FRS 102, the Financial Reporting Standard applicable in the UK and the Republic of Ireland is evolving. The changes on the horizon are likely to be significant.
FRS 102 is subject to periodic review, with a significant review every five years alongside a three-yearly review in the intervening period. The latest version of this, Financial Reporting Exposure Draft 82 (or “FRED 82” as it is catchily known) was published in December 2022.
One of the proposed key changes is a new model for revenue recognition, using the 5 step model of IFRS 15. The aim is to provide greater consistency of revenue recognition for users of financial statements and a clearer process for preparers to apply. In the legal sector, this will help users like private equity consolidators assess the underlying earnings and recurring revenues of legal practices.
This is a fundamental change, as revenue recognition is a key part of the financial statement preparation process. Revenue is one of, if not the, largest figure in the financial statements. It is a highly sensitive figure which is important in many ways; determining entity size, employee/partner bonuses and entity valuation figures. Views are being sought and will be taken into account when FRS 102 comes to be updated.
Final amendments will be made following the end of the consultation in April 2023. These may be published in Q3 2023. An implementation period is proposed with an effective date of accounting periods commencing 1 Jan 2025, i.e., for 31 December 2025 year ends. Although this date is subject to consultation too!
Firstly, it is useful to outline the five steps required in determining revenue recognition:
Key considerations include whether a modification to terms of existing contracts results in the creation of a new contract, for instance, if new performance obligations (major scope changes or revisions to terms) are added.
This can involve the “unbundling” of a contract. For instance, the conveyancing process could be deemed as consisting of separate processes relating to right to title, issues of planning, exchange and completion and registry of title.
Fundamentally, the transaction price will be the most likely value that the entity expects to be entitled to in exchange for the promised goods or services supplied under a contract. This requires consideration of variable consideration (for instance for rebates or incentives, although not likely relevant to the legal sector) and adjustments for financing components (for instance if cash is paid in arrears or advance).
Here, the individual selling price of the goods and services is allocated to the individual performance obligations. Consideration is paid to the allocation of variable considerations which are linked to specific performance obligations if certain conditions are met
The key point here is that the point of revenue recognition is the point when the performance obligation is satisfied. Revenue can be recognised in two ways – at a point in time or over time.
A move to the IFRS 15 method of determining revenue recognition will potentially have changes to the timing and profile of revenue recognition for law firms. The IFRS model is far more prescriptive than the current FRS 102.
In summary, the process of determining revenue recognition is to become far more prescriptive in the near future. With the changes to FRS 102 largely following IFRS 15, there is scope to determine in advance whether your entity’s revenue recognition will be affected. Action can be taken to review the content of engagement letters where these do not give the entity the right to be paid for work completed to date.