The coming end of financial year reporting period will be the first period that many entities will be applying the new accounting standards in relation to revenue recognition and leases in their financial statements.
These new standards bring fundamental changes to the way that the majority of entities will account for and report their revenue and lease arrangements.
Whilst many financial statement preparers are well placed to implement the new standards, we are also aware that, for a variety of reasons, many others will not be. To provide assistance with the application of the new standards here is an overview of the mandated changes.
Who do these financial statements apply to?
Any entity that lodges their financial statements with a regulator (e.g. ASIC, Australian Charities and Not-for-profits Commission, Consumer Affairs Victoria)
Companies who are approaching reporting or audit thresholds (e.g. medium or large not-for-profits, large companies, etc.) should also apply these new standards to ensure they are not breaching reporting or audit obligations due to the incorrect application of accounting treatments.
What are the new accounting standards?
- AASB 15 Revenue from Contracts with Customers
- AASB 16 Leases
- AASB1058 Income for Not-for-profit Entities
What are the changes?
AASB 15 Revenue from Contracts with Customers
AASB 15 applies to all contracts with customers, except for contracts covered by other standards, such as leases, insurance and financial instruments. AASB 15 was introduced to harmonise with international reporting requirements, overcome weaknesses in the previous revenue standards, deliver more accurate commercial financial reporting and a single revenue recognition model for investors to understand and compare the revenue of different companies.
AASB 15 stipulates how and when revenue is recorded, requiring entities to provide users of financial statements with more information and reporting disclosures. Its core principle is the recognition of revenue for the transfer of goods or services, at a value that reflects the consideration to which the entity expects to be entitled, in return for meeting performance obligations.
AASB 15 will have the most impact on businesses which involve:
- Bundled products and services.
- Significant warranties/rebates.
- Variability in revenue collectability from contract to contract.
- Contracts where consideration varies.
- Renegotiation of scope/consideration of contracts.
AASB 15 introduces a five-step model for the recognition of revenue from contracts with customers, as follows:
- Step 1: Identify the contract with the customer.
- Step 2: Identify the performance obligations in the contract.
- Step 3: Determine the transaction price.
- Step 4: Allocate the transaction price to the performance obligations.
- Step 5: Recognise revenue when (or as) the performance obligations are satisfied.
Essentially, an entity should evaluate the probability of receiving consideration in exchange for the goods or services provided, taking into account the customers’ ability and intention to pay (including discounts, rebates, refunds, price concessions, incentives and performance bonuses).
The transaction price should be allocated to the performance obligations based on the proportion of their relative stand-alone prices. Stand-alone price is the price at which an entity will sell the promised good or service separately to a customer.
Costs to fulfil a contract with a customer that are not within the scope of any other standard are allowed to be capitalised and amortised.
AASB 16 Leases
AASB 16 supersedes the previous standard, AASB 17. Under AASB 17, an entity’s balance sheet did not need to include the company’s obligation to make future payments on an operating lease even though the future expenditure was committed. This means that balance sheets may not accurately reflect a company’s financial position.
AASB 16 was introduced to fully reflect an entity’s liabilities by providing transparency of leasing activities, a lessee’s financial leverage and the capital employed. The new standard should enable more accurate and understandable financial reports for investors and members, particularly for comparing the positions of entities that borrow to buy assets versus entities that lease assets.
AASB 16 is likely to affect almost every entity to some extent. The new standard will have a significant impact on entities who are ‘lessees’ of assets (e.g. premises, vehicles, office equipment, etc.). For the ‘lessor’ there is no change.
Under AASB 16 a lessee is required to recognise its leases on the balance sheet. This involves recognising:
- a ‘right-of-use’ asset, and
- a lease liability.
The lease liability is initially measured as the present value of future lease payments. For this purpose, lease payments include fixed, non-cancellable payments for lease elements, amounts due under residual value guarantees, certain types of contingent payments and amounts due during optional periods to the extent that extension is ‘reasonably certain’.
In subsequent periods, the lease liability is accounted for similarly to a financial liability using the effective interest method. The right-of-use asset is accounted for similarly to a purchased asset and depreciated or amortised.
AASB 16 provides important reliefs or exemptions for short term leases (i.e. less than 12 months) and low value assets (i.e. less than $5,000).
AASB1058 Income for Not-for-profit Entities
The new requirements are expected to result in better matching of income and related expenses as income recognition will now be deferred when there is a performance obligation or any other liability. For example, if a not-for-profit entity (NFP) receives a grant or donation which comes with a sufficiently specific and enforceable performance obligation, the entity will recognise revenue when it fulfils its performance obligation.
Under the new income recognition model, a NFP first considers whether AASB 15 Revenue from Contracts with Customers applies to a transaction or part of a transaction. In order for AASB 15 to apply to a transaction, the performance obligation(s) arising from the transaction needs to be ‘sufficiently specific’ and ‘enforceable’.
Where AASB 15 does apply to a transaction or part of a transaction, the NFP applies the general AASB 15 principles to determine the appropriate revenue recognition.
When AASB 15 does not apply to a transaction or part of a transaction, the NFP then considers whether AASB 1058 applies. AASB 1058 will apply when a NFP:
- enters into a transaction where the consideration to acquire an asset is significantly less than fair value principally to enable the NFP to further its objectives and
- receives volunteer services (recognition of volunteer services is only mandatory to entities in the public sector).
Under AASB 1058, the timing of revenue recognition will typically be aligned with the receipt of cash (e.g. grant funding).
AASB 1058 includes specific requirements with respect to grants for construction or acquisition of recognisable non-financial assets.
When a NFP receives a grant to construct a building to be controlled by the NFP, the funds received are initially recognised as a financial asset (cash) with a corresponding liability (obligation to construct the building). Subsequently, the liability is derecognised as the performance obligation is satisfied (i.e. as the construction of the building is completed).
Where a NFP receives a grant to acquire specific assets, it recognises income when the relevant assets are acquired.
You should contact our Audit Director, Jason Hargreaves, on (03) 5331 3711 or via email to:
- determine if the new standards will impact you
- determine what the impact of the new standards will be
- discuss the transitional arrangements that are in place (e.g. whether comparative figures need to be changed)
- discuss the additional financial reporting obligations (e.g. financial policy disclosures)
- determine whether you require assistance with the application of the standards
DISCLAIMER: The material and contents provided in this publication are informative in nature only. It is not intended to be advice and you should not act specifically on the basis of this information alone. If expert assistance is required, professional advice should be obtained.