IPSASB Exposure Draft on Revenue without Performance Obligations (ED 71)

What is a present obligation in the context of recognising revenue?

The International Public Sector Accounting Standards Board (IPSASB) developed ED 71 on Revenue without Performance Obligations as an update to IPSAS 23 on Revenue from Non-exchange Expenses (Taxes and Transfers). The IPSASB intends to resolve some of the issues with IPSAS 23 in ED 71, for example distinguishing between resources subject to a condition or a restriction, and a lack of guidance on multi-year funding arrangements. As explained in the article on What is revenue without performance obligations? [https://bit.ly/2SA6WG7], ED 71 applies to: 

1. Revenue transactions from binding arrangements without performance obligations, but with present obligations. 
2. Revenue transactions without binding arrangements. 

What are present obligations in ED 71?

The IPSASB considered whether it is possible to have an enforceable transaction with a “present obligation” that is not a performance obligation and concluded that such a present obligation can exist. The idea of having a present obligation related to a revenue transaction is not new and exists in IPSAS 23. This article explores how the use of present obligations in ED 71 differs from IPSAS 23. 

As the proposed accounting treatment for (a) and (b) above is different in ED 71, it is important to understand when a transaction from a binding arrangement without performance obligations has present obligations. 

ED 71 describes a present obligation as “a binding obligation (legally or by equivalent means), which an entity has little or no realistic alternative to avoid and which results in an outflow of resources”. Present obligations arise from binding arrangements that contain terms on how the transferred resources may be used by the transfer recipient. For example, funds are transferred to a transfer recipient for the sole purpose of the transfer recipient building a school or paying teachers’ salaries. 

The IPSASB decided that the present obligations in ED 71 would result from either a:

1. specified activity; or
2. requirement to incur eligible expenditure.

Specified activities

A specified activity is described in ED 71 as “a particular action, stated in a binding arrangement, that the transfer provider can compel the transfer recipient to perform”. Examples include constructing a hospital or conducting research. 

Specified activities are present obligations, as described in ED 71, because a binding arrangement requires the transfer recipient to use the transferred resources to undertake a specified activity, resulting in an outflow of resources. A specified activity is not a performance obligation because there is no requirement to transfer any good or service to the transfer provider or a third-party beneficiary. 

Requirement to incur eligible expenditure

A binding arrangement may require a transfer recipient to spend a transfer on particular expenditure. The expenditure may be to further the transfer recipient’s objectives. For example, paying for salaries or office rent. 

Eligible expenditure meets the description of a present obligation in ED 71, because a binding arrangement requires the transfer recipient to use the transferred funds as directed. The transfer recipient is unable to avoid the outflow of resources as the binding arrangement is enforceable. As with specified activities, the requirement does not meet the definition of a performance obligation because there is no requirement to transfer any good or service to the transfer provider or a third-party beneficiary. 

How do present obligations impact the proposed revenue recognition in ED 71?

ED 71 includes a flowchart (see pg. 14 of ED 71) related to asset, liability and revenue recognition for revenue transactions. The starting point of recognising transactions in ED 71 is the asset (the transfer resource). For revenue transactions without performance obligations but with present obligations, when an entity recognises an asset (debit), it recognises a liability to the extent that present obligations have yet to be satisfied (credit), and revenue to the extent that a liability is not also recognised (credit).

ED 71 explains that a present obligation (specified activity or requirement to incur eligible expenditure) gives rise to a liability because there is:

• A past event: the transfer provider and transfer recipient enter into a binding arrangement, creating enforceable rights and obligations on both parties. 
• An outflow of resources: the transfer recipient cannot avoid using those resources either to fulfil the requirements in the binding arrangement or in the event of a breach of a binding arrangement, repaying the resources to the transfer provider or incurring some other form of penalty.
• No realistic alternative to avoid outflow of resources: the binding arrangement is enforceable.

For example:

Specified activity –

A transfer provider is required to provide R10 million funding to a government science agency (transfer recipient) on 1 January 20×1 to conduct research and development over a two-year period, in terms of a binding arrangement. Any intellectual property developed by the transfer recipient remains the transfer recipient’s property. The transaction is therefore without performance obligations. The detailed project plan identifies two individual stages of research and development on which the transfer recipient is required to report back. Each of these stages constitutes a specified activity and are as follows:

Stage 1: Research with an associated cost of R3 million, estimated to take one year.

Stage 2: Development with an associated cost of R7 million, estimated to take one year. 

Revenue would be recognised when (or as) the specified activities are completed and for the amount incurred in completing the specified action. The journal entries are as follows:

1 January 20×1: Debit Bank/Receivable R10 million

                                                                         Credit Liability R10 million

[Receive transfer/raise receivable in terms of binding arrangement]

31 December 20×1: Debit Liability R3 million

                                                                          Credit Revenue R3 million

[Recognise revenue for stage 1 specified activities completed]

31 December 20×2: Debit Liability R7 million

                                                                         Credit Revenue R7 million

[Recognise revenue for stage 2 specified activities completed] There may be instances where instead of recognising an asset, an entity decreases a liability. For example, advanced receipts are initially recognised as a liability. The liability is reduced and revenue recognised as the entity becomes entitled to the revenue. The article does not deal with the accounting for advanced receipts.

Eligible expenditure – 

Funding of R4 million is provided to the National School of Government (NSG) to employ a marketing manager to promote the NSG’s courses regionally. The NSG will be entitled to R1 million a year for four years. The binding arrangement specifies that the funding is to be spent on the marketing manager’s salary (R3 million), travel expenses (R800 000) and any promotional materials used (R200 000), which represents eligible expenditure. 

The NSG accounts for the transfer based on the actual eligible expenditure incurred. Revenue is recognised as eligible expenditures are incurred. The journal entries are as follows for year 1:

Debit Bank/Receivable R1 million

Credit Liability                R1 million

[Receive annual transfer/raise receivable in terms of binding arrangement]

Debit Salaries                   R750 000

Debit Travel expenses    R150 000

Debit Promotional materials R45 000

Credit Bank/Accruals              R845 000

[Incur eligible expenditures]

Debit Liability                           R845 000

Credit Revenue                         R845 000

[Recognise revenue to the extent that eligible expenditures were incurred]

What are the accounting implications when compared to current requirements?

Similar to ED 71, IPSAS 23 requires entities to recognise an asset and revenue when the definition and recognition criteria of an asset are met, to the extent that a liability is not also recognised. 

A liability is recognised to the extent that present obligations have not been satisfied. “Present obligations” in IPSAS 23 are described as “a duty to act or perform in a certain way”. Conditions must be distinguished from “restrictions” when assessing whether a transaction contains present obligations. The difference between conditions and restrictions are as follows:

	Conditions	Restrictions
Definition	Stipulations that specify that the future economic benefits or service potential embodied in the asset is required to be consumed by the recipient as specified or future economic benefits or service potential must be returned to the transferor (own emphasis added).	Stipulations3 that limit or direct the purposes for which a transferred asset may be used, but do not specify that future economic benefits or service potential is required to be returned to the transferor if not deployed as specified (own emphasis added).
Present obligation?	Yes – the recipient entity is unable to avoid the outflow of resources as it is required to consume the future economic benefits or service potential embodied in the transferred asset in the delivery of particular goods or services to third parties or else to return to the transferor future economic benefits or service potential.	No – restrictions do not impose a present obligation on the recipient entity to sacrifice future economic benefits or service potential to satisfy the restriction. An outflow of resources in the form of a penalty is the result of enforcement procedures when a binding arrangement is breached, which is a separate event.

Therefore, in IPSAS 23 liabilities are recognised where an entity has an obligation to return unspent resources, or if resources are not spent in line with the conditions, to the resource provider. This differs in ED 71 where specified activities and eligible expenditure from binding arrangements give rise to liabilities. Specified activities and eligible expenditure may be conditions or restrictions in IPSAS 23. Based on the change from conditions or restrictions to specified activities or eligible expenditure, ED 71 gives rise to more instances where liabilities are recognised in lieu of revenue. In IPSAS 23 revenue is recognised and the liability reduced as conditions are satisfied.

The Standards of GRAP dealing with revenue transactions are aligned to the existing IPSAS, including GRAP 23 on Revenue from Non-exchange Transactions (Taxes and Transfers). The Board would need to consider whether to align with any new or revised IPSAS that are issued. The potential differences in accounting will need to be explored and discussed in responding to the IPSASB.

Where can the EDs be accessed and how can you provide comment?

The EDs have been published on the ASB’s website and can be accessed here: https://www.asb.co.za/comment-on-proposals/. The EDs are as follows:

• ED 181 on IPSASB Exposure Draft on Revenue with Performance Obligations (ED 70)
• ED 182 on IPSASB Exposure Draft on Revenue without Performance Obligations (ED 71)
• ED 183 on IPSASB Exposure Draft on Transfer Expenses (ED 72) 

Comment can be submitted to the Secretariat of the ASB at info@asb.co.za.