Good Example Of Research Paper On Simplifying The Accounting For Revenue Recognition By FASB 2
Simplifying the Accounting for Revenue Recognition by FASB 2
I. Background 2
II. Scope of standard 7
III. Next steps and implications for practice 8
IV. Conclusion 10
Simplifying the Accounting for Revenue Recognition by FASB
The elaboration of a new standard simplifying revenue recognition was one of the highest priorities of the joint IASB-FASB convergence project. The purpose of the project was defined as eliminating a range of differences between International Financial Reporting Standards (IFRS) and United States Generally Accepted Accounting Principles (U.S. GAAP). The project was initiated in 2002 on the basis of the International Accounting Standards Board (IASB) and the Financial Accounting Standards Board (FASB) and has evolved over time (FASB, 2014). The main objective why this project was initiated was to put in place the sound policies to report useful information to users of financial statements. This is because different industries were using different accounting for economically similar transactions. Having been a result of more than 10 years’ work over divergent standards, the new guidance has significantly contributed to the resolution of inconsistencies in both IFRS and U.S. GAAP. As U.S. GAAP abides in sector-specific and industry-specific rules, the revenue recognition practices among industries often lacked similarity; as a result, financial statements comparability might have been affected. ASU 2014-09 allowed setting one standard for revenue recognition for different industries and segments. It also required a comprehensive footnote disclosure for both private and public companies. This significantly improved comparability of financial statements across different sectors.
Successful implementation of the project is aimed at:
Eliminating inconsistences and flaws in existing revenue requirements,
Providing a more vigorous framework for addressing revenue issues,
Improving comparability of revenue recognition practices across firms, industries, jurisdictions and capital markets.
Providing more useful information to users of financial statements.
Furthermore, it is an important initiative for the U.S. where for a decade Securities and Exchange Commission (SEC) has been closely reviewing the possibility of IFRS adoption to enhance the attractiveness of the US financial market for international investors. FASB proposed two standard changes that are designed to reduce complexity in accounting for income taxes. The new project is proposed to replace two major revenue recognition standards, IAS 18 - Revenue Recognition and IAS 11 - Construction Contracts. This is because they were believed not to be complicated. These two revenue recognition standards are replaced by IFRS 15 - Revenues from Contracts with Customers. The new standard can be applied retrospectively in accordance to IAS 1 - Accounting Policies, Changes in Accounting Estimates and Errors. The new law is said to be effective because it is able to break down different processes in order to obtain the right consideration for a contract. Once the project is adopted, several things will change that had been previously used in the revenue recognition standards.
Some of these changes are:
Incidental obligations and sales incentive can only be used in the new project if a company is able to separate the obligations and sales incentives.
Contingent revenue gap can only be used if the company can identify and allocate the transaction price paid by the customer.
No observable selling price - if it is not available, the company should use estimated amount likely to be paid by the customer.
Licenses - the new law has directions on how to apply revenue to different types of licenses.
Timing of revenue recognition - revenue will be recognized only when customer obtains control of promised good or service.
Estimates of variable considerations - valuation will be based on estimated amount or the most likely amount a customer is willing to pay
Significant financing components - should be considered when determining the transaction price and it may affect long term contracts.
Disclosure - it is required to disclose all qualitative and quantitative information about contracts with customers.
The board is suggesting an elimination of the exception in ASC Subtopic 740-10. This is to help an entity recognize current and deferred income tax impact on an intra-entity asset transfer. Major amendments such as changing internal controls compared will be expected by FASB; companies will therefore be required to sign off on these amendments on retrospective basis (Tysiac, 2015).
The second change by FASB would affect only companies that have classified financial statements. FASB proposes that classification income taxes that have been deferred for such entities. Tax liabilities and assets should be listed as noncurrent. The proposal will not alter the requirement currently used on deferred tax liabilities and assets. Once the proposed amendments are put in force, the GAAP and IFRS will be aligned in presentation of deferred income tax assets and liabilities. Companies would therefore start applying the proposed changes to all deferred income tax liabilities and assets.
The history of revenue in IAS 18 dates back to April 1981. During this period an Exposure Draft E20 Revenue Recognition was written. In 1982, the IAS18 was proposed but it became effective in 1 January 1984. In May 1992, another draft was created called E41 Revenue Recognition. In December 1993 IAS 18 Revenue Recognition was revised as part of the Comparability of financial Statements’ project. The revised part of IAS 18 became effective in 1 January 1995 and later in 1998 it was amended by IAS 39 Financial Instruments: Recognition and measurement which became effective in 1 January 2001. On 16 April 2009, an appendix to IAS 18 was attached which amended Annual Improvements to IFRSs 2009. This appendix provided guidance for determining whether an entity is acting as a principal or as an agent. In January, 2017 IAS 18 will be superseded by IFRS 15 Revenue from Contracts with customers.
The exact aim of IAS 18 is to give guidance on revenue recognition and help in the application of the revenue recognition criteria. Furthermore, revenue is measured at fair value of the consideration received or receivable. Therefore, if the inflow of cash or cash equivalent is deferred, the fair value of the consideration receivable is less than the nominal amount of cash and cash equivalent to be received, and so discounting is appropriate.
The initial aim to reach the convergence by the end of 2011 was not met, as the process of reconciling the differences appeared more difficult, given the U.S. tendency for detailed and prescriptive rules and the IASB’s principles-based approach (Fuller, 2012). The commitment to continue the work over the project was still reaffirmed both by G20 leaders in Cannes Summit Final Declaration (2011), and the boards (FASB, 2014). Both the IASB and the FASB have repeatedly confirmed the intention to achieve convergence, jointly working over different accounting topics. The new FASB\IASB joint guidance on revenue recognition is probably one of the most prominent examples of this mutual commitment. As a result of the joint project, the IASB issued IFRS 15, Revenue from Contracts with Customers, (IASB, 2015), and on 28 May 2014, FASB came with Accounting Standards Update (ASU) 2014-09, Revenue from Contracts with Customers ;( FASB, 2014).
The proposed changes in public business entities for annual periods, including interim periods within those annuals periods will take effect on Dec. 15, 2016. Early adoption would not be permitted for public business entities. The proposed amendments for other entities would take effect for annual periods at the beginning of Dec. 15, 2017, and interim periods in annual periods begin after Dec. 15, 2018. Early adoption would be permitted, but not before the effective date for public business entities.
II. Scope of standard
The basic step essential to elaborate a new guidance was a precise definition of a customer contract and the criteria to be met before the application of the revenue recognition model to that contract (Holt, 2014). The concept of contract was based on U.S. definition of an agreement creating enforceable rights and obligations between the parties. Subsequently, the guidance defined 5 steps to determine when the revenue from such a contract can be recognized, called “5-step model” (Holt, 2014). Identification of the contract meeting precisely the above mentioned definition, with the possibility of classifying several agreements as a single contract with the customer, is a first step. Identification of the company’s performance obligations under the contract is a second step. The key factor in identifying a separate performance obligation is the distinctiveness of goods or services, or their bundle (Holt, 2014), with the distinctiveness being determined by the benefits to the customer and the possibility of goods\services identified separately from other contract parts. Third step is the determination of a transaction price as the amount the company will be entitled to in exchange for goods or services transfer. This step accounts for some factors the company should consider in the price determination (significant financing components of the agreement, contingencies or price variables). The next step requires the allocation of the transaction price to the separate performance obligations made at the inception of the contract on the basis of the relative stand-alone selling prices of goods or services. Last but not least, the company must recognize revenue when performance obligations are satisfied and the customer obtains control over the corresponding goods or services.
III. Next steps and implications for practice
The guidance requires the companies to estimate the impact of different items such as discounts, incentives, warranties, contingencies and variable considerations. So the timing of revenue recognition may change for some point-in-time transactions and some companies will have to record revenue earlier or to make a more careful analysis (Holt, 2014). The new requirements to provide both qualitative and quantitative disclosures on the nature, amount, timing and uncertainty of revenue and cash flows will underpin the standard providing the stakeholders with clear and transparent information about the company’s contracts with customers.
The standard is scheduled to enter into force for reporting periods beginning after December 15, 2016, for U.S. public companies. It will also be mandatory for annual reporting periods starting from January 1, 2017, for companies that use IFRS. To tackle the issues which were expected to emerge during the implementation stage, the FASB and the IASB formed the Joint Transition Resource Group in mid-2014. The members of the group included users from different industry sectors, accountants and auditors whose task was to inform the IASB and the FASB on potential implementation issues (FASB 2014). Currently the Group has faced more than 40 issues related to the standard itself, part of them requiring revision to implementation guidance (e.g. the nature of the entity’s promise in granting a license of intellectual property or identifying performance obligations) (Tysiac, 2015). Despite disagreements on some issues between the IASB and the FASB, the boards have agreed on clarifications and revisions to be implemented in the near future. FASB is also planning to postpone the effective date of the standard to enable U.S. companies to adjust their business processes and informational systems to implement the standard.
There are several tax implications that may arise due to the change of new revenue recognition. The transaction price in the income tax recognition is required to include a variable consideration which allows for reversal in the cumulative revenue in case of uncertainties in the future. This change may lead to change in the book-tax differences and may call for adjustment. Software organizations will no longer be required to have Vendor Specific Objective Evidence (VSOE) of fair value to recognize revenue; instead they shall allocate the transaction price to goods and services based on relative selling prices. Furthermore, some firms will be required to report taxable income based on percentage of completion. This may also result to book tax difference. The change can be reported either retrospectively or through a cumulative effect adjustment to retained earnings (Fuller, 2012). Adoption of new revenue recognition also requires a change in tax accounting method which will lead to tax differences. The tax differences can be spread over four years. The law will also affect entities dealing with transfer prices. An entity is required to decide whether to change or update the transfer pricing strategies. Other than the implication of tax accounting, there are other implications such as income tax that may be affected when the new law comes to force. The new law can be adopted either retrospectively or cumulatively effect adjustment to retained earnings. This adoption can lead to cumulative temporary differences which need to be adjusted to show the effects of transition. The new law also requires capitalization of incremental costs such as sales commissions. However, the incremental costs cannot be amortized if it is one year. Furthermore, the law requires that for a contract to be binding the consideration must be probable. Adoption of new law may also affect investments in foreign operations. Deferred tax liability will arise if the foreign subsidiary exceeds the tax basis.
The new law will also affect the non-income based taxes in the income statement presentation and contract accounts. For income tax presentation, taxes collected from customers and remitted to the government must be presented on gross or net based on whether they were submitted by the principal or the agent. For contracting practices, there may be an impact on the sales tax because the consideration for goods and services may change under the new law. There are other implications that the management should consider when the new law is adopted. The management should prepare itself by training and communicating to their staff about the new law. Proper training should be done to departments that are concerned in order to ensure that they can implement the changes in the organization without errors. It is also important to communicate to the staff to create awareness of the future changes. For organizations with contracts, there may be changes in the financial reporting which will require revision. There will also be changes of foreign tax systems which will require statutory reporting changes.
Being designed to promote comparability across U.S. jurisdictions and industries and to reduce inconsistencies in the current standard, new guidance on revenue recognition was a major step to enhance the transparency of companies’ revenues for investors. Being rather principle than rule-based, ASU 2014-09 was established to combine the best principles embodied in U.S. GAAP and IFRS and provided a clear 5-step module of revenue recognition. Still, due to the years of divergence and different accounting practices, some challenges have been arising during the implementation stage, and those will be addressed by the Joint Transition Resource Group whose work will further contribute to the resolution of these issues.
Full implementation is now set on 1 January, 2017 and once the new law is adopted, there will be various changes and adjustment that will be necessary depending on the nature of industry. Once implemented, the revenue recognition accounting will be replaced by IFRS 15 Revenue from contracts with customers. There are various implications for the adoption of the new law which may include implications relating to accounting of tax, accounting for tax incomes, accounting for other aspects which are nontax and management responsibility in the adaptation of the new law. Different customer contracts will have a different tax implication which must be adjusted. Various aspects such as disclosure, licenses, significant financial changes, estimates of variable consideration, timing of revenue recognition, contingent revenue gap, incidental obligations and sales incentives, will not change in order to give the new project a chance to operate effectively.
Once the new law is adopted, the GAAP and IFRS will be in aligned meaning there will be clear rules to guide the recognition of revenue from contracts with customers. The new law will replace five standards and interpretations namely IAS 18 - Revenue, IAS 11 - Construction contracts, IAS 31 - Revenue-Barter transactions involving advertising services, IFRIC 13 - Customer loyalty programs, IFRIC 15 - Agreements for the construction of real estate and IFRIC 18 - Transfer of assets from customers. The major principle of IFRS 15 is the recognition of revenue which will indicate the transfer of goods and services to customers with a consideration which the firm expects in exchange of those goods and services. IAS 18 is considered inappropriate because it does not give a clear guidance on various components of a sale in order to allocate for the price.
Financial Accounting Standards Board (FASB) (2014). Retrieved from: http://www.fasb.org/
Fuller, J. (2012).Convergence RIP. Accounting and Business, 9, 34.
International Accounting Standards Board (IASB).IFRS Foundation (2015). Retrieved from: http://www.ifrs.org/
Holt, G. (2014). Step change. Accounting and Business, 9, 49-51.
Tysiac, K. (2015). FASB, IASB to propose clarifying revenue recognition guidance. Journal of Accountancy.Retrieved from: http://www.journalofaccountancy.com/news/2015/feb/revenue-recognition-clarifications- 201511839.html
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