The retail industry continually devises sales strategies to encourage customers to spend and we have seen a number of ways in which the industry has tried to entice consumers to part way with their hard earned dollars. Consumers are targeted with programs that ‘bundle’ products and offer ‘free goods or services’, coupons, discounts and loyalty schemes to encourage repeat purchases, offering chances for customers to win competitions, enter into ‘lucky draws’, etc.
This creativity and variability of retail marketing experts can be a nightmare for accountants trying to prepare the financial report of a retailer. This nightmare is likely to worsen under IFRS 15 Revenue from Contracts with Customers.
The new principle
The core principle in IFRS 15 is to recognise revenue in a way that reflects how the goods or services are provided to the customer. It contains a lot more specific and detailed guidance than the current IAS 18 Revenue standard.
IFRS 15 focuses on the ‘promises’ made to the customer and requires greater separation of the components or ‘promises’ made in the contract. Revenue needs to be allocated to each ‘distinct’ component in proportion to the standalone selling price of each ‘promise’.
When is it effective?
The new standard is effective for annual reporting periods beginning on or after 1 January 2018 with early adoption permitted. For many entities in the retail sector there will be significant need for changes to processes and systems, including far greater liaison between those designing sales packages and the accountants that will need to ensure compliance with IFRS 15.
Implications for the retail industry
Many of these sales promotion initiatives contain a number of separate ‘performance’ obligations which under the new revenue standard, IFRS 15, will each have to be accounted for separately. This will introduce significant complexity to the accounting processes whereby a standalone selling price will need to be introduced for each separate performance obligation, together with a separate profit margin for each.
If the separate ‘performance’ is consumed by the customer at a later date than the goods the customer has purchased, e.g. maintenance contracts, discount vouchers and loyalty rewards, then revenue on these performance obligations will be deferred. This deferral of revenue will move both revenue and profit into later periods, and could have serious implications on paying executive and staff bonuses, paying dividends, and meeting bank covenants.
This complexity should not be underestimated. Processes and systems will need changing, for example to:
- Identify all performance obligations that need to be accounted for as a separate sale
- Assign a value and a profit margin to each separate performance obligation
- Determine when revenue should be recognised on each performance obligation
- Modify systems so that each separate performance obligation is ‘captured’ at date of sale
- Modify systems to recognise revenue on each separate performance obligation at the appropriate time.
IFRS 15 sets out more detailed guidance on variable consideration than IAS 18, with revenue being recognised at the amount expected from the customer which may not necessarily be the same as the invoiced amount. It also contains more specific guidance on principal and agency relationships that can affect revenue recognition when on-costs are charged to the customer; this may be particularly challenging for online retailers.
In this series of articles, we will discuss the following areas likely to significantly impact retailers under IFRS 15:
- Offering ‘free’ goods or services as sales incentives
- Warranties
- Customer incentives
- Gift cards and vouchers
- Right of returns
- Volume discounts and profit margin guarantees
- Slotting/shelving fees.
There is no change to the accounting for customer loyalty programs under IFRS 15, which is the same as under IFRIC 13 Customer Loyalty Programmes.
The commercial effects
The adoption of IFRS 15 may lead to significant changes in the pattern of revenue and profit recognition. Careful consideration and planning will be needed for a wide range of issues, including the effect on:
- Compliance with bank covenants
- Performance-based compensation (including share-based payments)
- Internal budgeting processes
- Corporate tax obligations
- Market and investor communications, including compliance with regulatory requirements (which might arise from significant expected future changes to an entity’s reported financial position or performance).
A review of the terms and conditions of existing contracts will be needed (in particular long term contracts which extend into periods covered by financial statements affected by the adoption of IFRS 15) as well as those which are to be entered into in future. In some cases, entities may wish to consider whether changes should be made to contracts.
Conclusion
The retail industry needs to pay attention to the new revenue standard now. We predict that the new standard will be extremely difficult to apply for the retail industry. It is far more complex than the current accounting standard and can significantly alter the pattern of revenue recognition and pattern of profit for the retail industry. It will not just be a mere accounting change but will have wide spread implications to other business areas, e.g. significant IT systems changes will be required, sales contracts/terms may need to be modified, and marketing campaigns will need to be reconsidered. The impact on revenue will also have a flow on effect to bonuses, bank covenants, dividend payments, and corporate taxes.
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