How will IFRS 15 Revenue from Contracts with Customers impact the aged care sector?

The International Accounting Standards Board (IASB) published IFRS 15[1] Revenue from Contracts with Customers in May 2014 effective for reporting periods commencing on or after 1 January 2018[2].  Since IFRS 15 replaces all of the existing guidance on revenue recognition, and applies to all entities and industries, there has been considerable confusion (and debate) as to what the likely impacts are going to be, across different industries, when adopted. 

This article highlights what the key implications of adopting IFRS 15 are expected to be for the investment management sector. It is vital that organisations understand and prepare now for the impact IFRS 15 will have on your business to avoid any unintended consequences such as breaching debt covenants or missing earnings targets and KPIs.

Likely areas impacted upon by IFRS 15 include:

  1. Identifying the number of performance obligations that are contained within a contract
  2. Non-refundable upfront fees
  3. Trailing commissions
  4. Variable/performance-based payments
  5. Costs of obtaining a contract

1. Identifying the number of performance obligations that are contained within a contract
IFRS 15 requires all performance obligations contained in a contract to be identified, a portion of the transaction price allocated to each obligation, and revenue measured separately for each. 

Importantly, in the investment management sector, whilst there may be multiple performance obligations in a contract, they often have the same pattern of transfer to a customer and will be accounted for as a single performance obligation (IFRS 15.22(b)).  IFRS 15.23 states that:
a series of distinct goods or services has the same pattern of transfer to the customer if both of the following criteria are met:

(a) each distinct good or service in the series that the entity promises to transfer to the customer would meet the criteria in paragraph 35 to be a performance obligation satisfied over time; and
(b) in accordance with paragraphs 39–40, the same method would be used to measure the entity’s progress towards complete satisfaction of the performance obligation to transfer each distinct good or service in the series to the customer.
 
2. Non-refundable upfront fees
Many contracts contain up-front non-refundable fees (often described as establishment or set-up fees).  Most of these fees result in no transfer of any good or service to the customer (setting the customer up on a database is an administrative task only).

Under IFRS 15 these payments will be considered an advance payment for future goods or services.  Entities will need to consider what performance obligations these payments relate to and recognise revenue when these performance obligations are met.

Compared to existing accounting for these types of payments, IFRS 15 will more than likely result in a delay in the recognition of these amounts as revenue.
 
3. Trailing commissions
Trailing commissions are common in the investment management sector.  They are normally paid to a broker based on a customer staying with an entity for a period of time.  Under existing accounting standards there has been considerable confusion, debate and divergence in how entities accounts for trailing commissions.

IFRS 15 provides extensive guidance on how to account for these types of payments.  IFRS 15.108 states:
A receivable is an entity’s right to consideration that is unconditional. A right to consideration is unconditional if only the passage of time is required before payment of that consideration is due. For example, an entity would recognise a receivable if it has a present right to payment even though that amount may be subject to refund in the future. An entity shall account for a receivable in accordance with IFRS 9. Upon initial recognition of a receivable from a contract with a customer, any difference between the measurement of the receivable in accordance with AASB 9 and the corresponding amount of revenue recognised shall be presented as an expense (for example, as an impairment loss).

Since most trailing commissions are contingent on a customer staying with the entity they will fail the above requirement and be initially recorded as a contract asset under IFRS 15 and not a financial asset under IFRS 9 until the right to trailing commission becomes unconditional.

As trailing commissions are variable in nature they will be subject to the constraints on recognising variable consideration discussed below at point 4.
 
4. When should variable consideration associated with a contract be recognised
Contracts in the investment management sector often include variable elements such as bonuses for meeting certain criteria.  IFRS 15 requires one of the following methods to be used to estimate this revenue (depending on which method better predicts the outcome):

  • a probability weighted estimate; or
  • the most likely amount.
Importantly though, IFRS 15 restricts how much of this type of revenue is actually recognised.  Variable revenue (such as bonus payments) can only be recognised (IFRS15.56):
‘to the extent that it is highly probable that a significant reversal in the amount of cumulative revenue recognised will not occur when the uncertainty associated with the variable consideration is subsequently resolved’
In other words, the entity must be very confident they can predict the expected revenue with accuracy before it is permitted to be recognised.  IFRS 15.57 highlights some possible examples which would bring into question an entity’s ability to meet the requirements of test above:
  • the amount of consideration is highly susceptible to factors outside the entity’s influence. Those factors may include volatility in a market, the judgement or actions of third parties, weather conditions and a high risk of obsolescence of the promised good or service. the uncertainty about the amount of consideration is not expected to be resolved for a long period of time
  • the entity’s experience (or other evidence) with similar types of contracts is limited, or that experience (or other evidence) has limited predictive value
  • the contract has a large number and broad range of possible consideration amounts

Where variable revenue hasn’t been recognised, the entity will assess at the end of each reporting period, whether the uncertainties that prevented recognition have been resolved, and recognise revenue at that point.

Example (based on example 25 in IFRS 15 illustrative examples):

On 1 January 2020, Broker Co enters into a contract with a client to provide asset management services for five years. Broker Co receives a two per cent quarterly management fee based on the client’s assets under management at the end of each quarter. In addition, Broker Co receives a performance-based incentive fee of 20 per cent of the fund’s return in excess of the return of an observable market index over the five-year period. Consequently, both the management fee and the performance fee in the contract are variable consideration.
Broker Co accounts for the services as a single performance obligation in accordance with paragraph 22(b) of IFRS 15, because it is providing a series of distinct services that are substantially the same and have the same pattern of transfer (the services transfer to the customer over time and use the same method to measure progress—that is, a time-based measure of progress).

At contract inception, Broker Co considers the requirements in paragraphs 50–54 of IFRS 15 on estimating variable consideration and the requirements in paragraphs 56–58 of IFRS 15 on constraining estimates of variable consideration, including the factors in paragraph 57 of IFRS 15. Broker Co observes that the promised consideration is dependent on the market and thus is highly susceptible to factors outside Broker Co’s influence. In addition, the incentive fee has a large number and a broad range of possible consideration amounts. Broker Co also observes that although it has experience with similar contracts, that experience is of little predictive value in determining the future performance of the market. Therefore, at contract inception, Broker Co cannot conclude that it is highly probable that a significant reversal in the cumulative amount of revenue recognised would not occur if Broker Co included its estimate of the management fee or the incentive fee in the transaction price.

At each reporting date, Broker Co updates its estimate of the transaction price. Consequently, at the end of each quarter, Broker Co concludes that it can include in the transaction price the actual amount of the quarterly management fee because the uncertainty is resolved. However, Broker Co concludes that it cannot include its estimate of the incentive fee in the transaction price at those dates. This is because there has not been a change in its assessment from contract inception—the variability of the fee based on the market index indicates that Broker Co cannot conclude that it is highly probable that a significant reversal in the cumulative amount of revenue recognised would not occur if Broker Co included its estimate of the incentive fee in the transaction price. At 31 March 2020, the client’s assets under management are $100 million. Therefore, the resulting quarterly management fee and the transaction price is $2 million.

At the end of each quarter, Broker Co allocates the quarterly management fee to the distinct services provided during the quarter in accordance with paragraphs 84(b) and 85 of IFRS 15. This is because the fee relates specifically to Broker Co’s efforts to transfer the services for that quarter, which are distinct from the services provided in other quarters, and the resulting allocation will be consistent with the allocation objective in paragraph 73 of IFRS 15. Consequently, Broker Co recognises $2 million as revenue for the quarter ended 31 March 2020.
 
5. Costs of obtaining a contract
IFRS 15 permits only the incremental costs of obtaining a contract to be capitalised.  Costs that would have arisen regardless of whether the contract was obtained must be expensed when incurred.

Therefore, salary costs of employees and consulting fees (paid regardless of success) will need to be expensed under IFRS 15.  Success fees paid to internal staff or external consultants when a new contract is secured should be capitalised[3]
 

Example:

Broker Co pays an external consultant $1,000 per introduction to prospective clients.  Where the introduction leads to a new client relationship Broker Co pays the consultant an additional $2,000.
Under IFRS 15 Broker Co must expense the initial $1,000 per introduction as they incur this cost regardless of securing the contract.  The additional $2,000 success fee will be capitalised (when it occurs) as an asset as it is an incremental cost of obtaining a new contract.
 
The information contained in this article is for general guidance only and does not represent, nor intend to be, advice.  We recommend that prior to taking any action or making any decision, that you consult with an advisor to ensure that individual circumstances are taken into account.
 


[1] AASB 15 Revenue from Contracts with Customers in Australia.
[2] Effective for reporting periods commencing on or after 1 January 2019 for not-for-profit entities
[3] Costs that are explicitly chargeable to the customer regardless of whether the contract is obtained are recognised as assets.