IFRS 15 ‘Revenue from Contracts with Customers’ comes into force on 1st January 2018.
The new financial reporting standards (IFRS 15) have a particular impact for businesses who regularly have contracts that contain “elements of variable consideration”.
IFRS 15:51 provides us with examples of “variable consideration” which include rebates, incentives, refunds, performance bonuses, credits, price concessions, penalties or other similar items – items that impact the real net-net price and ultimately profit margins. IFRS 15.51 goes on to say that “Variable consideration is also present if an entity’s right to consideration is contingent on the occurrence of a future event.” One can imagine this might stretch to something like “If you run 4 marketing events a year to promote our product, we will provide an extra discount of x%”.
Building materials suppliers, buying groups, wholesale distribution companies in particular are accustomed to negotiating contracts that are conditional upon volumes and other performance related measures. These pricing strategies are designed to impact behaviour in the marketplace. For example, rather than offer a fixed price based on a promised volume purchase, a supplier might offer a retrospective discount or rebate based on actual purchase volumes over time.
Given that simple example, it makes perfect business sense to create deals that are geared around influencing behaviour but based on actions, not promises. The difficulty is that we have to account for those promises (contractual agreements) in some way.
IFRS 15:50 states that “Where a contract contains elements of variable consideration, the entity will estimate the amount of variable consideration to which it will be entitled under the contract”.
This can be hugely problematic for rebate accountants. Not only do they have to understand and document the agreements that have been made (we recently prised apart a contract that had no less than 300 deals contained within it!), rebate accountants have to work with buyers to understand the probability that its inclusion will not result in a significant revenue reversal in the future when the uncertainty has been subsequently resolved.
“Specifically, variable consideration is only included in the transaction price if, and to the extent that, it is highly probable that its inclusion will not result in a significant revenue reversal in the future when the uncertainty has been subsequently resolved”. [IFRS 15:56]
There has been huge press exposure given to Tesco’s £263m profit overstatement in 2014 and the more recent $80m penalty agreed by Monsanto after it allegedly misstated its earnings in connection with its top-selling Roundup product. In both cases, the source of the problem centred around rebate accounting.
So, how do we report rebate income correctly? How do we adhere to the IFRS 15 financial reporting standards? And how do we ensure that rebate accountants have the correct information to hand so that they can positively impact the bottom line without falling foul of the guidelines?
Download our guide "IFRS15 - 7 steps to prepare for January 2018" to find out more.