Revenue Recognition
- Identify the contract: what agreement are you entering in with a customer?
- Identify the performance obligations: what do you have to do to earn the revenue, there could be multiple obligations in the same contract?
- Determine the transaction price: how much for the agreed transaction?
- Allocate the transaction price: to each of the performance obligations, there could be significant judgement.
- Recognise the revenue as and when performance obligations are met: this could be at different points in the same contract.
Example
HaysMac United have entered into a commercial agreement with drinks brand Tangerine Cola for three years for a total of £3m.
For cashflow reasons for Tangerine Cola, it will be billed £500k in year one, £1m in year two and £1.5m in year three. As part of the deal Tangerine Cola get the following:
- Front of shirt sponsorship for the period
- In stadia advertising at every home game (including additional cup games etc)
- Use of a box for 10 home games over the three years
- Player appearance at Tangerine Cola events three times over the three years.
- 10 club social media activation points over the contract
- Other incidental benefits, signed shirts etc
HaysMac United have an excellent first season under the deal and make the playoffs. As a result, Tangerine Cola use the box eight times in year one.
As a start-up brand, they also use more of the social media activations (5) and player appearances in year one (2).
An appropriate treatment under current GAAP would be to spread the income over the sponsorship term see 23.15 of current FRS102 below. As simple as £1m per season.23.15 When services are performed by an indeterminate number of acts over a specified period of time, an entity recognises revenue on a straight-line basis over the specified period unless there is evidence that some other method better represents the stage of completion. When a specific act is much more significant than any other act, the entity postpones recognition of revenue until the significant act is executed.
New revenue recognition model
Follow five step model. Requirement to identify contract (three-year sponsorship), performance obligations (below), transaction price (£3m), allocate revenue to performance obligations.
- Front of shirt sponsorship (£1.8m)
- In stadia advertising (£750,000)
- Box (£100,000)
- Player appearances (150,000)
- Social media (£200,000)
- Other benefits (£nil, negligible)
The above shows a split for illustrative purposes, significant judgement involved in spread income of obligations which will need to have some basis for apportionment.
Recognise the revenue as performance obligations are met
- Front of shirt sponsorship – £600k (earnt evenly across the sponsorship term)
- In stadia advertising – £250k (earnt evenly across the sponsorship term)
- Box – £80k (earnt as box used, 80% usage at end of year one)
- Player appearances – £100k (earnt as player appearances used, 2/3’s usage)
- Social media – £100k (half of entitlement used)
Total income therefore of £1,130k in year one, more than current GAAP.
Lease accounting
The amendments also align (substantially but not completely) FRS 102 with IFRS 16. In simple terms removing the concept of operating leases. Most leases will now be classified as finance leases, requiring the recognition of associated assets and liabilities on the balance sheet. This change will impact profit and loss statements, as lease rental expenses will be replaced by depreciation and finance costs.
Example
HaysMac United enter a 10-year lease for training ground facility and pay £100,000 per annum.
Current GAAP is very straight forward.
- £100,000 expense through profit and loss annually and associated lease commitment note
New GAAP requires discounted lease calculations using appropriate discount rate.
- Assume 5% discount rate, current value of the total lease payments is £775k
Balance sheet
- Asset in use (training facility) of £775k and finance lease liability of the same amount
Profit and loss
- Depreciation – £77,500 (1 year of the 10)
- Finance cost – £38,750 (5% unwinding of discounted liability)
Total cost of £116,250 in year one. £100k payments will reduce the liability and costs over the lease term. Numbers are for illustrative purposes.
Commercial and operational considerations
The amendments to FRS 102 in some circumstances may have broad commercial implications for sports organisations. As you can see from the examples, these changes can impact profit, debt ratios, and budgeting.
Profit and sustainability rules
Sports, such as football, have profit and sustainability rules. The new revenue recognition and lease accounting standards could directly impact the profit and loss statements of football clubs and therefore compliance with the rules. Clubs will need to carefully manage their financial performance to ensure compliance with the new standards while maintaining compliance with the rules.
Debt ratios and borrowing implications
The recognition of lease liabilities on the balance sheet will increase the reported debt levels on balance sheets, as well as depreciation and finance costs. This change could affect key financial ratios, such as debt-to-equity and interest coverage ratios, which are often used by lenders to assess the creditworthiness of borrowers. It could also impact existing financing covenants in place, although measures such as EBIT/EBITDA will likely increase as you swap rental costs for depreciation and interest cost.
Organisations may need to renegotiate existing loan agreements or seek new financing arrangements to accommodate the impact of the new standards on their financial statements. It is advisable for organisations to engage with their finance providers early to discuss any potential concerns and explore possible solutions.
New commercial contracts
The introduction of the five-step model for revenue recognition will require sports organisations to allocate revenue to specific performance obligations within commercial contracts as shown in the example above. This may necessitate a review and standardisation of contract terms to ensure compliance with the new standards. Organisations should consider involving their finance teams in the negotiation and drafting of new commercial agreements to ensure that the revenue recognition criteria are considered as part of the negotiation process.
It is worth considering educating commercial teams on these changes, so they are aware of the revenue recognition considerations when negotiating deals.
Budgeting and forecasting changes
The changes to revenue recognition and lease accounting will also impact the budgeting and forecasting processes of sports organisations. Finance teams will need to build this into future forecasting and budgeting processes.
In conclusion, the amendments to FRS 102 represent a potential significant shift in financial reporting for sports organisations. However, this will be different on a case-by-case basis. Finance teams should review their exposure to the changes now to prevent future issues.
