Automating Compliance for IFRS 15, 16, and 17

WHAT IS IFRS 15?

The introduction of International Financial Reporting Standard (IFRS) 15 was led by the International Accounting Standards Board (IASB) and came into force in January 2018. It was introduced to standardize guidance internationally on accounting for revenue from contracts with customers. This is to ensure organizations recognize and report revenue from contracts at the right time, when the services or products sold have been fulfilled.

According to the IFRS Foundation guidance, IFRS 15 establishes the principles that organizations apply when recognizing the type, amount and timing of revenue from the sale of goods or services to a customer. This guidance includes five steps organizations must now apply to correctly recognize revenue under IFRS 15. These are:

1. Identify the contract with a customer.
2. Identify the performance obligations in the contract.
3. Determine the transaction price.
4. Allocate the transaction price to each performance obligation
5. Recognize revenue when a performance obligation is satisfied by transferring a promised good or service to a customer.

WHAT IS THE CHALLENGE FOR FINANCE AND ACCOUNTING?

One of the main challenges for finance is correctly accounting for the revenue from contracts that contain a bundled mix of physical goods and services, such as an IT project that includes computer hardware, software licenses and consultancy services. Whereas previously this might have been accounted for as a single transaction, each element of the bundle has to be accounted for and recognized separately. And, under IFRS 15, different types of revenue have different rules about the timing of when they can be recognized and reported.

This means finance teams must better understand the contracts the organization has with its customers and then align the costs with the revenues from those contracts using the principles defined by IFRS 15.

In a bundled contract scenario, finance teams must essentially unbundle the different elements and, using the five-step IFRS 15 framework, calculate how much revenue is assigned to each part of the contract and when they can recognize and account for each of those elements in compliance with reporting guidance.

To achieve this, finance needs more granularity in the contract data it uses for accounting than in the past so it can correctly calculate the portion for physical goods, person hours and any other elements of the contract. It requires more detailed data and more manipulation of that data to ensure compliance with IFRS 15.

For many organizations, their ERP systems will contain a lot of this data and have the functionality to do things such as earned value analysis. However, this still requires a lot of manual effort to upload the data and run reports in the ERP system.

HOW CAN REDWOOD FINANCE AUTOMATION SUPPORT IFRS 15 COMPLIANCE?

To apply finance automation effectively to help with IFRS 15 compliance, there are three key elements organizations need to have. These are: a repeatable contract bundle; contract data that is digitalized and detailed; and a defined methodology and process according to IFRS 15 rules.

The sweet spot where finance automation can really help with revenue recognition under IFRS 15 is when an organization has a repeatable product/service bundle that it sells to customers.

Take the example of a technology supplier that implements SAP for customers. A multi-year contract bundle like this might include supplying the physical computing infrastructure, the SAP software, as well as the consultancy service to configure the software, implement it, run it, and support and maintain it for the customer.

In that scenario, finance must identify clearly and analyze at a very granular level—usually from data in its ERP system—what types of goods or services are being sold as part of that bundle, what costs have been incurred, and what the correct revenue recognition period is for each of those goods and services.

Under IFRS 15 there are different recognition and accounting rules that apply for different types of revenue and according to when a performance obligation is fulfilled. For an IT project like the above example, some revenue might not be recognizable until the customer is live and running on the new software, whereas other types of revenue, such as supplying physical computer hardware can be recognized straight away, typically on acceptance by the customer.

With a repeatable goods/services bundle where the components are the same from contract to contract, even if the exact specification and volume varies, Redwood can automate the data retrieval process, perform automated splits and calculations and propose the required postings. By doing this, finance automation eliminates manual effort, creates a structured, compliant and auditable process and ensures fast processing.

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WHAT IS IFRS 17?

International Financial Reporting Standard (IFRS) 17 came into force from 1 January 2021 and applies to insurance contracts. IFRS 17 is the latest IFRS standard for insurance contracts and replaces IFRS 4 on 1 January 2022. According to the IFRS guidance, IFRS 17 provides consistent principles internationally for all aspects of accounting for insurance contracts. The guidance states:

“It removes existing inconsistencies and enables investors, analysts and others to meaningfully compare companies, contracts and industries.”

Under IFRS 17, insurance companies are required to measure both their obligations and profit information across the duration of an insurance contract to provide more transparent reporting about the company’s financial position and risk.

According to the IFRS guidance, this includes using updated estimates and assumptions about cash flow, recognizing profits only as insurance services are delivered instead of when premiums are received and providing information about future profit forecasts, as well as metrics that can be used to compare performance against other insurers.

WHAT IS THE CHALLENGE FOR FINANCE AND ACCOUNTING?

IFRS 17 forces finance teams at insurance companies to do far more risk-rated calculation and reporting of the value and profit from insurance contracts. It requires very granular data from different systems—policy, claims, commissions and actuarial—making the calculations required under IFRS 17 and then bringing all that information into the books through accounting records that will be reflected in financial reporting activities. And all of this additional work must be done during what is already a busy crunch time for finance teams in insurance companies during the financial period-end close.

Another challenge in pulling all this insurance contract data together is that it resides in what are typically inflexible legacy policy administration, claims and other line of business systems. This  makes the extraction and transformation of the data required by IFRS 17 particularly difficult, manually intensive and prone to errors.

HOW CAN REDWOOD FINANCE AUTOMATION SUPPORT IFRS 17 COMPLIANCE?

Automation can ease that burden on finance teams during the period-end close and manage the collection of that granular data from the various insurance systems. It can also then automatically apply the IFRS 17 accounting rules to those contracts.

This accounting process for insurance contracts can typically have up to 40 or 50 individual, but often interdependent, steps. Finance automation can not only orchestrate these steps so that they are defined and sequenced correctly, but it can also automate the steps and eliminate the manual burden on finance during that stressful and busy period-end close. The automation manages all the handoffs and handovers between people and technology with high transparency at every stage of the process. And with all the necessary checks and balances, along with comprehensive audit trails, this ensures you are fully compliant with the requirements of IFRS 17 with the minimum incremental effort.