IFRS 15 Revenue from contracts with customers

IFRS 15 Revenue from contracts with customers Ida Skog Bachelor's thesis Business administration Turku 2018

BACHELOR S THESIS Author: Ida Skog Degree Program: Business Administration Specialization: Accounting Supervisor(s): Marika Nygårds Title: IFRS 15 Revenue from contracts with customers Date 30.11.2018 Number of pages 31 Appendices 1 Abstract Globalization has had a big impact on the market and modern economies rely on crossborder transactions and a seamless cashflow. The number of cross-border transactions is expected to grow in the future, so it is vital that the reporting is meeting today s demands. This is where the international Financial Reporting Standards come in. The IFRS -standards help to give a more efficient, transparent accountability to the business world. In January 2018, a new IFRS standard was taken into use, the IFRS 15 -revenue from contracts with customers. The scope of this thesis is to give a clear and defined picture of what IFRS 15 is and what changes this new standard brings to organizations. In this thesis the research is conducted with several different outlets for the theory portion and an interview, with an IFRS 15 specialist, is conducted. The interviewee is giving insight into the practical side of IFRS 15; what the challenges have been with the implementation, what changes there is for the reporting process and what the overall spirits are for this change. Language: English Key words: IFRS, Accounting, Finance

EXAMENSARBETE Författare: Ida Skog Utbildning och ort: Företagsekonomi Inriktningsalternativ/Fördjupning: Redovisning Handledare: Marika Nygårds Titel: IFRS 15- Revenue from contracts with customers Datum 30.11.2018 Sidantal 31 Bilagor 1 Abstrakt Globalisering har haft en stor inverkan på marknaden och den moderna ekonomin är beroende av gränsöverskridande transaktioner och ett flytande kassaflöde. Antalet gränsöverskridande transaktioner väntas att öka i framtiden, därför är det vikrtigt att rapporteringen uppfyller dagens krav. Det är här de internationella redovisningsstandarderna kommer in. IFRS- Standarderna hjälper till att ge en effektivare, tydligare och mer ansvarsfull i business världen. I januari 2018 en ny IFRS- standard sattes igång. IFRS 15 omsättning från avtal med kunder. Syftet med denna avhandling är att ge en tydlig och definierad bild av vad IFRS 15 är och vilka förändringar den nya standarden ger till organisationer. I denna avhandling utförs forskningen med flera olika källor för teoridelen och en intervju med en IFRS 15 -specialist. Intervjuaden ger insikt om den praktiska sidan av IFRS 15; vad utmaningarna har varit med implementeringen, vilka förändringar det förekommer för rapporteringsprocessen och vilken anda denna standard har givit år organisationerna. Språk: Engelska Nyckelord: IFRS, Bokföring, Finansväsen

OPINNÄYTETYÖ Tekijä: Ida Skog Koulutus ja paikkakunta: Liiketalous, Turku Suuntautumisvaihtoehto/Syventävät opinnot: Laskentatoimi Ohjaaja(t): Marika Nygårds Nimike: IFRS 15 Revenue from contracts with customers Päivämäärä 30.11.2018 Sivumäärä 31 Liitteet 1 Tiivistelmä Globalisaatiolla on ollut suuri vaikutus markkinoihin ja nykyaikaiseen taloudet luottavat raja-ylittävään liiketoimintaan ja saumattomaan kassavirtaan. Rajaylittävien liiketoimien määrän odotetaan kasvavan tulevaisuudessa, joten on tärkeää että, raportointi vastaa nykyisiä vaatimuksia. Tässä kansainväliset tilinpäätösstandardit tulevat mukaan. IFRS - standardit auttavat antamaan entistä tehokkaamman, läpinäkyvämmän ja vastuulisemman liiketoimintamaailman. Tammikuussa 2018 otettiin käyttöön uusi IFRS -standardi, IFRS 15 -tulot asiakkaiden kanssa tehdyistä sopimuksista. Oppinäytetyön tarkoituksena on antaa selkeä ja tarkka kuva siitä, mitä IFRS 15 on ja mitkä ovat muutokset joka tämä uusi standardi tuo organisaatioille. Tässä oppinäytetyössä tutkimusta tehdään useilla eri teoria lähteillä, ja haastattelu tapahtuu IFRS 15 spesialistin kanssa. Haastateltava antaa tietoa IFRS 15:n käytännön puolelta; mitä haasteita on ollut toteutuksen kanssa, mitä muutoksia on raportointiprosessissa ja miltä tämä uusi standardi tuntuu, muutoksien kannalta. Kieli: Englanti Avainsanat: IFRS, Kirjanpito, Finanssiala

Table of Contents 1 Introduction... 1 1.1 Problem and purpose... 1 1.2 Limitations... 2 1.3 Research method... 2 2 International Financial Reporting Standard... 2 2.1 IFRS 15... 3 2.2 Disaggregation of revenue... 3 3 A five-step model approach... 4 3.1 Identify the contract with a customer... 5 3.2 Performance obligations... 7 3.3 The transaction price... 8 3.4 Allocating the transaction price... 9 3.5 Revenue recognition... 9 3.6 Example of the five-step model... 10 4 Changes... 12 4.1 Changes in different areas... 13 4.1.1 Changes in the cross functional areas... 14 4.2 Specific issues for different sectors... 15 4.2.1 Media and entertainment sector... 15 4.2.2 Technology sector... 16 4.2.3 Automotive, retail and consumer products sector... 16 4.2.4 New challenges... 17 4.3 Disclosure requirements for financial statements... 17 4.3.1 New disclosures... 17 4.3.2 Existing requirements for disclosures... 19 4.3.3 Expanded requirements for disclosures... 19 4.3.4 Conclusion... 20 4.4 Presentation on the financial statements... 20 4.4.1 Illustrative example KONE Corporation... 22 4.4.2 Impact on KONE corporation... 25 5 Empirical research... 25 5.1 Interview... 25 5.2 Implementation of IFRS 15... 26 5.3 Impact of IFRS 15... 26 5.3 Comparison of industries under IFRS 15... 27

5.4 Importance of proper training for IFRS 15... 27 5.6 Benefits of IFRS 15... 28 5.6 Future of IFRS 15... 28 5.7 Outcome of IFRS 15... 29 6 Analysis... 29 7 Critical examination... 30 8 Conclusion... 31 References... 32 Appendices...Appedix 1 Figure 1: Example of categories for revenue from contracts with customers... 4 Figure 2: Five-step model for recognizing revenue according to IFRS 15 (Lehr, 2017) 5 Figure 3: Decision tree for contract modification (Lehr, 2017)...6 Figure 4: Identifying the performance obligations.10 Figure 5:Determining transaction price... 10 Figure 6:Allocating the transaction price... 11 Figure 7: Recognizing revenue per period... 12 Figure 8:Cross functional areas that will be impacted by IFRS 15 (Lehr, 2017)... 13 Figure 9: Illustrates the disaggregation of revenue (EY, 2017)... 20 Figure 10:Consolidated balance sheets (EY, 2017)... 21 Figure 11: Example of sales fluctuation (Roberto Molteni, 2017)... 22 Figure 12: Example of the difference compared to IFRS 15 (Roberto Molteni, 2017) 23 Figure 13: Key figures (KONE, 2018)... 24

Abbreviations IASB International Accounting Standards Board IAS International Accounting Standards US GAAP United States Generally Accepted Accounting Principles IFRS International Financial Reporting Standards IFRS 4 Insurance Contracts IFRS 9 Financial Instruments IFRS 10 Consolidated Financial Statements IFRS 11 Joint Agreements IFRS 15 Revenue from Contracts with Customers IAS 11 Construction Contracts IAS 17 Leases IAS 18 Revenue IAS 27 Consolidated and Separate Financial Statements IAS 28 Investments in Associates and Joint Ventures IFRIC International Financial Reporting Interpretations Committee IFRIC18 Transfers of Assets from Customers SIC Standard Interpretations Committee SIC-31 Revenue Barter Transactions Involving Advertising Services

1 1 Introduction International Financial Reporting Standards (IFRS) is used in listed companies. IFRS is a global accounting standard. Globalizations has had a big impact on the market and modern economies rely on cross-border transactions and a seamless cashflow. The number of crossborder transactions is expected to grow in the future, so it is vital that the reporting is meeting todays demands. In the past these kinds of cross-border transactions were complicated because every country had their own national accounting standards. This added transaction costs, complexity and risks to companies making the financial reports and the shareholders making economic decisions based on these reports. IFRS solves this complexity and highrisk problem by providing a set of quality and internationally recognized accounting standards. This international reporting standard gives transparency, liability and efficiency to markets around the world. (IFRS, 2017) IFRS consists of many different parts, but this thesis concentrates on IFRS 15. This standard is used when reporting and recognizing revenue from contracts with customers. The standards effective date was 1 January 2018, which makes this a new reporting standard. In the IFRS 15 -standard the directions are more precise on how to report, than what they were in the previous standards. This standard is meant to give accurate and meaningful information of the sales and the nature, timing and uncertainties of the cashflow, to those who need it. (KPMG, 2017) 1.1 Problem and purpose The problem with the IFRS 15 is that it is new, and it must be correctly understood and implemented to be efficient. Not only does IFRS 15 have a high impact on the reporting and accounting processes, but it also has an impact on the cross functional areas in an organization. The standard is very important for international transaction reporting. It is crucial for organizations to understand this standard correctly otherwise it could lead to bad results financially. The aim of this bachelor s thesis is to get a clear and defined picture of what IFRS 15 is and what changes the standard is going to bring to the organizations.

1.2 Limitations 2 The IFRS is a system that is consisting of many standards. This thesis is only focusing on the IFRS 15 -revenue from contracts with customers. It concentrates on what IFRS 15 is and what the changes are for the organization and how it differs from the standards that it replaces. 1.3 Research method The methods used for this study are qualitative research method in a form of an interview with an IFRS expert. The literature is from various scientific articles, primary sources and relevant literature. 2 International Financial Reporting Standard To understand the IFRS 15 we must look at the background and basics of International Financial Reporting Standards. The IFRS -standards are developed and published by the international accounting standards board 1. (IFRS, 2017) The IFRS consists of regulations and accounting standards, for how particular transactions and events should be reported in financial statements. The reason why these standards were developed was that organizations around the world would have a common accounting language. These standards are meant to provide information on what is happening in a company. (Investopedia, 2017) IFRS are used in the EU and countries in Asia and South America, however, it is not used in the United States. Around 90 countries are using IFRS to its full extent. The Companies that benefit the most from IFRS, are the ones doing a lot of international business and investing. (AICPA, 2017) According to the EU law for International reporting standards Regulation (EC) No 1606/2002, all listed companies must prepare their financial statements with a set of international standards. These standards are the IFRS, previously known as International Accounting Standards 2. Regulation (EC) No 1126/2008 says that when a new standard is issued at EU level, the commission publishes a regulation that is directly used in all EU countries. (Commission, 2017) 1 IASB 2 IAS

2.1 IFRS 15 3 IFRS 15 replaces various existing standards and introduces a new model for revenue recognition. The reason for a new standard is that the previously set complex revenue recognition standards left too much room for free interpretation, and the standards were seen more as guidance than regulations. The standards are set by the International Accounting Standard Board and the Financial Accounting Standards Board. The new IFRS 15 reporting standard is being effective for companies beginning on or after 1 January 2018. The standard replaces the previous IAS 11, IAS 18, IFRIC, IFRIC18 and SIC-31 reporting standards. (iasplus, 2018) The IFRS 15 standard compels companies to launch a more informative and useful financial statement. The financial statement states the nature, amount, uncertainty and timing of the company s contracts with customers. There are other IFRS standards that cover customer contracts, but according to the publication from IASB, IFRS 15 paragraph 5 the exceptions that do not fall under the IFRS 15 are: IAS 17, IFRS 4, IFRS 9, IFRS 10, IFRS 11, IAS 27 and IAS 28. Also, non-monetary exchanges between units that practice the same business to stimulate sales, are not part of IFRS 15. (Lehr, 2017) One of the fundamental reasons to why this new standard came about, because the United States does not use IFRS standards, instead they use US Generally Accepted Accounting Principles 3, and are therefore recognizing revenue differently. The Boards want to unify the countries who use IFRS and US GAAP reporting standards, so that the reporting would become similar. This effort lead to a five-step approach for recognizing revenue. This fivestep model will be discussed in the next chapter. The new IFRS 15 offers a transparent and equal over industries standardized approach, for revenue recognition. It lowers the difficult structure and the companies must only implement one standard instead of many different ones. (Lehr, 2017) 2.2 Disaggregation of revenue The new IFRS 15 standard requires the revenue from contracts with customers to be divided into categories. The categories should tell how the amount, uncertainty, timing and nature of cash flow and revenue are affected by economic factors. An organization must also release 3 US GAAP

the information on the relationship between the divided revenue and information on the organization s disclosures. (KMPG, 2015) 4 Geography Timing of transfer of good or service Example categories Contract duration Type of good or service Market or type of customer Figure 1: Example of categories for revenue from contracts with customers When determining the categories, a business studies how revenue is divided. What the business looks at are; disclosures presented outside the financial statements 4, the information that the chief operating decision maker for financial performance reviews and other similar information that is used by the organization or users of the organization s financial statements to evaluate performance. (KMPG, 2015) 3 A five-step model approach The five-step model approach is used to recognize when and where, the sales proceeds, should be recorded. How difficult the stage/s of the five-step model is for a company, depends on which industry it operates in. The model is based on the fact that the sales proceeds are recorded in such a way, as it is described of the promised goods or services to the customer, and the amount that the organization expects to be entitled to. (KPMG, 2017) 4 Earnings releases, annual reports, or investor presentations

5 Step 1: Identify the contract(s) with a 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 in the contract Step 5: Recognize revenue when (or as) the entity satisfies a performance obligation Figure 2: Five-step model for recognizing revenue according to IFRS 15 (Lehr, 2017) In the following sub-chapters, the five-step model will be explained in detail. 3.1 Identify the contract with a customer According to the IFRS 15 manual, published by the IASB, paragraph 9 says that the following conditions must be fulfilled so that the contract with a customer can be considered valid; a) The parties to the contract have approved the contract and are committed to perform their respective obligations b) The entity can identify each party s rights regarding the goods or services to be transferred c) The entity can identify the payment terms for the goods or services to be transferred d) The contract has commercial substance (i.e. the risk, timing or amount of the entity s future cash flows is expected to change because of the contract) e) It is probable that the entity will collect the consideration to which it will be entitled in exchange for the goods or services that will be transferred to the customer. In evaluating whether collectability of an amount of consideration is probable an entity shall consider only the customer s ability and intention to pay that amount of consideration when it is due. The amount of consideration to which the entity will be

6 entitled may be less than the price stated in the contract if the consideration is variable because the entity may offer the customer a price concession According to paragraph 14, the company will continue to review the contract if a customer contract does not meet all conditions at once. (IFRS, 2014) One big challenge in contracts with customers is contract modification. If a customer wants to change their service. In the telecommunications industry, for example, it is common to change the phone plan. The organization must distinguish if the contract change can still be a part of the previous contract, or if this modification must be a new contract. Figure 3 will help to distinguish if a new contract is needed or not. Contract definition Modification of contract results in the additional goods or services? YES Subject of the modification is priced at standalone selling price? YES New contract No No Previous contract Figure 1: Decision tree for contract modification (Lehr, 2017) To summarize the first step; the contract must meet the requirements set by IASB. Contracts can be in different forms, but they must be executable, have profitable substance and be approved by the parties. The company can continually review the contract to determine if it successively meets the criteria. (ACCA, 2014)

3.2 Performance obligations 7 When the contract is ready, the next step is to fulfill the obligations. Performance obligations in the contract is the promise to transfer goods and services to a customer. This step entails the identification of the separate performance obligations in the contract. The good or service is separable, if the customer can benefit from the good or service either individually or combined with other goods or services. (KPMG, 2017) According to the IFRS 15 manual, published by IASB, paragraph 22 the following conditions must be met so that the goods or services that have been promised and identified as a performance obligation can be measured; a) A good or service (or a bundle) that is distinct, or b) A series of distinct goods or services that are substantially the same and that have the same pattern of transfer to the customer According to IFRS 15 paragraph 29, factors that indicate that an organization promise to transfer a good or service to is not separately identifiable; a) The entity does not provide a significant service of integrating the goods or services promised in the contract, b) The goods or services do not significantly modify or customize another good or service promised in the contract c) The goods or services are highly interrelated or highly interdependent with other goods or services promised in the contract (IFRS, 2014) If we go back to the telecommunication example, in this step, the distinguished separate performance obligation plays a central role. A separate performance obligation exists if the customer receives separate goods and services and because of this can benefit from each service individually. In the telecommunications industry the service provided monthly is measured based on the same monthly principle. (Lehr, 2017)

8 In the second step it is required to identify the separate performance obligations within the contract. This is often called unbundling and it is executed at the beginning of the contract. IFRS 15 requires a series of distinct goods or services, which are considerably the same with the same pattern of transfer, to be a single performance obligation. IFRS 15 does not provide criteria to determine when a good or service is distinct within the context of the contract, but it provides indicators. This gives the management the freedom to apply their judgement to determine the separate performance obligations that best reflects the financial matter of a transaction. (ACCA, 2014) 3.3 The transaction price To determine the transaction price is self-explanatory, in this step the transaction price is determined (i.e. the amount which an organization can expect for the exchange of goods and services). There are a few factors that must be considered when determining the transaction price: 1) The transaction price can be fixed, variable or a combination of these 2) It must be identified if the contract includes a significant financing component, which requires an adjustment to reflect the time value of money 3) A consideration allocated to a customer might represent a reduction of the transaction price 4) An entity must identify if the contract has variable considerations 5 that must be estimated. (Lehr, 2017) In step three, the transaction price must be determined. The transaction price does not include the amount from a third party, for example government taxes. The way a variable consideration should be estimated is according to either the expected value or the most likely amount. If it happens that a company finally accepts an amount lower that what was first promised in the contract, then revenue would be estimated at the lower amount. This can happen for example if there are discounts given. (ACCA, 2014) 5 Can include discounts, refunds rebates price concession, incentives, performance bonuses or penalties.

3.4 Allocating the transaction price 9 In a situation when an organization has a contract with a customer, and the contract has many different performance obligations, then the organization must give the transaction price respectively to each performance obligation in proportion to its single unit selling price. If there is a complication and the stand-alone price cannot be determined, then the business must foresee the transaction price. (Lehr, 2017) 3.5 Revenue recognition When the process has proceeded this far, to the revenue recognition, the organizations must use the new standard with the accounting. The first step in this process is to look at the identified performance obligations and the transaction prices. In this context control of an asset is the ability to direct the use of an asset and gaining all the remaining benefits from the asset. The remaining benefits can cause cash inflows for the entity. Consistent measurement is crucial, because the revenue amounts need to be remeasured at the end of the reporting period. So that an organization can understand the timely satisfaction of each performance obligation, the company must select an appropriate output or input method. IFRS 15 differentiates between output and input methods to measure progress to recognize a performance obligation. The output method is the direct measurement of the value to the customer of the goods or services transferred to date, relative to the remaining goods or services promised under the contract. The input method is an organizations efforts or inputs toward the satisfaction of a performance obligation 6 relative to the total expected inputs. When using the output method, the date is used as the point of measurement. This means what has been delivered by the organization must be differentiated. For example, at one certain milestone, from what has been delivered and which goods and services need to be delivered in the future. In the input method if the organizations efforts or inputs are used evenly throughout the performance period, it may be appropriate for the business to recognize revenue on a straight-line basis. A straight-line basis is a method that enables an organization to allocate a resource cost over several years. (Lehr, 2017) 6 For example, resources consumed, labor hours expended, costs incurred, time elapsed or machine hours used.

3.6 Example of the five-step model 10 In the next chapter an example of the five-step approach will be demonstrated. In this example a customer signed a legally binding contract to buy a phone for a stand-alone selling price of 500 euros and a service flat rate for 12 months. The cost of this is 80 euros per month. Also, as a part of the contract the customer must pay an upfront fee for the phone and the monthly fee. This is 50 euros for the phone upfront and 80 euros for the monthly fee. In the first step, the contract must be identified, and it must meet all the conditions. In the second step the performance obligations of the contract must be identified. Performance obligations in a contract include promises to transfer goods or services to a customer. In table 4 the identified performance obligations can be seen. Figure 3: Identifying the performance obligations In this case two performance obligations have been identified; the service and the device. Next, in step three, the transaction price must be set. At this point, when setting a transaction price, it is important to consider financing components. The important factor here is that for the basis of revenue that is going to be recognized the cash selling price, that would have been obtained, is used. Figure 4:Determining transaction price

11 Variable considerations can occur. These can for example be discounts, rebates, incentives and refunds. In this case however there are no variable considerations. Step four is to determine the correct allocation for the performance obligation to the transaction price. In this case what is known is that the stand-alone selling price is 500 euros for the phone and 960 euros for the service. When this is known we need to calculate the allocation factor. This shows how much of the price will be divided on the device and how much on the service. The sum of the both performance obligations is 1 460 euros 7. What has to be remembered is that the transaction price of both performance obligations is 1 010 euros. The percentage of each performance obligation is the allocation factor. This means: 500 euros /1 460 euros = 34,24 % for the phone 960 euros /1 460 euros = 65,75 % for the service After this the percentages have to be multiplied with the transaction price, 1 010 euros, to calculate the amounts for both performance obligations. This can be later used in the financial statements. 1 010 euros x 34,24 % = 345, 70 euros 1 010 euros x 65,75 % = 664,10 euros Figure 5:Allocating the transaction price 7 Device 500 euros + service 960 euros

12 It is time to recognize revenue in the final step. The data that has been calculated earlier identifies how much an organization can book in each period. IFRS 15 allows the organization to book the total amount of the device (345,70 euros) directly in the first period. However the service fee has to be divided in to 12 months, that is the whole contract period. Therefore each month can be booked 55,35 euros. Figure 6: Recognizing revenue per period As seen in figure 7, the total amount of the device can be booked in the first period (T1) and the 1/12 of the service fee, which is 401,05 euros in total. From T2 -T12 the revenue amount that can be recognized each period 8 is 55,35 euros. (lehr, 2017) The previous example is to show the five step model method for recognizing revenue under the IFRS 15 -standard. This is also how organizations must recognize their revenue effective 1 st of January 2018. 4 Changes The new IFRS 15 -standard will not just impact one area in an organization, but it will impact the organization in numerous ways. The new standard requires new technology or technology update so that an organization can uphold the requirements that are set by the IFRS 15. Outside the organization, IFRS 15 naturally has an impact on any of the organizations stakeholders, because of the new revenue recognition timing and scope. (Lehr, 2017) 8 One period is the length of one month

4.1 Changes in different areas 13 The application of IFRS 15 will most likely impact all processes related to revenue recognition, not just the accounting. The final impact will be dependent on what the organization offers, for example the type, the number of contracts and the bundle of products and services that are provided. The organizations may need to make changes in their processes, organization and technology, for them to be able to use IFRS 15. The areas that will be impacted are revenue-related processes 9, organization 10 and the systems in the CRM area 11. Because IFRS 15 is an accounting standard that applies to all contracts with customers to provide goods or services in the ordinary course of business, the standard comes with a wide, cross-functional reach and impact. There are areas that will be impacted by the adoption of IFRS 15. These can be seen in figure 8. (Lehr, 2017) Enterprise risk and control Processes Management information Operations in business Tax accounting and methods Change management IT systems Figure 7:Cross functional areas that will be impacted by IFRS 15 (Lehr, 2017) As can be read from figure 8 revenue recognition impacts the entire organization. When it comes to processes and systems IFRS 15 increases the trend of revenue automation, this means that excel and manual processes will be replaced. The change also impacts the quoteto-cash cycle 12 and involvement of IT is crucial. The changes for the core of the organization 9 Planning, procurement, supply chain, billing, customer management, contracting and legal 10 The new technology to enable revenue recognition will impact this area 11 Billing, contract management, order management, planning, consolidation and reporting 12 The process that is responsible for driving revenue for the organization; CRM, ERP-system and encompassing the entirety of sales

14 is going to be changing some business models, changing the pricing structure and impact on compensation. The cross-functional impacts are going to affect human resources, sales, legal, tax, financial planning and analysis, investor relations, audit committee and executive management. Under IFRS 15 there is going to be a significant impact on accounting and reporting as well, some of these are changes to revenue model, judgement and estimates and additional disclosures on financial statements. (Pwc, 2014) 4.1.1 Changes in the cross functional areas There are some changes that occur in the cross functional areas under IFRS 15. The areas, enterprise risk and controls should be revised. Companies must also give information on how processes are going to change, based on what is needed by internal auditors and compliance. IFRS 15 also has an impact on the accounting manuals and chart of accounts. Every organization should update its accounting manual to fill all the new IFRS 15 requirements. Also because of the different accounting in the local entity and the group reporting the chart of account in the accounting software needs to be updated. (Lehr, 2017) Locally and globally IFRS 15 gives a more transparency and control for organization. That is why more centralized and standardized operations of business must be set. There is going to be more higher complexity in revenue accounting and new pricing strategies must be implemented. Within tac accounting the impact of IFRS 15 will be country specific. It also will depend on the tax laws in each country. The reason for this is because the changes of the timing of revenue recognition the standard impacts on how deferred taxes are booked. (Lehr, 2018) For management information and investor relations it is crucial that all information about the changes of IFRS 15 is disclosed, because of the new timing, scope and revenue recognition of the standard. Management needs to know the full impact on the key performance indicators and financial statements. That is why in the annual reports a qualitative as well as a quantitative disclosure is needed. It is recommended that in all organizations the operations managers at all levels are involved in the implementation and the rollout of the standard. (Lehr, 2018) IFRS 15 requires more detailed information on organizations annual reports, therefor companies may need a re-design or modification to the IT systems, internal controls and processes. The accounting systems should be designed so that it is adjustable and it can catch all the new detailed infromation that is necessary under IFRS 15. The accounting system will

15 also need to be flexible to cope with changes in pricing and other product offers. The transition complexity depends on how many IT systems are involved. The key data that is being gathered comes from billing, commission, data warehouse systems and CRM. (Lehr, 2017) As can be read the cross functional impact is also high and therefor the organizations need to be aware of all the changes. The organizations also need to be prepared in early so that the transition and implementation of IFRS 15 is smooth and efficient. 4.2 Specific issues for different sectors With the new IFRS 15 -standard comes a new revenue recognition process. This process is going to be different for a variety of different sectors. There are different aspects to take to account, and every sector cannot be put under the same roof. The issues and changes depend on the organizations business models. In the following sub-chapters a few different sectors will be discussed and how IFRS 15 will impact and which issues will most likely arise in that sector. 4.2.1 Media and entertainment sector When producing a film, the organization must determine whether the whole contract or only elements of it are in the scope of IFRS 15. This can become challenging because there are many elements when it comes to producing a film. After granting a license for a project, the activities of the licensor might have consequences on the timing of revenue recognition. When it comes to licensing agreements it is necessary to determine whether one or multiple performance obligations exist, and what revenue recognition pattern should be used. In the media and entertainment sector the criteria for principal and agent assessment does not change. Royalties that are based on sales and usage are treated differently, because the estimate variable consideration requires significant judgement and an assessment of the potential change in the price structure. (EY, 2014) The impact of IFRS 15 in the media and entertainment industry will be an impact of medium level. The factors that will be mostly impacted are licenses, variable considerations and multiple element arrangements. (Pwc, 2014)

4.2.2 Technology sector 16 In the technology sector, degree of customization and integration of components as well as on the right to payment is what the outcome of revenue recognition is dependent on. The contracts that concern integrated solutions is necessary to conclude whether one or multiple performance obligations exist and what revenue recognition pattern is appropriate. (EY, 2014) The extended payment terms might result in an organization having to recognize interest on revenues. Depending on, whether a new performance obligation is created and pricing of that, the accounting for contract modifications is complex and differs significantly on the pricing. As in the media and entertainment sector, the activities of the licensor after granting the license might have consequences on the timing of revenue recognition. (EY, 2014) The impact of IFRS 15 in the technology industry will be an impact of high level. The factors that will be mostly affected are licenses, multiple element arrangements and variable considerations. (Pwc, 2014) 4.2.3 Automotive, retail and consumer products sector Under the new IFRS 15 -standard an evaluation and identification of all contracts as separate performance obligations is required. Specific issue for automotive organizations are that the cash incentives and incentives to provide free or discounted goods can be seen as separate performance obligations. Also, the judgement for weather a warranty is an assurance-type or service-type warranty, will need professionals. (EY, 2014) In the retail and consumer products professional judgment will be required in the estimation of returns and the accounting of loyalty programs, reseller agreements and licensing and franchising agreements. Revenue will need to be reported as net of sales taxes and the transaction price must exclude any amounts from third parties. As in the automotive sector judgement for the determination of whether a warranty is an assurance-type or service-type warranty is required to come from a professional. (EY, 2014) The automotive industry will be impacted on a high level. The factors that will be affected are subsidized services, warranties, tooling and products. The judgements of services and warranties has to be by professionals. (Pwc, 2014)

4.2.4 New challenges 17 In summary the factors that will be impacted across industries are new disclosures, staff needs to be trained and educated properly, revision of all contracts is required and assessment of collectability and time value of money. (Pwc, 2014) The challenges that an organization are going to face are the application of the technical accounting, the increased judgement by management, project management, operational process and system changes, data gathering and analysis and communications. (Pwc, 2014) When implementing IFRS 15 the factors for a successful transition are an early preparation and analysis of how the standard affects finances, shareholders and the way an organization does business. An organization must develop an approach that effectively influences the transition period and establish a vigorous governance structure 13. The project management and change management protocol must be agreed to and it is crucial to document everything, to maintain an audit. (Pwc, 2014) 4.3 Disclosure requirements for financial statements In comparison to the older standard, that IFRS 15 is replacing, the new IFRS 15 has explicit presentation and disclosure necessities. Under the IFRS 15, in the organizations interim and annual financial statements, there is going to be an increase in the volume of required disclosures to the financial statements. There are many things that organizations did not disclose, in the previous standard, but that IFRS 15 requires information of. In the previous IFRS standards, the revenue recognition closures were provided with brief disclosures. This lack of information could have been due to limited guidance. According to IFRS 15 paragraph 105 the contracts with customers is presented on an organizations financial statement as a position of a contract liability, a contract asset or a receivable. This depends on the organizations performance and customer s payment. (EY, 2017) 4.3.1 New disclosures There are many new changes when it comes to disclosures under the IFRS 15. The disclosures that has information about the contract balances are as follows; the new standard requires more specific information on the fiscal or annual financial statements, the 13 Dictates the policies of the organization, relationship between staff and the board, and the role and use of committees http://literacybasics.ca/board-governance/governance-structures/

18 recognized amount of revenue in the current period and the amount of revenue recognized of performance obligations that has been satisfied in previous periods. (KPMG, 2017) IFRS 15 standard requires an explanation for how the timing of performance obligation satisfaction relates to the typical payment terms and how these factors will affect the contract asset and contract liability balances. An explanation of the changes in the balances of contract assets and contract liabilities, including both qualitative and quantitative information, is required. Examples could include: Changes that arose from business combinations, increased catch-up modifications to revenue arising from a change in the measure of progress 14, damage of a contract asset, changes in the timeframe for a right to consideration becoming unconditional 15 or for a performance obligation to be satisfied 16. (KPMG, 2017) New disclosure requirements that concern performance obligations are; significant payment terms in the organization, for example if the contract has a significant financing module, if the consideration is adjustable and if the adjustable consideration is controlled. The aggregate amount of the transaction price allocated to performance obligations that are unsatisfied at the reporting date, this should also include a quantitative or a qualitative explanation of when the organization expects that amount to be recognized as revenue. (KPMG, 2017) The organization must apply significant judgement when using IFRS 15, for performance obligations that are satisfied over time. An organization must describe the method used to recognize revenue. For example, why such methods are the right way of transferring the goods and services. An organization also discloses information of the methods, inputs and assumptions used to determine the transaction price, allocation of the transaction price and what is used to measure obligations for returns and refunds, and other similar obligations. (KPMG, 2017) An organization also discloses, in the financial statements, the transaction price that arose from obtaining or fulfilling a contract with a customer, these costs are the amount of amortization and any recognized impairment losses in the reporting period. These costs are separated by their main category, acquisition costs, pre-contract costs, set-up costs and other execution costs. An organization must also describe the judgement that has been made when 14 A change in the estimate of the transaction price or a contract modification 15 Reclassified to a receivable 16 The recognition of revenue arising from a contract liability

19 determining the amount of the costs incurred when obtaining or fulfilling a contract with a customer, and the method that has been used to determine the amortization for each reporting period. (KPMG, 2017) As can be seen there are many new disclosures. These are all new disclosures to be disclosed on financial statements, under the IFRS 15. There are also existing requirements that are from the previous standards that IFRS 15 substitutes. These requirements will be talked about in the next sub-chapter. 4.3.2 Existing requirements for disclosures There are a few previously existing disclosure requirements that have been passed on to be included under the IFRS 15 standards. The organization must disclose when the organization typically satisfies its performance obligations 17. Obligations for returns, refunds and other similar obligations, must also be disclosed. For the performance obligations that are satisfied over time, an organization must describe the method that has been used to recognize revenue with a description of the output or input method and how those methods are applied. (KPMG, 2017) 4.3.3 Expanded requirements for disclosures Similar disclosure requirements already exist under current standards; however, they are more detailed or specific under IFRS 15. The opening and closing balances must be presented for contract assets, contract liabilities and receivables from contracts with customers 18. If the organization is acting as an agent then the nature of the goods or services that the organization has promised to transfer, highlight on any transfers of performance obligations to arrange for another party, must be disclosed. Also types of warranties and related obligations must be disclosed with more information. (KPMG, 2017) Under IFRS 15 an organization must provide a description of the changed judgements and changes made, concerning the determination of the amount and timing of revenue recognition, when applying the new standard. Specifically, those judgements that were used to determine the timing of the satisfaction of performance obligations, the transaction price and amounts allocated to performance obligations, must be disclosed. IFRS 15 requires an explanation on the judgements made to evaluate when the customer obtains control of the 17 On shipment, on delivery, as services are rendered or on completion of service 18 If not otherwise separately presented or disclosed

promised goods or services. This concerns the performance obligations that are satisfied at a point in time. (KPMG, 2017) 20 4.3.4 Conclusion What can be taken from the impact of IFRS 15 on the financial statements is a significant increase in disclosures, and an increase in the amount of information that must be documented. This is particularly directed at annual financial statements. Organizations must put more effort in preparing the required disclosures. Organizations that are working in many sections with many different product lines may have problems with gathering the data that needs to be provided for the disclosures. This indicates to that organizations must have the right systems, internal controls, policies and processes to collect and disclose the required data. (EY, 2017) 4.4 Presentation on the financial statements When it comes to the presentation within the primary financial statements under IFRS 15, organizations must separately present the amount of revenue recognized from other sources of income, from contracts with customers. In figure 9 below, the organization has separately disclosed revenue from sales and services from other sources of revenue. (EY, 2017) Figure 8: Illustrates the disaggregation of revenue (EY, 2017) After determining the transaction price, under IFRS 15, the revenue that is being recognized might include discounts given or rebates paid given by the organization to the customer. In this case IAS 1 standard must be applied. This standard allows an organization the results of this kind of transaction. (EY, 2017)

21 IFRS 15 requires organizations to present separately contract assets, contract liability and receivables, in the financial statements. Contract assets are an organization s right to payment for goods or services already transferred to a customer. Contract liability is an organization s responsibility to transfer goods or services to a customer and receivables is an organization s right to payment that is unconditional. In figure 10 the organization has presented these amounts separately. The organization has used terminology that is used under the IFRS 15 standard, however the standard allows organizations to choose alternative descriptions in the statements. An organization must still disclose relevant information, so that the users of these financial statements can get a clear understanding between unconditional rights 19 and conditional rights to receive consideration 20. (EY, 2017) Figure 9:Consolidated balance sheets (EY, 2017) Organizations must disclose losses from contracts with customers separately from other losses the organization has. This must be documented in the statement of comprehensive income or in the notes. (IFRS foundation, 2014) If an organization presents its financial statements on a liquidity basis, under the IFRS 15 it must present assets or liabilities arising from contracts as a current or a non-current asset or liability. A guide for this determination is not provided under IFRS 15. Organizations must consider the requirements under IAS 1 for this determination. (EY, 2017) Other presentation considerations that must be taken to account are contract assets and liabilities should not be determined at performance obligation level but at the contract level. 19 Receivables 20 Contract assets

22 What this means is that and organization would not recognize separately an asset or liability for each performance obligation within a contract but would assemble them into single contract asset or liability. These contract asset and contract liability positions are determined on a net basis. The reason for this is because the rights and obligations in a contract are interdependent. When an organization is required by IFRS 15 to combine contracts, with the same customer, the contract assets or liabilities would be combined. However, when two or more contracts are required to be combined under the standard, the rights and obligations in the individual contracts are interdependent. IFRS 15 does not provide requirements for offsetting 21, Organizations must apply the requirements of other standards to conclude whether it is appropriate to offset contract assets and liabilities against other balance sheet items. 22 (EY, 2017) 4.4.1 Illustrative example KONE Corporation KONE corporation is going to be affected by IFRS 15. KONE operates in engineering and service industry, and therefore they often have projects for a long period of time. In a publication made by KONE corporation they explain what will change and what will not, in accordance with IFRS 15. Around half of KONE s sales are going to be impacted by this. (Roberto Molteni, 2017) There is going to be a slightly shorter lead-time from order to sales and slightly less quarterly fluctuation in sales and profits within a year. What does not change is revenue recognition in maintenance and major projects, and there is no impact on the cashflow. (Roberto Molteni, 2017) Figure 10: Example of sales fluctuation (Roberto Molteni, 2017) 21 Takes place when organizations present their rights and obligations to each other as a net amount in their financial statements 22 Accounts, receivables

23 In figure 11 can be seen an illustrative example on how the quarterly revenue fluctuation might look like. The fluctuation is slightly less than before, because IFRS 15 obliges the company to recognize revenue not just at the end of a project, but during a project. Figure 11: Example of the difference compared to IFRS 15 (Roberto Molteni, 2017) In figure 12 can be seen an illustrative example of the revenue recognition process at KONE (numbers are illustrative). This order is new equipment order worth 100. As can be seen, currently before IFRS 15, in the profit and loss statement (P&L) the costs and profit are recognized at the handover to the customer phase, but when IFRS 15 is implemented, from 2018 onwards, the costs and profits are already recognized from first materials to customer s site phase. This means that at this phase 53 of cumulative sales has been received, because there are still 47 at order book. Cumulative costs at this point are 45, that leads to that the revenue recognition at this point is 53-45=8. The big change here is that the revenue is recognized at an earlier time, than previously before IFRS 15. That is why the performance obligations must be recognized at an earlier point. (Roberto Molteni, 2017) KONE Corporation has implemented IFRS 15. In a publication made 19 March 2018, they have also published a restated report to the previously reported key figures 2017, in accordance to IFRS 15. The same accounting principles has been used in the restated report as in KONE s financial statements 2017, except for that in the restated report IFRS 15 has been applied. (KONE, 2018)

24 As earlier stated the most significant impact of IFRS 15 is the application of percentage of completion- revenue recognition method. The revenue is recognized, according to IFRS 15, gradually. The long-term projects have already had this type of gradually recognized revenue method, but from now on all projects are implemented with this method. (KONE, 2018) Figure 12: Key figures (KONE, 2018) In figure 13 can be seen that some key figure has been changed, to accordance with IFRS 15. The interesting key figures are order book, sales, operating income, Net income and basic earnings per share. IFRS 15 impacts on all of these, and because of the impact on sales and the other key figures this also impacts on the earnings per share. IFRS 15 also has an impact on shareholders earnings. These restated numbers do not fluctuate significantly to the reported numbers, but what can be seen from this statement is the key figures that are going to change. The networking capital is also going to change, because inventories and advances received are going to decrease and accounts receivables are going to increase slightly. In the report, made by KONE, the working capital estimation is to be less negative by over 10%. (Roberto Molteni, 2017) For KONE performance obligation typically means delivery and installation of a single unit, for example an elevator, escalator or other People flow solutions. Percentage of completion is defined as the proportion of an individual performance obligation s cost. This percentage of completion method insists that accurate estimates of future revenues and costs