Double Whammy phenomenon – FRS115 on revenue & FRS109 on credit loss

There is an onslaught of new accounting standards that are effective from 1 January 2018, impacting most financial report for financial year 2018 which are due for reporting this year.

As a SME owner, you cannot take the easy way of leaving it to your accountants as these impacts your financials both top and bottom line. It is not just accounting impact, there are implications on corporate tax and GST, and tax adjustments would need to be considered for the financial impact, directly hitting the cash. Some business owners may need to review and recalibrate the business model, accounting systems or contracts to manage and minimise any accounting or tax compliance.

FRS115 deals with the way revenue can be recognised. All contracts have to go through a 5-step model to determine the components of revenue in contract, performance obligations and the amount of revenue that could be taken to P&L. The current FRS115 model adopts a transfer of control concept and revenue has to be recognise in line with the consideration that would be received in exchange for the transfer or performance of the goods or services. It specifically limits the option of progressive revenue recognition unless certain conditions are fulfilled. You can only now recognised revenue on progressive basis unless one of the following conditions is satisfied:

1. Your customer simultaneously receives and consumes the benefits provided by you (eg cleaning services) ;
2. You creates or enhances an asset (for example, work in progress) that you customer controls as the asset is created or enhanced; or
3. You create an asset with no alternative use to you and you has an enforceable right  (conditional on your satisfactory performance) to payment for performance completed to date.

We have seen a flurry of actions by some construction/renovation services searching through their contracts and trying to justifying the existence of enforceable right of payment under progress billing provided in the contracts. Unfortunately, it is specifically stated in the standard that the ability to bill under progressive milestones is not a right for enforceable payment for performance completed to date as the milestones does not track the actual performance at all time. In addition, there is a likelihood of refund that customer can exercise. Even though the enforceable right need not be an unconditional right (as it is usually subject to satisfaction performance before the right to payment can be enforced), the right to payment must at least entitles one to compensate minimally for any costs incurred at any point in time.

Under the good old times of the old revenue standard FRS18 (or FRS(I)15), the recognition of revenue is based on the transfer of risks and rewards of ownership and it is the gross inflow of economic benefits arising from ordinary operating activities of an entity. The standard does not deals with the various components in a bundled sales or specifically restricts progressive billings as long as it reflects the gross inflow of economic benefits.

As reported in Singapore Business Review – “3 in 5 Singapore firms face problems in FRS 115 implementation” published on 17 Feb 2017, less than 10% has completed the FRS115 implementation process, 62% has not started the implementation and less than 2% has completed. It is no mean feat in this FRS115 implementation.

Whilst most companies would have to take the first whammy of deferring income further to the point of transfer of control at completion – the first whammy to Top line, the second potential whammy for expected credit loss (ECL) of FRS109 on any receivables would further hits the bottom line.

Instead of the old FRS39 that put doubtful debts or credit loss onto the P&L based on actual indications of the debts turning bad, the new FRS109 take expected credit loss earlier onto the books on anticipated amount over next 12 months or over lifetime depending on whether there is a significant change in credit quality from the inception date.

Any receivables past the 30 days from due payments will indicate a significant increase in credit risk (rebuttable assumption FRS109 s109 B5.5.19) or otherwise max of 60 days assuming little correlation between 60 days past due vs default risk (FRS109 B5.5.20). This triggers the review of the both probability of default (PD) and loss given default (LGD) for longer duration from over next 12 months to lifetime, thus more likely than not that the estimated ECL over lifetime would be more probable vs ECL over 12 month, giving rise to a higher ECL hit on the bottom line.

It is therefore beneficial that as a SME owner that you have a good understanding what these two accounting standards are and what have changed over the new standards. Double whammy or not, but it is with certainty that the change is here in 2019.