Implementing PFRS 15: Challenges of an accounting

change
SUITS THE C-SUITE By Anna Maria Rubi B. Diaz
Business World (01/22/2018)
ON AUG. 15, 2017, the Securities and Exchange Commission approved the adoption of Philippine
Financial Reporting Standards (PFRS) 15, Revenue from contracts with customers, which became
effective for annual reporting periods beginning on or after Jan. 1, 2018.

Under PFRS 15, an entity recognizes revenue to depict the transfer of promised goods or services
to customers in an amount that reflects the consideration to which the entity expects to be
entitled to. An entity must apply the five -step model to comply with the new revenue recognition
standard:

Step 1: Identify the contract(s) with customers

Step 2: Define the performance obligations in each 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

CHALLENGES
Entities in varying degrees are conducting assessments on the impact of PFRS 15 and are finding
that implementing PFRS 15 is challenging. It requires more effort than what was originally
anticipated, as they have to reconsider not only its accounting implicati ons, but also its impact on
multiple workstreams such as processes, information technology, legal, sales, human resources
and investor relations. These areas include:
PROJECT TEAM AND PLANNING
Entities need to form adequate project teams equipped and enabl ed with the requirements of PFRS
15, since effective project management is crucial to implementation. The assigned project team
needs to obtain input from its business functions and stakeholders to plan and implement the PFRS
15 requirements to the various workstreams. Entities need to also ascertain that the conversion
project team has adequate and appropriate governance to ensure that key judgments and
decisions are appropriately vetted. Some entities find creating project teams to be particularly
challen ging as they need to confirm that project team members are: 1) competent on PFRS 15
requirements; 2) knowledgeable about the current revenue recognition policy and; 3) well -
informed on the business functions and practices.
SETTING THE SCOPE
To determine th e initial impact of PFRS 15, entities need to establish its effect on its revenue
streams, including a review of its relevant contracts. Some entities have a large volume of non -
homogenous contracts. Reviewing them takes a lot of time; thus, entities need to first agree on
the scope for the review of these contracts (i.e., by selecting representative contracts for similar
product and service offerings) and applying the five -step model to determine the revenue
accounting for such contracts. Entities also nee d to consider additional factors such as geography,
sales channels and customer types that could impact revenue streams and related contract
provisions. Once the scope is set, entities can apply the requirements of PFRS 15 while considering
its impact on their business functions. Thus, entities need to ensure that the scope is appropriate
and complete as the assessment of the representative contracts will be the basis of the design and
implementation of solutions across workstreams.
SIGNIFICANT JUDGMENTS AND ESTIMATES
PFRS 15 involves significant judgments and estimates since the new model uses broad principles
rather than specific guidelines. Examples of areas requiring significant judgments and estimates
include:
• Identifying a contract with customer
Entities need to identify when an arrangement will create enforceable rights and obligations as
they cannot directly conclude that their current arrangements will pass the criteria of a contract in
accordance with PFRS 15. Entities, along with their respective legal teams, will have to revisit the
enforceability of other forms of arrangements (e.g., written, oral and implied contracts).
• Identifying performance obligations
Entities cannot directly assume that the deliverables identified in the current revenue standards
will be the same as the performance obligations under PFRS 15.

An example of this is the recognition of bundled goods or services. Entities need to identify the
promised goods or services within the contract and determine whether these goods or s ervices
should be considered collectively within the context of the contract as a single performance
obligation. Otherwise, the promised goods or services will have to be treated as distinct and
separate performance obligations. Typical questions considere d by entities include:

• Is the entity fulfilling a single promise to the customer?

• Do one or more goods or services significantly modify or customize one or more of the other
goods or services in the contract?

• Do two or more promised goods or services each significantly affect the other goods or services
(i.e., two-way dependency between the promised goods or services)?

Entities will need to understand the facts and circumstances and apply significant judgment to
determine whether goods or services are to be combined into one or treated as separate
performance obligations.

Another example is the recognition of free goods or services, since PFRS 15 does not limit
performance obligations that are explicitly stated in the contract. Implied promises from an
entity’s customary business practice (e.g., free goods or services) can be considered performance
obligations if these will create a valid expectation that an entity will transfer a good or service to
the customer. Entities will need to evaluate whether t hese free goods or services which were
previously treated as marketing incentives may qualify as identified performance obligations in the
contract.

VARIABLE CONSIDERATION
Examples of variable considerations are discounts, rebates, refunds, performance bonuses and
penalties. Entities that simply recognized these amounts when cash is received will most likely be
affected since PFRS 15 requires entities to estimate and update such estimate throughout the term
of the contract. Under PFRS 15, recognizing rev enue until the product is sold to the customer may
no longer be acceptable if the only uncertainty is the variability in pricing; that is, the estimated
variable consideration may now be recognized as part of the transaction price. However, there may
be cases that the impact under PFRS 15 and legacy guidance (i.e., current revenue standards) will
be the same if the estimated revenue will be constrained. Constraining variable consideration
prevents over -recognition of revenue (i.e., significant reversal of c umulative revenue will not occur
in future periods). Entities need to use significant judgment in constraining variable consideration
by considering both the probability and materiality of revenue reversal.
ALLOCATING THE TRANSACTION PRICE
PFRS 15 requires entities to determine the stand -alone selling price of all the performance
obligations and allocate the transaction price based on their standalone selling prices. Entities that
determined bundled goods or services which should be treated as separate perf ormance
obligations under PFRS 15, may find allocating the transaction prices challenging, particularly
when the price is not currently observable.
PROCESS FLOWS AND INTERNAL CONTROL
Entities need to revisit whether they will require new/revised process fl ows and adjust their
transaction -level controls to make sure the information used is accurate and built around the
framework of sound internal control policies. Entities also need to pinpoint significant assumptions
and assess their estimation methods in a pplying the requirements of PFRS 15. It is also critical
that the new/revised processes and controls, significant assumptions and chosen methods are
appropriately documented. Documentation may provide sufficient and reliable evidence to
regulators and stak eholders that the management has already taken steps to consider the impact
of PFRS 15.
Where are you in the journey?
It is clear that implementing an accounting change of this magnitude is a significant challenge.
Entities should already be thinking about the impact and implications of PFRS 15, as proactive
implementation may overcome unwanted surprises and costly mistakes. Considering the challenges
of such an accounting change, how ready are companies to meet such challenges?

This article is for general information only and is not a substitute for professional advice where
the facts and circumstances warrant. The views and opinion expressed above are those of the
authors and do not necessarily represent the views of SGV & Co.