FASB, IASB Unveil Final Standard on Revenue Recognition
After a half-dozen years of planning, meetings, discussions, roundtables, public comment periods, and several proposals, the final joint revenue recognition standard from the Financial Accounting Standards Board (FASB) and the International Accounting Standards Board (IASB) has finally been issued.
The two standard-setting boards announced the release of the converged standard on the recognition of revenue from contracts with customers on Wednesday morning – the culmination of a project the FASB first initiated on its own in 2002. The FASB and the IASB have been collaborating on the standard since 2008.
The new guidance standardizes how companies should recognize revenue in financial statements under both US Generally Accepted Accounting Principles (GAAP) and International Financial Reporting Standards (IFRS). Experts say the final rule could especially affect businesses in such industries as telecommunications, software, and real estate.
How Standard Could Impact Companies
According to a KPMG LLP executive summary of the revenue recognition standard, a company could be impacted by the new rule in several ways:
- Existing contracts may need to be analyzed; some contracts may need to be combined, and some may contain additional performance obligations.
- A gap analysis of accounting policies may need to be performed.
- Tax changes caused by changing the timing and amounts of revenue, expenses, and capitalized costs may require adjustments to tax planning.
- Processes may need to be developed to capture management’s judgments and any subsequent changes on a timely basis.
- Systems may need to be updated or upgraded to capture data needed for the additional estimates, judgments, and disclosures.
- Staff bonuses and incentive plans may need to be reconsidered.
- Investors and other stakeholders will want to understand the impact on your business.
According to the FASB, the core principle of the new standard is for companies to recognize revenue “to depict the transfer of goods or services to customers in amounts that reflect the consideration (that is, payment) to which the company expects to be entitled in exchange for those goods or services.”
It also will result in enhanced disclosures about revenue, provide guidance for transactions that were not previously addressed comprehensively (such as service revenue and contract modifications), and improve guidance for multiple-element arrangements.
The revenue standard will replace the more than 200 specialized and/or industry-specific revenue recognition requirements under US GAAP and beef up the limited guidance that is currently provided in IFRS.
“The revenue recognition standard represents a milestone in our efforts to improve and converge one of the most important areas of financial reporting,” FASB Chairman Russell Golden said in a written statement today. “It will eliminate a major source of inconsistency in GAAP, which currently consists of numerous disparate, industry-specific pieces of revenue recognition guidance.”
The revenue standard will be introduced into the FASB’s Accounting Standards Codification as Topic 606 by Accounting Standards Update 2014-09, Revenue from Contracts with Customers. The new standard replaces the previous revenue recognition guidance contained in Topic 605.
The guidance will be included in IFRS as IFRS 15 Revenue from Contracts with Customers and replaces IAS 18 Revenue, IAS 11 Construction Contracts, and related interpretations.
“Together, we have improved the revenue requirements of both IFRS and US GAAP, while managing to achieve a fully converged standard,” IASB Chairman Hans Hoogervorst said in a written statement on Wednesday.
Companies using IFRS will be required to apply the revenue standard for reporting periods beginning on or after January 1, 2017, and early application is permitted. For public companies using US GAAP, they will be required to apply the standard for annual reporting periods beginning after December 15, 2016, including interim reporting periods therein. US private companies and organizations are required to apply the revenue standard for annual reporting periods beginning after December 15, 2017, and interim and annual reporting periods thereafter.
Prabhakar “PK” Kalavacherla, partner in the Audit Quality and Professional Practice group at KPMG LLP, who served as a member of the IASB from 2009 to 2013, told AccountingWEB the joint standard on revenue recognition is a major achievement for both standard-setting organizations and a milestone in financial reporting.
“The new rules achieve global convergence to a high degree, resulting in greater comparability among companies across industries and geographies,” he said. “Given that revenue is such an important metric – at the core of how companies do business – the investment community will be interested in these aspects, as well as any changes to the timing of revenue recognition and impacts on revenue trends.”
Last July, the FASB and the IASB established a joint transition resource group – comprising 10 to 15 specialists representing financial statement preparers, auditors, regulators, users, and other stakeholders as well as members of the two boards – that will be responsible for informing the FASB and the IASB about interpretive issues that could arise once companies, institutions, and other organizations begin implementing the revenue standard.
“The issuance of this standard is a major first step, but it is not the end of the process,” Golden said. “Through the transition resource group and a robust implementation period, the FASB and the IASB will work to ensure that reporting organizations are able to make a smooth transition to the new requirements by 2017.”
Five Steps to Recognizing Revenue
Under the new standard, companies under contract to provide goods or services to a customer will be required to follow a five-step process to recognize revenue:
- Identify contract(s) with a customer.
- Identify the separate performance obligations in the contract.
- Determine the transaction price.
- Allocate the transaction price to the separate performance obligations.
- Recognize revenue when the entity satisfies each performance obligation.
Kalavacherla noted that because the new standard is more principles-based, it may result in financial reporting that, in some cases, is more reflective of the underlying economics.
Companies will need to develop processes to capture and document judgments at the source – such as executive management, sales, operations, marketing, and business development – and feed those judgments into their accounting processes.
According to a KPMG executive summary about the revenue standard, the rule’s expanded disclosure requirements will help financial statement users understand the nature, amount, timing, and uncertainty of revenue and cash flows arising from contracts with customers.
“The degree of change will depend on the nature of a company’s revenue arrangements,” he said. “Companies in some industries will have greater change than in others. However, all companies will be impacted in one way or another. Even in the instance where there is no change in accounting for a particular company, the new disclosure requirements are extensive and might require changes to systems and processes to collect the necessary data.”
Kalavacherla added that companies that sell products and services in a bundle, or those engaged in major projects – in such industries as telecommunications, software, engineering, construction, and real estate – could see significant changes to the timing of revenue recognition.
For example, the vendor-specific objective evidence (VSOE) requirement will be eliminated from software arrangements, resulting in accelerated revenue for many licenses that are currently deferred due to lack of VSOE for undelivered elements, according to KPMG. Specified future upgrades or additional product rights or other vendor obligations that currently cause revenue referral due to lack of VSOE generally will not delay revenue recognition under the new standard.
The real estate industry will see the elimination of specific requirements for profit recognition on sales of real estate under current US GAAP, which may result in accelerated revenue or gains.
For telecommunications or cable companies, their current practice of recognizing revenue only to the extent of the cash received will be replaced by a requirement to estimate a stand-alone selling price for free or discounted goods or services (such as a wireless handset or free premium channel services for a limited time). Additional amounts may be allocated to these goods or services, which may require significant IT changes for tracking and calculating revenue, with revenue decoupled from customer billings.
“For other companies, it will be more a case of ‘business as usual.’ All companies need to assess the extent of the impact so they can address the wider business implications, including communications with investors and analysts,” Kalavacherla said.
Don’t Wait; Start Planning Now
Even though US and international companies aren’t required to implement the new revenue recognition rule until either 2016 or 2017, they should begin the process now of assessing the impact the standard will have on their business, Stephen Thompson, lead partner for KPMG’s revenue recognition accounting change practice, told AccountingWEB.
“While the effective date may seem a long way off, it is important for companies to understand how their accounting will change,” he said. “In some cases, change will be minimal – and companies will decide that they can defer further consideration until closer to the effective date. But for many, the assessment will reinforce the notion that planning for implementation should start early. What transition method will be followed? Will it be important to start down a path of dual reporting prior to the effective date? And what role might IT systems play in the implementation? These are key decisions that need to be made early in the process in order to map out the implementation plan.”
Thompson said companies should first determine what new information may be needed to apply the new standard.
“For some companies, the accountants will be faced with making new calculations, new judgments and estimates, and new disclosures. A substantial amount of new information may be needed as a result,” he added. “Determining whether that information is available today is important because gaps in that information will have to be filled through process or system changes. As a result, understanding the information gaps is really the most important first step on the path toward evaluating whether a process or system change is needed – and in determining how radical a solution will be required.”