In line with global practices, Bahrain is committed to adopting the new International Financial Reporting Standards (IFRS) as of January 1, 2018. Accordingly, IFRS 9 Financial Instruments and IFRS 15 Revenue from Contracts with Customers are coming into practice in the kingdom.
BACKGROUND FOR IFRS 15: The US Financial Accounting Standards Board (FASB) and International Accounting Standards Board (IASB) worked on a project leading to the development of IFRS 15 Revenue from Contracts with Customers. IFRS 15 is expected to supersede all the revenue recognition requirements in IFRS. The project aimed to eliminate the gap between the two sets of accounting standards and address other common issues faced by both sets of standards issued by FASB and IASB, respectively. Accordingly, a joint project was initiated to clarify the principles for recognising revenue and to develop a common revenue standard for IFRS and US Generally Accepted Accounting Principles that would
• Remove inconsistencies and weaknesses in previous revenue requirements;
• Provide a more robust framework for addressing revenue issues;
• Improve comparability of revenue recognition practices across entities, industries, jurisdictions and capital markets;
• Provide more useful information to users of financial statements through improved disclosure requirements; and
• Simplify the preparation of financial statements by reducing the number of requirements to which an entity must refer. A corresponding US GAPP standard is introduced in Topic 606 of FASB accounting standards codification.
The effective date of IFRS 15 was January 1, 2018. Accordingly, financial statements prepared after that date shall reflect the application of IFRS 15, whether they are interim or year-end financial statements.
OBJECTIVE: The objective is to establish the principles that apply when reporting useful financial information about the nature, amount, timing and uncertainty of revenue and cash flows arising from contracts with customers. Accordingly, the core principle is to recognise revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services.
In order to comply with the core principle, an entity shall apply the following steps in recognising revenue from contracts with customers, which is commonly called the five-step model of IFRS 15: 1. Identify the contract with customer; 2. Identify the performance obligations in the contract; 3. Determine the transaction price; 4. Allocate the transaction price to the performance obligations in the contract; and 5. Recognise revenue when (or as) the entity satisfies a performance obligation.
SCOPE: An entity shall apply IFRS 15 to all contracts when the counterparty to the contract is a customer i.e., when the counterparty obtains goods or services resulting from the entity’s ordinary activities in exchange for consideration.
• Lease contracts within the scope of IAS 17/IFRS 16 Leases;
• Insurance contracts within the scope of IFRS 4 Insurance Contracts;
• Financial instruments and other contractual rights or obligations within the scope of IFRS 9 Financial Instruments, IFRS 10 Consolidated Financial Statements, IFRS 11 Joint Arrangements, IAS 27 Separate Financial Statements and IAS 28 Investments in Associates and Joint Ventures; and
• Non-monetary transactions between same lines of business to facilitate sales to customers or potential customers.
RECOGNITION: An entity shall have a contract with customers when all of the following criteria are met:
• The parties to the contract have approved the contract and are committed to perform their respective obligations;
• The entity can identify each party’s rights regarding the goods or services to be transferred;
• The entity can identify the payment terms for the goods or services to be transferred;
• The contract has commercial substance; and
• It is probable that the entity will collect the consideration to which it will be entitled in exchange for the goods or services that will be transferred to the customer.
MEASUREMENT: When a performance obligation is satisfied, an entity shall recognise the amount of the transaction price that is allocated to that performance obligation as revenue.
CONTRACT COSTS: Contract costs consist basically of two types i.e., incremental costs of obtaining a contract and costs to fulfil a contract. a) Incremental cost of obtaining a contract: If the entity expects to recover the incremental costs of obtaining a contract, then the entity shall recognise an asset. This includes costs that would not have been incurred if the contract had not been obtained. Sales commission will be an example. However, such costs can be considered as expense if the amortisation period, if capitalised, is expected to be one year or less. b) Cost to fulfil a contract: If the cost to fulfil a contract does not fall under the scope of another standard, an entity shall recognise an asset from the costs incurred in fulfilling a contract only when those costs meet the following criteria:
• The costs relate directly to a contract or to an anticipated contract that the entity can identify;
• The costs generate or enhance the resources of the entity that will be used in satisfying performance obligations in the future; and
• The costs are expected to be recovered. An asset recognised in accordance with above (a) and (b) shall be amortised systematically to reflect the pattern in which the goods or services are transferred under the related contract. Also, such an asset shall be impaired when the carrying amount of the asset exceeds the difference between
• The remaining amount of consideration that the entity expects to receive in exchange for the goods or services to which the asset relates; and
• The costs relating directly to providing those goods or services and that have not been recognised as expense.
PRESENTATION: When either party to a contract has performed, an entity shall present the contract in the statement of financial position as a contract asset or a liability, depending on the relationship between the entity’s performance and the customer’s payments.
An entity shall present any unconditional rights for consideration separately as a receivable.
DISCLOSURE: An entity shall disclose qualitative and quantitative information about all of the following:
• Its contracts with customers;
• The significant judgements and changes in the judgements, made in applying IFRS 15 to those contracts; and
• Any asset recognised from the costs to obtain or fulfil a contract.
TRANSITIONAL PROVISIONS: An entity can elect one out of following two methods in applying IFRS 15:
• Full retrospective approach; or
• Modified retrospective approach.
FULL RETROSPECTIVE APPROACH: Entities electing the full retrospective adoption will have to apply provisions of IFRS 15 to each period presented in the financial statements in accordance with IAS 8 Accounting Policies, Changes in Accounting Estimates and Errors. However, practical expedients have been provided to relieve entities from unnecessary burden of searching for relevant information which was not previously held.
Using the full retrospective means that an entity has to apply IFRS 15 as if it had been applied since the inception of all its contracts with customers that are presented in the financial statements. Accordingly, all contracts with customers are recognised and measured consistently in all periods presented within the financial statements, regardless of when the contracts were entered into. This approach is especially useful when analyses between years are made.
As mentioned above, the following practical expedients are available for an entity when applying IFRS 15 using the full retrospective approach:
• Completed contracts – an entity need not restate contracts that begin and end within the same annual reporting period;
• Completed contracts with variable considerations – an entity may use the contract price at the date of completion rather than estimating variable consideration amounts in the comparative reporting periods;
• Contract modifications done before the beginning of the earliest period presented – an entity need not retrospectively restate contract for those contract modifications in accordance with IFRS 15. Instead, an entity shall reflect the aggregate effect of all of the modifications that occur before the beginning of the earliest period presented when:
• Identifying the satisfied and unsatisfied performance obligations;
• Determining the transaction price; and
• Allocating the transaction price to the satisfied and unsatisfied performance obligations. For all reporting periods presented before the date of initial application, an entity need not disclose the amount of the transaction price allocated to the remaining performance obligations and an explanation of when the entity expects to recognise that amount as revenue.
MODIFIED RETROSPECTIVE APPROACH: Entities that elect the modified retrospective approach will apply the standard retrospectively to only the most current period presented in the financial statements. In doing so, the entity will have to recognise the cumulative effect of initially applying IFRS 15 as an adjustment to the opening balance of retained earnings or other appropriate components of equity at the date of initial application.
Under this approach, IFRS 15 will be applied to contracts that were not yet completed at the date of initial application i.e., January 1, 2018.
This means that all contracts that are not completed by the initial application date have to be evaluated as if IFRS 15 had always been applied to them. Accordingly, an entity will:
• Present comparative periods in accordance with prior revenue standards;
• Apply IFRS 15 to new and existing contracts from the effective date onwards; and
• Recognise a cumulative catch-up adjustment to the opening balance of retained earnings at the effective date for existing contracts that still require performance by the entity in the year of adoption, disclose the amount by which each financial-statement line item was affected as a result of applying IFRS 15 and an explanation of significant changes.
SUPERSEDED STANDARDS: IFRS 15 supersedes the following standards:
• IAS 11 Construction Contracts;
• IAS 18 Revenue;
• IFRIC 13 Customer Loyalty Programmes;
• IFRIC 15 Agreement for the Assets Construction of Real Estate;
• IFRIC 18 Transfer of Assets from Customers; and
• SIC 31 Revenue-Barter Transactions Involving Advertising Services. The KSI’s view is that entities are required to spend a significant amount of time to get to know the major differences and communicate them to the staff working on the transition project, so that they will understand information requirements in advance as the impact of IFRS 15 is business wide. This is very important for entities that have not made sufficient effort so far, and in industries such as software, construction and automotive, media and entertainment, telecommunications, and power and utilities.
IAS 39 Standard came to effect in 2005. Its aim was to prescribe unified rules for the reporting of financial instruments so that companies presented them in a transparent and a consistent way. However, the standard was extremely complicated and contained too many exceptions, inconsistencies and derogations.
FINANCIAL INSTRUMENTS: Therefore, the IASB decided to rewrite and replace IAS 39. The new standard was called IFRS 9 Financial Instruments. The IASB published the final version of IFRS 9 Financial Instruments in July 2014, and it applies to annual periods beginning on or after January 1, 2018. The new standard aims to simplify the accounting process for financial instruments and address perceived deficiencies which were highlighted by the recent financial crisis. The replacement process evolves three main phases:
• Classification and measurement;
• Impairment methodology; and
• Hedge accounting. The introduction of new requirements in IFRS 9 Financial Instruments will be a significant change to the financial reporting of banks. They will affect a number of stakeholders, such as investors, regulators, analysts and auditors.
Given the importance of banks in the global capital markets and the wider economy, the effective implementation of the new standard has the potential to benefit many. Conversely, a low-quality implementation based on approaches that are not fit for purpose has the risk of undermining confidence in the financial results of the banks.
The key differences between IFRS 9 and IAS 39 are summarised below:
• Financial instruments that are in the scope of IAS 39 are also in the scope of IFRS 9. However, in accordance with IFRS 9, an entity can designate certain instruments subject to the own-use exception at fair value through profit or loss (FVTPL); hence, IFRS 9 will apply to these instruments.
• The IFRS 9 impairment requirements apply to all loan commitments and contract assets in the scope of IFRS 15 Revenue from Contracts with Customers.
CHANGES IN CLASSIFICATION & MEASUREMENT: undefined The classification categories for financial assets under IAS 39 of held to maturity, loans and receivables, FVTPL and available-for-sale determine their measurement. These are replaced in IFRS 9 with categories that reflect the measurement, namely amortised cost, fair value through other comprehensive income and FVTPL.
IFRS 9 bases the classification of financial assets on the contractual cash-flow characteristics and the entity’s business model for managing the financial asset, whereas IAS 39 bases the classification on specific definitions for each category. Overall, the IFRS 9 financial asset classification requirements are considered more principle based than under IAS 39.
Under IFRS 9, embedded derivatives are not separated (or bifurcated) if the host contract is an asset within the scope of the standard. Rather, the entire hybrid contract is assessed for classification and measurement. This removes the complex IAS 39 bifurcation assessment for financial asset host contracts.
Under IAS 39, derivative financial assets or liabilities that are linked to, and settled by, delivery of unquoted equity instruments, and whose fair value cannot be reliably determined, are required to be measured at cost. IFRS 9 removes this cost exception for derivative financial assets or liabilities; therefore, all derivative liabilities will be measured at FVTPL.
IAS 39 allows certain equity investments in private companies for which the fair value is not reliably determinable to be measured at cost, while under IFRS 9 all equity investments are measured at fair value For certain financial liabilities designated at FVTPL under IFRS 9, changes in the fair value that relate to an entity’s own credit risk are recognised in other comprehensive income, while the remaining change in fair value is recognised in profit or loss. Exceptions to this recognition principle include when this treatment creates, or enlarges, an accounting mismatch and also does not apply to loan commitments or financial guarantee contracts designated as FVTPL. In such instances, IFRS 9 requires the recognition of all changes in fair value in profit or loss.
Reclassification of financial assets under IFRS 9 is required only when an entity changes its business model for managing financial assets and is prohibited for financial liabilities. Therefore, reclassifications are expected to be very rare.
IMPAIRMENT: IFRS 9 applies a single impairment model to all financial instruments subject to impairment testing, while IAS 39 has different models for different financial instruments. Impairment losses are recognised on initial recognition and at each subsequent reporting period, even if the loss has not yet been incurred.
In addition to past events and current conditions, reasonable and supportable forecasts affecting collectability are also considered when determining the amount of impairment in accordance with IFRS.
The impairment requirements under IFRS 9 are significantly different from those under IAS 39.
IMPAIRMENT APPROACH: The general approach of IFRS 9 to recognising impairment is based on a three-stage process, which is intended to reflect the deterioration in credit quality of a financial instrument.
Stage 1 covers instruments that have not deteriorated significantly in credit quality since initial recognition or (where the optional low credit risk simplification is applied) that have low credit risk.
Stage 2 covers financial instruments that have deteriorated significantly in credit quality since initial recognition (unless the low credit-risk simplification has been applied and is relevant) but that do not have objective evidence of a credit loss event.
Stage 3 covers financial assets that have objective evidence of impairment at the reporting date.
12-month expected credit losses are recognised in stage 1, while lifetime expected credit losses are recognised in stages 2 and 3.