Conundrums in revenue recognition: why defer – it’s all mine!

by John Hughes

Here’s one of the significant IFRS/Canadian GAAP differences reported by TMX Group Inc.:

Of course, all such cases are different, and I don’t know much about the specific facts applying here; TMX is obviously in a very distinctive line of business. But it provides a useful reminder that the broad topic of up-front fees, non-refundable advances or lump-sum payments doesn’t necessarily play out in the same way between IFRS and Canadian GAAP. The subject best illustrating this, of all things, may be initiation fees for clubs. Suppose we imagine a particular form of initiation fee that gives you access to membership facilities, but little else; you still pay a separate charge for everything you actually do there (item by item, or through subscriptions, or a combination of both).

IAS 18 says: “If the fee permits only membership, and all other services or products are paid for separately, or if there is a separate annual subscription, the fee is recognized as revenue when no significant uncertainty as to its collectibility exists.” In other words, if it’s money in the bank, and nothing else has to be done to earn it, then why hold up recognizing it as revenue? But EIC-141, analyzing a similar situation, says this: “…the up-front fee is not received in exchange for services provided to the customer that represent the culmination of the earnings process and the up-front fee does not have a stand-alone value to the customer because ongoing use of the (club) is dependent on payment of an additional usage fee each month…(such) up-front fees, even if non-refundable, are earned as the products and/or services are delivered and/or performed over the term of the arrangement or the expected period of performance and generally should be deferred and recognized systematically over the periods that the fees are earned.” In other other words, no one gets something for nothing – even if you’ve put the money in the bank and you’re not giving it back, it won’t ultimately get you far unless you maintain the customer as an ongoing revenue source. Recognizing the revenue up-front, by this way of looking at it, allows the flow of cash to overshadow the substance of your business arrangements.

In last year’s exposure draft, the IASB proposed moving more in the old Canadian direction: “The entity’s activity of registering the customer (that is, in exchange for a non-refundable up-front fee) does not transfer any service to the customer and, hence, is not a performance obligation. The customer’s right to access the entity’s health clubs over a specified period is a right that the customer has as a result of entering into the contract. The promised service under the contract…can be provided to the customer only over time…Consequently, the non-refundable joining fee is recognized as revenue during the period that the entity expects to provide services to the customer.” But with something like 1,000 comment letters received on that project andd a new exposure draft to come later in the year, it’s far from being a done deal.

This is one of those key conceptual issues that one could use, it seems to me, to separate the population of accountants into two groups. I don’t think it’s inherently about what approach best reflects the underlying principles, because people can argue that in different ways based on their predispositions; rather, it’s an ideological matter, in the way that some people are intuitively conservative and others liberal and it’s awfully difficult to argue them to the other side of the line. It’s not hard to see the argument for recognizing amounts received or receivable as revenue, if they literally don’t have to be given back and don’t, in themselves, embody an obligation that carries any cost to fulfil. But it also shouldn’t be hard to see that recognizing revenue immediately for such payments doesn’t square with the motivations of the customer for making those payments, and doesn’t necessarily provide a basis for the most sustainable financial reporting in the long run. How one weighs these matters, as I say, seems to me to be largely subjective.

Of all areas, this ought to be one where disclosure in the notes and the MD&A is crucial, and yet you often receive far less detailed and useful information on the mechanics of revenue recognition (for example, what exactly do deferred revenue balances contain, over what period will they be released into income, etc.) than on comparatively less significant matters. If reported revenue is materially affected by up-front payments related to ongoing relationships (regardless that these meet the criteria for recognition) it seems clear to me that should be highlighted. But as of now anyway, you can’t count on that happening – the rules don’t tell you in so many words such disclosure is necessary, and the information provided is too often driven by compliance considerations. The transition to IFRS should have been a major opportunity to reset that mindset, but I think it passed us by.

The opinions expressed are solely those of the author.