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ANALYSIS: Asset management Revenue recognition and measurement

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When should revenue be recognised and how much revenue should be recognised? by Yusuf Dukander, Jenny Min and Gisela Spencer

The asset management industry is a unique and niche sector of the financial services arena, both locally and globally. With thousands of billions of rands invested in unit trusts and other investment instruments under management within the South African market and offshore, revenue recognition and measurement is a crucial indicator when assessing performance and future prospects. The introduction of a new revenue model issued by the International Accounting Standards Board (IASB) in May 2014 introduces significant changes and points for asset managers to consider when applying IFRS 15 Revenue from Contracts with Customers (IFRS 15).

IFRS 15 sets out the requirements for recognising revenue that applies to all contracts with customers (except for contracts that are within the scope of the standards on leases, insurance contracts and financial instruments). IFRS 15 will be effective from 1 January 2017 and earlier application is permitted. As such, IFRS 15 will apply to all asset management and performance fee agreements.

The IASB and Financial Accounting Standards Board (FASB) jointly set out to develop a high-quality global accounting standard which introduces a single, comprehensive framework for revenue recognition. The framework will be applied consistently across transactions, industries and capital markets, and will improve comparability in the “top line” of the financial statements of companies globally.

IFRS 15 establishes a comprehensive framework for determining when to recognise revenue and how much revenue to recognise. The core principle in the framework is that a company should recognise revenue to depict the transfer of promised goods or services to the customer in an amount that reflects the consideration to which the company expects to be entitled in exchange for those goods or services.

Companies will now apply the five-step approach below:

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The new standard is more prescriptive and introduces certain complexities for asset managers to consider, specifically:

  • Variable fees (performance fees, etc)
  • Recognition of initial upfront fees
  • Capitalisation of costs (sales commissions, etc)

VARIABLE FEES

Asset managers provide investment services to investors and charge investors initial, management and performance fees. Management fees are normally calculated at a fixed percentage of the net asset value of the underlying portfolio of investments. Performance fees are normally only due to asset managers when a specific target has been achieved or exceeded during a specified period.

In determining the transaction price of both management and performance fees, the asset manager needs to take into account that both are variable in nature and that the performance fee is due to the asset managers only when the target is achieved or exceeded. Asset managers are required to estimate the amount of revenue that should be recognised when there is a variable component.

The new standard is not expected to have a significant change on how management fees are currently recognised, as they are generally determined on a daily or monthly basis. That is, a decrease in the net asset value in the next period will not impact the management fee that was recognised in the previous period.

Complexity arises when estimating the performance fees and the timing of its recognition as revenue. As it is uncertain if and when the asset manager will achieve the specific target (as it is influenced by market factors), it is difficult – if not impossible in certain instances – to predict the amount that will be due to an asset manager.

The principle in IFRS 15 is to only include amounts in the transaction price to the extent that it is highly probable that a significant reversal in the amount of cumulative revenue recognised will not occur when the uncertainty associated is subsequently resolved.

In determining the above, one needs to consider both the likelihood and the magnitude of the revenue reversal. Factors that may play a role in this assessment are the volatility or stability of the portfolio of investments and the length of the time before the performance fee crystallisation date.

This is an area of significant judgement and in certain cases will limit revenue recognition before the performance crystallisation date is reached.

INITIAL UPFRONT FEES

Some asset managers charge initial upfront fees payable by the investors at the inception of a contract.

The recognition of these fees will be dependent on whether it relates to the transfer of services from the asset manager to the investor that are distinct from other obligations to deliver services (for instance management fees). If there is a transfer of distinct services, then the initial upfront fees should be recognised as those services are provided to the investor. If it does not relate to a distinct transfer of services then the initial fees should be combined and recognised with the fees for other distinct services under the contract.

In many cases, initial upfront fees are fees paid in advance for future services, such as investment services. As a result, the initial upfront fees should be recognised as those investment services are provided. Asset managers would need to exercise judgement to determine the investment service period over which the initial upfront fee should be recognised.

CONTRACT COSTS

There are two types of contract costs that IFRS 15 requires to be recognised as an asset, namely incremental costs of obtaining a contract and costs to fulfil a contract.

Asset managers should capitalise incremental costs if it is incurred as a result of obtaining a contract, that is, costs it would not have incurred if the contract had not been obtained, and it expects to recover these costs through future services it will provide.

In addition, asset managers should also capitalise costs to fulfil a contract if it directly relates to a contract (or an anticipated contract) that will generate (or enhance) resources to the asset manager and it is expected to be recovered.

If asset managers are able to recover the costs they incur (for instance through management fees) and the costs meets the criteria above (either incremental costs or direct costs to fulfil a contract), it is capitalised and amortised consistent with the pattern of the transfer of the services to which they relate.

If the amortisation period for capitalised incremental costs is less than one year, then the cost can be expensed as incurred.

IN SUMMARY

IFRS 15 provides a more principle-based methodology for recognising revenue. The most significant change is that significant judgement will need to be exercised by asset managers to estimate the amount of variable fees that can be recognised at a reporting date. This could result in the change of the profile of revenue recognition for some asset managers. ❐

Author: Yusuf Dukander CA(SA), SAICA; Jenny Min, CA(SA); and Gisela Spencer, KPMG

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