Revenue Recognition under US GAAP and IFRS
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International Accounting Standards Board (IASB) and Financial Accounting Standards Board (FASB) are working together to provide a single revenue recognition model that can be applied to a wide range of industries and transaction types. US GAAP currently has many industry-specific requirements that are not always consistent with each other.
Keywords: revenue recognition, IASB, FASB, contracts
The topic of the research is "Revenue Recognition under US GAAP and IFRS". Revenue is the largest item in financial statements, and issues involving revenue recognition are among the most important and difficult that standard setters and accountants face. Revenue recognition requirements in U.S. GAAP are different from those in IFRSs and both are considered in need of improvement. U.S. GAAP comprises broad revenue recognition concepts and numerous industry or transaction-specific requirements that can result in different accounting for economically similar transactions. Although, IFRSs contain less guidance on revenue recognition, its two main standards IAS 18 Revenue and IAS 11 Construction Contracts can be difficult to understand and apply beyond simple transactions. Also, they lack guidance on important topics such as revenue recognition for multiple-element arrangements.
Reporting inconsistencies in this accounting area arise because there are no comprehensive accounting standards covering revenue recognition. Several authoritative accounting pronouncements have addressed detailed, industry-specific revenue recognition issues which caused practitioners to use standards in situations for which they were not intended. As a result, in 2002, the FASB added revenue recognition to its project agenda.
In accounting, revenue recognition refers to the point when one is able to record a sale in the financial statements. Years ago, the sale was made and then an invoice was issued. Now, products are sold with added services, TVs are being sold with long term warranties, mobile phone contracts sold with a free phone, tickets sold for concerts which will not occur for a number of months, and software sold with free upgrades.
International Accounting Standards Board (IASB) and Financial Accounting Standards Board (FASB) (collectively, the board) are working together to provide a single revenue recognition model that can be applied to a wide range of industries and transaction types. U. S. GAAP currently has many industry-specific requirements that are not always consistent with each other. The boards intend to improve current revenue recognition guidance by:
Enhancing consistency and comparability.
Simplify U. S. GAAP. Currently, there are more than 100 revenue recognition standards in U.S. GAAP. Many of these standards are industry-specific, and some provide conflicting guidance.
Providing guidance lacking in IFRS. The two main IFRS revenue recognition standards are vague, inconsistent, and difficult to apply to complex transactions,
IASB and FASB published a joint discussion paper, "Preliminary Views on Revenue Recognition in Contracts with Customers," in December 2008 that proposed a single revenue recognition model built on the principle that an entity should recognize revenue when it satisfies its performance obligation in a contract by transferring goods and services to a customer. This principle is similar to many existing requirements. A contract is defined as "an agreement between two or more parties that creates enforceable obligations," and may consist of either explicit or implicit arrangements. However, IASB and FASB think that clarifying the principle and applying it consistently to all contracts with customers will improve the comparability and understandability of revenue for users of financial statements. The Discussion Paper sought comments on the Boards' preliminary views on a single asset and liability based revenue recognition model that they believe will improve financial reporting under U. S. GAAP and IFRS by (Ernest & Young, 2009):
Providing clearer guidance on when an entity should recognize revenue.
Reducing the number of standards which entities have to refer to in determination of revenue.
Establishing principles that will result in entities reporting revenue more consistently for similar contracts regardless of the industry in which an entity operates.
In September 2002, the IASB and FASB announced plans to achieve convergence in a document referred to as the Norwalk Agreement which called for detailed differences to be removed rapidly and then other differences gradually. In 2007, the Securities and Exchange Commission (SEC) accepted the plan to apply IFRS to the statements filed with the SEC in 2008. According to Mintz (2008), the SEC detailed a road map for the adoption of IFRS that would monitor progress until 2011, when the commission will consider requiring U. S. public companies to file their financial statements using IFRS. The road map includes a potential phased transition over three years, beginning with large accelerated filers in 2014 and then nonaccelerated filers starting in 2016.
The research will be done using secondary data collection from Google, Google scholar, ProQuest, discussion papers, and other academia databases. According to Dohrer (2009), U.S. GAAP revenue literature is built on principles that are similar to those in IFRS. However, U.S.GAAP has industry industry-specific revenue recognition literature, such as that for the software industry, which is limited under IFRS. U.S. also includes more detailed implementation guidance.
The problem for this research is to find a single asset and liability based revenue recognition model to improve financial reporting within both U. S. GAAP and IFRS. The researcher will seek to answer the following research questions:
1. How does realizability affects the measurements of rights?
How is performance obligations identified?
When will a customer control the asset?
Recognition under U.S. GAAP specifies that revenue should not be recognized until the revenue is either realized or realizable, and earned. Preparers, users, and auditors of financial reports have struggles with issues surrounding the timing of revenue recognition. This has led to fraudulent entries. In 1999, a report by the Committee of Sponsoring Organizations (COSO) of the Treadway Commission reported that more than one-half of financial reporting frauds studied from 1987 to 1997 involved overstating revenue. In response to the COSO report, the SEC issued SAB 101, "Revenue Recognition in Financial Statements." This bulletin summarized applying revenue recognition principles to specific conditions (Stout and Baxendale, 2006).
According to GAAP, revenue is realizable and earned when all of the following criteria are met.
- Persuasive evidence of an arrangement exists.
- Delivery has occurred or services have been rendered.
- The seller's price to the buyer is fixed or determinable.
- It is reasonably assured that payment will be collected.
According to RevenueRecognition.com (2006), regardless of the company's size, ownership structure, or what systems it has in place, having a written revenue policy is essential to accurate revenue reporting. The policy should govern how contracts are written, how orders are booked, define the revenue accounting workflow, as well as how journal entries are made as revenue is managed through the finance department.
Revenue recognition in IFRS is contained primarily within two standards:
International Accounting Standard (IAS) 18 Revenue, which applies to the sales of goods, rendering of services, and the use of company assets by others yielding interest, royalties and dividends. IAS 11 Construction Contracts, which prescribe the accounting treatment of revenues and cost associated with construction contracts.
These standards are that revenue is recognized when it is probable that future economic benefits will flow to the entity and these benefits can be measured reliably. This occurs when the "earnings process" is substantially complete and is realized or realizable and earned. The Discussion Papers stated that the proposed model should not significantly change the accounting for many arrangements from the current practices under IFRS.
Under IFRS, revenue is usually recognized when the risks and rewards associated with the goods or services have been transferred to the customer. Delivery is deemed to have occurred when the customer takes title to a good, indicating that the risks and rewards of ownership have passed to the customer.
RevenueRecognition.com surveyed senior financial executives from 515 companies about the Discussion Paper. RevenueRecognition.com worked with staff members from the FASB and IASB revenue recognition project to create an internet survey based on the key questions raised in the proposal. The survey was conducted in April 2009. More than 75% of respondents were senior finance executives including CFOs and Controllers. The key findings were that 54% of the respondents agreed or strongly agreed that a contract-based approach to revenue recognition would clarify the earnings process. And 66% said there would be little or no difference in the timing of their revenue recognition if delivery is defined as the transfer of "control" over good and services. Also, 70% agreed or strongly agreed that the Board's definition of a "performance obligation" as an accounting unit would help them identify components more consistently than existing practice.
The history of difficult with revenue recognition in the corporate sector is full with instances of fraud. A COSO report, Fraudulent Financial Reporting 1987-1997: An Analysis of U. S. Public Companies reported that half of frauds involved overstated revenue. Online business-to-business transactions have led to questions about the validity of reported revenue. Past revenue recognition has involved fraudulently setting aside inventory not actually sold. Also, practices include written agreement for sales that are not signed by both parties because the seller would recognize revenue with only the verbal acknowledgment which is no longer permits. Auditors focus on revenue recognition overstatement in financial statements.
Recommendations for improving revenue recognition are the following:
The person recording or auditing revenue should have a strong knowledge of U. S. GAAP for revenue recognition.
The audit committee should be aware of issues and make appropriate inquires.
All relevant individuals should be knowledge about recent revenue recognition guidelines, including SAB 101 and EITF 99-17 and 99-19.
In conclusion, International Accounting Standards Board (IASB) and Financial Accounting Standards Board (FASB) are working to provide a single revenue recognition model that will be applied to a wide range of industries and transaction types. Revenue
recognition requirements in U.S. GAAP are different from those in IFRSs and both are considered in need of improvement. Recognition under U.S. GAAP specifies that revenue should not be recognized until the revenue is either realized or realizable, and earned.
Under IFRS, revenue is usually recognized when the risks and rewards associated with the goods or services have been transferred to the customer.