In many transactions the amount payable may not be not known until sometime after the related asset, liability, income or expense is recognised in financial statements. In some cases, the accounting for this ‘variable consideration’ is clearly specified by IFRS. However, in others, including the purchase of fixed assets, companies are free to adopt different approaches.
Intangible assets arising from football player transfers are a good example of where companies can apply different accounting policies for variable consideration. We use the financial statements of Manchester United to explain the challenges for investors.
Football (soccer) player transfers often involve variable (contingent) consideration. The initial payment for the player’s registration may be supplemented by additional later payments contingent on one or more uncertain future events. The overall payment could vary based on the number of occasions the player plays in the club first team, on whether they are picked to represent their national team or on whether the club achieves certain performance milestones, such as winning their league title.
Player registrations represent an intangible asset in the financial statements of a football club. However, the final cost of this asset may not be known until some years after it is initially recognised in the balance sheet. This raises some interesting financial reporting questions, including whether the future variable consideration should be recognised as a liability at the time of the player transfer (and therefore included in the initial measurement of the intangible asset) and, if so, how should this variable amount be measured?
How these questions are dealt with for player transfers and, more widely for many other variable consideration transactions, is important for investors. The accounting choices affect the recognition and measurement of assets and liabilities, the timing of income and expenses in profit and loss (and sometimes other comprehensive income) and the presentation of key metrics such as return on capital and leverage.
Unfortunately, IFRS1US GAAP is like IFRS for many aspects of variable consideration. However, in this article we only focus on IFRS reporting.accounting does not provide an answer for football player transfers. Indeed, IFRS is silent on how contingent consideration is dealt with in the case of all purchases of tangible and intangible fixed assets. The only exception is for leases of tangible assets, where IFRS 16 does provide an answer – see below.
It is not just the purchase of fixed assets; there are many transactions that result in assets, liabilities, income or expenses being recognised in financial statements which involve variable payments, including:
- Business combinations: The purchase price of a business may depend on whether the acquired company reaches certain financial targets, the outcome of specific events or whether key management personnel remain in employment for a certain period.
- Share based payments: The vesting of equity granted to employees may depend on continued employment and whether certain company or individual targets are met, such as a minimum EPS growth rate.
- Revenue: The amount of revenue received from a transaction with a customer may depend on whether the product delivered continues to meet certain quality criteria or on the future income derived from that product by the customer.
There are many more examples. Having understandable, relevant and comparable accounting for these transactions is important for investors.
In some cases, IFRS specifies the accounting method that should be applied. However, these approaches differ, with no consistent underlying conceptual rationale for why a particular approach is required. This lack of conceptual underpinning means that, without a set of rules specified, companies have nothing to fall back on to help determine an appropriate accounting policy – as is the case for fixed asset purchases.
In our recent Footnotes Analyst article ‘Comparability is crucial for informed investment decisions’ we discussed the sources of a lack of comparability in financial statements and the implications for investors. Variable consideration contributes to this lack of comparability, both due to the different accounting practices applied and due to the estimations that are often required.
Intangible assets arising from player transfers
The key financial reporting questions concerning the recognition of player contracts as intangible assets are: (1) whether uncertain variable future payments are included in the amount initially recorded for the asset, (2) if so, at what amount these estimated future payments are measured; and (3) whether the adjustments affect the asset carrying value or whether they immediately impact profit and loss, when payments differ from the amounts previously recognised.
If potential future variable payments are excluded at initial recognition, the initial carrying value of the intangible asset is lower than the likely amount eventually payable with, consequently, a lower initial amortisation charge. Furthermore, there is no recognition of a liability for the future variable payments, although these would be disclosed as ‘contingent liabilities’ in the footnotes.
If expected future variable payments are included in the measurement of an intangible asset, and as a liability, this would appear to better reflect the economics of the transaction. However, the liability could be measured at different amounts, such as a probability weighted expected value, the most likely amount payable, or with some other recognition threshold applied, such as only including those payments deemed ‘probable’.
It is almost certain that what is eventually payable will differ from the amount initially recognised. The question then is whether this difference adjusts the asset balance, and therefore impacts profit and loss through a revised amortisation charge over the remaining life of the asset, or whether the adjustment is immediately recognised in profit and loss and the initial ‘historical cost’ amount is unchanged.
All the above choices in accounting for variable consideration for fixed asset purchases, including player registration intangible assets for football clubs, are unanswered by IFRS standards.
According to a guide to accounting at football clubs published by the accounting firm PWC2See ‘Accounting for typical transactions in the football industry: Issues and solutions under IFRS’. The guide covers many topics that are particularly relevant to financial reporting by football clubs, including other examples of variable consideration, such as revenue from broadcasting rights., there are three possible approaches that can be applied to player transfers:
(1) Exclude variable amounts until they become payable, at which time the additional amounts are added to the intangible asset.
(2) Recognise a liability for the estimated of future variable payments, with a corresponding increase to the amount initially recognised for the asset. PWC indicates that the estimated amount would be the fair value of the contingent payment liability, but we think other measurement approaches could also be used under IFRS – as is the case for Manchester United. When the variable payment liability is subsequently updated the effect is to increase or reduce the intangible asset balance.
(3) As for (2) above except changes in the liability are immediately reflected in profit and loss, with no adjustment to the asset.
Although we have not done any exhaustive research, we understand that approach 2 is most common in practice.
Understandably, approach 3 seems to be the least popular, not just amongst football clubs but also for other companies that must account for variable consideration for fixed asset purchases. This is presumably due to the increased volatility in profit that would likely result. Interestingly, it is method 3 that is required for business combinations – see below.
Nevertheless, all three approaches appear to be acceptable. Indeed, PWC states …
Accounting by Manchester United
Player registrations and the associated amortisation represent a significant asset and expense for Manchester United (MUFC), with the accounting for the variable (contingent) payment component having a material impact on the financial statements.
For variable payments, MUFC adopts the second of the accounting policies we list above. They initially recognise the present value of variable payments that are considered ‘probable’ in the cost of player registrations and amend that cost if the assessment of what is probable changes. The liability for contingent payments is included with other deferred fixed payments in current and non-current trade payables.
The threshold for ‘probable’ in IFRS is generally interpreted as ‘more likely than not’. Potential payments that do not meet this 50% threshold, and are therefore excluded from the balance sheet, are disclosed in the contingent liability note.
In effect, the approach to contingent payments adopted by MUFC is based upon the requirement in IAS 37 to recognise a non-financial liability when payment is ‘probable’ but disclose payments that are ‘possible’. IAS 37 is also followed on the asset side in respect of variable payments receivable due to player sales. In this case only ‘reasonably certain’ receipts are recognised in the balance sheet with ‘probable’ receipts disclosed as contingent assets.
Here are relevant extracts from the Manchester United 2023 annual report:
Manchester United: Player registration related disclosures (extracts)
Manchester United annual report and 10K, June 2023
Although MUFC certainly has uncertain and potentially variable payments, it is interesting that in the last 3 years there has been no change in the assessment of the payments that are ‘probable’ (and therefore included in the intangible asset carrying value) and those disclosed as contingent liabilities. We wonder if this has something to do with the recent relatively poor performance of the team not triggering additional payments.
A further interesting aspect of the accounting for player registrations by MUFC is the approach to intangible asset impairment. Even though it must be relatively easy to estimate the fair value of players, given the active transfer market, impairments are generally not done at the individual player level because of the inability to identify cash flows attributable to individual players and therefore the inability to determine ‘value-in-use’. This means that there is no indication of whether the player registration intangible asset balance itself is recoverable, only that the net assets of the cash generating unit (which it seems is the company as a whole) is below the value-in-use of the business. Of course, we suspect the fair value of player registrations does exceed the carrying value, considering the development of ‘home-grown’ talent – internally generated intangibles that are not recognised in the balance sheet. A company estimate of the fair value of all player registrations would certainly be an interesting disclosure.
It seems to us that the accounting for variable consideration is an important issue when analysing the financials of MUFC and that a different accounting policy for player transfers would have a material impact on the reported results. However, it is not possible to identify the extent of variable consideration recognised as an asset and liability. Although there is disclosure of deferred player transfer fees, the split of this between fixed and variable components is not provided.
Variable consideration that is covered by IFRS
In many IFRS standards the treatment of variable consideration is specified, with no opportunity for companies to apply their own accounting policy, as there is for fixed asset purchases. The problem is that there is little consistency between the approaches used. This may be explained by the relevant standards being developed at different times or by a lack of guidance provided (or different interpretations of) the IFRS conceptual framework. Whatever the reason, having different approaches to variable consideration is not helpful for investors.
Here are some examples where we think it is particularly important for investors to understand how variable consideration is dealt with by the respective accounting standards.
Business combinations – IFRS 3
IFRS 3 requires that contingent consideration be measured at fair value, both at the time of acquisition and subsequently until it is settled. Changes to the fair value are reported in profit and loss and do not update the purchase price for a subsidiary or the measurement of the assets and liabilities recognised in the group financial statements, including goodwill. The approach for business combinations is very different from that commonly applied to fixed asset purchases, where fair value is not generally applied, and changes in the estimate update the asset and are not immediately recognised in profit and loss.
The accounting treatment of variable consideration in business combinations is controversial, with many arguing that an amendment to goodwill would be more useful than recognising changes in profit and loss, particularly where the variable payment relates to the quality of the underlying assets acquired. For example, a Pharma company may link the payment for a business to the regulatory approval of a drug in development. In this case a payment below or in excess of the initial fair value estimate would seem to represent a reduced or higher payment for the underlying asset, rather than a gain or loss in the period. However, in other cases, such as where variable payments relate to underlying performance or management retention, recognising a gain or loss would seem to be more appropriate. However, others, including the IASB when IFRS 3 was first issued, take a different view.
In our article ‘Do not use non-GAAP measures in equity valuation’, we discussed variable consideration in business combinations and the effect on non-GAAP measures and analyst forecasts.
Leasing – IFRS 16
There are two types of variable consideration, each of which is dealt with differently by IFRS 16.
- Index or rate linkage: For variable payments that are linked to a rate or index, such as interest rates or inflation, the estimated variable amount, based on the index at the time the lease originated, is included in the lease liability and right-of-use asset. As the index changes so the asset and liability are updated.
- Activity or revenue linkage: Variable payments that are linked to an activity measure, such as revenue earned, are not included in the initial measurement of the asset or liability. Instead, these payments are expensed as they are incurred.
The main reason given in IFRS 16 for not recognising variable payments linked to activity as a liability is the difficulty of estimating the amount payable. However, confusingly, other variable amounts, particularly those related to business combinations, are included irrespective of the measurement uncertainty.
We discussed variable lease payments where the linkage is to inflation in our article ’Beware the IFRS 16 inflation headwind’. In this we explain how not including expected inflation in the measurement of the initial lease liability understates liabilities and leverage, and back-ends the expense.
Share based payments – IFRS 2
The number of shares or options that vest in a share-based payment arrangement can be variable. This is a complex area in accounting, but essentially there are two types of variability and two methods of accounting:
- Market linked variability: Where the vesting of shares or options depends on a financial market condition (such as vesting only taking place when the share price hits a certain target) this factor is simply included in the grant-date measurement of the compensation, which is not subsequently updated.
- Performance linked variability: This is where the number of shares or options that vest depends on the continued employment of the employee or on achieving certain individual or company wide performance targets, such as growth in EBITDA. The initial estimate of the share-based payment expense includes an estimate of the number of shares or options that will vest. This is updated each period with a catch-up adjustment applied.
The catch-up adjustment applied to performance-linked vesting is unusual in financial reporting, in most cases where estimates change the effect is recognised prospectively in profit and loss over the remaining term of the transaction. For example, if a fixed asset useful life is amended, the book value of the asset at that time is simply depreciated over the revised period. There is no catch-up to recognise the under or over depreciation in past periods.
We discussed the peculiarities of share-based payment accounting and the impact of catch-up adjustments in our article ‘Forecasting sticky stock-based compensation’.
Revenue recognition – IFRS 15
Where the consideration for a sale of goods or services to customers is variable, the transaction price should include an estimate of the total amount receivable. The estimate could either be the most likely amount receivable or a probability weighted average, whichever is most relevant.
However, IFRS 15 adds two constraints to the recognition of revenue which may mean that revenue is deferred to periods after the related performance obligation is satisfied. In effect IFRS 15 applies a conservative bias to the measurement of revenue that does not apply in other areas of financial reporting.
- Revenue can only be recognised where it is “highly probable” that a significant reversal in the cumulative revenue recognised to date will not occur.
- Where intellectual property is licenced to a customer, and payments under the licence are based on the sales or usage of that intellectual property by the customer, revenue is deferred until those sales or that usage occurs.
As with the other examples we briefly describe above, the accounting for variable consideration under IFRS 15 is somewhat more involved than our very brief summary above.
IFRS standards and variable consideration
Variable consideration can be material to understanding financial statements. The problem for investors is that for some transactions (notably fixed asset purchases) companies may adopt different policies, and for other transactions the standards are inconsistent. There may be good reasons for such differences, but it is difficult to rationalise these in the context of the IFRS conceptual framework.
The IFRS Interpretations Committee did consider the accounting for variable payments for asset purchases back in March 2016. Although it observed diversity in practice, it was unable to reach a consensus on whether the purchaser should recognise a liability for the variable payments at acquisition, or only once the conditions are met. The result of this is the three possible methods we describe above.
The IASB is not presently working on variable consideration. We hope that at some point the accounting for variable payments for fixed assets will be resolved and maybe the conceptual basis for the approaches adopted for other transactions clarified. Doing so would improve comparability and make financial statements easier to understand.
Insights for investors
- Companies may adopt different policies to measure and recognise variable consideration payable in respect of asset purchases. This may reduce comparability of balance sheet metrics and affect the timing of expense recognition.
- Investigate contingent liability disclosures to identify potential payments that are not included in the reported carrying value of fixed assets.
- Look out for catch up adjustments due to changes in estimates of variable consideration. Most companies do not include these in profit and loss for fixed asset purchases, but they must be reported as gains and losses when related to a business combination.
- Variable consideration applies to many transactions. Under IFRS there are different approaches to the accounting for such payments or receipts depending on the nature of the transaction.