Revenue recognition – let the discussion commence!

In a previous posting last May, we took a quick look at how the global revenue project was shaping up. I also boldly predicted that there would be a discussion paper issued on the topic ‘within the next few weeks’.

Well, so much for that prediction, but we did get a delightful, festive present on 19 December: a revenue discussion paper issued jointly by the IASB and the FASB. The discussion paper explains the preliminary views of both standard setters and proposes a single contract-based revenue recognition model that would replace the current revenue guidance.

So what are the proposals? The key change from the current model is that revenue will be based on the changes in contract assets and liabilities. What does this mean? Well, all contracts (with the possible exception of contracts for financial instruments, insurance and leasing) would be analysed into contract assets (the right to receive payment) and contract liabilities (the obligation to perform under the contract). Revenue would only be recognised when either the net contract liability is reduced or the net contract asset has increased, both as a result of the entity discharging its contract liabilities by performing.

All this seems relatively straightforward, although rather conceptual, and, of course, follows the IASB’s framework balance sheet approach. However, let’s examine it some more. Entities are going to have to identify what performance obligations have to be satisfied (the delivery of either a good or a service) and allocate a value to each. Also, remember that construction contracts, which are currently covered by IAS 11,’Construction contracts’, are within the scope of this project. It will be important to identify when performance has been satisfied, as it could take place over a period of time or at the very end of a project.

That is the current proposal in a nut shell; however, the standard setters acknowledge that there are several areas where a preliminary view has not yet been considered. These include the measurement of contract assets, how much someone is going to pay the entity to satisfy the obligations, the impact of any changes to contractual terms, how revenue will be presented and a decision on whether and how the fair value of certain performance obligations should be measured. 

The standard setters have stated that they believe the proposed model will not change the accounting for many transactions. In some cases that will clearly be true, but, as they also acknowledge, there are some significant changes in the proposals.  For example,

• What is the impact for a construction company if it can’t recognise revenue until construction is complete?
• How will revenue recognition patterns change for a consumer products company if its warranty obligations are contract liabilities?
• Will changes from detailed and sometimes industry-specific revenue guidance under US GAAP to a single principle-based model change business practices?

This is one of the most important convergence projects for both the IASB and FASB, and we are expecting a standard by 2011. It is important to determine how the proposals will impact your business. I therefore encourage you to respond to the IASB with any comments you have. I would also be very interested in your views on the proposals, either by commenting here or by email.

Comments

[Muhammad Ali]

Dear Richard,

It’s good to see that finally both standard setters are moving towards converging revenue related standard. The proposed model (i.e. component recognition approach) is gaining recognition among accountant fraternity. I wonder by focusing on contract based model we would rather negate the substance of the transaction. There are certain issues a part from which highlighted by you and your colleagues in recent IFRS news publication, which I guess would be addressed once Board start crystallizing ED on Revenue standard, including when it will be deemed that the seller has discharged all its obligation and what if some ancillary service obligation has to be fulfilled. Should seller wait to complete all of its obligation before recognition of revenue and what if that obligation constitute a minor portion of overall arrangement with customer. What if some performance obligation still needs to be consummated before customer considers as fulfillment of the contract arrangement.
If we go for component accounting for revenue recognition, we have to see enforceability on fulfillment of part of obligation where I guess it seldom to enforce the payment when the contract is half way, rather all payment consideration were contingent on fulfillment of obligation in its entirety.
I would be interested if you provide further insight of the upcoming amendment and the difficulty that would be encountered in practical application of the standard. I would rather consider that the Standard Setters should conduct a walkthrough of the principle so that the practical application would better be understand before moving forward.
Thanks

[Richard Keys]

Many thanks for your posting. We will continue to publish guidance on the revenue recognition requirements as they develop, in addition to the IFRS news article and supplement in the March edition [LINK1]. Our recently relaunched webpages on IFRS issues [LINK2] highlight the guidance we release and any other news updates on the topic.

[Rod Mattheyse]

How should one account revenue in an instance where a service provider acts as an agent and pools funds, takes out a service fee, and redistributes the funds to others based on the outcome/prediction of a sporting event.

I am specifically referring to a totalisator operation or betting exchange.

I would assume only the take out or commission should be regarded as revenue?

In the same light if a percentage of the take out/commission was as an agent to a government department and paid over as a tax does one recognise this as a revenue and a cost?

Regards

Rod