It’s been more than a decade in the making, but the Financial Accounting Standards Board (FASB) and the International Accounting Standards Board (IASB) are in the final throes of issuing a global revenue recognition standard to replace all others, including the mirage of industry-specific guidance the United States follows today. The new guidance is “principles-based,” so you’re not going to find specific rules or instructions—no more recipes for that special occasion. Instead, the new guidance is about substance, judgment and transparency.
The core principle is “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 services.” The FASB provides a five-step process to achieve this: (1) identify the contract with the customer, (2) identify the separate performance obligations, (3) determine the transaction price, (4) allocate the transaction price and (5) recognize revenue when the performance obligation is satisfied. The objective: enable companies to recognize revenue based on the substance of the transaction with the customer, while providing enough guidance to help ensure consistency with other companies. This is a difficult balance, as evidenced by how long this guidance has been in the cooker.
Lots of judgment required, but no measuring cup
Principles-based guidance requires judgment—lots of judgment! Have you entered into a new contract with a customer or modified an existing contract? Which of the performance obligations can or should be separated? Not all will qualify. Special terms and pricing arrangements can create variability in the amount of revenue a company is entitled to receive, and probability has to be assessed. Companies will need to estimate the stand-alone selling price for each performance obligation—that means you too, software companies. Performance obligations are satisfied when control is transferred to the customer, but for companies that provide services, this is more complicated—services don’t come in a box, so delivery is more theoretical and an appropriate measure of progress needs to be evaluated. Finally, revenue has to be “reasonably assured” to be recognized. That’s a qualitative threshold—no measuring cup required.
Disclosure is hot: share your secret sauce
And it should come as no surprise that where significant judgment is applied in accounting, especially for revenue, transparent disclosure is vital to understanding the financial statements. At the bottom of the statements the footnote should read, “See accompanying notes to the financial statements … seriously.” The level of disclosure continues to be a hot topic as the guidance makes its way through the comment process, and the latest exposure draft also includes enhancements to interim disclosures as well. Companies will need to disclose their secret sauce, providing qualitative disclosures, including a description of the judgments involved, and also quantitative disclosures, which may require additional financial system reporting requirements. While it may be more difficult for the SEC to question the judgment applied in recognizing revenue, you can bet that they will be all over companies that do not provide adequate disclosures. For companies currently employing a “less is more” disclosure process, this will be a dramatic change.
Want to see what’s cooking? Download a PDF of the latest exposure draft from the FASB website. Comments are due March 13, 2012, and a final standard is expected in the second half of 2012. The proposed effective date is 2015.
Think you have time to prepare?
Think again. In its proposal stage, the guidance requires full retrospective application, so public companies presenting three years of financial statements will also have to present 2013 and 2014 for comparative purposes. Don’t let this overwhelm you—give us a call to see how RoseRyan can help make the transition easier.