Simplifying the complex: Understanding the new revenue recognition model

05/04/2024

The Financial Reporting Council (FRC) has introduced amendments to the UK GAAP, specifically within FRS 102 and FRS 105, centring on a new revenue recognition model.

The cornerstone of the amendments is a simplified (yet comprehensive) five-step model for revenue recognition.

1. Identifying the contract with a customer: First, you need to identify and agree on the contract with a customer that establishes the formal terms of your engagement.
2. Identifying the performance obligations in the contract: Next, determine the distinct goods or services you have promised within the contract. Each promise to deliver a good or service is a performance obligation.
3. Determining the transaction price: Ascertain the total amount of consideration to which you expect to be entitled in exchange for fulfilling your performance obligations.
4. Allocating the transaction price to the performance obligations: Divide the total transaction price amongst the identified performance obligations, based on their standalone selling prices.
5. Recognising revenue when (or as) you fulfil each obligation: Finally, recognise revenue in your accounts at the point in time or over the period in which you satisfy each performance obligation, transferring the promised good or service to the customer.

This model, adapted from IFRS 15, may require you to adjust how you report revenue, potentially affecting your financial statements and how stakeholders view your financial health.

Understanding the nuances of your contracts is going to be more important than ever.

The new model requires a clear delineation of the goods or services promised to a customer, which may involve unbundling packages or addressing contract modifications.

It’s crucial to examine each contract for distinct performance obligations to ensure accurate revenue recognition.

The timing of revenue recognition under the new model hinges on when you satisfy a performance obligation.

This could be at a specific point in time or over a period, depending on the nature of the goods or services provided.

It’s imperative to establish criteria for when an obligation is considered fulfilled, which will directly influence when revenue is recognised.

A note on the other amendments and their implications

The FRC’s amendments extend beyond revenue recognition.

Notable changes include enhanced disclosures for small entities and updates reflecting the IASB’s Conceptual Framework.

These changes aim to improve clarity and consistency across financial reporting, requiring you to perhaps reassess and refine your reporting processes.

The introduction of a new section on Fair Value Measurement, aligned with the principles of IFRS 13, and the phase-out of the option to adopt IAS 39, are also significant.

This may affect your financial statements, especially regarding the valuation of assets and liabilities.

Understanding these implications is key to maintaining compliance and ensuring a true and fair view of your financial position.

Adapting to these amendments will require a proactive approach.

Updating your accounting systems and processes, as well as ensuring your team is well-versed in the new standards, will be essential steps.

Additionally, engaging with your accountant or a financial adviser can provide the necessary guidance and support during this transition.

Changes to lease accounting

Perhaps the most significant alteration for many will be the changes to lease accounting, requiring you to recognise all leases on your balance sheet.

Understanding the specifics of this requirement, including the right-of-use asset and lease liability, is going to be vital for continued compliance.

There will be some exemptions and reliefs available:

• FRS 102 exemptions: For leases of 12 months or less and low-value assets, FRS 102 allows businesses to avoid putting these leases on their balance sheet. Instead, businesses can simply record lease payments as an expense over the lease term, simplifying reporting for short-term and minor leases.
• FRS 105 simplifications: FRS 105 keeps the distinction between operating and finance leases for very small businesses, allowing them to report lease expenses straightforwardly without the need to recognise all leases on the balance sheet. This approach reduces complexity and administrative work for micro-entities.

The operational impacts of these lease accounting changes may affect everything from your budgeting processes to how you negotiate lease terms.

Anticipating these impacts – and some strategic planning with your accountant – can mitigate potential challenges.

The changes also offer an opportunity to reassess your approach to leasing versus buying decisions and align these with your long-term financial goals.

Your next steps should be to review your existing leases, assess their impact on key financial ratios, and communicate these changes to stakeholders.

With careful planning and the right support, you can navigate these changes effectively, ensuring your business remains on a solid financial footing.

For more information, please get in touch with our expert team.