Published: February 2019

By Dr. Kamaruzzaman Muhammad and Associate Professor Dr. Erlane K Ghani

Introduction

Revenue recognition has always been a controversial issue in accounting especially on long-term contracts or services (Silvia, 2014). For many entities, revenue is the largest single number in the financial statements and often used as a key determinant for many performance indicators such determination of key personnel remuneration package, future investment decisions, tax expenses and more importantly, their reputation (ACCA, 2011). Acknowledging the importance of revenue to be measured and presented fairly in the financial statements, the Malaysian Accounting Standards Board (MASB) has issued MFRS 15 Revenue from Contract with Customers in 2014. The objective of MFRS 15 is to establish principles for entities reporting on the nature, amount, timing and uncertainty of revenue and cash flows arising from contracts with customers (MASB, 2015; Delloite, 2016). Prior to the implementation of MFRS 15, the existing revenue standards such as MFRS 118 Revenue and MFRS 111 Construction Contracts have limited guidance particularly on complex transactions, resulting in different accounting treatments for similar transactions.. With MFRS 15, it addresses shortcomings of MFRS 118 and MFRS 111 asbetter guidance is laid down on how and when an entity shall recognise revenue from contract with customers and provide more information and disclosure in the financial statements. This standard is to be adopted for annual periods beginning on or after 1 January 2018, but earlier adoption is also permitted.

The Five-Step Model Framework for MFRS 15

The core principle of MFRS 15 is that an entity shall recognise revenue to show the transfer of promised goods or services to the customers in an amount that reflects the consideration to which the entity supposes to be entitled in exchange for the goods or services. Under this standard, the core principle of revenue recognition is represented by a five-step model framework, depicted in Figure 1 and briefly explained further below: 

Figure 1 Five-step model framework of revenue recognition under MFRS15

Step 1: Identify the contract(s) with a customer.

MFRS 15 defines a contract as an agreement between two or more parties that establishes the enforceable rights and obligations and sets the criteria for each contract to be fulfilled.

Step 2: Identify the performance obligation in the contract.

A performance obligation is a promise (explicit and implicit) in a contract with a customer to deliver goods or services.

Step 3: Determine the transaction price.

The transaction price is the total consideration that the entity is expected to be entitled in exchange for the transfer of the goods or services promised to the customer, excluding the amount collected on behalf of the third party (if any).

Step 4: Allocate the transaction price to the performance obligations in the contract.

Once a performance obligation is identified, the transaction price is allocated. Some contracts may have more than one performance obligation. For example, a contract that includes the delivery of a product with packages involving free services and extended warranties. In this situation, the transaction price is allocated based on the respective stand-alone selling price (SSP). The SSP is the price of the goods or services if sold separately to the customers based on an observable price. When SSP is not directly observable, significant judgement is needed to estimate the SSP.

Step 5: Recognise revenue when (or as) the entity satisfies a performance obligation.

The obligation of performance is satisfied when the asset is transferred (or as) the customer acquires control over the asset whose obligations of execution can be fulfilled either at one time or from time to time, depending on the contract with the customer. Upon satisfying the obligation, revenue can be recognised.

Issues and Challenges of MFRS 15 Adoption

The requirements set out in MFRS 15 significantly impact some industries such as construction, telecommunication and automotive industries (Silvia, 2014). The entities in these industries are facing difficulties in implementing this standard, at least at the initial stage of its adoption.  The issues and challenges faced by these industries are attributed to the nature of the business environment and the types of business activities of the entities (Ling & Ramesh, 2017).

Construction Industry

The contracts in the construction industry often include design and building houses that come with fully-furnished or semi-furnished, free parking lot, security and maintenance services. The contractors provide a significant integration of goods and services to their customers, incurring costs during the bidding process and sale commission (KPMG, 2014). Such contracts are agreed upon the completion of the houses. However, in the Malaysian scenario, the contracts often are agreed before the completion of the houses and this poses a challenge to the contractors on how to recognise revenue using the five-step model. In particular, the contractors need to consider the following:

• Whether the revenue is to be recognised progressively over time (stage of completion) or at a point of time (completion method)?
• Which method can be used to measure the stage of completion should the contract with customers contains a clause that permits revenue to be recognised progressively?
• Whether the revenue is to be recognised at a specific on time; for example, on the transfer of control should the contract does not permit revenue to be recognised progressively?
• How the contractor should measure the contract progress?
• How the contractor should account for contract modification and variations?
• How the contractor should account for a loss-making contract?
• Whether the cost during the bid process can be capitalised?

Telecommunication Industry

Contracts in the telecommunication industry often include packages with free handsets with 12- or 24-months service plans/agreement that provide voice, SMS and data services (Fern, 2017). In addition, there are some contracts that include additional goods and services such as an option to upgrade the handset, roaming passes, weekend data, pocket Wi-Fi, free trial access to video on demand services and club member privileges. The transaction price needs to be fairly and appropriately allocated to all goods and services according to performance obligation in the contract based on SSP. With the variety of goods and services bulked into one contract, the telecommunication entities may face challenges in applying the five-step model. This is because the SSP of the goods and services are not all observable and easily measured. In particular, the entities need to consider the following:

• Whether the revenue is to be recognised over time or at a point in time?
• How to allocate revenue related to the distinct goods and services?
• How to account for the contract modification?
• Whether the costs relating to obtaining a contract need to be capitalised or otherwise?
• Whether the revenue needs to be adjusted in order to account for time value of money?

Automotive Industry

The contracts in the automotive industry often contain delivery of a vehicle with packages involving discounts or rebates, free services and extended warranties. MFRS 15 requires the entities including automotive entity to allocate the transaction price into individual goods or services. This involves identification of performance obligation and assessment of the SSP for each performance obligation, and allocation of the transaction price into the respective performance obligation (Ramesh, 2017). The contractors may face challenges in the allocation of transaction price to the respective departments such as revenue on the sale of the vehicles to the sales department and the revenue on the maintenance services provided to the customers to the maintenance service department. In addition, the contractors may face difficulties in identifying the performance obligation when the services have not been provided yet by the contractors to the customers. In particular, the automotive entities need to consider the following:

• Whether the revenue needs to be recognised over time or at a point in time?
• What would be the impact of the standard on the pricing mechanism such as variable amount?
• How to account the different types of warranty coverage offered to the customers?
• How to account the distinct vehicle and maintenance services offered?

Conclusion

In sum, the introduction of MFRS 15 has a significant impact on the entities’ financial reporting where the five-step model framework provides a new and general guideline of revenue recognition for contract with customers. It is important to understand the mechanism and requirements of the framework in order to successfully applying the standard. The application of the five-step model framework requires support and inputs from all divisions of an entity and at times, involves significant judgement. Furthermore, the entity should take into account the model framework in drafting future contracts with the customers in order to mitigate issues arising from MFRS 15 implementation.