FASB, IASB Issue New Revenue Recognition Rules
The International Accounting Standards Board (IASB), responsible for International Financial Reporting Standards (IFRS), and the Financial Accounting Standards Board (FASB), responsible for United States Generally Accepted Accounting Principles (US GAAP), have issued a converged standard on the recognition of revenue from contracts with customers.
Revenue is seen to be very important for users assessing a company's financial performance and prospects, and it is intended that the new standard will improve both the financial reporting of revenue and also the comparability of the top line in financial statements globally.
It has been pointed out that the previous requirements of both IFRS and US GAAP were different and have often resulted in different accounting for transactions that were economically similar. In addition, while revenue recognition requirements of IFRS lacked sufficient detail, the accounting requirements of U.S. GAAP were considered to be overly prescriptive and conflicting in certain areas.
The core principle of the new standard is for companies to recognize revenue to depict the transfer of goods or services to customers in amounts that reflect the payment to which the company expects to be entitled in exchange for those goods or services.
That core principle, it is said, will be achieved by following five steps – identifying the contract(s) with a customer; identifying the performance obligations in the contract; determining the transaction price; allocating the transaction price to the performance obligations in the contract; and recognizing revenue when (or as) the entity satisfies each performance obligation.
The standard will therefore require enhanced disclosures. To allocate an appropriate amount of consideration to each performance obligation, an entity will have to determine, at the beginning of the contract, the standalone selling price of the separate goods or services underlying each performance obligation. If a standalone selling price is not observable, it must be estimated.
Companies will be affected in different ways – some being able to report revenue earlier and some later. For example, a car dealer selling a vehicle with maintenance and servicing over succeeding years will have to reduce the initial price of the car and account later for its future performance obligations, while a telecoms company selling a mobile phone package on a fixed-period contract, that generally subsidizes part of the phone price through the monthly fees, will have to report more revenue upfront.
The standard will take effect for US public companies for annual reporting periods beginning after December 15, 2016, while, for nonpublic US companies, the standard will take effect for annual reporting periods beginning after December 15, 2017. Companies using IFRS will be required to apply the standard for reporting periods beginning on or after January 1, 2017, with early application being permitted for companies that use IFRS.
The FASB and the IASB have established a joint transition resource group in order to aid transition to the new standard. Further details about that group will be announced shortly.
Russell Golden, Chairman of the FASB, commented that "the revenue recognition standard represents a milestone in our efforts to improve and converge one of the most important areas of financial reporting. It will eliminate a major source of inconsistency in GAAP, which currently consists of numerous disparate, industry-specific pieces of revenue recognition guidance."
Hans Hoogervorst, Chairman of the IASB, added that "the successful conclusion of this project is a major achievement for both boards. Together, we have improved the revenue requirements of both IFRS and U.S. GAAP, while managing to achieve a fully converged standard. Our attention now turns to ensuring a successful transition to these new requirements."
Fitch Ratings noted that "the rules will affect the timing of revenue recognition, but not overall contract profitability or timing of contract-related cash flows – unless contract terms are altered in response to them. … However, some companies may use the transition period as an opportunity to restructure future sales contracts to receive the most favorable revenue recognition."
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