IFRS 15, quantified description of effects of future adoption, contracts, bid costs, revised policies

Serco Group plc  – Annual report – 31 December 2017

Industry: manufacturing

  1. Significant accounting policies (extract)

New standards and interpretations not applied: IFRS15 Revenue from Contracts with Customers

IFRS15 Revenue from Contracts with Customers (effective 1 January 2018), provides a single, principles-based five step model to be applied to all sales contracts, based on the transfer of control of goods and services to customers. It replaces existing revenue recognition guidance for goods, services and construction contracts currently included in IAS11 Construction Contracts and IAS18 Revenue.

Under the transition rules IFRS15 will be applied retrospectively to the prior period in accordance with IAS8 Accounting policies, changes in accounting estimates and errors, subject to the following expedients:

  • contracts completed prior to 1 January 2018 and that begin and end within the same annual reporting period will not be restated;
  • for contracts that have variable consideration and which have completed prior to 1 January 2018, the revenues recognised will reflect the actual outcome, rather than being estimated and trued up; and
  • the disclosures required for comparative periods in respect of amount of revenue allocated to the remaining performance obligations and an explanation of when that amount is expected to be recognised will not be made.

The cumulative effect of initially applying the standard will be shown as an adjustment to brought forward retained earnings as at 1 January 2017.

Below is set out the expected revenue recognition policy under IFRS15 together with the estimated impact of adopting the standard.

Revenue recognition: Repeat service based contracts

The majority of the Group’s contracts are repeat service based contracts where value is transferred to the customer over time as the core services are delivered and therefore in most cases revenue will be recognised on the output basis, with revenue linked to the deliverables provided to the customer. Where any price step downs are required in a contract accounted for under the output basis and output is not decreasing, revenue will require deferral from initial years to subsequent years in order for revenue to be recognised on a consistent basis.

There are some contracts where a separate performance obligation has been identified for services where the pattern of delivery differs to the core services and are capable of being distinct. In these instances, where the transfer of control is most closely aligned to our efforts in delivering the service, then the input method is used to measure progress, and revenue is recognised in direct proportion to costs incurred. Where deemed appropriate, the Group will utilise the practical expedient within IFRS15, allowing revenue to be recognised at the amount which the Group has the right to invoice, where that amount corresponds directly with the value to the customer of the Group’s performance completed to date.

Under IFRS15, unless upfront fees received from customers including transition payments can be clearly attributable to a distinct service the customer is obtaining, then such payments do not constitute a separate performance obligation and instead are deferred and spread over the life of the core services.

Any changes to the enforceable rights and obligations with customers and/or an update to the transaction price will not be recognised as revenue until there is evidence of customer agreement in line with the Group’s policies.

Any variable amounts will only be recognised where it is highly probable that a significant reversal will not occur.

Where the Group is required to assess whether it is acting as principal or as an agent in respect of goods or services procured for customers, the Group is acting as principal if it is in control of a good or a service prior to transferring to the customer and an agent where it is arranging for those goods or services to be provided to the customer without obtaining control.

Revenue recognition: Long-term project based contracts

The Group has a limited number of long-term contracts for the provision of complex, project-based services. When control of such a deliverable is passed onto the customer at the final stage of a contract, the recognition of revenue is delayed until control has been passed. However, where the customer has control over the life of the deliverable or where the Group has a legally enforceable right to remuneration for the work completed to date, or at milestone periods, revenue will be recognised in line with the associated transfer of control or milestone dates.

Revenue recognition: Other

Sales of goods are recognised when goods are delivered and title has passed.

Interest income is accrued for on a time basis, by reference to the principal outstanding and at the effective interest rate applicable, which is the rate that exactly discounts estimated future cash receipts through the expected life of the financial asset to that asset’s net carrying amount.

Dividend income from investments is recognised when the right to receive payment has been established.

Contract costs

Bid costs are capitalised only when they relate directly to a contract and are incremental to securing the contract. Any costs which would have been incurred whether or not the contract is actually won are not considered to be capitalised bid costs.

Contract costs are charged to the income statement as incurred, including the necessary accrual for costs which have not yet been invoiced, unless the expense relates to a specific time frame covering future periods.

Contract costs can only be capitalised when the expenditure meets all of the following three criteria and are not within the scope of another accounting standard, such as inventories, intangible assets, or property, plant and equipment:

  • The costs relate directly to a contract. These include: direct labour, being the salaries and wages of employees providing the promised services to the customer; direct materials such as supplies used in providing the promised services to a customer; and other costs that are incurred only because an entity entered into the contract, such as payments to subcontractors.
  • The costs generate or enhance the resources used in satisfying performance obligations in the future. For initial contract costs capitalised, such costs only fall into one of the following two categories: the mobilisation of contract staff, being the costs of moving existing contract staff to other Group locations; or directly incremental costs incurred in meeting contractual obligations incurred prior to contract delivery, which are required to ensure a proper handover from the previous contractor. Redundancy costs are never capitalised.
  • The costs are expected to be recovered, i.e. the contract is expected to be profitable after amortising the capitalised costs.

Estimated impact of the adoption of IFRS15

The estimated impact for the Group of adopting IFRS15 is as follows:


The Group will continue to work to design, implement and refine procedures to apply the new requirements of IFRS15 and to finalise accounting policy choices, including in its subsidiaries and joint ventures. As a result of this ongoing work, it is possible that there may be some changes to the impact above prior to the 30 June 2018 results being issued. However, at this time these are not expected to be significant.

The total adjustment to the opening balance of the Group’s equity at 1 January 2017 is a decrease of £32.8m. The principal components of the estimated adjustment are as follows:

  • A decrease of £14.4m due to revenues being recognised at a constant amount over the life of the contract where the level of services provided is broadly consistent.
  • A decrease of £11.4m due to a change in the basis of measuring progress for asset maintenance and replacement services, including dry docking. Where the resources used to fulfil the performance obligations best depicts how control is passed to the customer, the input method of accounting has been applied.
  • A decrease of £6.8m due to upfront fees and transition payments being deferred and spread in line with delivery of the core services.

The following table details the specific areas impacted as a result of the adoption of IFRS15 and cross-referenced below the table are Serco’s policies in adopting the requirements of the standard:

serco3(i) Upfront fees. For some contracts, the Group receives non-refundable amounts at the start of the contract to cover initial costs. Under IFRS15, unless upfront fees are attributable to a good or a service the customer is in control of, such fees do not constitute a separate performance obligation and instead are allocated to the performance obligations of the contract, therefore being spread over the life of the other services. In some instances such upfront fees were recognised as revenue under IAS18 but are deferred under IFRS15. Upfront payments are analysed to determine whether they constitute a material financing arrangement under IFRS15.

(ii) Transition, transformation and other mobilisation activities. Transition activities which are administrative in nature are not treated as separate performance obligations. Transition and transformation activities which are more than administrative in nature are assessed to determine whether they form a separate performance obligation. Where it can be demonstrated that the transition activities benefit the customer without future activities being provided then the transition phase is accounted for as a separate performance obligation under the contract and revenue recognised accordingly. Where it is concluded that the transformation, transition or mobilisation activity does not form a separate performance obligation under the contract, any payments received from the customer are allocated to the performance obligations of the contract and recognised over the life of the other services. In some instances revenue recognised under IAS18 is deferred under IFRS15.

(iii) Asset maintenance and replacement, including vessel dry docking. In many of the contracts the Group enters into, the provision of maintenance and replacement services are capable of being distinct and therefore these have been accounted for as separate performance obligations. The input method of accounting is used to reflect the pattern of delivery to the customer and the enhancement of customer owned assets. In some instances the output method of accounting is used due to the ongoing repetitive nature and frequency of the services. Adopting IFRS15 will result in the deferral of revenue recognised under IAS18 on certain contracts.

(iv) Percentage of completion accounting. Changes to the Group’s current accounting policy arise when the percentage of completion model under IAS11 is replaced by the output method of accounting. The output method is used where the customer simultaneously receives and consumes the benefits in direct proportion to the deliverable performed rather than the level of expense incurred to date.

(v) Pass through revenues and procurement arrangements. A pass through arrangement is where goods or services are provided by a third party, but sourced by the Group on behalf of the customer. In this instance, the Group does not recognise revenue for the amount received from the customer as compensation of the cost of the good or service but rather only the margin element (if any) is recorded as revenue. Recognition of such revenues under IFRS15 is linked directly to whether the Group has control of the deliverable prior to transfer rather than an assessment of the risks and rewards associated with the services as was the case under IAS18. For certain procurement arrangements the Group does not have control prior to transfer, but does have a level of risk associated with the activity, and therefore these arrangements are not recognised on a net basis instead of the gross basis under IAS18.

(vi) Consideration payable to a customer. Under IFRS15 all amounts payable to a customer (including all payments to the customer and all reductions to amounts paid by the customer) are recorded as a reduction in revenue. In 2017, an element of reductions have been recorded as costs.

(vii) Variable pricing. It is not uncommon in outsourcing arrangements for the payment terms to be set to decline over the future periods (i.e. a 5% reduction in fees is built into years five to six, 6% reduction in years seven to eight and so on). However, where revenue recognition under IFSR15 is based on the output method and the service remains consistent over the contract life, the reduction in the amounts paid by the customer should not be reflected in declining revenues, even if this was appropriate under IAS18. As a result, revenue recognised in prior years for certain contracts will be deferred under IFRS15.

(viii) OCP charges and releases. Where an adjustment is required by IFRS15 and the relevant contract is loss making, the deferral of revenue from prior years can result in a decrease in the level of OCP needed under IFRS15, as future losses will reduce by the level of deferred revenue. During the year one contract recorded a release against the OCP balance held under current accounting standards. As a result of IFRS15, revenues on this contract have been deferred, reducing the opening OCP balance, increasing deferred revenue and therefore the release of the relevant OCP balance is lower under IFRS15.

In addition to the areas where a financial impact has been identified as a result of adoption of IFRS15 as identified above, there are certain accounting policies which are new or change existing policies applied by the Group and may have an impact on the future financial performance of the Group. The policies in these areas to be adopted by the Group are set out below:

(ix) Contract variations. Contract modifications such as change orders, variations, change notices and amendments could be approved in writing, by oral agreement or implied by customary business practices. Under IFRS15 contract modifications are changes in the scope or price (or both) of a contract that is approved by the parties to the contract. If the parties to the contract have not approved a contract modification, revenue should be recognised in accordance with the existing contractual terms and associated cash payments are deferred until the contract modification is approved. The judgements historically applied have been consistent with this policy.

(x) Variable revenues requiring estimation. IFRS15 provides clear guidance on variable income unlike IAS18 and two areas may be impacted as a result. First, if the consideration paid by a customer includes a variable amount requiring judgement, it is only recognised where it is highly probable that a significant reversal will not occur. Second, service penalties or any claims made by us against the customer which must be recognised in revenue unless it is highly probable that they will not result in future settlement. However, judgements taken historically are consistent with the requirements of IFRS15 and there is no impact of these changes on the Group.

(xi) Capitalised redundancy costs. Under certain contracts there is an obligation to make redundancies and the Group is compensated for these costs. Historically, the Group may have recognised revenues as and when the customer makes payments or the Group may have capitalised the expense to match with payments being made in the future. Under IFRS15, all redundancy costs must be expensed in the period they are incurred and revenue is not recognised on these redundancy transactions, with any cash payments deferred over the contract in line with the other services being delivered. No adjustment was required in respect of this difference.

(xii) Licence income. Where the Group receives income for software licences and maintenance services provided through ongoing support and operational functionality, this licence revenue is recognised over the period when the maintenance obligation exists. There are currently no significant licencing arrangements entered into by the Group with its customers which are impacted by IFRS15.

(xiii) Extension periods granted or other options. Providing the option for a customer to obtain extension periods or other services may lead to a separate performance obligation where a material right exists. If a separate performance obligation exists then there would be an allocation of the transaction price from the original contract in addition to any revenues earned through the option period. A separate performance obligation exists for options under a contract if both of the following conditions are met. First, if the customer is unable to obtain the right to acquire the additional goods or services on the same or similar terms without entering into the original contract (for example they cannot get the option without first entering into the main contract, which would be the case for any extension period). Second, the option does not simply give the customer the right to acquire additional goods or services at a price that reflects the stand alone selling price for those goods or services (for example if the pricing of the option is consistent with what the pricing would have been in any case there is no separate PO, as the customer gains no incremental benefit from the existence of the option). No differences were noted under IFRS15 in this area.

(xiv) Work in progress. Revenue is only recognised when control is passed to a customer and therefore where revenue is recognised over time no work in progress is created unlike under current accounting standards. None of the contracts with revenues recognised over time have work in progress balances.

(xv) Significant financing component. Where the timing of payments agreed with the customer provides either party with a significant benefit of financing (either explicitly or implicitly), the associated asset/liability is adjusted for the time value of money and an interest charge or income is recognised and a corresponding offset in revenue. The Group’s policy under IFRS15 is to consider “significant” to be greater than 5% of the total transaction price of the contractual arrangement and no such arrangements are in place.

(xvi) Non-cash consideration. If a customer contributes goods or services (for example, materials, equipment or labour) to facilitate the fulfilment of the contract, the Group assesses whether control is obtained for those contributed goods or services. If the Group obtains control of the contributed goods or services, then the estimated fair value of these would be recognised as revenue. No such transactions have been noted.