After six years of discussion, outreach, exposure and re-exposure, the Financial Accounting Standards Board (FASB) and International Accounting Standards Board (IASB) have issued the final version of their revenue recognition standard, which introduces fundamental changes to how revenue is recorded in financial statements.
TThe standard, ASU-2014-09 Revenue from Contracts with Customers (Topic 606), was released on May 28. It is part of the FASB/IASB convergence project, which aims to produce a unified set of rules that can apply to both U.S. generally accepted accounting principles (GAAP) and International Financial Reporting Standards (IFRS).
Since it was first proposed in 2008, the standard has generated a significant amount of attention, attracting some 1,500 comment letters from around the world. Indeed, the Society has been among those watching the standard closely through its development, issuing comment letters on the matter both in 2010, when it was first exposed, and 2012, when it was re-exposed.
In response to the outpouring of feedback, the FASB and IASB undertook an extensive outreach effort to gather opinions on the merits and flaws of their previous drafts. “It is important that we get this right,” then-IASB Chair David Tweedie said in 2011. “That is why … we are keen to treble-check that our conclusions are robust and can be implemented with minimal disruption.”
The boards gave an overview of the final version of the standard, and explained some of the reasoning behind its provisions, in a June 5 webcast that featured Patricia McConnell, an IASB member; Allison McManus, senior technical manager for the IASB; Kristen Bauer, a FASB practice fellow; and Larry Smith, a FASB member.
The revised standard is meant to address what both boards saw as deficiencies in their current approaches to recording revenue in financial statements. According to Smith, in the case of GAAP, the new standard will replace the myriad industry- and transaction-specific guidance with a singular approach, while in the case of IFRS, it will address a lack of guidance altogether. Current IFRS practices can be difficult to apply to anything but simple transactions, Smith said, with practitioners sometimes using GAAP to fill in the gaps.
While the standard itself is quite complex, the core principle behind it is that entities would recognize revenue based on contracts: their creation, their breakdown into discrete performance obligations—that is, promises to transfer a distinct good or service—and their ultimate completion. Essentially, according to the standard, when performance obligations are completed, the revenue is recognized. The boards offered a framework for conceptualizing the new standard, breaking things down along a five-step process.
The first step is to identify the contract with the customer. A customer is defined as a party contracted with an entity to obtain goods or services that are the output of the entity’s ordinary activities in exchange for payment, as opposed to a collaborator that shares the benefits, such as two entities that share development costs. Bauer said that non-revenue contracts are scoped out of this standard, as are leases, insurances and financial instruments, which have their own rules. She added that guarantees and non-monetary exchanges between entities that are in the same line of business are similarly scoped out.
Second, the entity identifies the performance obligations. These form the basic accounting unit to which entities allocate payment and recognize revenue. A performance obligation, Bauer continued, can be explicitly stated, as in a written contract, or implied through customary business practice.
“If a customer has a valid expectation of receiving a good or service, you may have a performance obligation,” she said.
Third, the entity determines the transaction price, which is the amount the entity expects to be paid in exchange for the promised good or service. It then allocates the transaction price to the performance obligations in the contract. After this, the entity allocates the transaction price to the performance obligations. The general rule, Bauer said, is to allocate the price on a relative stand-alone selling basis; in limited circumstances, he added, discounts and variable consideration are allocated entirely to one or more performance obligations.
Finally, the entity will recognize revenue when it satisfies the performance obligation. Generally, the sale of a good will be recognized at a specific point in time, and the sale of a service will be recognized over time, though this may not always be the case.
Bauer said that, while the five-step process itself is not part of the standard, it helps to think of it in these terms. She also noted that not every step will be applicable to every transaction performed by every entity and that the steps may not always be sequential.
New standard, new disclosures
Another big change stemming from the new standard is new disclosures. McConnell said that the boards tried to reach a balance between the interests of users, who have generally wanted more disclosure, and preparers, who have generally expressed concern about the associated costs. In general, she said, the boards wanted to improve the users’ ability to understand the judgments and decisions behind the entity’s accounting.
For example, she said, under the standard, the entity must disclose information about opening and closing balances of receivable contract assets and liabilities, rather than include a roll-forward. Moreover, an entity must disclose the transaction price related to performance obligations that are unsatisfied or partially satisfied at the end of the reporting period, a requirement that can be satisfied by explaining when the entity expects to recognize that amount as revenue. And, according to the standard, the entity should disclose disaggregated revenue based on how the nature, timing and amount of revenue and cash flow are affected by economic factors. The implementation guidance, she said, includes several examples that may be used, sorted by factors such as types of good or service, geographical regions, market, or type of customer.
The NYSSCPA Reacts
While the Society largely agreed with the proposal in its 2012 comment letter, it did express concerns over the standard’s application of performance obligations of more than a year (it felt that, instead of a time threshold, performance obligations should be booked based on materiality).
It also pointed out that an entity could reach different conclusions about nearly identical performance obligations, such as in a case where there is a performance obligation with estimated completion in 11 months and another in 13 months, both estimated to incur a loss, allowing the entity to record the loss on one but ignore the other. Further, the Society said an entity may have an overall profit on a contract but may still incur losses on individual performance obligations, and wondered whether it is logical to record a loss on the first day when, at the overall contract level, the entity is not expected to record a loss.
Though the boards did change the time-threshold provision, they did not switch to a materiality-based threshold. Instead, they said in the standard that, “an entity need not adjust the promised amount of consideration for the effects of a significant financing component” if the entity expects, at contract inception, that the period between when it transfers a promised good or service to a customer and when the customer pays for that good or service will be a year or less.
In general, Jo Ann Golden, an NYSSCPA past president, member of the Society’s Financial Accounting Standards Committee and one of the letter’s original authors, said she felt very positively towards the methodology proposed in the final standard.
“The whole concept of mapping—of going from point A to the final point of how you actually recognize revenue and disclose it—seemed to be pretty clear and seemed very thoughtful in terms of the way they took a look at this,” she said.
What she found interesting about the final product was that it seemed much more principles based, than rules based and could be compared more to guidance than rules. However, she also pointed out that it is the first major convergence standard to be completed by the two boards and was intended to be a new way of looking at things. She said it will be “interesting” to see how this plays out in the long run.
“The effective date for public entities and certain nonprofits and employee benefit plans to implement the new standard is Dec. 15, 2016 for public companies and Dec. 15 2017 for nonpublic companies, though they are allowed to implement earlier back to years starting Dec. 15, 2016.