By Paul Cooper, corporate reporting manager, ACCA
IAS 18 Revenue and IAS 11 Construction Contracts currently determine how entities subject to IFRS recognise their income. The IASB has been conducting a lengthy consultation on this important area, beginning in 2008. This process culminates in a replacement IFRS on Revenue Recognition, with publication expected during the first half of 2013. Responses to the final consultation stage were submitted by mid-March 2012.
The project has been jointly undertaken by the IASB and FASB in the United States, and represents a further step towards global convergence at a time of more general concern over the future of the convergence process. At the same time as updating international and US GAAP, the new Standard should establish common principles, and provide additional guidance on revenue recognition.
There have always been questions about the recognition and disclosure of revenue which is subject to complexity or uncertainty. Complexity can arise because of the long time-period for the fulfilment a contract, the numerous components within a contract, and the extent of tailoring of the good or service to a customer’s specific requirements. Credit risk (not being paid for the work) and warranties (whether statutory or specific to the contract) add uncertainty about the overall amount and timing of total contract revenue.
As the final Standard, reflecting any changes consequent on the last consultation stage, has yet to be published, the following points reflect the most recent proposals, and ACCA’s responses to them. However, it is not anticipated that the published Standard will look much different.
The IASB’s consultation process on revenue recognition has been evolutionary: changes to the proposals along the way have not caused a major or widespread impact. Revenue is to be recognised in a stepped process, starting with the separate identification of a project, then the components within the contract, called ‘performance obligations’, and the price of each. When an obligation is satisfied, the revenue attaching to it can be recognised in the financial statements.
For an obligation to be satisfied, the customer must have control of the good or service. For example, a contract to supply and deliver furniture may involve several deliveries, each of which the customer accepts by signing to confirm satisfaction with the goods on receipt. Each delivery may involve items which can be enjoyed (i.e., controlled) separately by the customer, and so revenue is recognised on each delivery. Alternatively, the deliveries are of parts, all of which are necessary before the customer can use any of the furniture, and this results in revenue being recognised only on the acceptance of the final delivery.
The methodology for revenue recognition established by the Standard should be practical across industries, and the IASB has provided additional detail which should reduce potential uncertainties in the application of the Standard. It should be noted that for certain long-term contracts, especially where control of the good passes to the customer at a late stage, it is likely that the recognition of revenue will be later than under a percentage of completion method, even if this change goes against industry practice, or any other accepted idea of what is the true ‘substance’ of the contract.
The step process for revenue recognition, based on individual performance obligations, has the advantage of clarity and applicability across industries. This will represent a change for entities which assess the performance of a contract as a whole. They may not find it appropriate to recognise individual loss-making obligations, or onerous commitments, when they view these in the context of the overall contract profitability, and accepted the obligations on this basis.
The value of the consultation process, and the continuing involvement by ACCA in it, is however evident in the clarifications and simplifications made by the IASB. For example, it is no longer proposed that credit risk will be deducted from the revenue figure disclosed in the Income Statement. The amount reflecting credit risk will instead be disclosed adjacent to the revenue figure. The treatment of warranties will now also be closer to current practice.
Once a Standard has been issued, it is not left to operate as it is until an overhaul is considered necessary. After an IFRS has been in operation for two years, the IASB now conducts a Post-Implementation Review of how it is working in practice. In addition, concerned parties are also able to lobby the IFRS Interpretations Committee, if they have concerns such as over divergences in accounting practice. The comments made can then result in proposals for amendments to particular areas of a Standard.