How Are You Recognizing Revenue? New Model to Impact Many Industries

One amount almost everyone looks at on a company’s financial statements is REVENUE. Whether you know a lot or a little about accounting and finance, most people realize this number is at least somewhat important in analyzing a company’s performance and earnings quality.

There are currently over 100 standards on revenue and gain recognition in U.S. GAAP. This has resulted in many industry-specific standards that produce conflicting results for similar transactions leaving companies and practitioners with inconsistent and sometimes vague guidelines. As a result the IASB and FASB have issued Preliminary Views on Revenue Recognition in Contracts with Customers, a discussion paper to clarify the principles for revenue recognition and improve comparability and understandability.

The main concept of the paper is the Contract-based Revenue Recognition Model. This proposed model works to reflect:

  • The transfer of promised goods and services to customers, and not
  • The activities of the entity in producing those goods and services

The IASB and FASB recommend a company should recognize revenue when it satisfies a performance obligation in the contract. This change in method is consistent with many of the existing standards, and, as a result, revenue recognition would not change for many entities and industries.

However, while implementation would not produce major changes for certain industries and entities, others would see significant modifications to revenue recognition procedures. One industry in which these changes would have a significant impact is CONSTRUCTION.

Construction contracts are accounted for by the percentage-of-completion and completed contract methods. The new method proposed would eliminate the recognition of estimated revenue during the contract term and recognize revenue when goods and services are transferred to the customer and expenses incurred. Software transactions would also be recognized when and if certain elements of a bundled arrangement have been performed, which could result in more revenue being recognized earlier in the contract. Even professional services, including those in accounting, would see changes if work-in-progress is not recognized.

The IASB and FASB boards are currently reviewing the comments submitted on the discussion paper. Their intent is to release an exposure draft in early 2010 with a final version of the standard expected in 2011. We will be watching and reporting on the progress.