IFRS 15 – Some practical issues relevant to the Travel, Hospitality and Leisure Industry
IFRS 15, Revenue from Contracts with Customers contains principles relating to the measurement of revenue and timing of when it is recognised, and is effective for reporting periods beginning on or after 1 January 2018. The underlying principle is that an entity will recognise revenue to depict the transfer of goods or services to customers at an amount that the entity expects to be entitled to. The standard could significantly change how entities recognise revenue, and it also results in a significant increase in the volume of financial statement disclosures.
Under IFRS 15, revenue is recognised based on the satisfaction of performance obligations (“PO” or “POs”). In applying IFRS 15, entities must follow this 5 step process:
As a result of the introduction of IFRS 15, potentially significant changes relevant to the industry include, but are not limited to:
- identifying separate POs in one contract;
- recognising fees received in advance such as the receipt of membership fees;
- accounting for loyalty programmes;
- determining whether the entity is a principal or an agent;
- the pricing mechanism especially when price includes a variable element; and
- the impact on the accounting for breakages.
In this brief article we focus on Step 2, including the identification of whether an entity is a principal or an agent.
Under IFRS 15, an entity is required to identify all POs in a contract; POs are promises to transfer goods or services to a customer and are similar to what we know today as ‘elements’ or ‘components’. This is of particular relevance to operators in the industry since, for example:
- a hotel may offer accommodation, food and beverage, and access to the spa, fitness centre, and pool facilities in a single contract; or
- operators in the industry may offer ‘welcome packages’ (so-called ‘gifts’) upon signing up to a service; or
- airlines, hotels or restaurants may offer customer loyalty programmes.
Under IFRS 15 an entity accounts for each promised good or service as a separate PO if the good or service is distinct; the definition of distinct therefore becomes critical. A good or service is distinct if both of the following criteria are met:
- the customer can benefit from the good or service either on its own or together with other resources that are readily available to the customer (that is, the good or service is capable of being distinct); and
- the entity’s promise to transfer the good or service to the customer is separately identifiable from other promises in the contract (that is, the promise to transfer the good or service is distinct within the context of the contract).
The identification of POs might result in one of two possible changes to current practice:
Elements for which revenue is today recognised separately need to be assessed further under IFRS 15; revenue is only recognised separately under the new standard if there exist separate POs. It is important to note that there is a deliberate focus in IFRS 15 on the customer being able to obtain a benefit for there to exist a PO.
Thus, for example, if an operator charges a booking fee, a credit card booking charge, or an administration fee, it will need to assess whether this provides the customer with a distinct PO, i.e. “the customer can benefit from the good or service either on its own”. The fact that the operator may incur administrative costs is not sufficient to conclude that a separate PO exists.
|Unbindling||On the other hand, operators may need to unbundle certain POs that are contained within the same contract, which could be prevalent in memberships or in loyalty programmes.|
Membership fees are common in the industry and IFRS 15 contains specific guidance on how to account for such fees; operators first need to identify whether separate POs exist in the contract. Although the upfront fee is today already viewed as an advance payment for future goods or services and is recognised as revenue when the future goods or services are provided (Step 5 of IFRS 15), unbundling may first be required if customers also receive distinct goods or services upon signing up, for example a travel or gym bag. In such a case, the operator is required to allocate the transaction price to the different POs (Step 4), and then recognise revenue in the income statement separately for each PO (Step 5).
Hotels, restaurants, and airlines often offer a loyalty programme whereby customers would have the option of redeeming points by getting a discount (of up to 100%) on future purchases of flights, accommodation or meals. Essentially, the customers would be paying for part of the future purchases through the consideration for the original transaction, and therefore a portion of the transaction price would need to be allocated to the future purchases. As an example, if a restaurant offers a 10th meal for ‘free’ after previously purchasing 9 meals, then a portion of the consideration collected for the first 9 meals is deferred and subsequently recognised as revenue when control over the separate PO (the 10th meal) is transferred to the customer.
It follows from the above discussions that operators in the industry also experience what is referred to in IFRS 15 as breakage. This is where the operator receives an upfront, non-refundable fee (or it defers part of the consideration from the initial transaction(s) in a customer loyalty programme) and the customer does not exercise the right to access future goods or services at a discount. Operators will recognise the expected breakage amount as revenue in proportion to the rights exercised by the customer, or when the right is terminated (for example through expiry).
Principal vs Agent
When an arrangement involves two or more unrelated parties that contribute to providing a specified good or service to a customer, management will need to determine whether the entity has promised to provide the specified good or service itself (as a principal), or to arrange (as an agent) for those specified goods or services to be provided by another party. Determining whether an entity is the principal or an agent is not a policy choice.
Like IAS 18 before it, IFRS 15 includes indicators that, although written from the perspective of transfer of control over POs, are broadly similar to the guidance in IAS 18. IFRS 15 however adds perhaps the most obvious indicator that an entity is an agent, namely that the entity’s consideration is in the form of a commission. Thus, if a tour operator which sells hotel accommodation:
- facilitates payment between the hotels and the customers at prices that are set by the hotels;
- requires payment from customers before orders are processed and all orders are non-refundable;
- has no further obligations to the customer after arranging for the accommodation to be provided to the customer (essentially having acted as an introducer and a payment collection agent); and
- is entitled to a commission upon booking of accommodation
the entity would generally be concluded to be an agent for the hotel, and would only recognise the commission as income.
This article is not all-inclusive. Operators will therefore need to carefully assess their revenue streams and the impact that IFRS 15 will have, including how the 5-step model might affect current business activities, and how the other four steps impact revenue recognition.