Users of financial statements rely on information about revenue to assess a company’s performance and prospects, and to compare that company with other companies. Although accounting for revenues would appear to be straight forward – the invoice amount should equal revenue – it is not that easy when the objective is to measure revenue in the amount an entity expects to receive in exchange for goods or services transferred to a customer.
In that case, some the variables that need to be taken into account are:
- multiple deliverables
- collectibility, and
- period covered.
Since all of these factors will impact the revenue generated by the sale or the performance, management needs to factor them into the revenue equation at the time of the transaction.
Part I – IFRS
In November, 2011, the FASB and IASB (the “boards”) jointly issued their revised exposure draft (ED) on revenue recognition. The ED’s core principle is that an entity must “recognize revenue to depict the transfer of goods or services to customers in an amount that reflects the consideration that it receives, or expects to receive, in exchange for those goods or services.” The ED lists five key steps for entities to follow in recognizing revenue for contracts within the proposal’s scope:
- Identify the contract(s) with a customer: The proposals in the ED and the final revenue standard will apply to an entity’s contracts with customers, with certain exceptions for contracts within the scope of other standards (e.g., lease contracts or insurance contracts). The proposed guidance notes that a contract may be written, verbal, or implied and provides specific criteria for entities to consider in determining whether a contract exists.
- Identify the separate performance obligations in the contract: The ED proposes that a good or service would be accounted for as a separate performance obligation if it is deemed “distinct” (i.e., sold separately or could be sold separately because it has a distinct function and profit margin).
- Determine the transaction price: The ED proposes that, when the transaction price is subject to variability, an entity would be required to use an estimated transaction price (based on a probability weighting) if the price can be reasonably estimated.
- Allocate the transaction price to the separate performance obligations: The ED requires an entity to “allocate the transaction price to all separate performance obligations in proportion to the standalone selling prices of the goods or services underlying each of those performance obligations at contract inception (that is, on a relative standalone selling price basis).”
- Recognize revenue when the entity satisfies each performance obligation: The ED introduces the concept of “control” in the determination of when a good or service transfers to a customer (and thus, when revenue is recognized), which may be at a point in time (e.g., delivering a good) or continually over a period (e.g., rendering a service).
The boards have held various roundtable discussions, and will redeliberate the proposals throughout the balance of 2012, with an estimated completion date for the project in the first quarter of 2013. The effective date of the final standard have yet to be determined.
PSAS – Public Sector Accounting Standards
Although governments and government organizations may be involved in the sale of goods and receive revenues from the provision of services and long-term contracts, these transactions are rarely of an exchange nature (i.e., exchanges of equal value). Therefore, revenue recognition principles need to be developed to apply to revenues commonly encountered in the public sector and not addressed in standards for profit-oriented entities, such as government transfers, tax revenue, fines and penalties, royalties, license fees, other fees, sales and rental, etc.
In 2011, the PSAB received an analysis of the nature of government’s sources of revenue in relation to the nature of revenue being addressed in the IASB’s Revenue Recognition project. The PSAB concluded that a public sector focused revenue recognition standard was needed and it asked staff to develop a revised Project Proposal for the Board’s consideration. PSAB expects to approve a statement of principles in September 2012.
Consideration pointsReporting the following items may require significant management’s estimates and judgments. Directors should discuss with management its selection of assumptions to ensure that management has considered a variety of scenarios to reach a balanced approach:
- Credit risk
- Electronic commerce
- Changes in rates of return
- Changes in product/services offerings
- Long-term arrangements
- Archive of IASB/FASB Webcast on New Revenue Recognition Standard (IASB, FASB)
- IASB and FASB publish revised proposal for revenue recognition (IASB, FASB)
- Review the exposure-draft: Revenue from Contracts with Customers (IASB, FASB)
- Proposed Accounting Standards Update, Revenue Recognition (Topic 605): Revenue from Contracts with Customers (FASB)
- SAB 104 - Revenue Recognition (SEC, PDF)
- SAB 101 - Revenue Recognition in Financial Statements (SEC)
- SAB 101 - Revenue Recognition in Financial Statements - Frequently Asked Questions and Answers (SEC)
- Revenue recognition: finally, a Standard approach for all (IASB, 5-page PDF file)
- Staff Notice 52-701 - Initial Report on OSC Staff's Review of Revenue Recognition (OSC)
- Financial Statement Restatements: Trends, Market Impacts, Regulatory Responses, and Remaining Challenges (GAO)
- Report Pursuant to Section 704 of the Sarbanes-Oxley Act of 2002 (SEC, PDF)