How to Plan for IFRS 15 – Insight and Information for Finance Professionals



Chris Hooper: Hello and welcome to the CIMA & Certinia live webinar on how to plan for IFRS 15 / ASC 606. My name is Chris Hooper and I’m a senior editor at Financial Management Magazine, which is produced on behalf of CIMA. We’re delighted to have so many of you joining us today for what promises to be a fascinating discussion bout the legal accounting standards, the deadline for which is approaching at a rate of knots.

Joining us today is our special guest Colin Glass. Colin is the EMEA Controller for Certinia, who is the leading cloud enterprise resource planning provider for the new service economy.

Founded in 2009 and headquartered in San Francisco, Certinia unifies data across an enterprise in real time, and they bring companies to rapidly evolve their business models with customers at their center.

Based in Harrogate, Colin describes himself as a frustrated engineer who plays in amateur radio circles and is also a proactive permaculturalist. Passionate about all things service cloud and describing himself as a true Cloud geek, Colin has spent 10 years in various finance roles at Sun Microsystems, Kinetic, Emergent Bio Solutions, Yell, and before that as a consultant for a number of smaller software companies.

Colin, thank you so much for joining us.

Colin Glass: Thank you, Chris.

Chris Hooper: Now, we’re going to spend the next 30 minutes or so chatting with Colin about the challenges presented by IFRS 15 / ASC 606. We’re going to cover what the general changes to reporting requirements are, how businesses can assess the extent to which they will be affected, and the steps those in finance departments can take to make the transitions to these new reporting standards as seamless as possible.

In 2014 and after 12 years of work, the International Accounting Standards Board and their American counterparts (the Financial Accounting Standards Board) published their new standards for recognizing revenue from contracts with customers. The goal was to simplify and harmonize revenue recognition practices and was based on one overarching principle: the companies must recognize revenue when goods and services are transferred to the customer, in an amount that is proportionate to what has been delivered at that point.

Now, these changes have not been without controversy. Denise Lugo of Bloomberg has called this shift the biggest accounting change to hit capital markets in decades. Scott Davidson, who is the CFO of software provider Hortonworks has said that the requirements impact every aspect of how you go to market and run a business. Requiring changes in systems, processes, and reporting both internally and externally to investors, both public and private.

Now, whether it’s quite severe as that will be discussed here, but it’s worth noting the deadline for these changes is fast approaching. The new IFRS 15 / ASC 606 revenue recognition rules start after December 15th, 2017 for public companies, and a year later for private firms.

So, without wasting any more time, let’s bring our guest today.

Colin, let’s start, I suppose, if you could give us a sort of general picture, really. Would you mind giving us a little more detail about the IFRS 15 revenue recognition standard? Specifically, what are the most important developments financial professionals should know?

Colin Glass: Sure. Excuse me.

For me, IFRS 15 and ASC 606, as you mentioned there, have been a long time coming, but they are built – certainly 606 – is actually built on the fabric of 605 and iterations of the American Accounting Standards before that. IFRS 15 is built on the current International Accounting Standards.

So, you know, there were standards before this. We’re building on what was there before. But the key thing to sort of draw out of the core principle of IFRS 15 is you’re recognizing revenue against product or service, which reflects the consideration to which the entity expects to be entitled in exchange for the goods or the services that it’s selling.

One of the inferences from this is that IFRS 15 begins to specify by much more granularity, how an IFRS reporter will recognize the revenue, as well as requiring much more information and disclosures to users of financial statements as well as stakeholders of financial statements.

So, it’s an evolution of what was there before, but there’s a lot more granularity, and obviously, as a consequence, there’s a lot more detail to get into when you begin to apply the standard.

Chris Hooper: Yeah. We sort of mentioned in the intro there about the deadlines that are fast approaching. What are those? I think it’s worth reiterating. What are those current deadlines that organizations need to be aware of to comply with these new standards?

Colin Glass: Absolutely.

Chris Hooper: Go on. Sorry.

Colin Glass: I was going to say, on the slide you’ll see there that we’ve actually got the dates for the 606. In the US for public companies, it’s on and after December 15th, 2017. So, really, US public companies have already begun to prepare for this standard. For private companies, it’s after December 15, 2018.

In IFRS for any public or private company, it’s for periods beginning on or after the first of January 2018. So, there’s not a lot of time. It’s now December. The first of January will be looming fairly soon. But, obviously, you may not necessarily report those numbers for another 12 months after that point. So, as we go through this presentation, perhaps we’ll talk a little bit about the preparation and timeliness of how you go about it.

Chris Hooper: Let’s pick up on that, then, because we’re talking about I think how sort of businesses can initially assess how they’re going to be affected. One aspect of the writing contribution of services to overall revenue is the challenge of accounting from multiple revenue streams with different characteristics, which is, of course, enshrined in IFRS 15.

What would you say are the sort of practical challenges of implementing this standard? Why is this potentially so stretching for finance functions?

Colin Glass: Well, one of the key things of the standard – which is nice in some respects – is it does lay a foundation of what to follow in order to get through the standard. So, the slide kind of helps with this here. You know, specifically, there are five steps.

Step one: identify the contract with the customers. 15 defines a contract as an agreement between two or more parties that creates enforceable rights and obligations. I think that’s pretty consistent.

Step two: identify the performance obligation in the contract. The performance obligation is that promise in a contract, for the customer, to transfer either a good or a service or both.

Determine the transaction price. The transaction price is the amount of consideration. It could be a payment, but it could be other, in exchange for those goods and services.

Step four: allocate the transaction price to the performance obligation. For each contract, there is more than one performance obligation. Your entity should allocate the transaction price to each of those obligations in a way that best depicts the amount of that consideration.

Then step five: we have to then recognize the revenue. So, after those four steps, we can then begin to recognize the revenue against it.

Does that help?

Chris Hooper: Yeah, it does. Yeah, very much so. Sort of still staying on the practical side of things for a moment, if a finance professional has identified that his or her sort of company will be affected by these changes, with whom should they be business partnering with within their organization to ensure that their transition goes as smoothly as possible? How would you advise finance coordinates with sales, legal, and other departments, for example, to adapt performance criteria in the context of these new rules?

Colin Glass: Absolutely. You’ve already touched on one or two of the key functions within any organization. I mean, sales are out there leading the charge to get the sales orders to come through for your organization. Really, they need to be very much aware of how to coordinate a negotiation to reflect this IFRS within the contracts they’re attempting to sell. Behind all of that, you may have implementers. Once the sale’s gone through, there may be an implementation stage to meet the criteria of the contract, but to support sales efforts, you need legal other departments within the organization to help implement and coordinate the standard itself.

With regards to the performance criteria within those rules, defining the acceptance criteria is key, clearly articulating that acceptance criterion. The point of sales is going to be key. Then, the ongoing acceptance and how we measure that with the customers.

Beyond all of this, actually getting the customer to buy into this. At that point, your sale is a major part of the challenge as we roll IFRS 15 out.

Chris Hooper: Yes, Colin. Sort of staying looking internally at sort of a company for the time being, how can a finance department take the lead in establishing a roadmap for all the areas of an organization that will be affected by the new revenue recognition standard? Do you foresee a development of a likely relationship between finance and IT, for example?

Colin Glass: Absolutely. So, you know, obviously, finance is probably the closest to this standard than any other function in the business. So, they are leaders as an entity, as a function, key to support from your best place to apply the standard; but the standard needs to be communicated so that the internal functions become aware of it, are cognizant of it, and will support it. That maybe needs to be led from the CEO down or pushed out from the finance perspective – depending on how the businesses operate.

But the way to drive that, you’re going to need to look at, perhaps, doing an impact study and some analysis, involve various functions within workshops or discussions, prepare and make a decision. Select, perhaps, some appropriate software. A business of maybe 20 or 30 contracts could, perhaps, quite happily manage revenue recognition, IFRS 15 on an Excel spreadsheet, no problem. But, if you scale a business up to multiple legal entities, perhaps multiple geographical locations, the challenge of running those entities on Excel or some other mechanism becomes a bit more challenging. So, perhaps looking at what’s out there in the market to help support the implementation is going to be key. Obviously, there’s the implementation itself and how you go about doing that, and then how you actually collect the data and migrate your current data to make all of this work. By all means, I wouldn’t underestimate …

I was listening to another presentation a couple of days ago on sales commissions, which we may touch on again. Just the implications on the cost side, never mind the revenue side, of the multiplication factor that Rev Rec throws out in terms of data and the handling of excess data shouldn’t be underestimated.

You know, after all of that, throughout finance lead as a project manager, communicator, and knowledge transfer expert. So, pushing this forward really does need the leadership of finance to make it all happen.

Chris Hooper: You sort of mentioned there about some of the implementation strategies like impact studies and analysis and things like that. What do you foresee as the most significant obstacles that finance professionals and their organizations are likely to encounter when complying with a new standard? I think following on from that, a lead-on question is how can these challenges then be overcome?

Colin Glass: Sure. I mean, with regards to sort of the challenges. The finance team will have to identify how IFRS affects the changes. So, the key to all of this is working with those delivery teams, sales teams, legal contracts, managers, with whom they can business-partner and driving – as I already said – that communication piece.

Working with IT, you know, as I said, again, depending on the size of your business, you could quite happily, as a finance function on its own, run through the implementation, running Excel. But if your business is complex, you’re going to need to work alongside your IT function. If you are a back-office function with servers and there aren’t ERP systems in the background, you may need to investigate buying packages which can run alongside that, or you may – like us – offer something in the Cloud, which is a little bit easier to implement. But by no means, we can’t underestimate the complexity of the challenge. Don’t underestimate how long it’s going to take to pull it all together.

I mean, one of the key things we’ve taken as we’ve gone through our journey with this, is to engage with our audit team, and potentially also talk to other third parties who have either helped companies go through this implementation earlier than the standard required, or are helping companies right now go through it in preparation.

So, your auditor is a great resource for that, but there are other organizations out there who can offer some similar services and advice.

Chris Hooper: That makes sense. Thank you, Colin. I’m aware that we’ve got some questions coming in from the floor. So, I just have one more from me, and then we’ll move to those.

A sort of quick reminder to the listeners, actually. If you do have a question you want to get in, make sure you do so very quickly because we’re running out of time here. If we don’t have time to cover it, then, as I said before, the team at Certinia are on hand to answer any queries that you might have or elaborate on things that we haven’t had time to cover here.

So, just lastly for me, then, really. What would you summarize are the key recommendations, if you’d like. What are the key takeaways here, Colin, that listeners should remember from this discussion? What advice would you give as some of the next steps for further learning on this subject?

Colin Glass: Absolutely. So, you know, for me, just to sort of… It’s almost connected to the previous question. I kind of liken the implementation of revenue recognition of IFRS 15 or 606 to something like [inaudible] if you were ever involved in an American company rolling something like that out in Europe, you’ll know that it was a very coordinated effort. Many functions were involved. Documentation of the processes was a key. Then, the application of that as you rolled it out. Really, Rev Rec is kind of akin to that. It has a big enough impact across the organization. The implications to the way your revenue is recognized. It’s not only your revenue but potentially the margins and the profitability you may then recognize are also impacted has quite interesting dynamics across the organization in the way the business might be heading.

So, that’s one kind of key take I would give.

You know, if you’ve got in-house staff who are comfortable adapting to the challenge, then that’s great. But, as I’ve already sort of iterated, do speak and get your auditor involved. They’re probably exposed to a lot of this already. So, they may have limitations in capacity, but the sooner they access the talent pool the better; or, alternatively, seek some third-party advice and Excel consultancy advice to help you through it.

For me, and I know this from our own experience, think about the timelines. If you get a project plan away, you’re better placed to get the process ready. So, think about the timelines. Is your business inside these timelines and know you’re ready for it?

Then, think about the complexities. Complexities of not running with the standard. You know, there are lots of implications. You could run, as you are right now, to the 31st of December, 2018, not run the standards, but have quite a few challenges with your order to come to the point which you report your accounts. So, that’s not recommended.

Similarly, there are other challenges. How do you then report and do the comparator under IFRS? Do you have to go back and restate your previous years as well as your current years? Then, beyond all of that, do you really need a database system to help you with the revenue recognition process and produce those deferred revenue entries, capitalize the items as an asset, and then amortize it accordingly?

Until we have… It’s pretty standard, offers three, it has the three methods: equal, split, percentage, complete, and deliverable built into it. But you have to go through some type of implementation process to make it all work.

Again, as I said, there’s nothing wrong with running a business on Excel, but you’ve got to think about the magnitude or the volume of the data you’re delinquent. So, for me, I’ll probably get the big takeouts to move this all forward.

Chris Hooper: Okay. That’s a good point to wrap things up, for me. I think let’s move on to some questions from listeners, then. The first one is an interesting one, actually. We’ve been talking a lot so far in sort of generalities, and taking a very broad view on things. But, this first question is are there any specific sectors that stand to be more affected by these changes than others? If so, what are they?

Colin Glass: Yeah. That’s a great question. In fact, we have a slide with all the sectors on it – all the various sectors that are available. The four that really jump out for me in the sort of important sectors that are directly affected by IFRS (though all of them are)… One is the Telco sector. You know, telecommunications. When you think about the performance obligations and the way the transaction price may have to be allocated for a telco, that could be quite a challenge under IFRS 15.

Another area is manufacturing. You know, you think about the way manufacturers operate these days in their supply chain with all the various contract mods that go on there. Again, manufacturers will be affected.

Real estate, if we call it that in the UK, but more property development, perhaps better known. You’ve got to think about the revenue over time. That’s a long timeframe building properties. So, what’s the revenue over time, and at the point of time how can you recognize your revenue accordingly?

For me, Certinia is a SaaS software development company at heart, but it’s a SaaS company operating in the Cloud. How do you deal with the contract obligations? Do you have to split a development versus a licensing contract into two contracts? Being a subscription-based business, we own the IP, and we rent that software to our customers. So, it’s an interesting sort of challenge to deal with the revenues accordingly in that business.

So, there are the four I would call out. As you can see from the slide, there are many others: media, healthcare, transportation & logistics, to name a few. Each one of those will have some facet which may or may not be affected by IFRS 15.

Chris Hooper: The second question actually ties in, I think, somewhat to what you were saying just then, actually. What allowances does IFRS 15 make for subcontracting the company’s supply chain? For example, if an organization is offering a complete service to a customer but then contracting out some aspects of that service, will this result in a change of assessment?

Colin Glass: That’s a great question. The best way for me to actually answer this, there is a part – an element – in the standard which talks about the net versus the gross argument, or the principal versus the agent. I actually came across a really good example. It was an American example, but it applies to IFRS 15. It was a chap who bought a pair of Beats headphones from Walmart – online Walmart – and he noted… Which is kind of a sad thing, if you’re buying a pair of Beats headphones, that although Walmart was where he was buying this from, he wasn’t actually being supplied from it – through Walmart. It was a third party, a subcontractor of Walmart, who was supplying the Beats headphones. So, you know, 110 pounds of 110 dollars for the Beats headphones. 100 pounds would have been for the subcontractor. So, who recognizes the 110? Do you recognize? Does Walmart recognize this, was really the question. Does Walmart recognize the 110, or does Walmart recognize the 10 – i.e. the margin it makes as the revenue. In this instance, because Walmart was not the principal, it only recognized the 10 rather than the 110.

It, again, depends on the circumstance, but that’s a really sort of simple example of how this subcontract piece can be wedded in when you’re reviewing your contracts – whether you’re the principal or whether you’re the agent.

Chris Hooper: I see. The next question we’ve got, actually, sort of … I mean, I think the Walmart example might extend to this, too. The question is how are sales returns dealt with under IFRS 15?

Colin Glass: Yeah. So, I mean, obviously, the inventory costs of the item expected to be returned are quite often excluded from the cost of sale. So, there’s a piece which sort of that has to look at what you forecast as your returns against your sales. Then, build that into the revenue recognition piece.

So, let’s say you’re a company that has roughly 10% return on sale. Then, as you plan your revenue, as you book your revenue, the cost of sales against that would have to reflect the expected return. So, again, that’s a convoluted way of getting to a revenue recognition position. You’re effectively comparing an estimated number to get that return value.

Chris Hooper: Okay. I think the next question actually harks back to one of your previous answers as well, actually. When you were talking about your own company – Certinia – being a sort of subscription-based service. But the question is this: there seems to be a very specific guidance in IFRS 15 related to licenses and intellectual property; initial starting point is to determine whether a license is distinct, but how is this assessment made?

Colin Glass: Yeah. It’s a fascinating area. One in which we have lots of challenges with ourselves internally, and we’ve spoken to our external council in support for this. The whole concept of SaaS – the SaaS model – and whether you develop the software that you are then passing onto to your customers has to be sort of considered carefully. Like I mentioned before, if you’re a reseller – if you’re a SaaS reseller or somebody else’s software – then this implication isn’t really there for you. But if you develop, as we do – we’ve got a team of developers here on site – they develop the intellectual property. We have to think about how we book not only the revenue but the intellectual property on our books. So, we’re looking at capitalizing our intellectual property and then renting the use of that to our customers. You know, it’s a fascinating change from what, perhaps, used to occur before.

Chris Hooper: Okay. We’ve just got time for one more, actually. It’s another one that sort of harks back to maybe something that needs elaborating from what we said earlier on. You mentioned that IFRS 15 is kind of a development on what sort of came before it. So, this question here is what types of disclosure are required under IFRS 15, and how do these compare to existing disclosure requirements?

Colin Glass: Yeah. I mean, again, we’ve sort of touched on it at the very beginning, but one of the main themes of IFRS is to give the reader of your financial statements – and that could be an investor, that could be a stakeholder, that could be internal, it could be a bank you’re wanting to loan money – more information about how your business operates.

So, the keywords that come out of the statement are quality, quantitative, and qualitative information in the disclosure notes around the customer contracts. So, significant judgments, changes to judgment, and how they are applied in each of those contracts are key. Certainly year on year, or how many years you’re reporting. Any assets that are recognized from the costs to obtain or fulfill a contract with a customer are also needed for the disclosure.

So, for the initial starting point, it’s always to determine whether a license is distinct. You know, once you understand that, you can then begin to disclose it.

Chris Hooper: Okay. I think that’s a good point to end things on, actually, Colin. Unfortunately, we’ve sort of run out of time.

As I said earlier on, Colin and the team at Certinia have kindly agreed to answer any more questions you have via email. So, if you want Colin or one of his team to elaborate on anything at all that we’ve covered today… There’s obviously a wealth of stuff that we didn’t have time to cover. So, please get your questions in, and then they’ll respond to you in good time.

As you’ll see on the final slide there, there are some resources available to you for more information on this subject. You can follow the link to where you’ll find plenty more reading on the IFRS 15. Also, a very informative case study video about how one of Certinia’s clients has transformed their business so far.

So, all that remains for me to say is thank you to Colin for your time today and for giving us a fascinating insight into what is a very complex subject. So, Colin, thank you very much.

Colin Glass: Yes, thank you very much. Thank you very much for hosting the event.

Chris Hooper: No problem at all. I’d just like to say thank you to all of you for listening. Please join us next time. Thank you. Goodbye.

Colin Glass: Goodbye.