Unquestionably, what IFRS 9 Financial Instruments means for financial institutions in terms of new challenges and complexities, the new IFRS 15 Revenue from Contracts with Customers means for corporate institutions. Although financial institutions’ reporting is currently focusing on IFRS 9, IFRS 15 will not bypass the financial services industry without tangible effect because of its potential impact on the amount and timing of revenue recognition. The IASB (International Accounting Standards Board) recently revised the effective date of the standard to 1 January 2018 from its original 1 January 2017, giving companies more time to prepare for this change.
IFRS 15 applies to various revenues generated by banks or insurance companies, such as fees, commissions and other income that may result from servicing loans, asset management, custody services, pension administration, insurance broking or claims handling, but are not limited to those.
In asset management, variable performance fees that are linked to the returns of an underlying portfolio in excess to its benchmark are common. The variable consideration shall be estimated using the most appropriate method of either the ‘expected value’ or the ‘most likely amount’. However, regardless of the method used, the revenue recognition is restricted to the ‘constraint’ that only those amounts shall be included in the transaction price to the extent that it is ‘highly probable’ that a significant reversal in the amount of cumulative revenue recognized will not occur once remaining uncertainties about the final fees are resolved.
In practice, this will regularly lead to a revenue recognition when the performance fees are fixed after cut-off date, but does not systematically preclude an earlier revenue recognition as long as the constraint is respected. In Switzerland, under IAS 18 it is already the industry practice to recognize revenue from performance fees at a very late point in time, i.e. once the uncertainties about the effective performance fees are resolved. Therefore, the asset management industry in Switzerland will not largely be impacted by the variable consideration constraint of IFRS 15.
Non-refundable up-front fees
Non-refundable up-front fees at or near contract inception may relate to the transfer of specific goods or services, or may represent an advance payment for future goods or services. This kind of revenue is recognized when or as goods or services are transferred. Under IFRS 15, fees for services that do not represent a separate performance obligation (e.g. fees for client setup or front-end loaded fees for asset management contracts) are only recognized as revenue once the future goods or services have been provided to the customer.
Different products that involve different services may be offered to customers (e.g. mortgages and insurance products). If all or part of the contract is in scope of IFRS 15, each distinct performance obligation needs to be identified and the transaction price is allocated to each performance obligation in proportion to its stand-alone price. Under the new revenue standard, banks and insurance companies will need to consider changing their current systems, developing new processes and appropriate controls to identify distinct performance obligations and determining stand-alone prices for goods and services that are usually not sold individually.
Costs to obtain a contract
IFRS 15 requires capitalizing incremental costs generated whilst obtaining a contract if the entity expects these costs to be recoverable and the amortization period is more than 12 months. Introducer fees paid by banks and asset managers and insurance broking commissions are examples of costs generated to obtain a contract. Capitalized costs are amortized systematically, consistent with the transfer pattern of the related service or product (including anticipated renewal periods), and are subject to impairment testing. Financial institutions will need to apply judgment when determining the appropriate amortization period and pattern since, for example, private banking clients have no binding stay period.
Credit card loyalty programs
In Switzerland, several banks offer credit card loyalty programs that may give rise to a distinct performance obligations to the card issuer. If the card issuer identifies a separate performance obligation, it will need to allocate a portion of the interchange fee to that obligation. The allocation is based on the relative stand-alone selling price of the loyalty program points and will be accrued until future benefits are transferred to the cardholder.
Financial institutions need to evaluate the above aspects when planning their transition to IFRS 15. The new standard will require the allocation of transferred prices more often to separate performance obligations that also tend to be at a later point of time than required under the current revenue recognition standard. Moreover, the amortization of costs generated to obtain a contract will require judgment of users of the standard.