Convergence
Collaboration: Revising
Revenue Recognition
B Y J A C K T. C I E S I E L S K I , C P A , C F A ,
WHILE
AND
T H O M A S R . W E I R I C H , P H . D . , C PA
REVENUE RECOGNITION IS CRITICAL, REGULATIONS HAVE BEEN DEVELOPED ON AN
AD HOC BASIS UNTIL NOW. THE JOINT
FASB/IASB
PROPOSED ACCOUNTING STANDARD
ON REVENUE RECOGNITION IS A MEANINGFUL CONVERGENCE OF STANDARDS THAT WILL
REQUIRE A MAJOR ADJUSTMENT FOR FINANCIAL STATEMENT PREPARERS. THE PROPOSAL
IS A RADICAL DEPARTURE FROM THE WAY REVENUE HAS BEEN RECOGNIZED BY
GAAP. FOR
U.S.
INDUSTRIES SUCH AS CONSULTING, ENGINEERING, CONSTRUCTION, AND
TECHNOLOGY, IT COULD DRAMATICALLY CHANGE REVENUE RECOGNITION, IMPACTING THE
TOP LINE. THIS ARTICLE OUTLINES THE NEW PROPOSED STANDARD, ITS POTENTIAL
IMPACT, AND THE CRITICAL ROLE THAT CONTRACTS PLAY.
he “revenues” line often is the single biggest
number in the income statement. It is one of
the most crucial financial measures investors
will ponder, and it is often the focus of management mischief. Think of the accounting
chicanery, for example, to which investors have been
subjected in the last decade:
◆ “Round-tripping” of contracts to increase revenue
and add to investor appeal,
◆ “Buy-and-hold” transactions where early customer
purchases were not really sales at all, and
◆ “Principal vs. agent” transactions where transactions
were reported on a gross basis for, say, a ticket price,
when the real revenue earned only amounted to a
commission on that gross price.
To deal with the many different types of revenue
transactions, the U.S. accounting standards for revenue
recognition have multiplied. The section of the U.S.
Accounting Standards Codification® covering revenue
recognition is composed of more than 140 pronouncements issued over the years. Some of it is very specific
to certain kinds of transactions; some of it is very specific to certain industries. Oddly, none of it contains general guidance on revenue recognition for services. Revenue recognition issues have been frequent agenda
items for the Emerging Issues Task Force of the Financial Accounting Standards Board (FASB), indicating that
the current standards are themselves inadequate.
Since 2002, the FASB has worked with the International Accounting Standards Board (IASB) on a joint
T
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project to improve revenue recognition standards. On
the FASB side, the greatest improvement would be a
comprehensive set of revenue recognition principles
that do not require constant repair and maintenance.
On the IASB side, the greatest improvement would be
more consistent principles that could be applied in
more specific situations. For example, there is little
guidance on revenue accounting for arrangements containing multiple elements. Both sides have something
to gain from this project, and developing a joint standard is a meaningful standards convergence step. The
basic objectives of the new standards include:
◆ Remove the many inconsistencies and weaknesses
in existing standards;
◆ Provide a more robust framework for addressing
revenue recognition issues;
◆ Improve comparability of practices across entities,
industries, and capital markets; and
◆ Simplify the preparation of financial statements.
The IASB standards, on the other hand, are the polar
opposite of the FASB standards. There are two chief
IASB revenue standards—International Accounting
Standard (IAS) 11, “Construction Contracts,” and IAS
18, “Revenue”—and they are not complementary. IAS
11 details the accounting for a narrow kind of transaction, and IAS 18 is a broad, somewhat vague document,
which is short on “how-to” kinds of guidance. For
example, there is nothing in either document that
addresses the revenue recognition issues inherent in
multiple-deliverable arrangements, something fairly
common and also addressed by the FASB last year.
While dealing with the single most important figure
on the income statement, both sets of standards have
serious, though different, deficiencies. That makes revenue recognition a perfect project for the combined
forces of the two standards setters. Trying to remedy
the opposing weaknesses inherent in both sets of standards gave both Boards a chance to develop an
approach that addresses both sets of weaknesses. They
may have succeeded, but at the same time it will be a
major adjustment for financial statement preparers and
investors to become comfortable with the new way of
thinking about the kind of transactions that constitute
revenues.
Here is how the joint proposal will work—in its
current form—and how it could affect current revenue
recognition practices in various industries.
T H E C U R R E N T TO P L I N E
The current revenue recognition standards are best
described as the result of a long-term ad hoc approach.
There has never been a comprehensive revenue recognition standard that presented a framework for working out
unmapped issues. Instead, revenue recognition standards
have often been developed in response to a request from
a particular industry that views itself as somehow different from others in the way that revenues get recognized.
U.S. standards setters have thus built a towering mound
of rules around revenues—more than 140 standards—
with no guiding principles running through them. Without a central theme, the continued issuance of more
narrow-range accounting standards is a certainty. The
new standard should also help address the many common revenue fraud techniques that have negatively
impacted the capital markets. Such frauds have included
sham sales, premature revenue recognition before all the
terms of the sale have been completed, conditional sales,
improper cutoff of sales, improper use of the percentageof-completion accounting, and consignment sales.
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T H E N E W TO P L I N E
The proposed standard starts with a strong basic
premise: Revenues recognized will depict the transfer
of goods or services to customers in an amount that the
firm receives or expects to receive in exchange for those
goods or services. Applying that principle consists of
five steps (see Figure 1). Understanding these steps is
the key to understanding how current revenue recognition will change. Be aware: It will not be as easy to put
into practice in the real world as it might sound.
Step 1: Identify the contract(s) with a customer. Contracts may be written, oral, or implied by customary
business practice. (Think of retailing: There is no
explicit contract, but one is implied in the act of
exchanging cash for, say, sweaters.) A contract exists
only if:
◆ It has commercial substance (no round-trippers,
please),
◆ The parties to the contract have approved it and are
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Figure 1:
Steps in Applying Revenue Model
1. Single contract
(1) Identify the Contract
2. Combine two or more
contracts into one
3. Segment single contract
as two or more contracts
Enforceable promises in a
contract
(2) Identify Performance
Obligations in the Contract
(3) Determine Transaction
Price
In proportion to the standalone selling price of
goods/services underlying
each performance
Amount of consideration
received or expected to be
received
(4) Allocate Transaction
Price to Performance
Obligations
(5) Recognize Revenue
upon Completion of
Performance Obligations
Recognize revenue when
customer has obtained
control of goods or services
Source: Lori Olsen and Thomas R. Weirich, “New Revenue-Recognition Model,” Journal of Corporate Accounting & Finance,
November/December 2010, p. 56.
committed to fulfilling their obligations,
◆ Each party’s enforceable rights regarding the goods
or services to be transferred can be identified, and
◆ The firm can identify the terms and manner of payment for those goods or services.
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This sounds simple enough, but the hard part is in
the details: Multiple contracts may have to be combined
if their prices are interdependent, or a single contract
may have to be segmented into discrete units if it contains elements with independent prices. Say two con-
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tracts, A and B, contain two prices for services, but the
services in Contract A cannot be completed without the
services to be provided in Contract B. The prices would
be interdependent, and they would be combined for
recognizing revenue. Now suppose there is only one
contract that covers the fulfillment of three different services, and none of them requires each other’s completion in order to be delivered. Those services have independent prices, and they would be segmented into
separate contracts.
The proposal takes into account that contracts can be
modified over time. If a contract modification’s price is
interdependent on the existing contract, a firm would
recognize the modification’s cumulative effect in the
period it occurs. After the cumulative treatment, the
contract’s revenue would be reported the same as if the
modification had been built into the contract from the
start. If the modification’s price is independent of the
existing contract, it will be treated as a separate contract.
Much of the industry-specific jargon embedded in
revenue recognition standards will be gutted by this
proposal. Gone will be terms like “downgrade” or
“enhancement” (software related), “lifted flight
coupon” (airlines), “other than retail land sales” (real
estate), and 100 other terms of revenue art. In their
place will be some new terms related to important concepts in the new accounting as explained in the revenue recognition glossary (see Table 1).
Table 1:
Contract: An agreement between two or more
parties that creates enforceable rights and
obligations.
Contract asset: A firm’s right to consideration
from a customer in exchange for goods or
services transferred to the customer.
Contract liability: A firm’s obligation to transfer
goods or services to a customer for which
the firm has received consideration from
the customer.
Control (of a good or service): A firm’s ability
to direct the use of, and receive the benefit
from, a good or service.
Customer: A party that has contracted with a
firm to obtain goods or services that are
an output of the firm’s ordinary activities.
Performance obligation: An enforceable
promise (whether explicit or implicit) in a
contract with a customer to transfer a
good or service to the customer.
Revenue: Inflows or other enhancements of
assets of a firm or settlements of its liabilities (or a combination of both) from
Step 2: Identify the separate performance obligations in
delivering or producing goods, rendering
the contract. The “performance obligation” is a key ele-
services, or other activities that constitute
ment in this proposal. Basically, a firm’s performance
obligation is its promise to deliver the goods or services
for which the customer contracted. It is crucial to identify
all goods and services in a contract to see if they should
be accounted for as separate performance obligations.
A key concept here is whether or not a good or service is “distinct.” It is only distinct if it can be sold separately and has a distinct function and profit margin. A
distinct good or service is accounted for as a separate
performance obligation. If a good or service is not distinct, it is combined with other promised goods or services to a point where a bundle of distinct goods or services is reached; then it is accounted for as a separate
performance obligation.
For some transactions, this criterion can alter revenue
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Revenue Recognition
Glossary
the firm’s ongoing major or central
operations.
Stand-alone selling price (of a good or
service): The price at which a firm would
sell a good or service separately to the
customer.
Transaction price (for a contract with a customer): The amount of consideration that a
firm receives, or expects to receive, from
a customer in exchange for transferring
goods or services, excluding amounts
collected on behalf of third parties (for
example, taxes).
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profiles from their pattern today. Consider a free good
given by a seller in the hopes of obtaining a long-term
service contract. For example, a telecom company could
give away a cell phone in order to obtain a two-year service contract. Currently, the telecom firm might allocate
zero revenues to the cell phone, only recognizing the
revenue of the two-year service contract, which presumably includes some charge to the customer for the
“free” phone. Under the proposal, delivery of the cell
phone could be considered distinct if it is usable—and
some specific portion of revenue would be recognized
for it. The current practice would allocate that phone
price to the recognized revenue of the service contract.
By comparison, the proposed accounting would lower
the future service contract revenue; it would not contain any revenues allocated to the phone.
Step 3: Determine the transaction price. Determining
the transaction price is simple if it is a fixed amount for
a specific good or service. It is more complex if a price
is variable because of discounts, rebates, refunds, credits, incentives, performance bonuses/penalties, contingencies, price concessions, the customer’s credit risk, or
other similar items. Whether figuring the price is simple
or complex does not matter; firms have the burden of
estimating (on a probability-weighted basis) the total
consideration they expect to receive even if it is contingent on other matters. If a transaction price is estimated, it must be updated each reporting period, including
the revenue effects of updated estimates.
Recognizing contingent revenue is a break from current practice. Generally, revenue does not get reported
until a seller’s price is fixed and determinable. All else
equal, the allowed recognition of revenue from estimated selling prices will result in earlier revenue recognition than in today’s reporting. Two conditions have to
be met for the price to be reasonably estimated:
(1) The firm must have experience with similar types of
contracts (or can access other firms’ experience with
them, if it has none of its own), and (2) the experience
must be relevant to the contract because no significant
changes are expected.
For investors, this is one of the difficult aspects of
the proposal. Recognizing estimated revenue should
not be a license for mischievous managers to print money, and the proposal puts a few additional controls
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around the process. If the estimated price cannot be
reasonably estimated, then revenue will be limited to
the amount that can be reasonably estimated. If circumstances change and the transaction price can become
reasonably estimable, a firm can recognize revenue
from satisfied performance obligations.
Whether the transaction prices are fixed or estimated,
determining prices must take into account:
Collectability of promised consideration. Firms must
take into account the credit status of their customers
and report as revenue only what they expect to collect, on a
probability-weighted basis—another break from current
practice. If a contract price is $100 and the seller considers the customer to be a bad credit risk at the outset,
expecting to collect only $80, then $80 is the price to be
used. Likewise, if a product is sold with a right to
return it, the seller records revenue only for the part not
expected to be returned. A return liability is recorded
for the rest.
Time value of money. While the time value of money
does not matter to many contracts, there could be cases
where payment from the customer is due either significantly before or after goods or services have been transferred by the seller. In those cases, the sales consideration is discounted at the rate that would be used in
separate financing between the seller and customer, and
separate recognition of financing income is shown.
Noncash consideration. If the seller is to receive noncash consideration in payment for a contract, it is measured at its fair value.
Consideration payable to the customer. When a seller
also promises to pay a customer, the seller needs to
determine if it is a reduction of selling price or whether
the seller is separately acquiring goods or services.
Recognizing revenue only to the extent it is expected to be collected is a new concept. It means that
allowances for doubtful accounts will reflect only
changes in customer credit status that have occurred
after a sale.
Step 4: Allocating the transaction price. When all the
performance obligations have been identified, the next
step is to allocate the transaction price to the obligations
in proportion to the stand-alone selling price of each
good or service linked to a performance obligation. The
best evidence of a “stand-alone selling price” is the
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price at which a firm separately sells a good or service—
not a contract or list price. If there is no observable
stand-alone selling price available, then one must be
estimated. Estimates can be based on an expected cost
plus profit margin, or they can be estimated by evaluating the market for the goods and services. Competitors’
prices may provide a foundation for estimated selling
prices and should include adjustments for a firm’s own
costs and margins.
While percentage-of-completion accounting will not
be eliminated, the requirement to isolate the individual
performance obligations in a contract could cause some
elements to be recognized separately, and earlier, than
if they were part of a larger amount being recognized on
a straight percentage-of-completion basis. The smoothing effects of percentage-of- completion accounting
could be diluted: Revenue might be “lumpier” than it
has been historically.
For example, a firm currently might recognize
$50 million of revenue evenly over five years as it completes an equal physical stage of progress at the end of
each year. Revenue equals $10 million per year. Suppose the project contains a separable element completed at the end of the first year and has a value of $5 million. That would leave $45 million to be recognized
over five years, with $9 million per year. Year 1 total
revenues would be $14 million, including the $5 million
from the single element.
Step 5: Recognize revenue when a performance obligation is satisfied. When the customer gains control of the
promised goods or services, then the seller can recognize revenue from the sale. The proposal offers some
indicators to tell when the customer “gains control”:
◆ The customer has an unconditional obligation to pay,
◆ The customer has legal title,
◆ The customer has legal possession, or
◆ The design or function of the good or service is
customer-specific.
Construction industry players have feared the worst
from this potential accounting change: It implies that
percentage-of-completion accounting is off-limits for
them. They fear that all contract revenue can be recognized only at the completion of a contract. That is a
misconception, however; the percentage-of-completion
method of accounting will not face extinction if the proposal becomes a final standard. If the customer controls
the work-in-process, a contract may be deemed to have
a “continuous transfer” of the goods and services to the
customer. The seller could then recognize revenue
during the execution of the contract. Percentage-ofcompletion accounting would qualify as a “continuous
transfer” method of recognizing revenue, which
includes:
◆ Output methods that recognize revenue on the basis
of units produced or delivered or on contract
milestones;
◆ Input methods that recognize revenue on the basis
of efforts expended to date (costs of resources consumed, labor hours expended, and machine hours
used) relative to total efforts expected to be
expended; or
◆ Methods based on the passage of time, such as for
licenses or subscriptions.
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OT H E R P R O P O S E D C H A N G E S
The concept of onerous performance obligations, the
accounting for costs, bill-and-hold arrangements, the
treatment of licenses, and the method of presentation
are other aspects of the proposal that are worth understanding. Here is a quick overview.
Onerous performance obligations. A performance
obligation is deemed “onerous” if the allocated transaction price is less than the probability-weighted direct
costs of satisfying it. Before recognizing any liability for
an onerous performance obligation, a firm must first
record any impairment loss on assets related to that
contract—for instance, an impairment of inventory
acquired for the customer. At each reporting period, the
measurement of an onerous performance obligation
must be updated, and any changes in measurement are
recognized as an expense or reduction of expense.
When the onerous performance obligation’s liability is
satisfied, the corresponding income is a reduction of the
related expense.
Contract costs. These costs are to be treated as
expenses when incurred:
◆ Costs of obtaining a contract,
◆ Costs related to past contract performance, and
◆ Costs of abnormal amounts of wasted materials,
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labor, or other resources used to fulfill the contract.
to such custodial services.
As firms become more comfortable with the “contract concept” of revenue recognition, it might not be
surprising to see more firms try to use bill-and-hold revenue recognition practices. The proposal does not do
anything to make it more difficult to achieve and will
foster more of a contract mentality among sellers, so
they might as well start to craft sales arrangements in
this direction.
Presentation. When either party to a contract has performed its obligation, a firm will present the contract in
the balance sheet as either a contract asset or a contract
liability, depending on the relationship between the
firm’s performance and the customer’s performance at
the point in the contract as of the balance-sheet date. If
the firm has performed by transferring goods or services
to the customer before the customer pays consideration,
the firm presents the contract as a contract asset. If the
customer performs by paying in advance of the receipt
of goods or services, the firm presents the contract as a
contract liability.
If nothing more is required of the firm—i.e., all contract goods or services have been transferred to the customer—and the only remaining open contract item is
payment to the firm, then right to payment is classified
as a receivable and not a contract asset. Any costs recognized as assets as part of executing the contract—such
as inventory or property, plant, and equipment—are
presented separately from the contract asset or contract
liability. Any liability recognized for an onerous performance obligation is reported separately from any contract asset or contract liability.
Licensing transactions. A licensing arrangement gives
a customer the right to use—but not own—intellectual
property of the provider. Intellectual property includes
software and technology; motion pictures, music, and
other forms of media and entertainment; franchises;
patents, trademarks, and copyrights; and other intangible assets.
The proposal contains implementation guidance for
revenue recognition in licensing arrangements involving
these items:
◆ If the customer controls all of the rights to an intellectual property—as in an exclusive right to use the
property for its entire economic life—it is accounted
If it cannot be determined whether a cost relates to
future performance or past performance, the cost should
be treated as an expense when it is incurred. Not all
contract costs will get the expense treatment. They can
be capitalized as an asset only if they:
◆ Are directly related to a contract,
◆ Generate or enhance resources to be used in satisfying future performance, and
◆ Are expected to be recovered.
Costs related directly to a contract are direct labor,
direct materials, allocations of costs related directly to a
contract, costs chargeable to the customer, and other
costs incurred only because of the contract.
Bill-and-hold arrangements. These arrangements have
an unsavory heritage, gaining notoriety in the late 1990s
when Sunbeam Corporation used them to inflate its
revenues. The company gave customers enticing purchase terms in order to stimulate sales beginning in the
second quarter of 1997, effectively pulling future sales
into an earlier quarter.
The proposal does not bar bill-and-hold arrangements. These conditions must be fulfilled for a billand-hold arrangement to take place:
◆ The customer must have requested the contract to
be on a bill-and-hold basis,
◆ The product must be identified separately as the
customer’s,
◆ The product currently must be ready for delivery at
the location and time specified or to be specified by
the customer, and
◆ The firm cannot use the product or sell it to another
customer.
These conditions give control of the goods to the
customer, despite the fact that they remain in physical
possession of the seller. In these cases, the customer
may direct the use of the product and derive benefits
from it but has chosen not to exercise its right to use
the product. What has transpired is that the selling firm
provides custodial services to the customer over the
customer’s asset. The seller should consider whether
some part of the transaction price needs to be allocated
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for as a sale instead of a licensing transaction.
◆ If a customer does not obtain control of a firm’s intellectual property but is promised exclusive rights to it,
the firm has a performance obligation that is satisfied
continuously over the term of the arrangement.
◆ If a firm grants nonexclusive rights, the license
would be treated as a single performance obligation
and would be satisfied as soon as the customer is
able to use and benefit from the rights.
ance of contract assets and contract liabilities, including the amount recognized in revenue arising from
performance obligations completed in the current
period; changes in transaction price to performance
obligations completed previously; interest income
and expense; foreign currency effects; cash received;
amounts transferred to receivables; noncash consideration; contracts acquired in business combinations;
and contracts disposed. (The reconciliation of
changes in contract assets and liabilities will be particularly useful for investors and will be helpful in
answering a long-standing analytical question: How
much was a firm’s revenue growth affected by acquisitions in a certain period? The reconciliation also will
be helpful in assessing the level of organic growth in
a particular period because it will isolate effects of
catch-up adjustments to transaction prices and foreign
currency effects. Those items are not consistently
well-disclosed from company to company.)
◆ Information about performance obligations, including a description of goods or services that have been
promised for transfer; when performance obligations
are typically satisfied (upon shipment, delivery, as
services are rendered, or upon completion); significant payment terms; refund and return obligations;
warranties.
Licensing arrangements are found in a variety of
companies, including those in the software, electronics,
biotechnology, pharmaceutical, movies, and apparel
industries, to name just a few. While there could be
hundreds of companies affected by the proposal, the
effect it could have is amorphous. It will depend on the
terms dictated by the structure of the contracts surrounding the licensing transactions.
PROPOSED DISCLOSURE REQUIREMENTS
The proposal is a radical departure from the way revenue has been recognized in U.S. GAAP, and the disclosures are radical as well. Generally, the most visibility
that investors have had regarding revenues has been in
the accounting policies section of the footnotes. While
there will still be that discussion, there is additional disclosure to be included, and with good reason. The proposal enables firms to estimate their revenues to a
degree never seen before, so getting companies to
explain how they made their estimates will be critical if
investors are to be comfortable with the results.
Firms must disclose qualitative and quantitative
revenue information in two broad areas:
1. Contracts with customers and
2. Significant judgments, and changes in judgments,
made in determining revenues for those contracts.
For contracts expected to last more than one year,
information must be disclosed about the lapsing of
remaining revenue to be recognized in future periods.
This would create a lapsing schedule or maturity analysis of remaining performance obligations similar to the
minimum lease payment schedule appearing in footnotes. Investors constantly request companies to disclose their “backlog” of orders, and it is often denied.
This lapsing schedule is not the same thing as a backlog, which usually has to do with revenue yet to be realized, but it is more instructive about the timing of
future revenues based on contracts that are already in
hand. Investors might find this more useful than what
they have been requesting.
Contracts with customers. Specific disclosures related to
contracts with customers would include:
◆ A disaggregation of revenue for the period, by appropriate categories, e.g., type of good or service (product lines), geography, market or type of customer
(such as government vs. nongovernment), or type of
contract (fixed price vs. time-and-materials).
◆ A reconciliation from the opening to the closing bal-
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Significant judgments. A firm must disclose the judgments, and changes in judgments, applied in the revenue recognition decision that significantly affects the
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determination of the amount and timing of revenue
from contracts with customers. Firms must explain the
judgments used in:
◆ Determining the timing of satisfaction of performance, including discussion of methods used to recognize revenue (such as output methods, input
methods, passage of time) and explanation of why
methods work.
◆ Determining the transaction price and allocating it to
performance obligations, including disclosure of
methods used to determine transaction price, to estimate stand-alone prices of goods or services, to measure return or refund obligations, and to measure liability for any onerous performance obligations.
recording as revenue only what they expect to collect
on a contract rather than what they hope to collect.
This will make the allowance for doubtful accounts and
the provision for uncollectible accounts reflect the
changes in a customer’s credit after a sale more in line
with the economic events reported in the period.
The use of estimates changes. Firms will be permitted
to estimate transaction prices—and, consequently,
revenue—when it is reasonably estimable and they
have experience with those kinds of contracts. While
some fear that it will be a license to “print revenues,”
it is not an available course of action if it cannot be reasonably estimated and if there is not some kind of prior
experience with such contracts.
There is now more specific guidance on accounting for
Entities impacted. This proposal will change revenue
costs that arise in long-term contracts. The way some
recognition in a number of ways.
firms account for costs could now be different.
The level of disclosures is greatly expanded. This will
result in both quantitative and qualitative information
about the most important number in the income
statement—something that has been in short supply for
years.
Make no mistake about it: If this proposal is enacted
in its current form, it will impact the top line for many
companies. Those changes are not slight, nor even
familiar, for many companies. The hard part is picking
out the companies where the proposed changes would
be likely to have the most effect. For investors, this is
usually done by looking at the investable universe
through an industry prism. It would be satisfying to
investors and analysts to simply cite here the industries
that would be most likely to see a speed-up or slowdown of revenue recognition. But that would be a gross
oversimplification.
The basic economic unit being accounted for in this
proposal is a contract, and no two contracts will always
be alike. Two competitors in the same industry could
account for an apparently similar transaction and come
up with two different results. Suppose that two rival
manufacturers of custom healthcare equipment contract
with two customers for building equivalent magnetic
resonance imaging (MRI) units to be constructed over the
same time frame. One manufacturer is a well-established,
highly-regarded firm and has entered a contract whereby
the MRI unit is continuously transferred to the cus-
Only the transfer of goods or services will cause revenue to be recognized. It will not affect, say, truckloads of
deodorant shipped by consumer products companies or
railcars of soybeans sold by farmers. But for consulting,
engineering, construction, and technology firms
engaged in longer-term endeavors with their customers,
it could change revenue recognition dramatically. It cannot be determined clearly whether it would increase or
decrease revenue recognition without knowing in what
kind of contractual arrangements a firm has engaged.
Firms will have to identify their performance obligations separately. At present, firms might consider a sale
to occur for one bundle in a transaction. Now they will
have to isolate all the items or services that they are
required to deliver. (Think back to the earlier cell
phone/service contract example.) This might make revenue a more volatile number for some firms, including
construction firms using percentage-of-completion
accounting. They might recognize revenue for a particular part of an arrangement that was previously
deferred, with less revenue being recognized in future
periods.
Licensing and rights to use a good or service will be
reexamined. The timing of revenue recognition will
hinge on whether a license to use intellectual property
will be granted on an exclusive or nonexclusive basis.
The result could be different from the current practice.
The effect of credit risk is impacted. Firms will now be
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tomer/hospital as construction milestones are completed
and the firm receives progress payments. The revenue
may be recognized using an acceptable percentage-ofcompletion method. The other manufacturer, an upstart
with a reputation to earn, agrees to a contract with a different customer/hospital whereby the MRI unit being
constructed will not be considered complete until the
hospital decides that the MRI unit is to its liking. The
manufacturer may have agreed to such terms because it
wants to get a contact with this new customer. No recognition of revenue would be permitted in that scenario—
there is no completion of the contract until the very end,
when the customer decides it is done. Even though
both manufacturers are in the same industry and are
building similar projects over the same time frame, the
first manufacturer earns revenue much earlier than the
second. The contract terms are the key to revenue
recognition, period.
In short, the proposal does not affect revenue recognition of particular industries as directly as it affects revenue recognition related to particular contracts. The
question should not be: “Which industries would see
revenues increase or decrease if this proposal becomes a
standard?” It should be: “What industries deal with
contracts that might be accounted for differently if this
proposal becomes a standard?”
That said, some industries can be ruled out fairly
quickly. Longer-term contracts will bear more of an
impact from the proposed accounting than rapidturnover, short-term contracts. A shipment of dresses
will still receive the same kind of accounting it always
did. The goods get delivered, and an account receivable
is recorded to be turned into cash later. Companies in
the transportation, materials, chemicals, retailing, hospitality, food service, food and beverage, and consumer
products industries typically deal in short-duration transactions. Viewed through a different prism, firms in these
industries provide their customers with goods or services
that have short lives and are not often provided on a customized basis. They would be unlikely to enter contracts that would require expansion into discrete parts
with separate revenue recognition for each. Therefore,
firms in these industries might be expected to have a
minimal effect on their top line from this proposal.
Looking in the other direction, there are plenty of
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candidates where contracts are plentiful and likely to
extend over multiple reporting periods, possibly with
customization of the products or services provided. The
construction, home building, and engineering industries
are the most obvious ones. These attributes can also be
found in organizations engaged in management consulting, technology services, and outsourcing activities; software and related services; utilities; biotechnology and
life sciences; capital goods manufacturing; healthcare
services; real estate; media and entertainment; and
telecommunications.
CHANGE COMING SOON
The Boards expect that this new proposed standard will
provide a more robust revenue recognition framework
and enhance comparability across entities, industries,
jurisdictions, and capital markets. At the June 16, 2011,
FASB meeting, the Board decided to re-expose the
standard to gather additional feedback regarding the
effect it might have on specific companies and the transition requirements. The re-exposure is intended to be
released in the third quarter of 2011. ■
Jack T. Ciesielski, CPA, CFA, is president of R.G. Associates
and is a registered investment advisor. He can be reached at
[email protected].
Thomas R. Weirich, Ph.D., CPA, is a professor of accounting at Central Michigan University and chair of the
Michigan Board of Accountancy. He belongs to the Saginaw
Valley Chapter of IMA®. His e-mail address is
[email protected].
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