Several groups in the GCC real estate sector elected to adopt IFRS 15 as early as 2015. The new standard allowed for early adoption and if real estate contracts met certain conditions it allowed real estate companies to recognise their off-plan real estate sales earlier than under International Financial Reporting Interpretations Committee (IFRIC) 15.
All companies have been required to disclose the anticipated impact of IFRS 15 in their previous years’ financial statements. Many businesses stated that the process of performing an impact assessment was ongoing, and therefore it was difficult to gauge the impact for the industry. However, from 31 December 2018, all companies would have adopted IFRS 15 in full and the impact of IFRS 15 will be reflected in all companies’ financial statements prepared in accordance with IFRS.
The objective of IFRS 15 is to establish the principles that companies shall apply to report useful information to users of financial statements about the nature, amount, timing and uncertainty of revenue and cash flows arising from a contract with a customer. However, the standard does require companies to make a number of judgments to determine the applicable accounting treatment, which can lead to significant changes in the timing and quantum of revenue being recognised.
Contractor cash flows remained under significant pressure in 2018 due to challenging economic conditions, compounded by the implementation of VAT from 1 January 2018 in certain territories, which has impacted the certification of work done as certification results in the VAT tax point and hence output VAT being due at that point.
While GCC countries continue their plans to diversify their economies and require continued investment in key projects to help achieve this diversification, the funding of these projects remains a key focus area. GCC countries continue to see an increase in foreign capital flows, with the main source of inflows being sovereign bond issuance, including the $30.5bn Eurobonds raised in the region during the first half of 2018, according to the Institute of International Finance (IIF).
In the construction industry, companies are required to estimate the variable amount of consideration to which they are entitled under the contract. Variable consideration in construction is relevant to unapproved claims and variations. The standard permits revenue recognition to the extent that it is ‘highly probable’ that a significant reversal will not occur when the uncertainty is subsequently resolved. This is a higher bar than previously set in IAS 11, which only required it to be ‘probable’ to be accepted or approved by the customer and that negotiations around claims have reached an advanced stage. This change was driven by the fact that stakeholders are more concerned about the revenue amounts not reversing in the subsequent period for them to predict future revenues better.
The new standard also requires additional disclosures around these judgement areas so users can clearly understand the degree of judgement in the variable revenue taken to book.
As such, the new standard may result in delays in recognition of variable revenue, which could adversely impact the performance of a project in a financial year until the conditions for recognising this variable revenue can be met. This may therefore result in variable margins year-on-year, as costs need to be recognised as incurred. These key judgements are driven by management and are critical to representing the performance of a capital project at the financial year-end and over the life of the contract.
The disclosure requirements under IFRS 15 should provide enhanced information to the users of the financial statements to allow understanding of cash flows arising from contracts with customers, allowing stakeholders to make better decisions in respect of cash flow funding and these key judgements.
Based on the results of the survey conducted by Deloitte in 2016, the two areas that were expected to be particularly challenging for companies implementing IFRS 15 were data gathering, including related processes and information systems; and developing internal controls to ensure the completeness and accuracy of the financial information being presented.
Implementing changes in these areas can require a significant amount of time, resources and costs.
As we progress into the first year of adoption for many companies, we are seeing these expected challenges become reality. Companies need to gather and track new information that was not previously summarised in order to allow revenue recognition conclusions to be made, and judgments to be supported. Further, significant challenges are present in the exercise of forming judgments in applying certain aspects of the new standard. These include:
- Revenue disaggregation (ie, market or type of customer, type of contract, geographical region)
- Identifying performance obligations (a good or service that is distinct or a series of distinct goods or services that are substantially the same and that have the same pattern of transfer to the customer)
- Consideration of variable considerations in the transaction price
- Allocation of transaction price to the remaining performance obligations
Possible commercial sensitivities between stakeholders (ie, shareholders and competitors) that may arise from these disclosure requirements include (but not limited to) the following:
- Exposure of the contractors’ market share, business model and strategy
- Hindrance on future negotiations with customers and financers due to existing contracts with significant financing components
- Exposure of the contractors’ budgets, targets and future cash flows related to its ongoing and confirmed projects in pipeline
Accounting for construction contracts has always required judgment, and the broad principles of IFRS 15 should not, prima facie, have a significant impact on how revenue should be recognised on a construction contract, although the level of certainty around variable revenue has been increased before this revenue can be booked. However, as with many accounting standards, the devil is in the detail, and ensuring a consistent and appropriate basis for revenue recognition represents a key challenge for companies as they transition, in particular in some of the more nuanced areas of the standard.
The responsibility for IFRS accounting standards sits with the International Accounting Standards Board (IASB), an independent, private sector body that develops and approves International Financial Reporting Standards. The IASB operates under the oversight of the IFRS Foundation.
However, regional governments, bodies or regulators can also play a role in the consistent application of standards, in particular on areas specific to economic environments, sectors or countries.
As a starting point, mandating the preparation of financial statements under a consistent accounting framework drives consistency and comparability of financial information. We have seen transitions in certain Middle East territories towards International Financial Reporting Standards, something which is likely to continue over time.
It is clear that regulators consider comparability to be a key foundation for financial information, and the continued focus on financial reporting by a listed company, government and other regulators should continue to strengthen the consistency and comparability of financial information, and application of International Financial Reporting Standards.
About the authors
Cynthia Corby (left) is the Middle East audit and assurance operations and transformation leader, construction industry leader at Deloitte Middle East
Erantha Maithripala is senior manager – audit at Deloitte Middle East
Note: This article mentioned some of the key judgments and disclosure requirements in IFRS 15 Revenue from Contracts with Customers and provides potential challenges and possible commercial sensitivities. However, this article does not cover all the judgments and required disclosures either by IFRS 15 or any other standards.