Revenue Recognition

IASB and FASB release revenue recognition exposure draft What is the issue? On June 24th, the FASB and IASB issued an exposure draft proposing a new revenue recognition model that could fundamentally alter the way entities across a variety of industries recognise revenue. The proposal is an output of the boards’ joint efforts to develop a converged revenue recognition standard based on the same principles. A key objective is to increase the consistency of revenue recognition for similar contracts, regardless of industry.

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The proposed model requires a contract-based approach that focuses on the assets and liabilities that are created when an entity enters into and performs under a contract. The proposed model requires that revenue is recognised when an entity satisfies its obligations to its customer (performance obligations). The proposal defines a performance obligation as an enforceable promise in the contract that includes both explicit and implicit promises to transfer goods and services to a customer.

Performance obligations are satisfied when control of a good or service transfers to the customer, which is when the customer is able to use, and receive benefits from, the good or service. Identifying the performance obligations in a contract will be critical in applying the proposed model and will require significant judgment. This may be particularly challenging for service arrangements and long-term contracts. It will also be challenging to determine when performance obligations should be combined and when they should be separated, which will be a key driver in determining the amount and timing of revenue recognition.

Revenue is measured based on the transaction price, which is the amount the customer promises to pay in exchange for goods or services. The transaction price is usually easy to determine when it is a fixed amount of cash at the time of sale. It may be more difficult to determine if the consideration could vary in the future depending on the resolution of an uncertainty or when the transaction price is affected by the time value of money or involves non-cash consideration.

The transaction price will include variable or contingent consideration when such amounts can be reasonably estimated, which is a fundamental change from most current practice. In those cases, the transaction price is measured using a probability-weighted estimate of the consideration expected to be received. The transaction price should also reflect the customer’s credit risk by recognising only a probability-weighted estimate of the expected receipts and the impact of the time value of money, when material. The proposal will generally require greater use of estimates than under existing guidance.

The proposed model requires the transaction price to be allocated to performance obligations based on relative standalone selling prices. Other allocation methods used under existing guidance will not be allowed. The best evidence of the standalone selling price is the price of a good or service when the entity sells it separately. The selling price is estimated if a standalone selling price is not available. Performance obligations are not re-measured after the inception of the contract unless the transaction price changes.

For example, estimates of the transaction price could change particularly when there is variable consideration. The proposed model requires an on-going assessment of the costs expected to satisfy outstanding performance obligations. If the direct costs exceed the allocated transaction price related to a performance obligation, a loss is recorded immediately. ? The proposal includes application guidance for some of the more common issues that arise in accounting for revenue, including product warranties, rights of return, and licenses.

Product warranties will be accounted for differently than under current guidance, which may impact both the timing and measurement of revenue. The proposal also includes a model for customer return rights that is generally consistent with current practice. The timing of revenue recognition for licenses of intangible assets will depend on whether the license is exclusive, and whether or not the license is for the entire economic life of the asset. The new model will require more extensive disclosures than are currently required under US GAAP and IFRS.

These disclosures will focus on qualitative and quantitative information, and the significant judgments and assumptions made in measuring and recognising revenue. The proposal requires full retrospective application upon adoption, meaning that an entity must apply the model to all contracts in existence in any of the periods presented (even for contracts completed before the year of adoption). The exposure draft does not propose a specific effective date. We anticipate the final standard to have an effective date no earlier than 2014, given the proposed retrospective application of the new model.

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