Press Release Blog
NEWS, IDEAS, AND INSIGHTS FROM THE SIRION TEAM

IFRS 15 Compliance for Revenue Recognition from Customer Contracts: Is Your Contract Management System Ready?

Globalization continues to flatten the world. This time, in the area of financial reporting. In order to promote transparency, safeguard shareholders’ interests, and enable a meaningful comparative analysis of business performance, organizations are required to report their financial data in a particular manner – as defined by the applicable accounting and financial reporting standards. The …

Globalization continues to flatten the world. This time, in the area of financial reporting.

In order to promote transparency, safeguard shareholders’ interests, and enable a meaningful comparative analysis of business performance, organizations are required to report their financial data in a particular manner – as defined by the applicable accounting and financial reporting standards.

The two prominent financial reporting standards are International Financial Reporting Standards (IFRS) by the International Accounting Standards Board (IASB) and the Generally Accepted Accounting Practices (GAAP) published by the Financial Accounting Standards Board (FASB). While GAAP has been the dominant reporting standard in the US, IFRS has seen wider global adoption.

In recent decades, the growing pace of globalization has created the need for a single set of global accounting standards. Rising to the demand, the IASB and the FASB started working together in 2002 towards aligning and converging their two standards. The convergence process witnessed a significant milestone in May 2014 with the release of IFRS 15, a converged standard on recognition of revenue from contracts with customers.

This new standard necessitates suppliers to recognize revenue as it arises, thus giving due cognizance to the timing of delivery and customer acceptance thereof. The standard applies to all contracts with customers (with limited exceptions) and will take effect from 1st January 2018.

A quick glance at the 5-step compliance framework prescribed under IFRS 15 (see adjoining graphic) and it becomes clear that effective compliance will require a sound contract management foundation. While the challenges discussed here apply to both goods and services contracts, the complexity is significantly higher in case of services due to multiple layers of interconnected performance obligations, complex financial terms with intricate variable considerations, service delivery distributed over multiple years, frequent contract changes, etc.

To begin with, suppliers need to identify their customer contracts and determine which ones fall under the IFRS 15 scope. If only this was as simple as it sounds! The number of Fortune-listed companies that struggle to locate the current version of their contract documents goes up almost every time we speak to one! In this day and age of technology, it sounds almost impossible to believe that large professional businesses don’t yet have this under control. The bitter truth is that most traditional contract repository systems operate as dumping grounds for contract documents but do not support the management of contracts in a dynamic environment where contracts need to be accessed, retrieved, and updated regularly.

The next step is to identify the specific performance obligations – distinct/bundle of goods or services – which have been promised to the customer in the contract. Besides the number of individual obligations and the complexity of the language used to define these obligations, what makes the identification and management of these obligations more complex is the different types of obligations (performance, compliance, financial, etc.), different stakeholders, varying timeframes, and the correlation between linked obligations. To top it all, these obligations often frequently change. The traditional contract lifecycle management (CLM) technology, contrary to its moniker, focuses on the first half of the contracting lifecycle – i.e. contract authoring and does not offer the depth of functionality required to manage individual obligations during the post-signature phase.

Step 3 and 4 get into the financials. A supplier is required to determine the transaction price – the amount it will be entitled to for fulfilling its promise(s). And this needs to be done at the individual obligation level allocating a fraction of the transaction price to each individual obligation. Furthermore, the transaction price needs to take into account conditional additions or subtractions to the negotiated price in the form of discounts, rebates, refunds, credits, penalties, bonuses, etc. The latter half of the above requirement means that this is not a straight forward calculation of the raw financial information provided in the contract. Rather, an intelligent and dynamic computational logic is required that can sense when the applicable discounts should kick-in, when the price needs to be adjusted for volume variations, when performance based adjustments need to be made, etc. The technology set-up that most organizations have does not support this since the payment systems (P2P/ERP) are not integrated to the contract data or the performance data.

The final step 5 relates to revenue recognition. It states that revenue should be recognized in line with the pattern of transfer of control of a promised good or service (completion of the obligation) to the customer. This could happen over time or at a point in time. This makes it critical to pro-actively track and drive performance obligations to closure and ensure close alignment of this obligation management process to the management of the corresponding invoices. In order to support this effectively, a CLM system will need to enable obligation performance through stakeholder assignment, configurable workflows, real-time tracking, alerts, reports etc. Further, it must facilitate the generation of a compliant invoice based on the scope and the rates defined in the contract and the successful fulfilment of those obligations.

IFRS 15 is a great step forward in the simplification of financial reporting for global businesses. But with just over a year to go, a great deal of preparation is required to ensure that effective processes and technology are in place to support this. As part of this preparation, suppliers must closely review their existing approach to contract management (whether managed on spread-sheets or a CLM system) to ensure that their IFRS 15 program is built on a strong foundation and not on shaky grounds.

How are you overcoming these challenges while putting together your IFRS 15 compliance program? You can share your experience by dropping a note in the comments section.

Also, check out our whitepaper IFRS 15 Compliance – In the Driver’s Seat with Sirion to discover how Sirion’s granular contract management functionality during the post-signature phase enables large services suppliers to strengthen IFRS 15 compliance in their customer contracts while realizing higher value in such engagements.

SirionLabs is a Leader

2022 Garner Magic Quadrant for Contract
Lifecycle Management

GET THE FULL REPORT

See SirionOne in Action

One Platform for your Complete Contract Lifecycle Management Journey

SCHEDULE A DEMO
SHARE THIS
COMMENTS