IFRS 15 – Revenue from Contracts with Customers (part 8). Recognise revenue in advisory and legal services

Ewa KĄDZIELA
Audit Manager at RSM Poland

Advisory and legal services are among the industries (along with telecommunications, IT and real estate) where the evaluation of the actual impact of the new regulations (IFRS 15) on financial statements is going to require a meticulous analysis of the new standard as well as the terms and conditions of contracts concluded with customers. Analysing the new (five-step) algorithm of revenue recognition may produce doubts resulting from the fact that this model is primarily based on the entity’s predictions concerning their contractual obligations and the consideration it expects to be entitled for the performance of different contractual obligations.​

SCENARIO OF REVENUE RECOGNITION

For example, a tax advisory company has signed a contract with an accounting office to hold a training session on the amendments of tax legislation for the employees of this office. The amount of consideration for this training will be PLN 20,000 according to the contract. In addition, the contract includes a provision that if the average training rate given by training participants is at least 4 on a five-point scale, then the training company shall receive a bonus in the amount of PLN 5,000.

In accordance with IFRS 15, the advisory company shall recognise revenue in line with the most probable scenario. The company has already held dozens of similar training sessions (with the same trainer) and is convinced it will receive the bonus, the probability being 95%. Thus, the transaction price should amount to PLN 25,000 (the most probable value). Contractual penalties (e.g. for late contract performance), often provided for in contracts for advisory services, should be approached in a similar way.

When estimating the amount of variable consideration, one must keep it mind that this can be included in the transaction price only if it is highly probable that its inclusion will not result in a “significant revenue reversal” in the future following an overestimate (and it may occur e.g. if the entity has little or no experience with this type of contract or if the amount of consideration is very susceptible to factors outside the influence of the entity).

HOW SHOULD REVENUE BE RECOGNISED IN ACCORDANCE WITH IFRS 15?

In order to recognise revenue from advisory services correctly, one must pay particular attention to the identification of the moment in which the customer takes control and the service provider satisfies the performance obligation. It a good idea to analyse each of the three conditions (discussed in detail in previous parts of the blog) proving that the control over the service is transferred over time. If none of these conditions is met, it is assumed that the performance obligation is satisfied at a point in time.

To give you an example: an auditing company was hired by the ABC company to carry out an audit of their financial statements resulting in an audit report. Under the contract, there is a consideration in the amount of PLN 80,000 for the provision of the report. The contract includes a provision that the customer shall be obliged to cooperate and provide the auditing company with any and all documents and information needed to prepare the report. Should the customer decide to terminate the contract prematurely, namely before receiving the final product, i.e. the audit report, the customer shall be obliged to cover the costs incurred by the auditing company until the contract’s termination.

Below you will find an analysis of the three criteria that determine the time in which the performance obligation is satisfied:

1. The customer is receiving and consuming the benefits of the entity’s performance in the course of the performance

This condition is not met, because the discussed service is not consumed on a continuous basis. What is characteristic for a large part of advisory and legal services is that the customer receives the benefits from the service once it is provided (here: once the audit report is submitted). Should the auditing company fail to perform, company ABC would have to hire another company that would do the work from scratch.

2. The entity’s performance creates or enhances an asset (like production in progress) that the customer controls as the asset is created or enhanced

Meeting the aforementioned condition would mean that the customer has control over the asset (the audit report) already when it is being created. In this case, the control over the report is transferred only once the report is submitted.

3. The entity’s performance does not create an asset with an alternative use for the entity, and the entity has an enforceable right to payment for performance completed to date

It is hard to imagine that an audit report prepared by an auditing company could have an alternative use (this pertains to a given entity operating in given circumstances). In addition, in line with the concluded contract, in the case of early contract termination, the auditing company is entitled to consideration for the works performed.

Since the analysed contract for auditing the financial statements meets the third criterion, the performance obligation is satisfied over time.

Should you have any doubts or questions, please contact RSM Poland. Recognising revenue in the IT industry will soon be discussed in our blog.