International Financial Reporting Standard (IFRS) 15, Revenue from Contracts with Customers (in short ‘Revenue Recognition’) was issued in May 2014.
The standard is a joint project between the International Accounting Standards Board (IASB) with US Financial Accounting Standards Board (FASB), as are other projects like leases and insurance contracts.
The Boards understood when presenting this standard that it was bound to create trouble and therefore installed the Revenue Transition Resource Group (TRG) to aid in the transition process.
Since then, various topics have been discussed and will be presented for improvement shortly. It is therefore not surprising (another new phenomenon!) that the initial application date will be postponed from 1 January 2017 to 1 January 2018.
A simple conclusion could be that the standard was issued far too hastily. The “wish to perform” had won from the “quality to present”.Control
The above two elements - installation of the TRG and deferral of initial application - seem to be signs of a more complex problem, that of control.
Control from two perspectives: the control the Boards have over their standard-setting work and the concept of control as a guiding principle that replaces the Risk and Reward principles used in previous IFRS standards. For the Revenue Recognition standard it culminates in the discussion on control over services.
Control over standard setting
Perhaps you have read the IASB’s May 2015 agenda papers? In particular the document describing the issue emerging from the Revenue Transition Resource Group’s (TRG) discussions regarding “Principal” versus “Agent” considerations.
The issue at hand is whether goods and services provided to a beneficiary are received from the entity promising to perform the goods and services itself or from a third party, arranged to perform. TRG questioned how to interpret the indicators of control as it appeared unclear to them whether or when, from a control point of view, an entity acted as a Principal or as an Agent.
It then is remarkable to read (in para 20) the staff say: “We think that the Boards included the indicators within the new Standard to help an entity assess whether it controls a good or service before transfer-in scenarios when the assessment of control might be difficult”.
So apparently, the Boards recognise that assessments might be difficult - nevertheless consider that guidance via indicators would have sufficed!
Do the Boards have difficulty overseeing the wording of the standards and the consequential impact of their decisions - or do they feel that each new position taken will result in another edge, undermining the principle-based character that ought to underlie the standard?
The IASB staff, in defence, indicates that no, or hardly any, signals were received based on the Exposure Draft(s); it’s my view that for standards that are developing over a prolonged period of time interest fades, and in fact the IASB, for this very reason, is exposed to a higher risk of proper standard setting.
The European Financial Reporting Advisory Group (EFRAG), or other bodies, are unable to redress the negative effects of this process, probably as their interventions would mean delays and would require even more fundamental research.
In the above case, to alleviate the problem the staff seeks answer from the Board “whether the requirement in paragraph 22 to identify a series of distinct goods or services as one performance obligation should be changed to an optional practical expedient”.
Choosing this option will result in the least of changes in the work and wording already done, and at the same time upholds the Board’s line of thought - it is more principle based. In practise, the outside world receives the message: “we only alleviate but don’t change, and parties should find a mutual acceptable way out themselves”.
Principle based means accepting uncertainty and allowing for multiple interpretations; as such this starting point conflicts with the Board’s intent to provide clear, transparent guidelines which are applicable under all circumstances.
Control over Services
The current IFRS 15 states (in para 33): “Goods and services are assets, even if only momentarily, when they are received and used (as in the case of many services). Control of an asset refers to the ability to direct the use of, and obtain substantially all of the remaining benefits from, the asset. Control includes the ability to prevent other entities from directing the use of, and obtaining the benefits from, an asset…”
This existing wording rings bells well beyond the discussion about Principal or Agent.
It is stated that a service is an asset (to come to an understanding why control can be exercised). To compare, in the new leasing standard, a distinction is made between the finance element of a lease (resulting in assets and liabilities) and the service elements that can be excluded from calculating the balance sheet value of the lease liability (= equal to the asset value at origin).
So here, it is agreed that services are no assets, which fits in the logic of lease transactions.
Control, Risk and Reward and focus on the balance sheet
The services enigma illustrates the Board’s distance from “real life”. The dominant focus on the balance sheet, plus the concept of control, proves to be problematic. Services, like leases, are examples of “products” that require an open mind and where accounting should follow the intent of parties - providing/receiving assistance and relief through products (goods and/or services) that are instrumental to the various processes in an entity without being bothered who is the legal owner, ultimate beneficiaries to all benefits, or the exact value of future (cancellable) obligations.
Services is a wide group of activities ranging, for example, from the Notary Public’s advice to the maintenance of aircraft engines. In short, Services may have physical elements or absolute none.
Resolution and conclusions
There should be a reinstated dominance of the profit and loss (P&L) account - at least for Services
In my January article on leasing in AFI, I suggested going back to before IAS 17 and charging the P&L with the cash-out for the leasing contract and forget about the balance sheet altogether. This is the simplest and most logical treatment for service-oriented lease transactions.
But it is becoming more and more fashionable because of environmental and sustainability arguments to re-use physical products, at least the (rare) material components, and thus there will be a switch from ownership to usage. Usage seen in the form of a service.
When considering the above, then, the following points can be considered to overruling the control dilemma and the unjust dominance of the balance sheet in the primary financial statements:
● Physical, material, goods are tangible assets - these assets are presented on the balance sheet and depreciated straight line over the expected economic lifetime as decided at the start [current IAS 16, PPE’s];
● Services are intangibles, so not assets, thus not belonging on the balance sheet. Profit on services can be taken pro rata parte or pro rata tempore depending on the type of service (or service interval). Services should be disclosed in a separate note together with (intangible) lease transactions.
● Goods provided in a packaged deal (e.g. a lease), be it finance or finance and services, are tangible assets only for the physical part and when an entity so chooses [current IAS 17, Finance leases] or intangibles in all other cases when the goods provided are considered instrumental to the service [compare with current IAS 17, Operating leases]
These goods, when tangibles, are presented within leased assets on the face of the balance sheet and treated like physical assets in the P&L with similar disclosures as with IAS 16.
When classified as intangibles, a separate disclosure note Services is provided to present total (and when relevant by sub classes) cash movement in intangibles.
Also, for intangibles, disclosure is provided on expected future cash flows, in the same breakdown of periods as used for showing depreciation charges of tangible assets.
Not surprisingly, the outcome for leasing is current IAS 17! And that is in line with the practical outcome the FASB is propagating.
And the Control issue: will it be solved with the above proposal, too?
Not yet, or not fully: why not revisit the concept of Risk and Reward; a concept much closer to profit and loss?
Henk Uunk held the position of manager financial accounting and reporting at ING Lease Holding from 2004 to 2014. He is chairman of the accounting committee of the Dutch Leasing Association (NVL) and a member of Leaseurope’s accounting and taxation committee since 1992. Uunk is a contributor to the Dutch Accounting Standards Board working group on leases and acts as a consultant to the Dutch Car Leasing Association (VNA).