IASB-FASB Project on Revenue Recognition Standard - Research Paper Example

IASB-FASB Project on Revenue Recognition Standard Student’s Name: Instructor’s Name: Subject: Date: IASB-FASB Project on Revenue Recognition Standard Introduction Revenue recognition is an important aspect in preparation of financial statements as it influences the decisions made by users of such statements fro instance government, shareholders, investors, and management. It is thus important to have a standard way or principles adhered to by the accountants in recognizing revenue generated. On this basis, the International Accounting Standards Board (IASB) and Financial Accounting Standards Board (FASB) embarked on a project since June 2010 to harmonize the current guiding standards for revenue recognition. In thus project, the main objective was, at inception, and still is, to develop a single conceptual model and general principles for determining when revenue should be recognized in financial statements. This new revenue recognition model would be applied in various industries as well as any other revenue generation financial transaction. However, of particular interest, in this IASB-FASB project, is to formulate standards that will guide current recognition of revenue practices within the construction industry. In this note, IASB and FASB published an Exposure draft ‘Revenue from Contracts with Customers’ on June 24, 2010 (Lugo, 2011b). This exposure draft was designed to do away with inconsistencies in existing financial accounting standards and to simplify the preparation of financial statements by reducing the variety of professional literature (specifically between IFRS and GAAP) to which entities must refer when recognizing revenue. Objectives of the Project and Decisions Reached to Date The main aim of the IASB-FASB project is to identify ways in which revenue recognition from multiple element arrangements can be done geared towards; removing weaknesses and inconsistencies in existing standards for revenue recognition, provision of a strong framework in order to address revenue recognition practices across industries, entities, capital markets and jurisdictions and reduce number of requirements to which business entity ca refer to in order to simplify preparation of financial statements. On 7th February, 2011, IASB and FASB discussed various topics of the ‘Revenue from contracts with customers’ exposure draft. First, concerning segmenting a contract, the FASB/IASB boards have agreed that an entity can segment a contract only when it is capable of identifying separate performance obligations in the contract. Thus, the proposal to account for one contract as two or more in case price of particular goods/services within the contract is different from others was dropped. In regard, to identification of separate performance obligations. Boards decided that the aim of establishing separate performance obligations is to depict the transfer of goods or services and the profit margin which is attributed to those goods or service. The principle of ‘distinct goods or services’ was maintained as the basis of identifying separate performance obligation. for combined contracts, the IASB and FASB boards stipulated that business entities are supposed to combine and give an account fro single, two or more contracts which are entered into near or at the same time with the same client(s) in case, the contracts were negotiated as a package with similar commercial objective, price of one contract depends on the other, and the goods or services in the contract are related in terms of technology, function or design (Lugo, 2011c). Current Situation Similarities between US GAAP and IFRS on Revenue Recognition Under both IFRS and US GAAP, revenue recognition is based on total execution of the earnings process as well as realization of assets form completion of the aforesaid process. In regard to IFRS, revenue recognition is stipulated in IAS 18 in which it is defined as ‘the gross inflow of economic benefits (for instance cash, receivables, other assets) arising from ordinary operating activities of an entity’ if those inflows results in increases in equity other than increases relating to contributions from equity participants’. Besides, IAS 18 stipulates that fro an item to be recognized as revenue, it must fall within the above definitions as well as meet the following criteria: it is highly probable that future economic benefits related with the revenue item will flow to the entity and it is possible to measure the amount of revenue reliably. In particular, IAS 18 gives guidance with respect to revenue recognition only to sale of goods; rendering of services; interest, royalties, and dividends (Ernst & Young LLP, 2010). On the other hand, US GAAP gives guidance on revenue recognition in ‘ASC 605 Revenue Recognition’ standard. This standard describes revenue as expected or actual cash inflows that will result or that have occurred from major ongoing activities of an entity. From the above definitions, it is clear that in both IFRS and US GAAP, recognition of revenue is not done unless it is either realized (or realizable) and earned. Besides, in both of these accounting standards, revenue recognition is based on transfer of risks and also they aim at establishing completion of the earning process. It is also important to note that the criteria fro revenue recognition in both standards is similar although not identical in that, IFRS requires reliable measurement as one of its criteria whereas in US GAAP the revenue to be received should be determinable or fixed (Ibid, 2010). Differences between US GAAP and IFRS on Revenue Recognition Although both of these standards have similarities as explained above, there are variations in revenue recognition due to differing levels of specificity. The US GAAP in particular is highly specific; for instance, US GAAP gives special rules fro recognizing sale of real estate and software revenue while comparable principles do not exist under IFRS. Besides, US GAAP regularly contain exceptions fro certain types of transactions in various industries. Moreover, public companies in US are required to comply with additional accounting standards as provided by Securities and Exchanges Commission of US. In contrast, under IFRS single accounting standards, IAS 18 is used to give guidance on certain types of transactions. In the context of construction related transactions, which is for instance targeted by the proposed revenue recognition model, US GAAP and IFRS are significantly different. For US GAAP, accounting for construction contracts is done using percentage of completion method upon meeting a certain criteria. Otherwise, completed contract method is used. Besides, [it is optional to combine or segment construction contracts if they meet certain criteria. Conversely, for IFRS, accounting fro construction contracts is done by using percentage of completion method upon meeting a certain criteria. Otherwise recognition of revenue is restricted to the recoverable costs incurred. IFRS does not permit the use of complete contract method. Besides, construction contracts are segmented or combined upon meeting specific criteria and therefore it is clearly evident that US GAAP and IFRS are substantially different (Ibid, 2010). Concerns against the Proposed FASB-IASB Revenue Recognition Standard In the past, economic unit of measurement was the contract itself along with the related gross profit at completion. It was the progress of the job that was followed by applying a one-line, percentage of completion calculation on the work-in-progress schedule. In the proposed revenue recognition model, ‘performance obligation’ is the economic unit of measurement. Thus stakeholders in the construction industry are seeing it as much of a liability or obligation as opposed to what has been used for calculating contract revenue (Bouvier, 2010). According to Lund (2010), majority of stakeholders in construction industry have raised concern on the proposed revenue recognition model applicable in all industries. For instance, the Construction Financial Management Association (CFMA) of US identified various factors that characterize million dollar construction projects to include; monetary incentives for early completion of projects, significant penalties for delaying completion, several change orders encompassing order that remain un-priced for long periods, and owner allowances addition or options to the contract without additional compensation to the contractor. CFMA argues that these different conditions render construction contract practices to be significantly different from conditions of contract in other industries. Stakeholders are also concerned with the use of greater estimates in that part of the contract price would need to be allocated to each performance obligation. Thus, it would be necessary fro fore-casted risk-adjusted gross profit margin to be allocated to performance obligations regardless of ability to readily determine these amounts. On the other hand, it would be more complex to account for each Work-In-Progress of each performance obligation hence more schedules in financial reports (Lund, 2010). Another concern for stakeholders is that would be more difficult to evaluate the financial status of project. For instance, surety companies and banks which are used to using percentage of completion method would find it difficult to assess financial performance and progress of a construction project. Besides, another concern is in relation to compliance costs which construction companies are arguing to be higher. In another article by Burkholder, 2010), construction companies, other trade groups, and associated audit firms have requested IASB and FASB to be exempted from the proposed accounting standard. However, analysts have objected such exemption by arguing such ‘additional tightening’ principles would eliminate inconsistencies in current standards and also render recognition of revenue more comparable across industries, jurisdictions and entities. Burkholder (2010) also notes that the biggest concern is in regard to having revenue reporting hinge on separating ‘performance obligations’. CFMA argues that entities within construction industry do regularly engage in long-term contracts, which it would be impossible to appropriately account for, under the new proposal, for performance obligation coupled with elimination of percentage of completion method. On the other hand, Burkholder (2010) writes that most of the construction companies are worried about the practicality of sub-dividing ‘in-separable’ parts of contracts into ‘multiple profit centers’ or performance obligations. Thus most of them favor percentage of completion approach which according to Burkholder (2010), this approach recognizes and matches the reality of construction contracts. Furthermore, stakeholders in construction industry believe that the proposed model would not be practical as well as it would not provide useful information to users of financial statements. Also, stakeholders in construction industry believe that most of the users of financial statements would only be interested in total contract profit margin instead of revenue and profit margin of particular margin/services in the contract. Subsequently, other criticisms of the proposed revenue recognition model comes form the accounting committee of Financial Executives International (FEI). FEI’s committee on corporate reporting faults this model by suggesting that: it is proper for the standard to measure transaction prices applied in assessing performance obligations, at the probability-weighted amount of consideration than an entity can expect to receive from a client. Thus, the standard should encompass ‘management best estimate’ as the basic measurement of transaction price; the IASB and FASB should change the proposed revenue recognition model to be applied in prospective manner rather than the current required and proposed retrospective manner (Lugo, 2010a). Reason being retrospective application would create a challenge to thousands of outstanding multi-year contracts for each financial reporting period. Another related concern is that the model would require financial accountants to maintain dual reporting systems for retrospective periods, which would drive significant incremental costs in resources, systems and audit fees (Lugo, 2011b & Lugo, 2011c). Until now the FASB-IASB project is still on and various topics are being deliberated for instance onerous performance obligations and all conclusions reached to date are tentative and they are subject to change in future. References Burkholder, S. (2010). Construction sector leads criticism of revenue proposal. Accounting Policy & Practice Report. 6 (23), pp. 819-821. Bouvier, S. (2010). Revenue roundtable hears concerns about proposed control-based model. Accounting Policy & Practice Report, 6(24), pp. 879-881. Ernst & Young LLP. (2010). US GAAP vs. IFRS: The basics. Retrieved February 27, 2011 from http://www.ey.com/Publication/vwLUAssets/IFRS_vs_US_GAAP_Basics_March_2010/$FILE/IFRS_vs_US_GAAP_Basics_March_2010.pdf Lund, M. E. (2010). Proposed accounting standard would change revenue recognition practices for construction contractors. Construction Accounting & Taxation, 20(6), pp. 36-41. Lugo, D. (2010a). FASB-IASB Full retrospective requirement of revenue standard runs into opposition. Accounting Policy & Practice Report, 6(23), pp. 828-830. Lugo, D. (2011b). FASB, IASB begin final revenue recognition redeliberations. Accounting Policy & Practice Report, 7(3), pp. 97-98. Lugo, D. (2011c). Standard setters hammer out plan for revenue recognition redeliberations. Accounting Policy & Practice Report, 7(1), p. 10. Read More