On May 28, 2014, the Financial Accounting Standards Board (“FASB”) issued jointly written revenue recognition standards with the International Accounting Standards Board (“IASB”).1 The announcement of this update to revenue recognition marks over ten years of negotiation between the FASB and IASB to (1) develop a high-quality global accounting standard for revenue recognition, and (2) reduce instances where companies in different jurisdictions have different accounting for similar types of transactions and revenue.
Prior to the announcement of this unified standard, the FASB’s generally accepted accounting principles (“GAAP”), used in the U.S., and the IASB’s International Financial Reporting Standards (“IFRS”), used in Europe and other jurisdictions, differed significantly. Consequently, economically similar transactions frequently have dissimilar revenue reporting.2 According to the FASB and IASB, the GAAP guidelines are overly prescriptive, whereas the IFRS guidelines are not sufficiently detailed.3 Entities reporting revenue under GAAP often have to look to industry-specific guidance, while entities reporting revenue under IFRS often have little or no guidance for complex transactions.
The FASB observed that “revenue is an important number to users of financial statements in assessing an entity’s financial performance and position.” Because of the importance of revenue recognition, the FASB and IASB devised an updated and uniform standard in order to remove perceived shortcomings and inconsistencies in GAAP and IFRS revenue reporting standards. This updated standard aims “to clarify the principles for recognizing revenue and to develop a common revenue standard for GAAP and IFRS that [will]:
- Remove inconsistencies and weaknesses in revenue requirements.
- Provide a more robust framework for addressing revenue issues.
- Improve comparability of revenue recognition practices across entities, industries, jurisdictions, and capital markets.
- Provide more useful information to users of financial statements through improved disclosure requirements.
- Simplify the preparation of financial statements by reducing the number of requirements to which an entity must refer.”4
- Core Principles of the Update: Five-Step Model
The FASB and IASB’s update to revenue recognition standards will affect any entity that either (1) enters into contracts with customers to transfer goods or services, or (2) enters into contracts for the transfer of nonfinancial assets. This update will apply to revenue from contracts across all industries. In short, any company that has revenue will be affected by these updated standards.5
The core principle of this updated guidance regarding revenue recognition is that “an entity should recognize 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 in exchange for those goods or service. To achieve that core principle, an entity should apply the following steps:
Step 1: Identify the contract(s) with a customer.
Step 2: Identify the performance obligations in the contract.
Step 3: Determine the transaction price.
Step 4: Allocate the transaction price to the performance obligations in the contract.
Step 5: Recognize revenue when (or as) the entity satisfies a performance obligation.”6
This five-step process is principles-focused, and provides a single, comprehensive model for reporting revenue, thus superseding GAAP’s industry-specific guidance.7 In addition to consolidating revenue recognition guidelines into one standard, this five-step model places significant reliance on contract terms, and will require professional judgment to interpret and determine when revenue is recognized.8
Additionally, the updated standard mandates qualitative and quantitative disclosures that sufficiently enable “users of financial statements to understand the nature, amount, timing, and uncertainty of revenue and cash flows arising from contracts with customers.”9
The new standard will go into effect for public companies on January 1, 2017. The new standard will go into effect for non-profit and private companies on January 1, 2018. While the FASB precludes entities from applying this unified standard before these designated dates, the IASB will allow for premature application of the updated standard.
The FASB and IASB have announced the formation of the Joint Transition Group for Revenue Recognition (“TRG”). The TRG will discuss potential implementation issues that could arise for companies and organizations as they implement this new revenue recognition standard. Although the TRG will not issue guidance, stakeholders can submit potential implementation issues for discussion at TRG meetings.10 The TRG will hold its first meeting on July 18, 2014, and will hold five subsequent meetings before 2016.