Parsing New Revenue Recognition Proposal

The latest proposal from the Financial Accounting Standards Board for how companies should recognize revenue falls somewhere between an earlier proposal and current practice—maybe a little too close to current practice for at least one board member's comfort, but far enough away from current practice still to give financial reporting departments lots to consider.

FASB and the International Accounting Standards Board published a revised draft of their joint proposal to overhaul the rules for revenue recognition, one of the cornerstone projects in a larger effort to converge U.S. and international accounting standards. The plan retains the core principles established in the original proposal from June 2010 outlining a five-step process for companies to follow to determine when and how to recognize revenue. They require companies to: 

identify contracts with customers;

identify separate performance obligations contained in each contract;

determine the transaction price;

allocate that price to the separate performance obligations;

and then recognize revenue when or as it meets each obligation.

The new proposal, however, tackles concerns raised in nearly 1,000 comment letters about how to implement those principles in tricky areas like long-term service contracts and warranties. The proposal simplifies how a business would determine a transaction price when a transaction is affected by questions about collectability, the time value of money, and contract provisions that might vary payment amounts based on performance or other factors.

FASB and IASB also narrowed the scope on how to account for “onerous” services (those provided at a loss to retain a customer), and addressed concerns about how to recognize costs for short-term contracts. They also thinned out the disclosure requirements for non-public entities.

After such significant changes from the original proposal, FASB and IASB decided to republish it and ask for a second round of comments, to avoid creating unexpected problems with a standard that will have such a far-reaching effect on all companies. Comments will be accepted through March 13, 2012. As to an implementation date, corporate accounting departments can rest easy: FASB is promising years of lead time, perhaps to 2015 or longer.

“The new proposal clarified and refined the original proposal, and it certainly made it more usable,” says Ed Grossman, a partner with audit firm Crowe Horwath. “There were significant problems with implementation in the early version.” Based on those revisions, Grossman believes companies will face some process changes in how they recognize revenue, but not substantial ones. “For a lot of companies, I don't think this is going to change revenue recognition a lot,” he says.

“The new proposal clarified and refined the original proposal, and it certainly made it more usable. There were significant problems with implementation in the early version.”

—Ed Grossman,

Partner,

Crowe Horwath

At least one FASB member, Tom Linsmeier, dislikes the direction of the new proposal. He was the lone FASB dissenter in an alternative view published with the proposal, citing three primary objections. Linsmeier says the new draft introduces exceptions that veer from the core principles, produces inconsistent guidance for circumstances that are otherwise similar economically, and provides guidance that isn't operable or auditable. Citing numerous examples in his dissenting view, Linsmeier says FASB has resurrected too much guidance from existing standards in an effort to minimize differences from current practices.

Twists and Turns

Accountants studying the revised proposal agree that it brings revenue recognition closer to current practice than the original proposal, but still contains plenty of changes that companies need to study to determine the effect on current practices.

QUESTIONS FOR COMMENT

FASB and IASB are requesting comment on the following questions in regard to its revenue recognition exposure draft. Respondents should submit one comment letter to either the FASB or the IASB by March 13, 2012.

Question 1: Paragraphs 35 and 36 specify when an entity transfers control of a good or service over time and, hence, when an entity satisfies a performance obligation and recognizes revenue over time. Do you agree with that proposal? If not, what alternative do you recommend for determining when a good or service is transferred over time and why?

Question 2: Paragraphs 68 and 69 state that an entity would apply Topic 310 (or IFRS 9, if applicable) to account for amounts of promised consideration that the entity assesses to be uncollectible because of a customer's credit risk. The corresponding amounts in profit or loss would be presented as a separate line item adjacent to the revenue line item. Do you agree with those proposals? If not, what alternative do you recommend to account for the effects of a customer's credit risk and why?

Question 3: Paragraph 81 states that if the amount of consideration to which an entity will be entitled is variable, the cumulative amount of revenue the entity recognizes to date should not exceed the amount to which the entity is reasonably assured to be entitled. An entity is reasonably assured to be entitled to the amount allocated to satisfied performance obligations only if the entity has experience with similar performance obligations and that experience is predictive of the amount of consideration to which the entity will be entitled. Paragraph 82 lists indicators of when an entity's experience may not be predictive of the amount of consideration to which the entity will be entitled in exchange for satisfying those performance obligations. Do you agree with the proposed constraint on the amount of revenue that an entity would recognize for satisfied performance obligations? If not, what alternative constraint do you recommend and why?

Question 4: For a performance obligation that an entity satisfies over time and expects at contract inception to satisfy over a period of time greater than one year, paragraph 86 states that the entity should recognize a liability and a corresponding expense if the performance obligation is onerous. Do you agree with the proposed scope of the onerous test? If not, what alternative scope do you recommend and why?

Question 5: The Boards propose to amend Topic 270 and IAS 34 to specify the disclosures about revenue and contracts with customers that an entity should include in its interim financial statements. The disclosures that would be required (if material) are:

1. The disaggregation of revenue (paragraphs 114–116)

2. A tabular reconciliation of the movements in the aggregate balance of contract assets and contract liabilities for the current reporting period (paragraph 117)

3. An analysis of the entity's remaining performance obligations (paragraphs 119–121)

4. Information on onerous performance obligations and a tabular reconciliation of the movements in the corresponding onerous liability for the current reporting period (paragraphs 122 and 123)

5. A tabular reconciliation of the movements of the assets recognized from the costs to obtain or fulfill a contract with a customer (paragraph 128).

Do you agree that an entity should be required to provide each of those disclosures in its interim financial statements? In your response, please comment on whether those proposed disclosures achieve an appropriate balance between the benefits to users of having that information and the costs to entities to prepare and audit that information. If you think that the proposed disclosures do not appropriately balance those benefits and costs, please identify the disclosures that an entity should be required to include in its interim financial statements.

Question 6: For the transfer of a nonfinancial asset that is not an output of an entity's ordinary activities (for example, property, plant, and equipment within the scope of Topic 360, IAS 16, or IAS 40), the Boards propose amending other standards to require that an entity apply (a) the proposed guidance on control to determine when to derecognize the asset and (b) the proposed measurement guidance to determine the amount of gain or loss to recognize upon derecognition of the asset. Do you agree that an entity should apply the proposed control and measurement guidance to account for the transfer of nonfinancial assets that are not an output of an entity's ordinary activities? If not, what alternative do you recommend and why?

Source: Financial Accounting Standards Board.

“One of the big things for companies to get their heads around is the change-in-control model,” or the guidance that helps companies determine when they have satisfied a performance obligation with a customer by giving the customer control over a product or a service, says Dusty Stallings, a partner with PwC. “It doesn't necessarily give you the same answer that a risk-and-rewards model will give you. Don't assume there will be no change as a result of this new guidance. I've seen very few companies that won't see some level of change.”

Mark Crowley, director in the standards and communications group at Deloitte & Touche, says one refinement that deserves attention is guidance around collectability. Where companies have doubts about their ability to collect revenue fully, they currently create an allowance for doubtful accounts and show that as an expense. The proposal would require companies to display it as a line item reducing revenue. That would change the calculation of gross margin, which is an important performance metric for many companies. “This is a big change from current practice,” he says.

Companies also should study the guidance on onerous performance obligations, says Lisa Filomia-Aktas, a partner with Ernst & Young. An onerous performance obligation arises in a contract that, when viewed separately from the contract, leads to a loss—such as when companies cross-sell products or throw in added services to win or retain business. “This is saying you have to book a loss upfront if you know there is going to be a loss,” she says. “That could be a fairly big change for certain companies.”

For U.S. companies following a huge patchwork of Generally Accepted Accounting Principles, the changes likely will be most pronounced for companies in certain sectors following industry-specific guidance, says Tamara Mathis, a partner at KPMG. Sectors such as real estate, software, and construction are following guidance written over the years often with a specific purpose in mind, like addressing possible abuses, long-term arrangements, or situations where a company might have continuing involvement that affects revenue timing.

Companies in some sectors would follow an entirely new process to analyze and determine when to recognize revenue under the new proposal. And in some cases they would find differences in the amounts to recognize or the rate at which it would be recognized, Mathis says. “When you transition from an industry-specific model to a general model, there could be some significant differences,” she says.

While FASB has promised the proposal will not take effect before 2015 to give companies plenty of time to implement, it will creep up quickly, warns Brian Marshall, a partner with McGladrey & Pullen. The reason: retrospective application, meaning companies will be required to restate two prior years under the new guidance in the year it is implemented. So if the new standard goes into effect in 2015 for calendar-year companies, those companies would also present their 2014 and 2013 results as if the guidance had been in place.

If Marshall were a CFO for a public company, “I'd want to know where the standards are now and keep an eye on changes,” he says. “If something significant is going to affect you, you don't want to wait until it is too late.”