IFRS 15 for automotive suppliers - KPMG

IFRS 15 for automotive suppliers

Are you good to go?

Application guidance

December 2017

Contents

Contents

Purpose of this document

1

What may change?

2

1 Tender offer phase ? Nomination fees

4

2 Framework agreements

9

3 Pre-production engineering

14

4 Tooling

23

5 Financial assistance by OEMs ? Significant

financing component

29

6 Pricing arrangements ? Customer options

33

7 Production phase

38

8 Modifications and price adjustments

46

9 Transfer of work in progress from OEM

50

10 Transition adjustments

53

11 Disclosures

56

Further resources

58

Purpose of this document

What is Good to go?

IFRS 15 Revenue from Contracts with Customers may change the way automotive suppliers (suppliers) account for various stages of their projects, such as framework agreements, tooling arrangements, serial production, modifications and price adjustments. In the past, when major IFRS change has led to large-scale implementation projects, management at companies ? usually group financial controllers ? have asked us `How will I know when we're done?'

To help to answer that question, we've created a SlideShare accompanied by this guide that list the key considerations that all suppliers need to focus on to get to the finish line.

Each section within this guide deals with a different issue and considers the new requirements and how they differ from existing requirements.

More information

Please refer to the back of this publication for further resources to help you apply the new standard's requirements.

? 2017 KPMG IFRG Limited, a UK company, limited by guarantee. All rights reserved.

2 | IFRS 15 for automotive suppliers

What may change?

This documents focuses on the following areas that may result in a change in practice for automotive suppliers on adoption of IFRS 15.

Nomination fees

The new guidance on accounting for payments to customers in the new standard may result in more payments to Original Equipment Manufacturers (OEMs) accounted for as a reduction of revenue compared with current practice. Judgement will be required to determine whether payments that are made before a contract exists under the new standard ? e.g. when there is only a framework agreement ? could be capitalised and amortised as a reduction of revenue over the expected purchases in the agreement.

Framework agreements

The new standard contains more detailed guidance on whether a contract exists, which may result in no revenue being recognised for pre-production activities under certain circumstances, or a change in the transaction price allocated to certain activities in a project. The guidance on contract combination under the new revenue standard differs in some respects from the existing guidance. This may require analysis of whether, and which, purchase orders made under the same project need to be combined.

Pre-production engineering and tooling

The new standard excludes from its scope collaborative arrangements and activities that are in the scope of other standards. This may result in some preproduction activities being accounted for outside of revenue. Further, some pre-production activities may not be considered as a separate deliverable and any consideration paid for them may be attributable to the provision of future goods or services.

Financial assistance

Suppliers may need to recognise interest expense on prepayments made by OEMs. The interest expense recognised also causes an increase in the transaction price.

Pricing arrangements

If suppliers offer predetermined or implicit price reductions to OEMs, then any consideration received at the beginning of the contract may require allocation to future purchase orders. Other price reductions may represent variable consideration ? i.e. they need to be estimated and updated throughout the contract term.

? 2017 KPMG IFRG Limited, a UK company, limited by guarantee. All rights reserved.

What may change? | 3

Production phase

The new standard may result in different timing of revenue compared with current practice. Subtle differences in the contract terms and the nature of parts or tools produced could result in different outcomes. Revenue for parts that is currently recognised at multiple points in time could be recognised as a single continuous series. This may bring forward the revenue recognised for learning curve costs.

Modification and price adjustments

The new standard's modification guidance differs from current requirements. Some modifications of purchase orders that are currently accounted for as separate contracts may need to be combined with previous, unfinished purchase orders and pre-production activities.

Transfer of work in progress

Similar to current requirements, work in progress transferred from an OEM is recognised as a supplier's asset only if the latter controls it. However, because of more specific guidance on the transfer of control in IFRS 15, the accounting outcome may differ in some circumstances.

? 2017 KPMG IFRG Limited, a UK company, limited by guarantee. All rights reserved.

4 | IFRS 15 for automotive suppliers

1

Tender offer phase ?

Nomination fees

Overview

Automotive suppliers may be required to make a payment to OEMs to take part in the tendering process for specific projects (sometimes also referred to as `programmes'). These payments are often called `pay to play' or `nomination fees'. Judgement is required when determining whether these payments are recognised up-front as an expense, as a reduction of revenue or may be capitalised as an asset. If capitalised, then they are amortised as a reduction of revenue.

Requirements of the new standard

Consideration payable to a customer includes cash amounts that an entity pays or expects to pay to the customer, or to other parties that purchase the entity's goods or services from the customer.

An entity evaluates the consideration payable to a customer to determine whether the amount represents a reduction of the transaction price, a payment for distinct goods or services, or a combination of the two.

Does the consideration payable to a customer (or to the customer's customer) represent a payment for a distinct good or service?

Yes

No

Can the entity reasonably

No

estimate the fair value of the good

or service received?

Yes

Does the consideration payable exceed the fair value of the distinct

good or service?

Yes

No

- Excess of consideration payable is accounted for

as a reduction of the

transaction price

- Remainder is accounted for as a purchase from

suppliers

Consideration payable

is accounted for as a purchase from suppliers

Consideration payable is accounted for as a reduction of the transaction price and recognised at the later of when:

- the entity recognises revenue for the transfer of the related goods or services

- the entity pays or promises to pay the consideration (which might also be implied)

These requirements are discussed further in Chapter 5.3 of our Revenue Issues InDepth publication.

? 2017 KPMG IFRG Limited, a UK company, limited by guarantee. All rights reserved.

1 Tender offer phase ? Nomination fees | 5

How does this approach differ from existing requirements?

Customer incentives Currently, there is diversity in practice over whether payments to customers are accounted for as a reduction in revenue, an expense or an asset. The requirements of the new standard may change the accounting for some automotive suppliers.

Application of the new requirements Judgement may be required when determining whether payments to potential customers could be capitalised Non-refundable up-front payments, including payments such as `pay to play' or `nomination fees', may be made before there is a contract with a customer. For example, they may be paid to participate in the tendering process, or upon signing a framework agreement ? e.g. a master service agreement ? which may not on its own meet the definition of a contract under IFRS 15 (see Section 2). If up-front payments are not in exchange for a distinct good or service, then they are accounted for as a reduction of the transaction price. However, if an automotive supplier makes these payments when there is no enforceable contract with a customer or the contract term is very short, then judgement may be required to determine whether these payments: ?? may be capitalised and amortised as a reduction of revenue over expected

purchases; ?? are recognised as a reduction of revenue over the existing contract; or ?? are recognised immediately in profit or loss. When determining the appropriate accounting for an up-front payment, factors to consider may include: ?? the underlying reason for the payment; ?? whether the payment is recoverable ? e.g. if an exclusive relationship is

secured and it is probable that the customer will make sufficient purchases to recover the payment; and ?? the history of renewals and the average project life, which usually indicate whether the expected initial contract will be obtained and whether the payment will be recovered through the initial contract or anticipated renewals.

? 2017 KPMG IFRG Limited, a UK company, limited by guarantee. All rights reserved.

6 | IFRS 15 for automotive suppliers

Scope of consideration payable to a customer is wider than payments made under the contract

Payments made to a customer that are not specified in the contract may still represent consideration payable to that customer. A supplier needs to develop a process for evaluating whether any other payments made to a customer are consideration payable under the new standard.

Consideration payable may include payments made outside a direct distribution chain

Determining how broadly payments within a distribution chain need to be evaluated requires judgement.

Consideration payable to a customer includes amounts paid to a customer's customer ? i.e. amounts paid to end customers in a direct distribution chain.

In addition, in some cases, a supplier may conclude that it is appropriate to apply the guidance more broadly ? i.e. to amounts paid outside the direct distribution chain. However, a supplier need not always identify and assess all amounts ever paid to a customer to determine whether they represent consideration payable.

Example ? Consideration paid to a customer's customer

Automotive Supplier X enters into a contract in the scope of IFRS 15 with Automotive Supplier Y to sell components worth 1,500 during the year as a subcontractor. Y will then integrate these components into parts it sells to OEM Z.

As part of the arrangement, X has agreed to pay a one-off administrative fee of 15 to Z so that it can be added to Z's list of suppliers.

Supplier X (components)

Fee

Components

OEM Z (Supplier Y's customer)

Final product

Supplier Y (parts)

X notes that Z is the end-customer in a distribution chain that includes Y. Therefore, payments to Z may be considered as consideration payable to a customer.

X concludes that the payment to Z is not in exchange for a distinct good or service. Consequently, X determines that the payment of 15 is a reduction of the transaction price, which it recognises as a reduction in the revenue earned as it transfers the promised components to Y.

? 2017 KPMG IFRG Limited, a UK company, limited by guarantee. All rights reserved.

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