Revenue Recognition Exposure
By Tammy Goldstrich, Senior Manager, Assurance Services
Since May 2002, the Financial Accounting Standards Board (“FASB”) has been working with the International Accounting Standards Board (“IASB”) to converge on revenue recognition standards. On January 4, 2012 an Exposure Draft, Revenue from Contracts with Customers, was published by the FASB and open for comment through March 13, 2012. The last update made to the draft was on July 24, 2013 when the FASB and IASB reached an agreement on several areas of the project. The staff is currently in the process of drafting a final revenue standard expected to be issued later this year.
Revenue is a critical area to users of financial information in determining a Company’s financial performance.In current practice, differences exist between revenue recognition for financial statements prepared in accordance with U.S. generally accepted accounting principles (“GAAP”) and those prepared under International Financial Reporting Standards (“IFRS”).
Current GAAP requires revenue to be recognized when realized or realizable and earned under numerous standards, some of which are noted below:
- Staff Accounting Bulletin Topic 13: Revenue Recognition
- FASB ASC Topic 605, Revenue from Contracts with Customers
- Subtopic 926-605, Entertainment – Films – Revenue Recognition
- Subtopic 928-605, Entertainment – Music – Revenue Recognition
- Subtopic 922-605, Entertainment – Cable Television – Revenue Recognition
- Subtopic 970-605, Real Estate – General – Revenue Recognition
- Subtopic 932-605, Extractive Activities – Oil and Gas – Revenue Recognition
- Subtopic 954-605, Health Care Entities – Revenue Recognition
- Subtopic 958-605, Not-for-Profit Entities – Revenue Recognition
- Subtopic 985-605, Software – Revenue Recognition
Under IFRS, current revenue recognition standards consist of only the following:
- IAS 18, Revenue
- IAS 11, Construction Contracts
Current GAAP standards are extremely detailed, by industry and transaction, but have been developed over the past several years which may result in inconsistent treatment for similar types of transactions. On the other hand, IFRS standards are very high-level which can also lead to inconsistencies in financial reporting applications.
Proposed New Standards
The new standards were developed with an intention to improve comparability of revenue recognition across entities, industries, and markets.
The proposed new revenue recognition standards are aimed at simplifying the financial statement preparation process and focus on a five step process to determine the amount of revenue to recognize for a particular transaction.
- Identify the contract with a customer
- Identify performance obligations in the contract
- Determine the contract price
- Allocate the transaction price to the separate performance obligations in the contract
- Recognize revenue when (or as) the entity satisfies a performance obligation
FASB is expected to create a new Implementation Group to assist users with questions that arise in transitioning to the new standards. Additionally, various illustrations and samples will be provided to demonstrate the use of the new standards on specific types of transactions throughout various industries.
Two methods of adoption will be allowed:
Transition will be permitted based on either the full retrospective or modified retrospective methods. Entities that choose to adopt the standard on a full retrospective basis would have to update all financial statement captions for all periods presented. Entities that use the modified retrospective approach would need to present comparative periods under the current revenue guidance. New guidance would be applied to new and existing contracts as of the effective date, and entities would need to recognize a cumulative catch-up adjustment to opening retained earnings at the effective date for existing or outstanding contacts. In addition, entities would be required to disclose all line items in the year of adoption as if they were prepared under current revenue guidance.
These new standards will have a minimal effect on entities with simplistic sales transactions, such as straightforward retail transactions.
On the other hand, industries that may significantly be impacted by the new standards include software, real estate, and construction companies whose sales include multi-deliverables, or delivery spans over multiple reporting periods.
Proposed Disclosure Requirements
The proposed standards include new quantitative and qualitative disclosure requirements to help readers of financial information better understand the nature, timing and uncertainty of revenue and cash flows from contracts with customer which include the following:
- Details regarding the entity’s contracts with customers
- Remaining performance obligations that give rise to reporting revenue in future periods
- Assets recognized from the costs to fulfill customer contracts
- Onerous performance obligations
- Significant judgments and changes in judgments made in applying the new standards to contracts
Proposed Effective Date
The proposed revenue recognition standards are anticipated to be effective for interim and annual reporting periods beginning after December 15, 2016 for public companies and for periods beginning after December 15, 2017 for non-public entities.