For some companies the change in revenue recognition due to the adoption of IFRS 15 in 2018 has resulted in a material change in reported revenue and profit. However, your analysis needs to go beyond the transition effect and also consider the impact on future growth.
We illustrate how your forecast of profit growth can be impacted using a simple interactive model.
With IFRS 15 already implemented by most companies, you will probably already be aware that, where relevant, the effect can be to either advance or defer the timing of revenue recognition. For some the impact has been highly significant, while for others it has not made a whole lot of difference. If the timing of revenue recognition changes then this almost certainly results in changes to the balance sheet and shareholders’ equity and may also change reported profit, although the latter depends on other factors such as the rate of growth of the business and any change in product mix.
One impact of IFRS 15 that is important to your analysis, and which seems to get less attention, is the effect it may have on future growth in revenue and profit. The impact is greatest where the rate of change in growth is also greatest. If, for example, growth is constant at 5% in the past and expected to remain so for the foreseeable future, then, however revenue recognition changes under the new standard, future growth will also be 5%, albeit from a reset base.
However, if say a company has previously experienced high growth and this is now falling, then you may find that the implementation of IFRS 15 will affect the rate of that reduction. For example, depending on how the pattern of revenue recognition changes, it may be that IFRS 15 results in higher growth for longer.
Below we present a simplified model to illustrate. It is based on a particular revenue recognition scenario, but you can change input assumptions to model other situations and examine how variations in revenue recognition timing and growth rate changes interact to determine how IFRS 15 may impact current profit and future growth in profit.
Interactive model: Impact of IFRS 15 on forecast growth
Please note: This model is for illustrative purposes only. It reflects a particular scenario and includes simplifying assumptions. Further explanations and instructions are included below.
About the model
This model is designed to illustrate how a change to revenue recognition due to the adoption of IFRS 15, can impact not only current period revenue and profit, but also forecast growth.
Although certain inputs can be changed, the model illustrates a single specific type of contract and includes particular simplifying assumptions about how IFRS 15 will change the timing of the recognition of revenue and expenses. The illustrative effects of IFRS 15 are specific to the scenario presented and the actual effect of IFRS 15 in practice will differ in other circumstances.
The model is based on a contract where the goods or services provided are the same in each period of the contract and therefore, under IFRS 15, revenue is recognised on a straight-line basis over the contract term. Revenue under IFRS 15 is based on satisfaction of performance obligations in the period which may not necessarily be straight line. Revenue recognition under prior accounting (IAS 11 and 18) may differ, often being closer to cash flow or reflecting activity rather than the delivery of services to the customer. The revenue recognition pattern prior to IFRS 15 is a model input and can be modified.
In this model it is assumed that cost recognition does not change as a result of IFRS 15. In practice changes to cost recognition are likely and may have a further impact on forecast growth.
To use the model:
Clearly, the model is simplistic in its assumptions. It is merely designed to illustrate that IFRS 15 can have a significant impact on forecast growth rates where (1) an entity has long term contracts; (2) the timing of revenue recognition changes under IFRS 15 and (3) there are forecast to be changes in the rate of growth of new contracts.
Some of the effects of IFRS 15 that the model can illustrate ….
Experiment by including these and other scenarios in the model to get a feel for how IFRS 15 might impact your analysis and forecasts. But remember …
The impact of IFRS 15 on revenue and profits and on future growth in revenue and profit is highly specific to the activities of the entity. The factors affecting the outcome for a specific entity include: