Revenue is a key performance indicator and considered to be of critical importance to many users of financial statements. U.S. Generally Accepted Accounting Principles (GAAP) contain multiple industry specific revenue recognition guidance that sometimes result in different accounting treatment for transactions that may be economically similar. Furthermore, revenue recognition guidance for companies following U.S. GAAP is different than guidance contained in International Financial Reporting Standards (IFRS) which further impedes comparability of financial statements.
The Financial Accounting Standards Board (FASB), which establishes U.S. GAAP, and the International Accounting Standards Board (IASB) are nearing completion of a multi-year project to create a single revenue recognition model that will be applied across all industries and will be consistent for both U.S. GAAP and IFRS. The objectives of the proposed rules are to provide a more robust framework for revenue recognition, remove inconsistencies of existing requirements, improve comparability, provide more useful information to users of financial statements and simplify the preparation of financial statements by streamlining existing guidance.
The final rules are expected to be issued in late 2013. The FASB’s current technical plan anticipates issuance of a final standard during the third quarter. The new standard will likely become effective no sooner than for annual periods beginning after December 15, 2016 for public entities and a year later for non-public entities.
The basic concept outlined in the most recently issued exposure draft requires a company to apply a five-step process to determine appropriate revenue recognition:
While the five steps appear straightforward, application will, in some instances, require significant judgment.
Contracts that contain multiple performance obligations, for example, will create considerable complexity. The exposure draft contains various indicators rather than distinct criteria intended to guide companies in identifying performance obligations. Companies will have to consider the indicators and apply judgment in making their determinations of when the delivery of goods and services should be bundled rather than accounted for separately. Generally when goods and services convey a distinct benefit that is not highly dependent on another element contained in a contract, it will constitute a separate performance obligation.
The identification of separate performance obligations within a contract is important as total revenue associated with a contract must be allocated among those deliverables based on the relative selling price for each element on a standalone basis.
The new standard may impact the timing of revenue recognition. There may be situations in which revenue recognition is delayed under today’s standards due to collectability concerns or other unresolved contingencies. In certain instances, depending on the availability of historical experience, the new standard will allow for earlier recognition. Companies in which performance occurs over time should pay particular attention to the nuances contained in the new standard.
The new standard will also contain both qualitative and quantitative disclosure requirements that are more extensive than what is required by current GAAP. Companies will be required to disclose revenue by contract type and reconcile beginning and ending contract assets and liabilities. Any remaining performance obligations will also be disclosed along with costs incurred to obtain or fulfill contracts. Disclosures will also address qualitative factors and judgments impacting the timing of revenue recognition. The FASB is expected to provide additional guidance on the applicability of these new disclosure requirements to non-public entities.
Companies that currently follow industry specific revenue recognition guidance, have contracts that contain multiple performance obligations, provide for variable consideration or which currently satisfy performance obligations over an extended time period should pay particular attention to the new standard. In some cases, application of the new revenue recognition model will yield similar results to current accounting methodologies. In others, timing of revenue recognition will be impacted and, in some cases, accelerated. Companies should also consider the need to compile historical and other data that supports their judgments and estimates and should evaluate whether their current systems will require modification.
This standard-setting project, which began in 2008, is nearing completion. While the effective date may still be a few years off, particularly for non-public entities, all companies should become familiar with the new standard when it is issued later this year and begin planning for its implementation.