards agreed to:

• remove the word ‘unconditional’ from the guidance on put options;

• clarify that only substantive option terms would be considered; and

• clarify that processing costs would be excluded when determining the repurchase price of an asset.

The Boards agreed that no significant additional guidance was required to address sales with residual value guarantees or sales of assets that are repurchased subject to operating leases.

What are the implications?

Different accounting for what some view as economically similar transactions

A variety of sale and repurchase agreements are common in the automotive industry. Entities considering how to apply the ED’s proposals may find that transactions they consider to be economically similar would be accounted for in different ways.

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For example, if an entity sells a car and grants its customer a put option, then the entity would not recognise revenue if the customer has a significant economic incentive to exercise the put option. Instead, the entity would account for the transaction as a lease. Conversely, if the entity sells the car and grants the buyer a residual value guarantee instead of a put, then the entity could recognise a sale. These different accounting outcomes reflect the application of the control concept, although the entity’s continuing exposure to changes in the car’s residual value could be the same in both cases.

Judgement required to assess whether options are substantive

Applying the proposal would also require judgement when analysing:

• whether an entity does not have a significant economic incentive to exercise a put option; and

• whether an option is substantive.

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SALES OF NON-CURRENT ASSETS

Applying the revenue constraint to the disposal of an asset that is used in the business may impact the gain or loss recognised on date of disposal.

What’s the issue?Should an entity apply the ED’s proposals to transactions that do not result in recognition of revenue?

The ED proposes to change other IFRSs dealing with the sale of non-current items that are not an output of an entity’s ordinary activities – i.e. sales that do not result in the recognition of revenue – such as the disposal of a head office building. Under these changes, an entity would apply the recognition and measurement requirements of the ED to determine when to derecognise the asset and the amount of the gain or loss on sale.

IFRSs that would be affected include IAS 16 Property, Plant and Equipment, IAS 38 Intangible Assets and IAS 40 Investment Property. Currently, these IFRSs follow IAS 18 Revenue when accounting for such transactions.

Most respondents agreed with the proposed changes. However, some believed that:

• sales of non-current assets would be addressed as part of a separate project; and

• applying the measurement requirements of the ED could result in counterintuitive results in some cases – e.g. when an asset measured at fair value is sold for variable consideration.

What’s new in January 2013?Proposals retained

The Boards reaffirmed that an entity would follow the recognition and measurement guidance of the ED when accounting for sales of non-current assets that are not an output of its operating activities. The decision will retain consistency in the accounting for sale transactions that do and do not form part of normal operating activities.

The Boards also clarified that, to determine whether a sale contract exists, an entity would apply the general criteria in the ED on contract existence.

What are the implications?Revenue constraint to apply to sales of non-current items

The proposals would probably have the biggest impact on transactions that include variable consideration. This is because the entity would not necessarily recognise the fair value of the consideration in measuring the gain or loss at the date of transfer, due to the ED’s requirement to constrain the revenue to the amount to which the entity is reasonably assured to be entitled. This may result in some or all of the consideration being recognised later than is currently the case.

For example, suppose that an entity sells an office building that it used in its operations to a property developer. The consideration includes a fixed up-front payment plus a percentage of the onward sales price if the developer sells the building to a third party within five years. The developer has discretion as to whether and how to develop the building. In this case, the entity would recognise the disposal when it transfers control of the building to the developer. In measuring the gain or loss on disposal, the entity would include only the consideration to which it is reasonably assured to be entitled. This may exclude the fair value of the contingent payment to which the entity would be entitled if the developer sells the building within five years.

In addition, irrespective of whether the consideration is fixed or variable, the date on which the disposal is recognised may change, because entities would be required to apply the control model rather than the risk and reward model to determine when to derecognise the asset.

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SUMMARY OF PREVIOUS DISCUSSIONS

Meeting date

Topics discussedIFRS

Newsletter

July 2012

• Recognition of onerous obligations

• Identification of separate performance obligations

• Criteria for when revenue should be recognised over time

• Licensing

• Rights to useIssue 1

Significantly, the Boards decided to remove guidance on identification and measurement of onerous obligations from the revenue project.

September 2012

• Collectibility (presentation of credit risk adjustments)

• Constraining the cumulative amount of revenue recognised

• Time value of money

• Contract issues and distribution networks

Issue 2

October 2012

• How to measure contract progress and contract modifications

Issue 3Significantly, the Boards rejected a practical expedient that would have allowed contract manufacturers to automatically apply the units-of-delivery or units-produced method to measure progress.

November 2012

• When to recognise revenue from licences

• Presentation of collectibility adjustments

• Constraining the cumulative amount of revenueIssue 4

Significantly, the Boards agreed on a new approach for licences, under which they would be analysed and then separated into two categories with different revenue profiles (at a point in time and over time).

December 2012

• Contract acquisition costs

• Allocating the transaction price – residual method, discounts and contingent consideration

• Bundled arrangements – application to the telecommunications and satellite and cable television sectors

• Licences of intellectual property – sales-based royalties

Issue 5

Significantly, the Boards reaffirmed the ED’s core proposals in a number of key areas, rejecting exceptions that might have permitted current practice to continue in certain sectors.

AcknowledgementsWe would like to acknowledge the effort of the principal authors of this publication: Glenn D’Souza, Katja van der Kuij-Groenberg, Brian O’Donovan and Anthony Voigt.

We would also like to thank the following reviewers for their input: Phil Dowad, Catherine Morley and Paul Munter.

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IFRS NEWSLETTERFINANCIAL INSTRUMENTS

Issue 8, December 2012

We welcome the plan for the IASB to discuss stakeholder feedback on the general hedging review draft before issuing a final standard. 

Andrew Vials,KPMG’s global IFRS Financial Instruments leaderKPMG International Standards Group The future of IFRS financial

instruments accountingThis edition of IFRS Newsletter: Financial Instruments highlights

the discussions and tentative decisions of the IASB in December 2012 on the financial instruments (IAS 39 replacement) project.

Highlights

Impairment

l    Re-exposure is expected in the first quarter of 2013, with a 120-day comment period.

Hedge accounting

General hedging

l    The IASB will discuss feedback received on the general hedging review draft in January 2013.

l    A final general hedging standard is now expected later in the first quarter of 2013.

Macro hedging

l    The portfolio revaluation approach for macro hedging activities may be extended to commodity price risk and foreign exchange risk.

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IFRS NEWSLETTER 

INSURANCEIssue 32, December 2012

In December, the IASB discussed the residual margin and impairment of reinsurance contracts held by an insurer.

Moving towards global insurance accountingThis edition of IFRS Newsletter: Insurance highlights the results of the

IASB-only discussions in December 2012 on the joint insurance contracts project. In addition, it provides the current status of the project and an

expected timeline for completion.

Highlights

l   The residual margin would be unlocked for differences between current and previous estimates of cash flows relating to future coverage or other future services.

l   The residual margin for participating contracts would not be adjusted for changes in the value of the underlying items as measured using IFRS.

l   At inception, a cedant would determine the residual margin on a reinsurance contract by reflecting in the expected fulfilment cash flows all the effects of non-performance, including those associated

with expected credit losses. Subsequent changes in expected cash flows resulting from changes in expected credit losses would be recognised in profit or loss.

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Issue 4, November 2012IFRS NEWSLETTER 

THE BALANCING ITEMS

Another cycle of proposed annual improvements has been issued – what are your views?

Proposed improvements to IFRS – 2011-2013 cycle

This IFRS Newsletter: The Balancing Items brings into focus the latest cycle of proposed narrow-scope amendments to IFRS.

The IASB has published Exposure Draft ED/2012/2 Annual Improvements to IFRSs – 2011-2013 Cycle as part of its annual improvements process to make non-urgent but necessary

amendments to IFRS. The exposure draft includes proposed improvements to the following standards. Comments are due by 18 February 2013.

Questions for constituents to consider

l   IFRS 1 First-time Adoption of International Financial Reporting Standards Which version of an IFRS should a first-time adopter apply in its first IFRS financial statements, if

there is a new/revised IFRS that is not yet mandatory?

l   IFRS 3 Business Combinations Does IFRS 3 apply to the formation of joint operations in IFRS 11 Joint Arrangements?

l   IFRS 13 Fair Value Measurement Do all contracts within the scope of IAS 39 Financial Instruments: Recognition and Measurement /

IFRS 9 Financial Instruments potentially qualify for the ‘portfolio exception’?

l   IAS 40 Investment Property Is the acquisition of an investment property an acquisition of a business?

IFRS NEWSLETTER: LEASES Special edition: September 2012, Issue 12

Highlights

• Boards conclude redeliberations on leases

• On-balance sheet approach for lessees

• ‘Dual’ model for income/expense recognition

• Increase in complexity for lessee and lessor accounting

• Revised exposure draft delayed until first quarter of 2013

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The future of lease accounting

The home straight? In September 2012, after many months of joint discussion, the Boards concluded their redeliberations on the lease accounting proposals published in August 2010. We can now look forward to a revised exposure draft (ED) in the first quarter of 2013, most likely with a 120-day comment period.

After a long period of redeliberation, with many twists and turns, the proposals to be included in the new exposure draft are now clear, at least in outline. This special edition of our newsletter highlights the key impacts of those proposals on lessees and lessors.

Central to the proposals will be the right-of-use model, under which all but short-term leases would be on-balance sheet for lessees. The goal of eliminating lease accounting as a source of off-balance sheet finance has become the project’s touchstone. In most instances, the proposals achieve that goal. However, the costs of achieving this goal include complexity and conceptual compromise.

The proposals will introduce new ‘dual models’ for income/expense recognition. Lessees and lessors would apply a new lease classification test, on a lease-by-lease basis, to determine which model to apply. Lease classification would depend on the extent to which the underlying asset is consumed over the lease term, and the nature of the underlying asset (real estate vs other assets).

Many leases of real estate would qualify for straight-line income/expense recognition. Lessors would achieve this by applying an approach similar to current operating lease accounting. Lessees would apply a version of the on-balance sheet right-of-use (ROU) model in which the asset is measured as a balancing figure to achieve straight-line expense recognition.

Many leases of other assets would result in an accelerated profile of income/expense recognition. Lessors would apply the new receivable and residual (R&R) model, recognising a lease receivable and a residual asset representing their interest in the underlying asset at the end of the lease term; lessors might also recognise an upfront profit. Lessees would generally recognise total lease expense on an accelerated basis, being the sum of a straight-line amortisation charge and an accelerated interest charge.

Lessees and lessors would not need to apply the models to leases with a maximum contractual term of 12 months or less. In such cases, they would not recognise lease assets and liabilities, and would recognise straight-line income/expense.

The proposals are certain to prove controversial. Several Board members have indicated that they may dissent from the proposals, and initial reaction from some user groups has been cool. We will all have a chance to comment in 2013.

FIND OUT MORE

For more information on the revenue project, please speak to your usual KPMG contact or visit the IFRS – revenue hot topics page, which includes line of business insights.

You can also go to the Revenue Recognition page on the IASB website.

Visit KPMG’s Global IFRS Institute at kpmg.com/ifrs to access KPMG’s most recent publications on the IASB’s major projects and other activities.

Our IFRS – financial instruments hot topics page brings together our materials on the financial instruments project, including our IFRS Newsletter: Financial Instruments. Our IFRS – insurance hot topics page brings together our materials on the insurance project, including our IFRS Newsletter: Insurance.

Our IFRS – leases hot topics page brings together our material on the leases project, including our IFRS Newsletter: Leases. Our IFRS Newsletter: The Balancing Items, which brings into focus narrow-scope amendments to IFRS, is available at kpmg.com/ifrs.

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KPMG International Standards Group is part of KPMG IFRG Limited.

Publication name: IFRS Newsletter: Revenue

Publication number: Issue 6

Publication date: February 2013

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IFRS Newsletter: Revenue is KPMG’s update on the joint IASB/FASB revenue project.

If you would like further information on any of the matters discussed in this Newsletter, please talk to your usual local KPMG contact or call any of KPMG firms’ offices.