This is the time of year when people look back at what just gone by. Another 365 days will have passed and become perpetually etched in history. The reckoning of the year that is changing in three days will be interesting as it ushered a mix of the most opportune and appalling events. The most recent one was the bizarre weather in the US. While the Southern California wildfires spread through counties, Houston experienced the rare appearance of snow.
In several ways, these weather occurrences are unusual but they do happen and the same goes for the accounting world, which has experienced its fair share of changes and bizarre events that you can just simply refer to as controversies. To be fair to 2017, there was not a year in an accountant’s life that did not see change or amendments in standards or a good old-fashioned accounting scandal. It is just a matter of gravity and magnitude. To kick-start the reckoning, there are a couple of accounting areas for further reflecting before the year draws to a close.
PFRS 15 finally gets to meet 2018
Half of 2017 was spent on training and getting comfortable with the Philippine Financial Reporting Standard (PFRS) 15, revenue from contracts with customers. While it took some time (or years, for that matter) to finalize this new standard on revenue recognition, it will merely be three days from today before it becomes formally effective. No amount of preparation can provide an accountant, or even the whole company, wide headroom to process the entirety of its impact.
The significance of this standard spans almost all conventional finance areas: IT system configuration, tax implication, control procedures and contracts that need to be modified, as necessary, to align with the new revenue recognition model. The five steps that are key to comprehending the new model are briefly interpreted below with PwC IFRS Reporting Insight as reference.
1. Identify contract with the customer
This is a constant. However, the new model requires a more detailed assessment of the contract arrangements and any modifications.
A contract can be written, oral, implied by the company’s customary business practices or any agreement that creates legally enforceable rights and obligations. Further, a history of amendments and side agreements to a contract that either modify the original term or provide additional discounts or privileges to a customer should be diligently assessed as all of these have implications to the revenue recognition and accounting conclusion. Also, identifying a contract may prove to be more complicated in other industries due to multiple parties involved and contract modifications to be considered.
2. Identify separate performance obligations
Once the contract is identified, determining all the promises in an agreement is crucial. This entails significant judgment considering the evolution and diversity of sales strategies that involve varying free goods or services and even construction of assets at a customer’s location (e.g. permanent displays). Other complexities include activation, connection services and other upfront fees for the telecommunication industry, and design services and procurement of equipment for construction business.
3. Determine transaction prices
The new revenue recognition model requires methodically assessing the consideration for each good or service to be delivered. Any variable consideration (i.e. discounts, rebates, customer incentives and other promotional schemes) may impact the calculation of transaction price at the time of revenue recording.
4. Allocate transaction price
If there is more than one performance obligation in a contract, the same should be identified and allocated with the transaction price. Arrangements that may impact allocation of transaction price include loyalty programs, loyalty points, selling price that varies among customers for a broad range of amounts (for telecommunication), and award and incentive payments (for construction).
5. Recognize revenue when/as performance obligation is satisfied
Under the new model, control commands the revenue recognition. Transfer of risks and rewards now only serves as one of the considerations in determining if control has been transferred. To simply demonstrate, revenue should not be recognized for goods with a high probability of return. The new model also requires balance sheet accounting of this right of return that will result in recognizing a refund liability and the corresponding cost of the inventory as an asset (currently not specified under the old revenue standard). Other industries will have similar complexities in determining transfer of control.
We’ve only scratched the surface of the new revenue recognition model. With divergent interpretations and multiple arrangements and contract provisions, PFRS 15 transforms the revenue recognition of companies across many industries in more ways than one. We have the next 12 months to process the ins and outs of the control-based revenue recognition model. With cautious optimism, we can assert that on the same day next year, most of us will already have a better grip of the new standard.
The F word
Fraud carries with it a stigma that’s difficult to overcome. This is why every accountant, or any reasonable human being for that matter, is apprehensive of the word. Fraud defies all existing controls and puts into question the credibility built over time. We were not spared this year of fraud incidents and missteps that rocked the accounting world. We continue to see reported fraud cases or worse have been a victim of one that’s consistent with the PwC Global Economic Crime Survey finding that while economic crime is evolving, preventive measures are lagging.
Fraud is often perpetrated by those who have unrestrained access to systems and information and who are under pressure to meet certain targets and KPIs. Even organizations with relatively good controls have fallen victim to unwanted financial incidents. As the economy grows and accounting standards continue to change, fraud morphs into different forms that normally make use of accounting estimates, journal entries, editable documents and limitless access to the accounting system, among others. A good measure is to take a look back and revisit the basic but key areas that need reinforcement as you close 2017 accounting records. Cited below are three common areas and steps that can be your starting points:
1. Address basic IT audit issues (i.e. unrestricted access).
2. Ensure journal entries are supported with business rationale and approved based on matrix.
3. Inputs to and assumptions used in accounting estimates and judgment should be airtight and backed by business facts and circumstances, and applicable accounting standards.
Each organization has a different risk profile and will require additional areas to monitor and top up procedures to prevent a fraud incident from happening. Fraud could be enormously damaging – both in cost and to integrity. With this, the evolving risk landscape calls for each organization to take prior incidents seriously and invest in re-designing controls and procedures.
It pays to be equipped with the know-how and to appreciate history. This holds true as we welcome 2018. While 2017 was relatively good, it would not hurt if we go back to the drawing board at the start of the New Year armed with the lessons and takeaways, and everything in between, from the past.
Corina Molina is an Assurance Director of Isla Lipana & Co., the Philippine member firm of the PwC network. For more information, please email email@example.com. This content is for general information purposes only, and should not be used as a substitute for consultation with professional advisors.