IFRS 15, which came into effect on 1 January 2018, is a new revenue recognition standard that was drawn up by the international accounting standards board (IASB) to force businesses to consider the timing of revenue recognition, particularly in relation to long term contracts. It establishes a comprehensive framework for recognition of revenue from contracts with customers, based on a core principle that an entity should recognise revenue representing 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 reality, it is aimed at preventing businesses from manipulating financial statements by delaying or accelerating revenue.
So what does this mean for software companies?
If the various components of a software contract can not be unbundled – i.e. the software licence, associated hardware and professionals services require to implement it – the software provider would have to recognise these revenues and expenses over the period of the contract, regardless of how payments might be structured. Software companies that provide a mix of services and software may need a more detailed review of specific performance obligations to determine when to recognise revenue.
To recognise revenue under IFRS 15, an entity must apply the following five steps:
Step 1: Identify the contract(s) with the customer
Step 2: Identify the performance obligations in the contract
Step 3: Determine the transaction price
Step 4: Allocate the transaction price
Step 5: Recognise revenue when a performance obligation is satisfied
The introduction of IFRS 15 will require many software companies to reset their numbers. Those providers operating up-front licence models and with significant associated hardware and professional services revenue will feel the impact most, while cloud-based SaaS providers operating annual subscription models should be much less affected. IFRS 15 is effective for the first interim period within annual reporting periods beginning on or after January 1 2018, with early adoption permitted. Tech giant Google was an early adopter, but the impact was minimal: a $15m revenue hit in Q1 2017 versus $24bn of revenue reported in the quarter. Very few companies in the UK quoted tech sector have already adopted the standard, so the market should brace itself for a swathe of restatements this year. Next stop IFRS 16, which requires operating leases to be recorded alongside financial leases on the balance sheet…but that’s a blog for another time.