Update

IFRS: the impact of IFRS 15 on your financial statements prepared under the Swiss Code of Obligations


International Financial Reporting Standard (IFRS) 15 introduces fundamentally new rules on revenue recognition. The ramifications of implementing the new standard may be complex. Besides compliant presentation in IFRS financial statements, it raises questions regarding the design of contracts with customers, how to capture such contracts in IT systems – and the knock-on implications of IFRS 15 for companies reporting under the Swiss Code of Obligations, the focus of this article.


Stefan Haag

Stefan Haag

Director, Assurance, PwC Switzerland

David Baur

David Baur

Director, Assurance, PwC Switzerland

IFRS 15 “Revenue from Contracts with Customers” contains fundamentally new rules on revenue recognition. Application of the standard is mandatory for annual reporting periods starting from 1 January 2018 onwards. The standard requires entities reporting under IFRS to provide useful information on the nature, amount, timing and uncertainty of revenue and cash flows from a contract with a customer. The idea is that revenue recognition should represent the economic reality of contracts with customers as closely as possible. The key principle is that an entity should recognise revenues corresponding to the amount of the expected consideration at the point-in-time, or over the period (“over-time”) during which, control of the agreed goods or services is transferred. IFRS 15 provides extensive guidance. By contrast, the Swiss Code of Obligations (Swiss CO) does not contain any provisions on revenue recognition which are directly applicable to an entity’s financial statements. It does, however, require the economic situation of the entity to be presented in such a way that a third party can form a reliable opinion.

In our view, revenue recognition in line with IFRS 15 is fundamentally compatible with the provisions of Swiss CO. Transactions would only have to be treated differently between the two frameworks if a specific IFRS 15 rule contradicts the overriding Swiss CO objective. IFRS and Swiss CO financial statements are based on two independent sets of accounting framework, so there is no requirement to apply the IFRS 15 guidance to Swiss CO financial statements. However, it would seem to contradict the principle of prudence stipulated in the Code of Obligations if in its Swiss CO financial statements an entity producing IFRS-consolidated financial statements recognises revenues earlier than under IFRS when it has not yet met its performance obligations.

Harmonisation sought – and possible

Since most IFRS users in Switzerland must additionally prepare Swiss CO financial statements, for reasons of practicality they may want to align their revenue recognition between both ledgers. If an entity now switches its revenue recognition from the old rules to IFRS 15, transition entries may be required as the total amount and timing of revenues from contracts with clients under IFRS 15 may be different.

If an entity now also wants to recognise revenue in its Swiss CO financial statements in accordance with the same principles as IFRS 15, it will have to address how it will deal with these transition effects under the Swiss CO and Swiss tax law – especially in the case of contracts that are still running at the transition date. One straightforward approach would be not to change the treatment of any ongoing contracts and only apply the new IFRS 15 guidance for contracts entered into after the transition. This would mean, however, that two different revenue recognition models are used over this transition period in the Swiss CO financial statements.

Handling transition effects in Swiss CO financial statements

Under the IFRS 15 transitional rules there is a choice available to preparers. Either they can opt to apply the standard retrospectively in full and then adjust the opening balance and comparative information accordingly, or they can opt for “modified retrospective application”. Under this second option the opening balance as of 1 January 2018 will be adjusted rather than the earliest period presented. Regardless of the method chosen, transition effects will occur for contracts with customers that have not yet been fulfilled, and these effects will have to be recognised in the opening balance sheet in the IFRS financial statements and adjusted via retained earnings. Regarding the Swiss CO financial statements the question arises what justifies a change in revenue recognition. Considering the adoption of IFRS 15 for the consolidated financial statements an entity may argue that it has reassessed the presentation of ongoing contracts with customers for its Swiss CO financial statements to present revenue more adequately.

Contrary to IFRS, retrospective recognition of transition effects is not permitted in Swiss CO financial statements; instead, transitions are made prospectively. The corresponding effects are recognised in profit or loss for the current period, typically as extraordinary and explained in the notes. Figure 1 provides an example to illustrate how the effects of a change in revenue recognition can be presented in Swiss CO accounts.

Figure 1: Effects of switching revenue recognition method using the example of a contract with multiplied components (sale and maintenance of equipment)

Example: contract with multiple components (sale and maintenance of equipment)

At the end of Year X1 a company sells a piece of equipment (retail price 70) and an accompanying three-year maintenance deal (retail price 30). The margin on each component is 20 %. The entire selling price is paid in Year X1. On 1 January of Year X3, the entity adopts the new revenue recognition method. On this date, the remaining deferred maintenance expenses of 16 are expensed, and deferred maintenance revenue of 16 is recognised for the next two years.

Old revenue recognition policy:

The entire revenue (100) for the equipment and maintenance, the cost of equipment (56) and accrued expenses (24) are recognised at the date of delivery of the equipment. It is assumed that the services are to be delivered uniformly over time, and therefore the accrued expenses are released on a linear basis in Years X2 to X4.

New revenue recognition policy:

Revenue for the equipment (70), cost of equipment (56) and deferred maintenance revenue (30) are recognised in X1. The deferred maintenance revenue is released to revenue over time on a linear basis in the subsequent years.

How is the 1.1.X3 transition in revenue recognition presented in the Swiss CO statements?

Note to the X3 Swiss CO financial statements:

Option 1:
Adjustment via extraordinary expense or income
Option 2:
Adjustment via sales revenue and service expense

Entries

Accrued expense or deferred income (cost) / exceptional expense or income 16 service expense or income 16
Extraordinary expense or income / accrued expense or deferred income (revenue) 20 Sales revenue / accrued expense or deferred income (revenue) 20

Recognition of net proceeds from sales of goods and services

Revenues from transactions with customers involving both the sale and maintenance of equipment are recognised on the basis of the retail prices of the equipment and maintenance as the company fulfils each performance obligation. …

Changes in the financial statements

Following the introduction of IFRS 15 for the purposes of the consolidated financial statements, the company has reviewed the recognition of revenues from transactions with multiple performance obligations. With effect from 1.1.X3, revenues from contracts with customers will be recognised in the financial statements under the Swiss CO in accordance with the same principles as in the consolidated financial statements. For contracts that involve both the sale of equipment and a period of maintenance support at a price set in advance, from 1.1.X3 onwards, revenue will be recognised on the basis of the relative retail selling prices of the equipment and maintenance. Under the previous policy, the revenue was recognised in its entirety on the date of shipment of the equipment and future maintenance expenses were accrued. The release of the accrued maintenance expense and the deferral of revenue on 1.1.X3 are presented in profit and loss as extraordinary income of 16 and extraordinary expense of 20. At transition, the release of the accrued maintenance expense and the deferral of the maintenance revenue at 1.1.X3 are recognised separately in profit and loss as service expense of 16 and as net proceeds from sales of goods and services of 20.

Option 1:
Adjustment via extraordinary expense or income
Option 2:
Adjustment via sales revenue and service expense

An evaluation of the options

The transition on 1.1.X3 involves changing from an accrued expense mode to the modalities of the new revenue recognition method. Since these effects bear no relation to sales revenues and/or (service) costs for the current period, Option 1 (recognition as an extraordinary item) is preferable to Option 2.

Important in terms of corporate income tax

Changes in commercial law accounting occurring on the basis of changes in the consolidated reporting standard rather than changes in the law are unusual. However, in our view the key principle that the taxation of a Swiss entity is based on the Swiss CO financial statements also applies in instances where changes have been made to an entity’s accounting policies provided such changes are sufficiently justified. This means that transition effects would in principle also have an effect on taxable net profit.

In practice, it would always be appropriate to seek a dialogue with the tax authorities and explain the background of these changes. Significant extraordinary income or expenses in particular are often challenged. It also makes sense from a tax point of view to include a detailed description of transition effects and the background to them in the notes to the financial statements.

If the decision is made not to align the Swiss CO financial statements to the IFRS 15 guidance, this will likely give rise to temporary differences between the Swiss CO and IFRS balance sheets with associated deferred tax impacts.

A word on value-added tax (VAT)

VAT follows its own principles which differ from the revenues principles for Swiss CO and IFRS. Basically, VAT is calculated on the basis of agreed compensation. If the entity pays on the basis of collected compensation, VAT is calculated on the payments made by the customer. So from a VAT point of view there can be uncertainty, especially concerning the date on which revenues are taxed. The VAT on the revenues for the three-year maintenance contract in (Figure 1) has to be paid in the first year, because the cash has already flowed. Transition effects may lead to difficulties in reconciling VAT statements. Under the terms of the Value-Added Tax Act (VAT Act), an entity must reconcile VAT to sales and demonstrate that its VAT returns tally with its financial statements. Transition effects will inevitably lead to discrepancies. The entity should provide these details to the Federal Tax Administration.

The essence of the matter

Revenue recognition as per IFRS 15 is also appropriate for accounting and reporting under the terms of the Swiss Code of Obligations (Swiss CO). For more complex sales transactions, we recommend disclosing the revenue recognition principles applied, also in Swiss CO financial statements. Under Swiss CO, revenues from contracts with customers can be recognised later than under IFRS 15, but not earlier. Since switching revenue recognition methods can lead to significant extraordinary effects, entities should provide appropriate explanations in the notes to the financial statements. These disclosures should be accompanied by relevant explanation which is also essential to ensure acceptance for VAT and tax purposes.

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Stefan Haag

Stefan Haag

Director, Assurance, PwC Switzerland

+41 58 792 71 29

David Baur

David Baur

Director, Assurance, PwC Switzerland

+41 58 792 26 54