The development of a new standard for revenue recognition was discussed in the summer 2011 edition of Financial reporting. Since then the IASB has issued a revised exposure draft in response to feedback received on their original proposals.
The IASB decided to revise its proposals after receiving over a thousand comment letters on the original exposure draft (ED), many of which expressed concern that it was not clear how to apply the proposed core principles in practice, particularly to contracts for services and construction contracts.
Proposals in the revised ED
The core principle set out in the revised ED is consistent with the original ED, that "an entity shall recognise 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 to in exchange for those goods and services".
The ED outlines the five steps any entity needs to consider in order to recognise revenue.
Step 1: Identify the contract with a customer.
Step 2: Identify the separate performance obligations in the contract.
Step 3: Determine the transaction price.
Step 4: Allocate the transaction price to the performance obligations.
Step 5: Recognise revenue when a performance obligation is satisfied.
For many companies, step 5 will be the most important in determining the amount of revenue to be recognised in each accounting period.
Smith & Williamson commentary
For many contracts, such as straightforward retail transactions, the proposals will have little, if any, effect on the timing and amount of revenue recognised. However, in other circumstances, for example long-term service contracts, contracts that contain multiple deliverables (e.g. mobile phone contracts) or contracts for services, the proposed new standard could result in changes to both the timing and amount of revenue recognised.
Revenue should be recognised when an entity satisfies its performance obligations by transferring control of the goods or service to the customer. If control is clearly transferred at a point in time, for example in a retail transaction when the customer pays for and obtains custody of the item, revenue should be recognised at that point. If control is obtained over a period of time, then revenue should be recognised over that period of time.
The proposals in the original ED would have prohibited the recognition of revenue over time for many construction and service contracts where the asset created by the seller's performance (i.e. the work in progress) is not controlled by the customer until the end of the contract.
However the focus on requiring control before revenue can be recognised over time has been amended in the revised ED. Revenue can be recognised even if the customer does not have control of the work in progress provided that the work in progress does not have an alternative use to the seller and certain other criteria are met (including a right to payment for partial completion). This will mean that more transactions will be accounted for over time than would have been the case under the original ED.
A key change from the original ED and from current practice is the proposed treatment of credit losses. The revised ED requires the amount of any expected credit losses and any subsequent adjustments (i.e. any bad and doubtful debt expense) to be presented in a separate line item within the statement of comprehensive income adjacent to the revenue line.
The revised ED proposes a more comprehensive set of disclosures that require both qualitative and quantitative information about revenue and cashflows arising from contracts with customers. Apart from some minor amendments and clarifications, these disclosure requirements have remained unchanged from the original ED.
The comment period for the revised ED ended on 13 March and it is possible that the final standard will be issued by the end of 2012. The IASB will not make a final decision on the effective date of the new standard until it has received and reviewed all comments. However, it has indicated that the earliest date by which the new standard will be mandatorily effective is for periods beginning on or after 1 January 2015.
Smith & Williamson commentary
Although the new standard may not apply yet, it will be retrospective and the impact on some companies could be significant. For entities in the service sector in particular it may be advisable to consider the proposals in the revised ED and understand how the requirements could change the company's accounting policies for revenue recognition.
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