As from 1 January 2018, the new revenue standard affects the way you account for revenue. In July 2014, Hong Kong Institute of Certified Public Accountants (“HKICPA”) issued Hong Kong Financial Reporting Standard (HKFRS) 15, “Revenue from Contracts with Customers” that has been revised twice, in September 2015 then in June 2016. HKFRS 15 introduces a new recognition model for contracts with customers. Under the new standard, an entity recognizes revenue when a Performance Obligation (“PO”) is satisfied, ie. when control of the goods or services underlying the particular PO is transferred to the customer. For some, the new standard will have a significant impact on how and when they recognize revenue. The principles in HKFRS 15 provide a more structured approach for measuring and recognizing revenue, and principle guideline is available. All companies are subject to extensive new disclosure requirements.
HKFRS 15 establishes a new five-step model to account for revenue arising from contracts with customers: (1) identify the contract with a customer; (2) identify the PO; (3) determine the transaction price; (4) allocate the transaction price; and (5) recognize revenue when or as PO is satisfied. As a result, revenue is recognized at an amount that reflects the consideration to which an entity expects to be entitled in exchange for transferring goods or services to a customer (instead of the payment profile).
1) Identify the contract with a customer
An entity should account for a contract with a customer when ALL of the following Contract Criteria are met:
1.1 The parties to the contract have approved the contract and are committed to perform their PO;
1.2 The entity can identify each party’s right regarding the goods or services to be transferred;
1.3 The entity can identify the payment terms for the goods or services to be transferred;
1.4 The contract has commercial substance; and
1.5 It is probable that the entity will collect the consideration to which it will be entitled, taking into account consideration of both the customer’s ability and intention to pay. (HKFRS 15.9)
When a contract with a customer does not meet the Contract Criteria above-mentioned, and an entity receives consideration from the customer, the entity shall recognize the consideration received as revenue only when either of the following events has occurred:
- the entity has no remaining obligations to transfer goods or services to the customer and all, or substantially all, of the consideration promised by the customer has been received by the entity and is non-refundable; or
- the contract has been terminated and the consideration received from the customer is non-refundable. (HKFRS 15.15)
2) Identify PO
Distinct test – both the customer’s benefit from the good or service is capable of being distinct; AND the entity’s promise to transfer the good or service to the customer is separately identifiable from o the promises.
3) Determine the transaction price
- need to consider the terms of the contract and its customary business practices
- For variable consideration, either expected value (probability weighted) OR most likely amount, but should be consistently applied throughout the contract. Information can be obtained from the bid and proposal process. Time value should be taken into account also.
4) Allocate transaction price to PO
- On a relative Stand-Alone Selling Price (“SASP”) basis (HKFRS 15.76-80)
- at contract inception
- suitable methods for estimating SASP include:
4.1 adjusted market assessment approach
4.2 Expected cost plus a margin approach
4.3 Residual approach
4.4 Combination of the above
5) Recognize revenue when PO is satisfied
- When the customer obtains control of the good or service (ability to direct the use of, and obtain substantially all of the remaining benefits from the asset) as promised by an entity
- A PO may be at a point in time OR over time
- An entity recognizes revenue over time, if one of the following criteria is met:
5.1 the customer simultaneously receives and consumes the benefits provided by the entity’s performance as the entity performs;
5.2 the entity’s performance creates or enhances an asset (for example, work in progress) that the customer controls as the asset is created or enhance; or
5.3 the entity’s performance does not create an asset with an alternative use to the entity and the entity has an enforceable right to payment for performance completed to date (HKFRS 15.35).
- If a PO is not satisfied over time as above-mentioned, it is assumed to be satisfied at a point in time. (HKFRS 15.38)
Far more prescriptive guidance has been added to deal with specific scenario. In fact, Application Guideline has been included as Appendix to the new standard, and 63 Illustrative Examples (“IE”) have been included as a separate booklet. Whilst there is an assessment that the new standard may affect some specific industries more#, we enlist hereunder some considerations for 3 selected types of industries for your reference:
An entity in the retail sector have to consider if a warranty provides assurance that a product meets agreed-upon specifications only, or if it provides for additional maintenance service. For the latter, separate performance obligation needs to be accounted for.
HKFRS 15 distinguishes between licences that represent the transfer of a right to use an entity’s intellectual property (recognized at a point in time) and licences that represent the provision of access to it over a period of time (recognized over the period of access).
Media companies often offer bundles of goods and services. As an example, a multimedia advertising campaign may include different types of advertising placements such as print, online and television. Entities need to assess whether these advertising services represent separate POs, to which the transaction price will have to be appropriately allocated, or whether they should be accounted for as an obligation.
HKFRS 15 offers 2 major transition options: Retrospective method Vs Cumulative effect method. Using Retrospective method, entities recognize the cumulative effect of applying the new standard at the start of the earliest period presented. There are optional practical expedients so that the new standard is only applied to only those contracts that are not considered completed contracts under current HKFRS at the start of the earliest period presented. Using Cumulative effect method, entities recognize the cumulative effect of apply the new standard at the date of initial application (earliest 1 January 2018), with no restatement of the comparative periods presented. This means that the comparative periods are presented in accordance with current HKFRS. However, entities are required to disclose the quantitative effect and an explanation of the significant changes between the reported results under the new standard and those that would have been reported under previous HKFRS in the period of adoption. This latter method may ease transition burden but would reduce comparability for account users.
The standard also introduces extensive qualitative and quantitative disclosure requirements, including disaggregation of total revenue, information about PO, changes in contract asset and liability account balances between periods and key judgements and estimates.
# Enlist hereunder is an assessment that the different steps in the 5-step model may most likely affect the following industries:
|Some selected industries||Steps|
|Building and construction||√||√|
|Licensors (media, franchisors, life sciences)||√||√||√|
|Telecommunications (mobile networks, cable)||√||√|