Question

Find an article regarding the revenue recognition. In 250-300 words, summarize the article that you found. Please post the article link or title & author.

Answer 1

ANS:

Revenue is one of the most important measures used by investors in assessing a company’s performance and prospects. However, previous revenue recognition guidance differs in Generally Accepted Accounting Principles (GAAP) and International Financial Reporting Standards (IFRS)—and many believe both standards were in need of improvement.

On May 28, 2014, the FASB and the International Accounting Standards Board (IASB) issued (press release) converged guidance on recognizing revenue in contracts with customers. The new guidance is a major achievement in the Boards’ joint efforts to improve this important area of financial reporting.

Presently, GAAP has complex, detailed, and disparate revenue recognition requirements for specific transactions and industries including, for example, software and real estate. As a result, different industries use different accounting for economically similar transactions.

The objective of the new guidance is to establish principles to report useful information to users of financial statements about the nature, amount, timing, and uncertainty of revenue from contracts with customers. The new guidance:

• Removes inconsistencies and weaknesses in existing revenue requirements
• Provides a more robust framework for addressing revenue issues
• Improves comparability of revenue recognition practices across entities, industries, jurisdictions, and capital markets
• Provides more useful information to users of financial statements through improved disclosure requirements, and
• Simplifies the preparation of financial statements by reducing the number of requirements to which an organization must refer.

Introduction

1 It is currently expected that within the next month or so EFRAG, the German standard-setter (the Deutsches Rechnungslegungs Standards Committee or DRSC), and other European national standard-setters will together issue a discussion paper, entitled ‘Revenue Recognition: Towards a European View’. This paper will be issued as part of Europe’s Proactive Accounting Activities in Europe initiative.

2 The discussion paper seeks to stimulate debate within Europe—and thereby to encourage the development of European views—on a very important subject for the future of accounting: when should revenue (by which the paper means turnover) be recognised. This might sound like a non-issue—“everyone knows what revenue is and when it arises”—yet, except in the simplest of transactions, it would seem that there is little agreement as to what revenue is and when exactly it arises, and the existing standards do not help very much.

3 This note briefly summarises the key issues raised in the discussion paper.

Background

The importance of revenue

4 Revenue as the top-line of the income statement is usually the largest single item in the financial statements in monetary terms. It is also very significant in terms of its information value for investors. Investment analysts, for example, consistently report that the 'revenue number' is one of the key inputs to their analysis and assessment of an entity’s past performance as well as to their forecasts of the entity's future earnings capacity.

5 Revenue has to date been important for another reason: for most businesses, the point at which revenue has been recognised has been the earliest point of profit recognition under historical cost.

6 Revenue recognition is therefore an important subject; one which entities need to address in a consistent manner. Clear, comprehensive, generally accepted revenue recognition principles are needed to ensure that consistency.

7 Currently, there are two main standards that address revenue: IAS 11 ‘Construction contracts’ and IAS 18 ‘Revenue’. However, it is widely accepted that the material on revenue in those standards is incomplete—it says little for example about multipleelement arrangements—and is not internally consistent—the principles underlying the two standards are not the same3 and the examples in IAS 18 are not fully consistent with the main standard. Consequently, although the standards seem to work reasonably well for fairly simple types of transactions, they give either conflicting guidance or no guidance at all for more complex transactions.

8 Some companies have responded to this by looking to US GAAP for help. However, US GAAP on revenue recognition is set out in numerous very narrowly-scoped pronouncements of varying authority that have been issued by several different bodies. The SEC has sought to help by issuing SAB No. 101 'Revenue Recognition in Financial Statements' (which has subsequently been replaced by SAB 104 'Revenue Recognition'). However, although SAB 104 lays down some principles, it also raises further issues.

9 The result is that different entities and industries have adopted different practices, and inconsistencies and uncertainties are arising. It has also become apparent that there are different views of what revenue should represent, and of how financial statements should portray an entity's activities. This has been a particular issue for start-up businesses in some of the newer industries where investors have been focusing on revenue growth as an indicator of a company’s profit potential.

The IASB/FASB project

10 Faced with these concerns, the IASB and FASB decided to undertake a project on revenue recognition. In theory there are a number of different ways of tackling the problem. At one extreme standard-setters could attempt to resolve the problems by making a series of ad hoc changes to the existing standards. Although such an approach might seem attractive because the existing revenue recognition and measurement literature seems to work for the vast majority of transactions, it would mean that the standards would still be based on different revenue accounting principles. That in turn would mean that there would still be boundaries between principles that will be problematical and it would still be difficult to extrapolate the existing material to address new types of transactions that will emerge in the years ahead. There would also continue to be different views of what revenue is and of how financial statements should portray an entity’s activities. In other words, the approach described above would provide only temporary relief.

11 The IASB and FASB have therefore taken the view that a fundamental rethink is necessary. This does not necessarily imply that there needs to be a fundamental change to existing practice; indeed, if the existing literature on revenue really does work for the vast majority of transactions, it is likely that the changes resulting from the fundamental rethink will not be major. However, by considering why exactly we do the things we do and what are the alternatives, it ought to be possible to develop a comprehensive set of conceptually-based principles for revenue recognition and measurement..

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Article LINK: http://www.focusifrs.com/content/download/1440/7279/version/1/file/Revenue+Recognition.pdf