With many implementing IFRS 9 Financial Instruments and IFRS 15 Revenue from Contracts with Customers in the 2018/19 reporting season for the first time, we asked a panel of experts for their views on how it went and, for those yet to report, the challenges to watch out for. The panel included Helen Shaw of Deloitte, Moses Serfaty of BDO, Danielle Stewart OBE of RSM and Phil Barden of Deloitte.

IFRS 9 Financial Instruments

Helen Shaw, Director, Deloitte

The introduction of an impairment model based on expected rather than incurred losses has been one of the headline changes on the adoption of IFRS 9. There are particular challenges that are associated with applying the new model to intercompany loans. Such instruments are sometimes poorly documented and may not be considered until relatively late in the transition process because they do not appear in the consolidated financial  statements. In the absence of historical loss data it may seem difficult to calculate a loss allowance, however, the wealth of other information available on group companies should allow a reasonable basis for calculation.

The priority for most transition projects has been the underlying accounting and the impact on the primary financial statements. However, extensive new disclosure requirements are included in IFRS 7 Financial Instruments: Disclosures due to the introduction of IFRS 9. It is easy to underestimate the amount of work needed in relation to disclosures especially where there is not a big change in the accounting treatment between IAS 39 Financial Instruments: Recognition and Measurement and IFRS 9. In particular, even where an entity chooses to continue to apply the IAS 39 hedge accounting model they are still required to make the new hedge accounting disclosures in IFRS 7.

IFRS 9 allows entities to apply hedge accounting in a wider range of circumstances than IAS 39. However, it can be easy to miss the impact of the new standard on existing hedges. In particular, where an entity hedges foreign exchange risk with a derivative they will now need to consider foreign currency basis spreads. Foreign currency basis spreads are an unavoidable cost of hedging with foreign currency derivatives which, under IFRS 9, may be excluded from a hedge relationship. Irrespective of whether they are excluded, their effect will need to be quantified which will require additional time and expertise to update valuation methodologies.

Moses Serfaty, Director, BDO

Despite the simplified approach to measuring expected credit losses for trade and lease receivables, companies are required to take into account forward-looking information, including macro-economic information such as unemployment levels and interest rates, when calculating all their impairment provisions.

This means that preparers have had to first identify the macro-economic factors that have affected historical loss rates and then source and incorporate forward-looking information about these economic factors into the estimation of expected loss rates. This is proving to be a challenging area for many preparers, both in terms of gathering the relevant historic analyses and overlaying this data with forward-looking information.

While the headline was always that IFRS 9 would not bring about much change in the accounting for financial liabilities, one notable area of change relates to the accounting for modifications. Under IAS 39, if a financial liability was modified but did not meet the criteria for derecognition, then the difference between the original carrying value and the modified carrying value was typically deferred and amortised over the remaining life of the liability.

IFRS 9 though, specifically requires the difference to be recognised in profit or loss at the date of modification. This requirement must be applied retrospectively on transition to IFRS 9, meaning that any deferred gains or losses relating to previously modified financial liabilities, that are still recognised at the date of initial application of IFRS 9, must be identified in order to determine the appropriate transition adjustments. This change has been missed by some, resulting in additional work being required relatively late in the day.

IFRS 15 Revenue from Contracts with Customers

Danielle Stewart OBE, Partner, RSM

The challenges of initial transition to IFRS 15 were enormous. Much energy was expended analysing sales contracts and working out how the five criteria in paragraph 9 of the standard related to them. Framing the seller’s obligations as ‘performance obligations’ was often a challenge – were those obligations distinct or a ‘bundle’ of interlinked promises? Allocation of the contract price across the elements was another task, and the timing of revenue recognition also had to be considered.

Timing has been a particularly error-prone area, despite some excellent guidance within the standard. We have seen situations where the performance obligation is fully satisfied upfront, but the company has produced a confidently argued board paper explaining why it should be recognised over time, as well as companies trying to take revenue early, where an ongoing obligation means they should be deferring it forward. This is an area of developing GAAP and new interpretations are being made all the time. Accountancy firms have their latest guidance on their websites, but when decisions on interpretation were being made prior to transition, most of this guidance didn’t yet exist. It is indeed a challenge for a CFO who has presented management accounts all year on one basis, to go back to the board and tell a very different revenue story. While they can explain that GAAP has developed over the past 15 months, there will be consequences with shareholders, financiers and other stakeholders.

This is both the curse and the blessing of GAAP. If we had a static, rules-based approach, this problem would not exist. But developing GAAP as we go delivers intelligent reporting, so we must persist, never underestimating how hard it is to introduce a new way of approaching one of the most important figures in any entity’s accounts.

Phil Barden, Partner, Deloitte

If you still have your first year-end under IFRS 15 to look forward to, here are a few areas that you might watch out for.

The guidance on agent/principal has triggered much discussion. It looks deceptively similar to the IAS 18 guidance but, in fact, it is much more prescriptive. Identifying which entity has the primary contractual responsibility to the customer is often key. Where there is an intermediary between you and the end consumer, it can be very important to establish which of them is your customer for the purposes of applying IFRS 15.

With limited exceptions, IFRS 15 requires consideration payable to a customer to reduce revenue. This requirement also applies if you make payments to other parties that purchase your goods or services from your customer – which is easy to miss.

Don’t underestimate the new disclosure requirements, which can be quite detailed and quite prescriptive; some of them may require information that was not previously readily available. I’d particularly highlight the disclosure of revenue associated with performance obligations not yet satisfied. This includes all amounts contracted at the reporting date, but should exclude any elements that are optional for the customer or cancellable without significant penalty. Any variable amounts included need to be estimated, and perhaps constrained.

In addition, there are important disclosures around key judgements, and in respect of the methods, inputs and assumptions used for estimating and constraining variable amounts, allocating amounts between performance obligations and measuring return and  refund obligations.

Finally, if you choose not to restate comparatives on adoption, remember to disclose how your profit and loss account and balance sheet would have differed had you remained on previous GAAP.