By: Annapaola Llanas, CPA, Masters in Accounting Instituto Tecnológico Autónomo de México
When to recognize revenue is one of the current issues that has impacted the accounting field. It seems to be a simple matter in itself or a simple concept, without complexity, however, revenue recognition in economic environments is critical and its determination is often as sophisticated as the different economic activities.
According to Zha (2014), the records of the Securities and Exchange Commission (SEC) show that by 2013, 53 percent of the errors in financial statements were related or associated with revenue recognition. At the same time, different studies have shown that the incorrect application of the rules relating to revenue recognition often leads to the restatement of financial statements.
The US GAAP (generally accepted accounting principles in the United States) issued by the Financial Accounting Standards Board (FASB) contains a comprehensive framework in relation with the methodology related to the various moments of revenue recognition. According to Bohusova (2009) there are more than 100 standards or detailed regulations in various industries that relate to revenue recognition.
Although not as extensive as those applicable to the U.S. standards, the International Accounting Standards (IAS, issued by the International Accounting Standards Board (IASB), includes the requirements and the basis for income recognition as well as other interpretations (IFRIC) in two standards (IAS 18 and IAS 11).
In 2002, both the IASB and FASB initiated a joint project to develop a new standard in order to generate a single standard that would prevent substantial differences between the two regulatory bodies governing revenue recognition and to provide a more robust framework for addressing different special features related to the topic. This project ended on May 28, 2014, when the standard ASU 2014-09 was published for the FASB, and IFRS 15, for the IASB, which will take effect for public companies on January 1, 2017 (for public companies using US GAAP, it will be on December 15, 2016, and for the other entities, on December 15, 2017).
The standard establishes a comprehensive conceptual and implementation framework to determine when and for how long revenue should be recognized. In principle, the basic criterion for revenue recognition is related to the moment when the company transfers goods or services to customers in an amount that reflects what it expects to receive in exchange for them.
In general terms, in accordance with the new standard, a company must recognize revenue by applying the following five steps:
Identify the contract (s) with a customer. The contract (whether written, oral or implied) must create rights and obligations between two or more parties and meet certain criteria to be recognized. Among the criteria to be considered is that the contract must contain commercial substance and, if possible, that the company receives economic benefits in exchange for goods or services rendered.
Identify the performance obligations in the contract.A performance obligation refers to the promise of transferring to the customer (1) either a different good or service (or a package of goods and services) or (2) a sequence of different goods or services that are substantially the same or have the same pattern of transfer to the customer.To determine whether a good or service is of a different nature, the company must consider if the client can benefit from the good or service by itself or together with other resources that he already has available. Similarly, a company must consider whether the good or service should be identified separately from other promises in the contract.
Determination of the price. The price refers to the compensation that the company expects to receive in exchange for the transfer of goods and/or services. This price includes discounts, rebates, refunds, credits, incentives, bonuses, penalties or other similar things, and can be fixed, variable or both.In determining the price, the following effects should be considered:
variable consideration – expected value: estimate analyzed by probabilities or the most probable import;
value of money over time if there is a significant financial component;
noncash compensations – valuation at fair value; and
compensations that have to be paid to the customer.
Price allocation to the performance obligations. When the contract contains more than one performance obligation, the company will distribute the price to each performance obligation using independent retail prices.If an independent retail price is not observable, the company would have to estimate (using the adjustment for market risk, expected cost plus a margin and the technique of residual amounts). Sometimes, the price of the transaction may include a discount or a variable remuneration that applies in full to a specific part of the contract. The requirements specify when the company must allocate the discount or variable compensation to a specific part of the contract and not to all performance obligations established in the contract.
Recognize revenue when a performance obligation is satisfied.Finally, the company will recognize the revenue when transferring a promised good or service to a customer, i.e., when the customer obtains control of that good or service. Gaining control refers to when there is the legal obligation to carry out the compensation, there is legal ownership of the asset, there is physical possession of the asset, there are risks and benefits of the asset and the customer has accepted the asset.As can be seen, the implementation of these five steps is based on satisfying the performance obligations, and is based on the revenue recognition from a perspective that is not unilateral. The entity that receives or contracts the service is also considered, which will generate a significant evolution within the conceptual framework of these activities.
Moreover, with the publication of this new standard, a joint effort of several years is shown, which yielded a single comprehensive model for companies with regard to the accounting of the revenue coming from contracts with customers. Also, this standard replaces most of the current guidelines related to revenue recognition.
Without doubt, this will improve the comparability of financial statements of companies worldwide.?
References
Bohusova, H., “Revenue Recognition under US GAAP and IFRS Comparison,” The Business Review, Cambridge, summer 2009, 284-291, 2009.
Crowley, M., and K. Bauer, “Heads Up — Boards Issue Guidance on Revenue From Contracts With Customers,” Deloitte & Touche LLP, Volume 21, Number 14, May 28, 2014. Consulted on May 29, 2014 at www.iasplus.com/en/publications/us/heads-up/2014/revenue
FASB, “Accounting Standards Update No. 2014-09: Revenue From Contracts With Customers,” 2014. Consulted on May 29, 2014 at http://www.fasb.org/cs/BlobServer?blobkey=id&blobnocache=true&blobwhere=1175828814244&blobheader=application%2Fpdf&blobheadername2=Content-Length&blobheadername1=Content-Disposition&blobheadervalue2=1265035&blobheadervalue1=filename%DASU_2014-09_Section_A.pdf&blobcol=urldata&blobtable=MungoBlobs
GAO, Financial Restatements – Update for Public Company Trends, Market Impacts, and Regulatory Enforcement Activities, GAO-06-678, Washington, D.C., 2006.
IASB, “IASB and FASB issue converged Standard on revenue recognition”, 2014. Consulted on May 29, 2014 at http://www.ifrs.org/Alerts/ProjectUpdate/Pages/IASB-and-FASB-issue-converged-Standard-on-revenue-recognition-May-2014.aspx
Zha, J., “The Roles of Receivables and Deferred Revenues in Revenue Management,” AAA Western Region Meeting, 2014. Consulted on May 29, 2014 at SSRN: http://ssrn.com/abstract=2424848
New Revenue Recognition Standard
Instituto Tecnológico Autónomo de México
When to recognize revenue is one of the current issues that has impacted the accounting field. It seems to be a simple matter in itself or a simple concept, without complexity, however, revenue recognition in economic environments is critical and its determination is often as sophisticated as the different economic activities.
According to Zha (2014), the records of the Securities and Exchange Commission (SEC) show that by 2013, 53 percent of the errors in financial statements were related or associated with revenue recognition. At the same time, different studies have shown that the incorrect application of the rules relating to revenue recognition often leads to the restatement of financial statements.
The US GAAP (generally accepted accounting principles in the United States) issued by the Financial Accounting Standards Board (FASB) contains a comprehensive framework in relation with the methodology related to the various moments of revenue recognition. According to Bohusova (2009) there are more than 100 standards or detailed regulations in various industries that relate to revenue recognition.
Although not as extensive as those applicable to the U.S. standards, the International Accounting Standards (IAS, issued by the International Accounting Standards Board (IASB), includes the requirements and the basis for income recognition as well as other interpretations (IFRIC) in two standards (IAS 18 and IAS 11).
In 2002, both the IASB and FASB initiated a joint project to develop a new standard in order to generate a single standard that would prevent substantial differences between the two regulatory bodies governing revenue recognition and to provide a more robust framework for addressing different special features related to the topic. This project ended on May 28, 2014, when the standard ASU 2014-09 was published for the FASB, and IFRS 15, for the IASB, which will take effect for public companies on January 1, 2017 (for public companies using US GAAP, it will be on December 15, 2016, and for the other entities, on December 15, 2017).
The standard establishes a comprehensive conceptual and implementation framework to determine when and for how long revenue should be recognized. In principle, the basic criterion for revenue recognition is related to the moment when the company transfers goods or services to customers in an amount that reflects what it expects to receive in exchange for them.
In general terms, in accordance with the new standard, a company must recognize revenue by applying the following five steps:
Moreover, with the publication of this new standard, a joint effort of several years is shown, which yielded a single comprehensive model for companies with regard to the accounting of the revenue coming from contracts with customers. Also, this standard replaces most of the current guidelines related to revenue recognition.
Without doubt, this will improve the comparability of financial statements of companies worldwide.?
References
stract=2424848