Over the past year, the Financial Accounting Standards Board (FASB) and the International Accounting Standards Board (IASB) have worked collaboratively to revise the standards businesses use to report revenue recognition. The Boards wish to align current US revenue recognition standards as closely as possible with IFRS standards so that if the two standards converge it will be a smooth transition. The goal is simple: one world-wide standard.
The Securities and Exchange Commission, which governs U.S. financial reporting requirements, will determine what is required for U.S. companies. In preparation for the SEC's upcoming decision, the two boards are combining their revenue recognition standards so outcomes will be essentially the same no matter which reporting standards (IFRS or US GAAP) the SEC chooses.
Customer Consideration - The Newly Proposed StandardThe fair-value model currently used for recognizing revenue does not take into account "value-added" dimensions of products or services. The newly-proposed customer-consideration model allows the seller to assign a probability to separate parts that make up a purchase.
For example, when a customer buys a laptop, it usually comes with an operating system, some popular software, and a 90-day product warranty.
Using the fair-value model, the accountant ignores the value-added items and only accounts for the physical laptop as a single sale item.
The customer-consideration model, however, takes the value-added items into account as well, allowing the business to assign a probability-weighted average revenue to the additional components like the software and the warranty.
New Guidelines for "Distinct" Take Contracts and Warranties into ConsiderationThe newly proposed standard makes an effort to more precisely define a distinct good or service. A distinct good is a box of cereal, book, or tennis racquet. The customer buys the item and the purchase is complete.
Other products and services are not so cut and dried. The new revenue-recognition model takes more complicated products and services into account, like the laptop example. When and how to recognize revenue for a less distinct good is still under discussion, though the probability-weighted average appears to be how the Boards are leaning. So, this guideline will need to be flexible.
Guidance for distinct products is clear. Products like warranties are trickier. There are some warranties that are built into the product and are not priced out separately, such as the 90-day laptop warranty. Other warranties are purchased separately for longer terms. Companies will use a sliding scale based upon experience to recognize revenue.
While the performance obligation for a 3-year warranty does not expire for 3 years, there is likely a statistical pattern for customer use of the warranty during the first, second, and third year. Those probabilities will vary greatly depending upon the product they cover. So, if a company buys a computer, it may have the built in 90 day warranty, which is a service but not sold or valued separately. But if the company buys an extended warranty, that is an additional service. The standards will need to give special consideration to warranty that is already built into the product-a better understanding of true overall value. Not easy to clear and calculate at the moment.
Using the laptop again as an example, one can see that services like a 90-day warranty are mixed in with the product itself, the physical hardware or laptop.
The newly-proposal standard specifies that if a contract is modified significantly, it should be accounted for as a separate contract.
When Do Reporting Standards Become Onerous?The proposal considers the topic of onerous revenue recognition obligations as well. If something is deemed onerous, the cost simply outweighs the benefit. The Boards are determining at what point items should be included on the balance sheet as onerous performance obligations. For instance, if a business leases phones, photo copiers, computers, and water coolers, should they be valued highly enough to be individually included on the accounting balance sheet or not?
After all, it takes time and money to track all of those small items, their status, and value. In the end, accounting for them on the balance sheet is not worth the effort. What is the break-even point before it becomes onerous?
The Boards discussed applying the onerous test to only long-term performance obligations satisfied over time and tentatively decided that the costs a vendor should consider when applying the onerous test are the lesser of:
? The costs that relate directly to satisfying the performance obligation; and
? Any amounts the vendor would have to pay to cancel the contract.
The Boards refer to this approach as the least-cost model.
Report What You Think You'll Get Paid, Not What You Hope You'll Get Paid
A company currently recognizes a set percentage of revenue each year over the length of the contract. The proposed change takes into account the realization that a project may not pay in full over its complete term.
When entering into a contract with a customer, company should account for the effects of a customer's credit risk and changes in that risk. The Boards tentatively decided that:
An entity should not reflect the effects of a customer's credit risk in the measurement of the transaction price and, hence, revenue upon transfer of a good or service to the customer. Consequently, an entity would recognize revenue at the promised amount of consideration (that is, at the stated contract price). That decision is a change from the Boards' earlier proposals.
The final revenue standard should not include a revenue recognition criterion that requires an assessment of the customer's ability to pay the promised amount of consideration.
An entity should recognize an allowance for any expected impairment loss from contracts with customers. The corresponding amounts in profit or loss should be presented as a separate line item adjacent to the revenue line item (as contra revenue).
Final Report Expected July, 2011The completed revenue recognition standard is expected for release in July 2011and is expected to clarify how companies report revenue in the future.
Lili DeVita is the vice president of marketing and communications at Financial Executives International, the preeminent
association for CFOs and other senior finance executives. FEI provides networking, advocacy and timely updates and CPE on financial management and reporting; Sarbanes-Oxley Act compliance; regulatory updates from the SEC, FASB, PCAOB and IASB; as well as career management and executive-level and other finance & accounting jobs.
(c) 2011 Liliana DeVita
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