Revenue revised

What does the re-exposure draft on revenue recognition mean for your business?

The global accounting profession has given a cautious welcome to the latest exposure draft on accounting standards for revenue recognition. Experts say that the proposed changes represent a move towards a clearer, more consistent standard, though some issues remain unresolved.

Because of the importance of revenue to every company, the International Accounting Standards Board (IASB) and the US Financial Accounting Standards Board (FASB) took the unusual step of re-exposing the proposals in November. The comment period ends on March 13th, and the boards aim to produce a final standard later this year.

The new standard will have a deep impact on many companies, especially those not yet using International Financial Reporting Standards (IFRS). Revenue recognition has been one of the most difficult areas for the boards to tackle because of the wide range of revenue models used in the global economy. Many commentators criticised a 2010 exposure draft for a lack of clarity.

Rebecca Mihalko, CPA, CGMA, director of financial reporting at US television network CBS Corp., says: “These changes are profound – every company needs to be looking at the new literature. While some will be able to say there is minimal impact, the majority of companies are impacted by it. They have taken away the unique industry aspects of US GAAP, so disclosure changes are significant because a lot of judgment is required.

“We appreciate the opportunity of having it re-exposed – and it has moved in the right direction. They have listened to us in several areas.”

Main changes

The core principle of the revised proposed standard is the same as that in the 2010 draft: that an entity would recognise revenue from contracts with customers when it transfers promised goods or services to the customer. The amount recognised would be the amount of consideration promised by the customer in exchange for the transferred goods or services.

However, following the nearly 1,000 letters received in response to the first draft, the boards have:

  • Added guidance on how to determine when a good or service is transferred over time.

  • Simplified the proposals on warranties and aligned them more closely with existing requirements.

  • Simplified how an entity would determine a transaction price (including ability to collect, time value of money, and variable consideration).

  • Limited the scope of the onerous test to apply to long-term services only.

  • Permitted an entity to recognise as an expense the costs of obtaining a contract (if one year or less).

  • Provided exemption from some disclosures for non-public entities that apply US GAAP.

There have also been some important refinements and clarifications in the areas of incidental obligations and sales incentives, contingent revenues and cases where there is no observable selling price.

According to the IASB, for many contracts, such as straightforward retail transactions, the proposals would have little, if any, effect on the amount and timing of revenue recognition. For others, such as long-term service contracts and multiple-element arrangements, the proposals could result in changes to the amount and timing of the revenue recognised. The nature and extent of the changes will vary between companies and industries because of the diversity in existing revenue recognition practices.

Once a final standard is issued, implementation will be no earlier than January 1st 2015. This is to ensure that, for a company providing two years of comparative information, the standard is issued before the beginning of the earliest comparative date.

Next steps

Dusty Stallings, partner in PricewaterhouseCoopers’ professional services group, says: “The boards have improved on the previous exposure draft and [created] a robust framework with good principles to increase comparability.”

In the US, the effect of the changes will depend on how large or complex the business is. US GAAP has hundreds of individual pieces of literature on when and how to recognise revenue, much of it industry-driven. Stallings says: “It will depend on the extent to which someone is relying on industry-specific guidance that might have given a different answer to this new standard.”

The telecommunications industry is particularly affected, according to Stallings, because the new standard will mean a change in the timing of revenue recognition. “Sometimes, the change in accounting is not the biggest challenge,” she says. “A lot of telecommunications companies are restricted in the amount of revenue they can recognise under GAAP, so their bill systems are set up to follow the invoicing of customers. But that will change if they have to recognise more revenues and not just the cash they receive. That might require a system change.”

Stallings adds that the changes could also prove difficult for the US software industry, which is accustomed to working within a large body of industry-specific US GAAP guidance. “The new standard is less restrictive than US GAAP on when revenue can be recognised in certain situations, so removing all of that detailed guidance will be a significant change.”

For example, in some multiple-element arrangements, an entity might not be able to recognise revenue when it provides a good to a customer because it does not have vendor-specific objective evidence (VSOE) for an undelivered item. The company has to defer revenue and recognise it when the other item is delivered. Under the new guidance, an entity might be able to recognise revenue for the first item when it is delivered if it can estimate the stand-alone selling price of the undelivered item, Stallings explains.

“Re-exposure is a rare second bite at the apple. So look at the standard and understand what it means to your company. If there are things that you think won’t work, now is the time to feed back,” she adds. “Companies will also need to put in a timeline, making sure they understand the accounting changes, and all the other things that might be impacted. These might range from taxes to human resources and bonus plans.”

In a podcast, Randall Sogoloff, leader for communications in the Deloitte IFRS global office, and Phil Barden, leader for the Deloitte global revenue recognition team, assessed how some of the details in the new draft might affect companies. Sogoloff agrees that companies need to understand the implications beyond the financial statements. “They also need to look at how contracts may need to be modified, whether there need to be changes to performance metrics and potential impacts to debt covenants,” he says. “A company may also think about their own field testing – taking actual transactions and applying the proposals, or they could participate in the IASB and FASB field testing over the coming months.”

Barden highlights five topics of interest in the exposure draft. They are decisions and factors around:

  • When to account for something as a separate performance obligation.

  • When to recognise revenue over time and when to treat something as a service rather than as a good.

  • Treatment of customer credit risk – where the boards are proposing something quite different from current practice.

  • Variable considerations.

  • Treatment of onerous performance obligations and the question of when to set up a provision at the start of a contract.

CBS’s Mihalko says: “There are a number of things about [the second draft] that have an influence on the media and entertainment industry, such as variable consideration, onerous performance obligations, customer options for additional goods or services and thinking about how it affects our TV licensing arrangements.

“In the first exposure draft there were rules regarding exclusivity of licensing arrangements that would give us accounting challenges and were included in numerous comment letters we were involved in. I am excited to say the board listened to us, re-deliberated and understood that exclusivity might not be the only way to look at a licensing arrangement.

“The board also listened to us in regards to variable consideration, which affects how we recognise revenue from moviegoers. The first draft had us concerned about the implications on our industry. It proposed that you would recognise the variable consideration when it was reasonably estimable. But when we can reasonably estimate it may be different to when our peers can do that. For example, we project the life of the movie based on how it does over a certain number of days at the box office. It’s based on an event that hasn’t yet occurred. That concerned us because it was very subjective and could cause a large degree of differentiation, depending on how aggressively you adopt those principles.

There is a specific paragraph (85) in the second draft that speaks to that, which we welcome.

This paragraph states: “if an entity licences intellectual property to a customer and the customer promises to pay an additional amount of consideration that varies on the basis of the customer’s subsequent sales of a good or service (for example, a sales-based royalty), the entity is not reasonably assured to be entitled to the additional amount of consideration until the uncertainty is resolved (i.e. when the customer’s subsequent sales occur).”

Mihalko continues: “Since the first exposure draft, they’ve limited the scope of the onerous performance obligations test to apply to long-term services only. This affects how we account for the sale of TV programming. In the second draft, they have clarified what they were trying to capture, and it makes a lot more sense. It needs to be applied to services performed in the period greater than 12 months. That scopes out all the performance obligations that would be delivered in less than 12 months, which includes those that we were concerned about from a practical point of view.”

Non-observable prices

Nick Topazio, ACMA, CGMA, head of corporate reporting at CIMA, welcomes the new proposals overall. However, he questions those related to non-observable selling prices: “The draft retains a requirement to create or estimate a selling price where no observable price exists. An example would be the installation of a large piece of manufacturing equipment that consists of various modules delivered and fitted at different times over the project life. Each module would not be sold individually, but as part of the total system. However, the revenue recognition proposals would require selling prices to be established for each module.”

“There is some guidance on how that might be done, but we think it could lead to inconsistency in application,” Topazio says. “Part of the revenue recognition process should affect how you report internally, and if you are coming up with artificial, self-generated selling prices, that may not be right.”

Jan Engström, member of the IASB, says: “I have been in more than 200 meetings with industry representatives, so we have a good base for saying that most people understand the proposal and we believe most like it. We know some won’t be happy, but we have a solid core principle in the standard now. More than 90% of all transactions for those who already use the IFRS standards will fit in easily, though there is a slightly bigger challenge with US GAAP.”

Engström says non-observable pricing should only present a hurdle in a very small percentage of cases. “I see the problem,” he says. “But in most cases people have a good view and know more or less the prices of these things.”

Executive summary

- The FASB/IASB revised proposal would create a single revenue recognition standard across industries for both US GAAP and IFRS.

- The proposal includes a detailed section of implementation guidance including: sale with a right of return, warranties, principal versus agent considerations, customer options for additional goods or services, customers’ unexercised rights, non-refundable upfront fees, licensing and rights to use, repurchase agreements, consignment arrangements, bill-and-hold arrangements, and customer acceptance.

- Companies would apply the model using the five-step process: Step 1: Identify the contract with a customer. Step 2: Identify separate performance obligations in the contract. Step 3: Determine transaction price. Step 4: Allocate transaction price for the separate performance obligations in the contract. Step 5: Recognise revenue when (or as) the business satisfies a performance obligation.

- Private companies would have an extra year to implement the proposed standard, and would be exempt from a number of mandatory disclosures.

- Comments are due March 13th and can be submitted at or