How can IFRS impact P&L topline?

How can IFRS impact P&L topline?

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Top-line being a vital indicator of a company's performance, assessing how it can change in the IFRS regime is business critical. It is thus imperative that executives from across the organisation are drawn into the transition process.

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Santosh Maller
As we approach the proposed date of transition to International Financial Reporting Standards (IFRS) in India, it becomes critical to assess the impact IFRS may have on a company's key financial parameters. One such parameter is a company's revenue popularly termed ‘top-line'. IFRS may confront a company with complex issues relating to measurement and/or timing of revenue recognition. In this article, we discuss a few such potential issues.
Multiple-Element Contracts: Many companies provide multiple products and/or services to their customers as part of a single arrangement. For example, software vendors often provide upgrades, training, installation or consulting in combination with a software licence, just as telecom companies sell handsets along with a subscription, and so on.
IFRS requires separate recognition of revenue for separately identifiable components of a single transaction to reflect the substance of the transaction. If an element has commercial substance on its own, its revenue should be recognised separately from other elements. Therefore, recognition of revenue for undelivered items of the contract has to be deferred till they are delivered.
Deferred consideration: IFRS requires revenue to be measured at the fair value of the consideration. Where realisation of the consideration is deferred beyond normal credit period, discounting to a present value is required; as such, an arrangement effectively includes a financing transaction.
This discounting of future receivables is done using an imputed interest rate, which is the more clearly determinable of the prevailing rate for a similar instrument by an issuer with a similar credit rating as that of the buyer or a rate of interest that discounts the nominal undiscounted amount to the current cash sales price. Such deferrals of consideration may be found in related party revenue arrangements within a group.
Embedded Derivatives: Many long-term revenue contracts have features such as price escalation clauses, foreign currency arrangements or other components that are sensitive to separate accounting under the principles for embedded derivatives in IAS 39. An embedded derivative is a component of a combined instrument that also includes a non-derivative host contract — with the effect that some of the cash-flows of the combined instrument vary in a way similar to a standalone derivative instrument.
For example, an Indian company enters into a US dollar-denominated construction contract with another Indian company (say, as part of a global competitive bidding process). In this case, the embedded foreign currency derivative may have to be separately accounted for, in turn, with an impact on the percentage of completion based contract revenue.
Joint Ventures: At present, IFRS allows use of proportionate consolidation for consolidating the financial results and position of joint ventures. In this method, revenues of a joint venture are proportionately included in the consolidated revenues.
There is an exposure draft issued under IFRS, which, inter alia, proposes to prohibit the use of proportionate consolidation method and mandates equity accounting method. Under this method, share of net results of the joint venture are accounted for instead of combining each P&L line item. Therefore, consolidated revenues would be excluding joint ventures' revenue, although consolidated profits would be inclusive of joint ventures' net results. This draft may be issued as a final standard before Indian companies go live on IFRS.
Apart from the ones mentioned above, there can be several other transition issues depending on the company's industry sector, the group structure, distribution channel structure, etc. Since top-line is a vital indicator of a company's performance, assessing the change it may undergo in the IFRS regime will be business critical. This will require careful understanding and assessment of revenue arrangements, improvement of business processes and enhancement of information systems.
It is, therefore, imperative that, apart from the accounting staff, executives from across the organisation are drawn into IFRS transition. Since, this process may take significant effort and time; it is imperative to start early.
(The author is a senior professional in a member firm of Ernst & Young Global. His views are personal.)