New proposals on revenue recognition will significantly affect industries
LONDON, 7 July 2010 ― Last week the International Accounting Standards Board (IASB) and the US Financial Accounting Standards Board (FASB) released a proposal to improve the accounting for revenue under both IFRS and US GAAP. The proposal is designed to provide a single revenue model for most transactions under both accounting frameworks.
Ernst & Young’s Global IFRS Leader, Ruth Picker says: “The existing requirements for revenue recognition within IFRS are largely quite old and contain internal inconsistencies. US GAAP and IFRS rules on revenue are also inconsistent. As a result revenue recognition has been an area of diversity in practice. For this reason we welcome the Boards’ efforts to create a converged standard with clear principles.
“For some entities, the proposed changes may not impact reported revenue. However for others, when and how much revenue is reported may be significantly impacted. The most affected industries will be those with long-term contracts for the sale of goods, where the percentage of completion method is currently used, such as the construction industry. These entities will need to assess whether the notion of “continuous transfer” of control of goods or services can be applied to their contracts in order to be able to recognise revenue progressively over the contract period. In addition, telecommunications companies are likely to see changes in the accounting for their handsets, and all entities will see changes to the accounting for product warranties.
“However, given the expected impact of the changes it is important that all entities assess how they will be affected and provide comments to the IASB and FASB.”
Notes to Editors
Whether a business currently reports under IFRS or US GAAP, the changes have the potential to be significant. For IFRS reporters, the proposed model provides greater and more consistent guidance on revenue, such as the accounting for multiple element arrangements. For US GAAP reporters, the proposals will significantly reduce the amount of industry specific guidance that currently exists. The main changes introduced by the proposals are:
- Revenue is only recognized when control of a good or service is transferred to a customer. This is expected to have significant impact on the construction industry or other industries that currently use the construction contract accounting. Depending on the facts and circumstances, these businesses may determine that revenue cannot be recognized until the physical good being constructed is transferred to the customer.
- Goods and services are accounted for separately if they are distinct, which could lead to greater separation of contracts than currently exists. The concept of “distinct” is similar to the concept of “stand-alone value” that exists under US GAAP, but is an area of expanded guidance for IFRS reporters.
- The use of estimates in determining the transaction price has increased. Businesses will need to estimate collectability, contingent consideration, non-cash consideration and payments to customers in determining the transaction price.
- Allocation of the estimated transaction price to each distinct good or service must be based on the relative standalone selling prices. Again, this will likely require further estimations.
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