Changes in Revenue Recognition Under IFRS
The world’s top accounting standard setters, the Financial Accounting Standards Board (FASB) and the International Accounting Standards Board (IASB) are engaged in a joint project to develop a common revenue standard. An exposure draft issued by these boards in June 2010 outlined a contract-based approach to revenue recognition. The core principle requires an entity to recognize revenue to depict the transfer of goods or services to customers in an amount that reflects the consideration it expects to receive in exchange for those goods or services. The exposure outlined a five-step recognize-revenue approach for entities:
- Identify the contract with the customer.
- Identify the separate performance obligations in the contract.
- Determine the transaction price.
- Allocate the transaction price.
- Recognize revenue when a performance obligation is satisfied (essentially when control is transferred to the customer).
Contracts can be written, oral or implied by an entity’s customary business practices. Revenue guidance would apply to each contract with a customer separately, unless specified criteria are met for combination.
Performance obligations are customer promises in a contract to transfer goods or services to the customer. Contracts can contain one or more performance obligations and, if certain criteria are met, entities must account for each obligation separately.
The transaction price is the amount of consideration an entity expects to be entitled to in exchange for fulfilling the performance obligations. Entities need to consider the impact of variable consideration, time-value of money, non-cash considerations and any cash or credit consideration given to the customer.
In order to allocate the transaction price to the performance obligations, first determine the standalone selling price of each performance obligation then allocate the transaction price based on each obligations relative standalone value. An entity can estimate a standalone selling price if it is unobservable.
Finally, recognize a performance obligation transaction price as revenue when the customer obtains control of the deliverable. To determine when a customer obtains that control and a performance obligation is thus satisfied, examine these indicators:
- The entity has a present right to payment for the asset.
- The customer has legal title to the asset.
- The entity has transferred physical possession of the asset.
- The customer has the significant risks and rewards of asset ownership.
- The customer has accepted the asset.
The final step could mean a significant deviation from current practice, so there was no surprise that initial draft solicited nearly 1,000 comment letters. Specifically, respondents raised concerns regarding transfer of control to customers in service contracts and contracts for the continuous transfer of a work-in-progress asset to the customer. Many also raised concerns that the exposure may achieve comparability of revenue recognition across different industries at the cost of losing the current comparability in the revenue recognition practices within each industry. In November 2011, the FASB and IASB issued a revised exposure considering the comments received. Significant updates include:
- Adding criteria to help companies determine when a performance obligation is satisfied over time.
- Simplifying the criteria for determining whether a good or service is distinct when identifying separate performance obligations.
- Eliminating the proposed requirement to adjust the transaction price for collectability, replacing it with a requirement to present an estimate of uncollectible amounts adjacent to revenue.
- Removing the proposed requirement to discount the transaction price when the period between payment and transfer of the promised goods or services will be one year or less.
- Permitting a company to use a most-likely-amount approach when estimating variable consideration.
A final standard is expected to be issued by the end of 2012. In order to provide ample time for entites to implement, both boards have indicated the final standard would be effective no sooner than for annual periods beginning after January 2015. It would also become effective at least one year later for most private companies and not-for-profit organizations.