New Standards for Revenue Recognition - Research Paper Example

New Standards for Revenue Recognition Introduction As per the Financial Accounting Standard Board (FASB) and The International Accounting Standards Board (IASB), firms rely on revenue to analyze financial statements. The analysis indicates how the company performs and gives room to important changes (www.fasb.org, March 2014). However, the guidelines that govern the US Generally Accepted Accounting Principles (GAAP) and International Financial Reporting Standards (IFRS) in relation to revenue recognition are always different. This means that they have to improve their service quality. In 2002, a strategy to make a new standard for revenue recognition began. The IFRS stipulates minimum requirements on matters of revenue recognition. All in all the IAS 18 Revenue and IAS Construction Contracts are the main fields that it addresses. However, IAS 18 offers little explanation on issues that relate to multiple-element arrangements. The existing guidelines for revenue recognition as per the U.S. GAAP are so many. In the real sense, they cannot address the exact transactions or the target industries. With the mushrooming of new trends in transactions, the Board is facing challenges in addressing the issue. The first proposal was made on December 19, 2008 by both the IASB and the FASB. Bearing in mind that GAAP had a different approach from that of IFRS; the objectives made in the proposal were to make an improvement on the already existing guidelines. This gave birth to the concept of developing one model that can be utilized in addressing revenue recognition. In application, a company will be only able to recognize its revenue when the obligation is satisfactory. In this case, all services and transactions must satisfy their customer’s needs as per the contract (www.fasb.org, March 2014). On June 24, 2010, the Boards made a proposal to have the new joint standard for revenue recognition in place. In their view, adopting this proposal would bring the single revenue recognition standard in place. This will make it easy for IFRS and GAAP to address issues across all capital markets and industries with little differences (http://www.ifrs.org March, 2014). With the proposal in place, both the IFRS and US GAAP will soon be able to: Give a strong base that tackles problems that arise in revenue recognition Ensure effectiveness and stability in the already existing standards Facilitate comparison in different operational fields Generate important pieces of information to financial statements’ users because of openness Bring simplicity in preparing financial statements. This is because references are minimized (Ey.com). In a press release made on November 14, 2011, it is clear that IASB and FASB through their revised proposal on the revenue standards, improvements are very necessary. They consider the great value that financial reports hold in companies’ evaluations. However, the proposal had the same suggestions as those made in 2010 (hhttp://www.iasb.org, March 2014). To make it unique though, the boards: Designed a formula of identifying tracking transfer of goods and services Made proposals made warranties much simpler than it always is Made it possible and simple to calculate transaction prices Exempted the US GAAP’s ideologies in the manner of disclosing non-public entities Made it practical in the manner of cost recognition Made modifications in the application of long-term services In July 2013, three topics were a major concern in the discussion. Clarifications were made considering the methods of estimating transaction cost and determination of the satisfaction offered in a contractual service. In this proposal, five steps were agreed upon to be used in determining revenue when contracts with customers are made. Step 1: contract identification with the interested customer A contract is only valid when it meets all the obligations stated. Therefore, if the contract grants unilateral right for its termination, the proposal suggests that it cannot qualify to be used in revenue recognition. In cases where multiple contracts show some resemblance in their specific terms and conditions, they can be grouped under a single contract for effective revenue recognition. The conditions are: Negation among parties is paramount For one contract to be considered, all the others must perform or behave in the same pattern All the goods under the different contracts are subject to the same obligation New price agreements upon negotiation or introduction of a new contract alongside the existing ones are among the factors that initiate modifications in a contract Step 2: identifying the seller’s performance obligations In the proposed Accounting Standards Update (ASU), FASB made a proposal that can satisfy the obligations, that is, the entity must be ready to sell the good independently without mixing it with other goods. This will then give pleasure and satisfaction to the customer who uses the good The proposal does not give a provision to discriminate the services that are offered as a bundle unless there is need for extra care as provided in the contract or the goods have been modified to soot the customer’s preferences and choice (www.journalofaccountancy.com, March 2014). Step 3: determination of the transaction price A service or a good can only be valid for transaction when a price is set. Therefore, as a seller, it is very necessary to calculate the costs incurred in production and the selling price that will cover the costs as and profits. However, discounts, bonuses, refunds among other terms can alter the product price. Price estimation depends on the value from the weighted averages that can give the expectations and the quantity of the good or service quality (Gray, 12). Contract prices also depend on time value for money and non-cash agreements between the seller and the buyer. Step 4: assigning of the set price to target obligations Each service or good has a price tag. The proposed guidelines will require those engaged in business ventures to provide a sum of all transaction prices on all separate tasks that offered satisfaction to customers. ASU has its strict guidelines that concern discount offers on several obligations and rigidity of prices. Step 5: determining the level of satisfaction in relation to revenue recognition In this proposal, the seller can claim a successful transaction when the rights to use the service or good are passed on to the customer. This is valid when the customer pays for it, transfer of ownerships, risks and legalizing the titles. The above five steps give a procedure which entities can recognize revenue. However, FASB is yet to adopt these ideas. Bearing in mind that they must undergo a series of tests, a two-year period is allowed before they can be adopted in law and legal procedures. On October 30, 2013, IASB and FASB made a proposal that will form the final standard on Revenue from Contracts with Customers (www.fasb.org, March 2014). The topics were: Constraint on estimates of variable consideration The implementation process Collectability 1. Constraint on estimates of variable consideration The American Institute of Certified Public Accountants (AICPA) agrees that main objective was to make a decision where it was agreed that including some of the variables in the price set for transaction does not lead to a revenue reversal that can be of any significance to the entity. By reassessing the sentiments, it is better to update the expected price level on the reporting date. This ensures effectiveness in tracking the revenue. In their discussion, the Boards reviewed models and patterns that are effective in revenue recognition in the sense that a valid license to protect intellectual property is used. This pattern was voted in but based on a sales-or-usage-based royalty. 2. The implementation process In connection to licenses, two of them were distinguished. The first type of license allows customers to have access to the owner’s intellectual property and the one that grants the right to use the owner’s intellectual property. While the first type of license offers satisfaction over a period, the second one offers satisfaction at a particular point (Keiso ET. Al, 28). 3. Collectability It refers to customer credit risk in relation to the patterns and models relevant in revenue recognition. The board used previous existing decisions that excluded customer risk cost to measure the degree of transaction. This directly translates to revenue. In addition, the boards made stipulations that define the criteria that grants and entity with the authority to use the revenue models when entering into contract with a customer. This includes the regulations concerning intellectual property. In their analysis, entities were only keen about customer risks at the time of revenue measurement and recognition. Some of the terms like probable referred to something different when used by the USGAAP as compared to when IFRS uses it. This is among the explanations as to why the boards had to set a new standard of revenue recognition that will favor both the USGAAP and IFRS (http://www.ifrs.org, March 2014). Notes from a financial statement Under both the GAAP and the FRS, the constituents of a complete set of financial statements will be inclusive of a statement of profit and loss or the income statement, a statement of financial position, and a statement of comprehensive income of a given company that make any references about the changes of revenue recognition. This may be either two consecutive statements or one continuous statement as well as a statement of cash flows together with notes to the financial statements. However, GAAP permits the changes in the equity of shareholders to be obtainable in the notes to the statement whereas IFRS needs the changes in the equity of a shareholder to come as a separate statement. Both necessitate that the financial statements be presented basing on the accrual approach of accounting except the cash flow statement. In addition, both standards have same concepts concerning consistency and materiality that entities have to put in mind in preparing their financial statements (Alexander & Britton, 98). Income statements and extraordinary items standards are restricted to items that are infrequent and unusual in GAAP. The balance sheet in GAAP involves current and non-current classification, based generally on the liability and asset nature. The third balance sheet is also not required. For the IFRS, all figures are classified as non-current in a company’s balance sheet. The income statement on extraordinary items is prohibited, but the third balance sheet is needed as of the start of the earliest relative time when there is a reflective application of fresh accounting policy (Fridson & Alvarez, 34). Conclusion The new standard of revenue recognition is still under review but is set for release before the end of 2015. However, AICPA is already playing a critical role in ensuring that the standards work. It has adopted the ideas into more than ten commercial industries. If the standards are adopted, then under IFRS, provisions like IAS 18Revenue, IAS 11 Construction Contracts will be replaced. Topic 605 of the FASB Accounting Standards Codification contained in the US GAAP will be replaced too. Work cited American Institute of CPA’s. Com. Web. March, 2014. Retrieved from: http://www.aicpa.org. Financial Accounting Standards Board. Com. Web March, 2014. Retrieved from: http://www.fasb.org International Accounting Standards Board. Com. Web. March, 2014. Retrieved from: hhttp://www.iasb.org International Federation of Accountants. Com. Web March, 2014. Retrieved from: http://www.ifac.org Keiso, Weygandt and Warfield. Intermediate Accounting. Fifteen Edition. Massachusetts: Wiley, 2013 Print. Tysiac, Ken “Six areas where new revenue recognition standard will require judgment.” Journal of Accountancy. Com. Web. March 2014. http://www.journalofaccountancy.com/news/20138470.htm. Gray Robert N. Proposed Revenue Recognition Standards. Rubino & Company. 28 Nov 2013. Web. 15 March 2014. International Accounting Standards.com. Revenue Recognition. Web. 15 March 2014 International Financial Reporting Standards.Org. Revenue Recognition. March 2014. Retrieved from: http://www.ifrs.org Fridson, Martin S., and Fernando Alvarez. Financial statement analysis: a practitioner's guide. Vol. 597. John Wiley & Sons, 2011. Alexander, David, and Anne Britton. Financial reporting. Cengage Learning EMEA, 2004. Read More