In an effort to improve revenue recognition, the Financial Accounting Standards Board and International Accounting Standards Board recently released converged guidance for contracts with customers.
Per the terms of the updates, a five-step process for assessing contracts will be implemented so that revenues from those contacts may be better recognized and specific disclosures can be more effectively made as necessary. Public organizations will see the updates take effect Dec. 15, 2016, including interim reporting periods within that reporting period. Early adoption is not permitted. For nonpublic companies, the official adoption period begins Dec. 15, 2017, but the guidance measures can be implemented for early adoption. In either event, the standards for revenue recognition in long-term contracts will be changed for good, and theoretically, for the better.
The five-step process includes:
- Identifying the contract with a customer
- Identifying performance obligations in a contract
- Determining the transaction price
- Allocating the transaction price based on the performance obligations
- Recognizing the revenue when the reporting organization satisfies these performance obligations
Also included are new disclosure requirements, which provide users with information regarding the timing, nature and amount of revenue and cash flow arising from a given contract. They include:
- Any revenue recognized from customer contracts, including a breakout of revenue into appropriate categories
- Contract balances, including the opening and closing of accounts receivables, as well as contract assets and liabilities
- Performance obligations, encompassing those in which the transaction price is allocated to the remaining obligations in a contract
- Any judgments or changes in judgments made while applying the requirements to those contracts
Adjusting IFRS and GAAP
The need for improved revenue recognition in financial reporting is derived from the always-complex Generally Accepted Accounting Principles, whose requirements can differ depending on the nature of the transaction and, in some cases, the industries in which they take place. As noted in the FASB’s release, different industries are often therefore compelled to employ different accounting standards for transactions that are otherwise similar, making guidance difficult to maintain, especially as different sectors continue their natural evolutions.
In the interest of mitigating these issues, which affect all industries at some point, the new guidance establishes uniform information-reporting principles while taking into account the nature, timing and uncertainty of revenue often derived from customer contracts.
The FASB anticipates that the updated guidance will:
- Offer a “more robust framework” for revenue issues and how to address them.
- Eliminate the inconsistencies and discrepancies that exist within the current revenue-reporting requirements.
- Enhance the ability of different industries and markets to compare revenue-recognition practices and allow them to more effectively mirror each other or at least operate within the same framework.
- Simplify the process for preparing financial statements, primarily by minimizing the number of requirements to which a given organization is subjected.
- Improve disclosure and generally provide better information to users of financial statements.
The FASB also released core principles for the new guidance, in addition to steps for identifying customer contracts, performance obligations within those contracts and transaction prices, as well as how to appropriately allocate those prices in conjunction with the obligations.
“Recognize revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services,” reads the FASB’s stated core principle.
Addressing contract obligations
Any organization entering into a contractual agreement with a customer for the transfer of goods and/or services – or the transfer of nonfinancial assets – will see their reporting process affected by these updates. The FASB also emphasized that the window between expected issuance of the guidance and its effective date is longer than normal – an intentionally long gap granted because of the scope of the organizations and industries that will be affected.
Please contact LaPorte Audit and Assurances Services Director Eric Bosch at [email protected] to discuss your particular company and any possible effects this new guidance may have on its financial reporting.