THERE ARE A COUPLE of words that pop up inside our head when we consider the timing of income recognition.
They are ‘risk’ and ‘reward’. Traditionally, the revenue of a contractor can be recognised when the risk and reward have been passed to the buyer. We are very familiar with this concept as it has already been adopted for more than a decade. However, changes are in the pipeline. Earlier this year, the Federation of Accounting Professions (FAP) announced a new accounting standard named ‘IFRS 15: Revenue from Contracts with Customers’ that will replace the existing standard. The new standard will become effective around January 2019 for Publicly Accountable Entities (PAE).
Accountants are required to recognise revenue earned by following a 5-step model. It starts by identifying the existence of the contract with the customer, followed by identifying the performance obligations of the contractor. The contract price is then ascertained and the amount allocated based on the proportion of each obligation performed. Finally, the time of the completion of each obligation is when the revenue under the contract can be recognised.
So the timing of recognition under this new accounting standard will not be considered only on the ‘risk and reward’ transferred. The key consideration in the future will be the transfer of control and ‘risk and reward’ is only one of the factors. The control transferred consists of five elements and whichever one arises first will trigger the recognition of revenue.
As yet, there has not been any signal from the Revenue Department regarding this change. Based on the current tax law, the accrual basis together with certain specific guidelines are adopted for corporate income tax computation. Much of the law relating to revenue recognition has remained in place for more than a decade. However, in the case where there is more than one obligation to be performed, e.g. where a sale, warranty and service are included in the same contract, the timing of the recognition of each of these would not be at the same point so the amount will have to be split according to the contract.
As a result of this dramatic change, it is likely that some companies may be able to match the accounting treatment with the tax law while others may find that they have a tax/accounting difference. The most important case will occur on the first time adoption. A retroactive adjustment might be required for comparison between fiscal periods, eg 2019 compared with 2018, for construction income on a long-term project that started prior to the change in accounting method but did not finish before the new standard adoption. The tax basis would have initially been aligned with the accounting basis for revenue recognition under the percentage of completion method (POC). After the change, the income stream will not be consistent with what was previously recognised for tax for the same project. Will the Revenue Department consider this as a change in the accounting method that requires its approval before it can be used? On the other hand, perhaps it is not a change in the method adopted but it is the method itself that has been transformed to the next level since the taxpayer will have no choice but to adopt the accounting practice. If the Revenue Department accepts that 2018 and prior years can be under the POC method as before and, in 2019 and after, the new accounting principle should be applied, the total revenue stream for the whole project could be different from the contract amount.
A taxpayer might even face other challenges arising from tax/accounting differences. Apart from the direct impact, the reconciliation of sales in annual tax return with the monthly VAT returns may be troublesome. The revenue stream might not be only from one source but from multiple sources. Even a trader or manufacturer, who has little difference between the revenue recognised in the accounts and the income in VAT returns, will have to be aware of this change. One example of this could be the splitting of the performance obligation from only sales of goods to be multiple obligations, eg warranty or transportation, whereby the income is recognised over a period of time while the VAT point is triggered upon the delivery of goods. The issues themselves may not be great but the volume of transactions and the need to keep track of them could be a major task.
Another interesting point is the effect of the change will have on a company’s transfer pricing reports. Normally, this report is derived from the information taken from financial statements. Once the new accounting standard is applied, the performance over several accounting periods could vary as a result of the change in accounting principle. Moreover, the selected comparable samplings may not be consistent since not all companies will apply this standard. This is one of the challenges faced by a company preparing transfer pricing documentation when first adopting the new accounting standard.
The above issues are some of the obvious examples that are likely to create additional works for the taxpayer. There may be more undiscovered tax/accounting differences that will impact directly on the corporate income tax computation as well as other tax areas and the documentation required. Taxpayers will need to keep their eyes open for any signs from the Revenue Department regarding this change and prepare the necessary internal systems to support their tax compliance.
This article was prepared by Somsak Anakkasela, Partner and Teerapong Jiaranaidilok, Manager, PwC Tax & Legal, Thailand