On May 28th, the FASB and the IASB released their much anticipated standard addressing revenue accounting and reporting. The standard, Revenue from Contracts with Customers, establishes new rules for recognizing, reporting and footnote disclosure for revenue generating transactions.
According to the summary of the FASB standard, the basic guiding notion is that an organization should recognize revenue for their business transactions in an “amount that reflects the consideration to which the entity expects to be entitled in exchange for [the related] goods or services [involved in the exchange]”.
To achieve its revenue recognition goals, the new guidance establishes a five step process:
1. Identify the underlying “contract” with the customer
2. Identify the “performance obligations” established by the contract
3. Determine the contractual “transaction price”
4. Allocate the transaction price to each of the separately identified performance obligations, and
5. Recognize revenue for each performance obligation when that obligation is satisfied.
Each step in the process is explained, with definitions provided for key terminology such as: contract, transaction price, and performance obligation.
The new standard is much less “rules-based” than current U.S. guidance, which by some estimates is a codification of over 200 separate pieces of authoritative literature. As most accountants will concede, principles-based guidance leaves room for professional interpretation and judgment, and, as a result, different accountants looking at the same facts and circumstances might reach different conclusions when applying the guidance. So, in near future, the FASB and IASB will likely provide follow-up application guidance.
The FASB standard is placed in its Accounting Standards Codification under a new section index, Topic 606, Revenue from Contract with Customers. The IASB issued IFRS 15, Revenue from Contracts with Customers, which will replace their existing standards and related interpretations, basically IAS 18, Revenue, and IAS 11, Construction Contracts.
The effective dates of the new standard differ for public entities and nonpublic entities. For public entities, the effective date is for annual reporting periods beginning after December 15, 2016, including interim periods within that reporting period. For public entities early application is not permitted.
For nonpublic entities the effective date is for annual periods beginning after December 15, 2017 and interim reporting periods within annual reporting periods beginning after December 15, 2018. For nonpublic entities, the new standard provides early adoption guidance.
The new standard provides two approaches for application of its guidance, either:
• Retrospectively to each prior reporting period presented, or
• Retrospectively with the cumulative effect of initial application recognized at the date of adoption.
Each approach has additional reporting requirements.
And, lastly, the FASB and IASB agreed on most of the provisions of this new “converged” guidance, but, their separate rules contain some application differences, such as:
1. The guidance contains a “collectability” threshold that must be met before an organization can record revenue from a contract. The collectability threshold centers on the “probability” that the organization will collect amounts due under the contract. Both Boards acknowledge that their conceptual definitions of “probable” differ. The new standard did not eliminate that definitional difference.
2. For interim period disclosures, the Boards will continue their existing guidance for interim reporting, which are not converged. Additionally, the FASB and IASB interim disclosures will differ somewhat.
3. With respect to early application, the IASB standard is more liberal than is the FASB guidance.
4. Existing guidance related to reversing losses associated with a recorded asset remain. IFRS permits certain reversals, when evidence indicates that an impairment write-down no longer applies. U.S. GAAP does not permit such reversals. The new guidance does not change this pre-existing accounting policy difference.