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2.docxStreaser, S., Jialin Sun, K., Perez Zaldivar, I., & Ran, Z. (2014). Summary of the New FASB and IASB Revenue Recognition Standards. Review Of Business, 35(1), 7-15.
Summary of the New FASB and IASB
Revenue Recognition Standards
Scott Streaser, Deloitte & Touche LLP, New York
Kevin Jialin Sun, The Peter J. Tobin College of Business, St. John’s University, New York
Ignacio Perez Zaldivar, Deloitte & Touche LLP, New York
Ran Zhang, St. John’s University, New York
Executive Summary
The joint task force of the Financial Accounting
Standards Board (FASB) and International
Accounting Standards Board (IASB) finalized its
project to develop a joint revenue recognition
standard on May 28th, 2014, when the FASB
and IASB issued Accounting Standards Update
(ASU) 2014-09 and IFRS 15, respectively (“the
Standard”). The new standard, Revenue from
Contracts with Customers, moves away from
the current risks and rewards model, and
adopts a contract- and control-based approach.
Specifically, an entity would be required
to identify a contract with a customer and
assign the transaction price to performance
obligations embedded in the contract.
Revenue can only be recognized when (or
as) a performance obligation is satisfied by
transferring the control of promised goods
or services to the customer. The standard
applies to all entities and replaces most current
industry-specific guidance.
While the provisions of the new revenue
recognition standard are substantially
converged under International Financial
Reporting Standards (IFRS) and U.S. Generally
Accepted Accounting Principles (U.S. GAAP),
minor differences continue to exist. Except
where specifically noted otherwise, this article
discusses the new framework and important
changes to the current revenue recognition
standards under U.S. GAAP only.
To illustrate the effect of the change in this
article, we apply the provisions of the new
revenue standard to a hypothetical contract
between a telecommunications company and
a customer, in which the company promises
to transfer a bundle of goods and services
consisting of: (1) a subsidized handset, and
(2) a non-cancellable service contract to the
customer for fixed consideration. The example
demonstrates that under the new standard,
revenue recognition of the bundled contract
will be accelerated when compared to current
revenue recognition guidance. Specifically,
revenue allocated to the sale of the handset
upon delivery will increase, and revenue later
will decrease.
Background
Since formally agreeing to work jointly on the
revenue project in 2002, the FASB and IASB
have collaborated on the joint task of issuing
a converged revenue recognition standard.
The goal of the task force is to develop a
more robust and consistent framework for
revenue recognition, as well as to increase the
comparability of revenue recognition practices
across entities, countries, and industries. The
boards issued Exposure Drafts of the proposed
Accounting Standards Update (ASU) in June
2010 and revised Exposure Drafts in November
2011. The final standard was issued on May 28th.
This article discusses the changes from the
current revenue recognition guidance and
certain challenges in applying the new
standard. To illustrate the effect of the change,
we use an example to give the readers a better
understanding of the effects of implementing
the new standard.
The new standard, Revenue
from Contracts with Customers,
moves away from the current risks
and rewards model, and adopts
a contract- and control-based
approach
The effective date of the ASU for public entities
applying U.S. GAAP is annual and interim
periods beginning after December 15, 2016.
The effective date for nonpublic entities is
annual reporting periods after December 15,
2017, and interim reporting periods within
annual reporting periods beginning after
December 15, 2018. Nonpublic entities may also
choose from one of three alternate adoption
dates: (1) the public entity effective date, (2)
annual reporting periods beginning after
December 15, 2016, including interim periods
thereafter (i.e., same initial year of adoption
as public entities, but allows nonpublic entities
to postpone adopting the ASU during interim
reporting periods during that year), and (3)
annual reporting periods beginning after
December 15, 2017, including interim periods
therein (i.e., one year deferral). The effective
date of the standard for entities that apply
IFRS will be for fiscal years beginning on or
after January 1, 2017. Early adoption will not
be permitted under U.S. GAAP, while entities
under IFRS will be permitted to early adopt the
standard.
In the initial year of adoption, entities have
the choice of retrospectively applying the new
standard, or adopting a modified transition
approach. The modified transition approach
requires entities to apply the new revenue
standard to contracts not completed as of the
date of adoption, and to record a cumulative
adjustment to beginning retained earnings in
the year of adoption.
Core principle of the Standard
Under current U.S. GAAP, revenue can only
be recognized if it is: (1) realized or realizable,
and (2) earned. The core principal of the new
standard states 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 services.
The ASU is based on a control approach,
which is different from the risks and rewards
approach under current U.S. GAAP and
IFRS. The current risks and rewards approach
stipulates that transfer of a good or service to a
customer has occurred when risks and rewards
are transferred to a customer and the seller has
relinquished control over the goods or services.
In contrast, the boards decided in the ASU that
an entity should assess the transfer of a good
or service by considering when a customer
obtains control of that good or service. The
ASU defines control as “the ability to direct
the use of and obtain substantially all of the
remaining benefits from the asset.” The boards
argue that the existing approach creates
difficulty when judging the completion of the
risk and rewards transfer to customers. The
boards provided an example of their assertion
in paragraph BC118 of the ASU:
“If an entity transfers a product to a customer
but retains some risks associated with that
product, an assessment based on risks and
rewards might result in the entity identifying
a single performance obligation that could
be satisfied (and hence, revenue would
be recognized) only after all the risks are
8
Summary of the New FASB and IASB Revenue Recognition Standards 9
eliminated. However, an assessment based
on control might appropriately identify two
performance obligations—one for the product
and another for a remaining service such as
a fixed price maintenance agreement. Those
performance obligations would be satisfied at
different times.”
… an entity should assess the
transfer of a good or service by
considering when a customer
obtains control of that good or
service.
The new model requires a five-step approach
to apply the core principle. All of the five steps
are mandatory:
Step 1: Identify the contract with a customer.
Step 2: Identify separate performance
obligations in the contract.
Step 3: Determine the transaction price (this is
the amount the entity expects to be entitled to
under the contract).
Step 4: Allocate the transaction price
determined to separate performance
obligations.
Step 5: Recognize revenue when (or as) the
performance obligations are satisfied (i.e. when
(or as) control of good or service is transferred
to customer).
First Step: Identify the Contract with a
Customer
The first step in applying the core principle
is to identify the contract with a customer,
which must meet the following criteria: (1)
the contract has commercial substance; (2)
all parties have approved the contract and
are committed to perform their respective
obligations; (3) each party’s rights are
identifiable; (4) payment terms are identifiable;
and (5) it is probable that the entity will
collect the consideration that it expects it
will be entitled to in exchange for the goods
or services that will be transferred to the
customer.
An entity would not recognize revenue from a
contract that fails to meet the criteria until all
performance obligations in the contract have
been satisfied, all (or substantially all) promised
consideration is collected (or the contract is
canceled), and the consideration collected is
nonrefundable. A contract does not need
to be in a written format (i.e., it can be oral
or implied by the entity’s customary business
practices). The key to a contract is enforceability
under applicable law.
In the above criterion (5), the word “probable”
has a different meaning under U.S. GAAP than
under IFRS. Under U.S. GAAP, probable means
the event is “likely to occur”, whilst in the IFRS,
probable means “more likely than not”, which
is a lower threshold than “likely to occur.”
Under the Standard, contracts may be required
to be combined with other contracts entered
into at or near the same time with the same
customer (or parties related to the customer) if
one or more of the following criteria are met:
(a) the contracts are negotiated as a package
with a single commercial objective; (b) the
amount of consideration to be paid in one
contract depends on the price or performance
of the other contract; (c) the goods or services
promised in the contracts (or some goods or
services promised in the contracts) are a single
performance obligation.
A contract modification can be approved in
writing, orally, or in accordance with another
customary business practice. If the contract
modification does not meet the criteria in the
Standard to be accounted for as a separate
contract, an entity should first evaluate
whether the remaining goods or services in the
modified contract are distinct (see the Second
10
Step in the next paragraph) from the goods
or services transferred on or before the date
of the contract modification. If the remaining
goods and services are distinct, the entity
should allocate to the remaining performance
obligations the amount of consideration
included in the transaction price that has
not yet been recognized as revenue. If the
remaining goods or services are not distinct,
(i.e., they are part of a single performance
obligation that is partially satisfied at the date
of contract modification), the entity should
update the transaction price, the measure of
progress toward complete satisfaction of the
performance obligation, and should record a
cumulative catch-up adjustment to revenue for
the entity’s progress to date.
Second Step: Identify the Performance
Obligations in the Contract
An entity should identify all separable
promised goods and services in a contract.
A performance obligation is a promise to
transfer to the customer a good or service (or
a bundle of goods or services) that is distinct.
If a promised good or service is not distinct,
an entity should combine that good or service
with other promised goods or services until
the entity identities a bundle that is distinct.
The Standard indicates that goods and services
are distinct if both of the following criteria
are met: (1) the promise to transfer the good
or service is separable from other promises in
the contract and (2) the customer can benefit
from the good or service either on its own or
together with other resources that are readily
available to the customer.
Third Step: Determine the Transaction Price
The Standard defines the transaction price
as the amount of consideration to which an
entity expects to be entitled in exchange for
transferring promised goods or services to
a customer, excluding amounts collected on
behalf of third parties (e.g., some sales taxes).
The transaction price can be a fixed amount
or can vary due to discounts, rebates, refunds,
credits, incentives, performance bonuses/
penalties, contingencies, or price concessions.
Variable consideration can be included in
transaction price only if the entity has sufficient
experience and evidence to support that the
amount included is not subject to significant
reversals.
… contracts may be required to
be combined with other contracts
entered into at or near the same
time with the same customer (or
parties related to the customer) if
[certain] criteria are met…
An entity would estimate the amount of
variable consideration in a contract either by
using a probability-weighted approach (i.e.,
expected value) or by using a single most likely
amount, whichever is a better estimate of the
amount to which the entity will be entitled.
An expected value approach is typically more
appropriate when an entity has a large number
of contracts with similar characteristics. A
most likely amount approach is typically more
appropriate if a contract has only a small
number of possible outcomes (e.g., the chance
of receiving a performance bonus is either
100% or 0%).
Generally under current U.S. GAAP, impairment
losses related to receivables should be
presented as a separate line item within
expenses. The Standard indicates that the
transaction price is determined based on the
amount to which the entity expects to be
entitled, regardless of the collection risk. As
stated in step one above, if collectability is not
probable, a contract may not exist.
Noncash consideration received in exchange for
promised goods or services is measured at fair
value. If an entity cannot reasonably estimate
allocate the discount proportionately to all
performance obligations in the contract, except
when the entity has observable evidence that
the entire discount belongs to only one or
some of the performance obligations in the
contract.
Fifth Step: Recognize Revenue When (or
as) the Entity Satisfies a Performance
Obligation
The Standard requires that an entity recognizes
revenue when (or as) the entity satisfies a
performance obligation by transferring a
promised good or service (that is, an asset) to
a customer when (or as) the customer obtains
control of that asset. Under the Standard, an
entity first evaluates whether the control of
a good or service is transferred over time. If
a performance obligation does not meet the
criteria to be satisfied over time, the performance
obligation is satisfied at a point in time.
Indicators of the point in time that a customer
has obtained control of a promised asset (and
that an entity has satisfied its performance
obligation) include: (1) the entity has a present
right to payment for the asset; (2) the customer
has a legal title to the asset; (3) the entity has
transferred physical possession of the asset; (4)
the customer has significant risks and rewards
of ownership of the asset; and (5) the customer
has accepted the asset.
For recognizing revenue over time, two
methods are used: output methods (preferred)
and input methods. Paragraph 606-10-55-17 of
the ASU, and paragraph B15 of IFRS 15, state
that “output methods recognize revenue on
the basis of direct measurements of the value
to the customer of the goods or services.”
While output methods can be the most faithful
depiction of the entity’s performance towards
complete satisfaction of a performance
obligation, many entities may be unable to
directly observe the outputs used to measure
progress without undue cost. Accordingly, the
use of an input method may be required.
Why Are Spanish Companies Implementing Downsizing? 11
the fair value of the noncash consideration, it
shall be measured indirectly by reference to
the standalone selling prices of the goods or
services provided.
Fourth Step: Allocate the Transaction
Price to the Performance Obligations
in the Contract
For a contract that has more than one
performance obligation, an entity would
allocate the transaction price to each
performance obligation at an amount that
depicts the amount of consideration to which
the entity expects to be entitled in exchange
for satisfying each performance obligation.
In other words, an entity would allocate
the transaction price to each performance
obligation on a relative stand-alone selling
price basis. The best evidence of a stand-alone
selling price is an observable price at which a
good or service is sold separately by the entity.
If the good or service is not sold separately, an
entity will be required to estimate its selling
price by using an approach that maximizes
the use of observable inputs. Acceptable
estimation methods include the expected cost
plus a margin approach, the adjusted market
assessment approach, or the residual approach.
“…output methods recognize
revenue on the basis of direct
measurements of the value to the
customer of the goods or services.”
Paragraph 606-10-55-17 of the ASU, and
paragraph B15 of IFRS 15
An entity may only use the residual approach
if the entity sells the same good or service
to different customers for a broad range
of amounts, or if the entity has not yet
established a price for a good or service and
it has not previously been sold. If a customer
receives a discount for purchasing a bundle
of goods or services, an entity is required to
Summary of the New FASB and IASB Revenue Recognition Standards
12
An entity that uses an input method
to measure progress towards complete
satisfaction of a performance obligation must
exclude the effects of inputs that do not depict
the entity’s performance in transferring control
of goods or services to the customer (e.g.,
the cost of unexpected amounts of wasted
materials). If an entity is not able to reasonably
measure the outcome of a performance
obligation (e.g., in the early stages of a
contract), but the entity expects to recover the
costs incurred after satisfying the performance
obligation, the entity shall recognize revenue
only to the extent of the costs incurred until
it can reasonably measure the outcome of the
performance obligation.
The Standard requires more
extensive disclosure than current
U.S. GAAP.
Similar to current U.S. GAAP, the Standard
indicates that revenue should not be
recognized for goods or services that are
expected to be returned (or refunded).
With regards to warranties, an entity may
continue to apply the guidance in ASC 460 to
accrue for warranty obligations that assure
goods or services comply with agreed-upon
specifications. The inclusion of an extended
warranty in a contract that guarantees a
product’s performance beyond the agreedupon
specifications should be accounted for as
a separate performance obligation.
Disclosure Requirement
The Standard requires more extensive
disclosure than current U.S. GAAP. The
objective of the disclosure requirements under
the Standard is to enable users of financial
statements to understand the nature, amount,
timing, and uncertainty of revenue and cash
flows arising from contracts with customers. An
entity is required to disclose the following in its
annual report:
1. Disaggregation of revenue into categories
that can describe “how the nature, amount,
timing, and uncertainty of revenue and
cash flows are affected by economic factors”
2. Information about contract balances
3. Assets recognized from the costs incurred
to obtain or fulfill a contract
4. Information about performance obligations
5. Description of significant judgments used in
recording revenue
6. Determining the timing of satisfaction of
performance obligations
7. Transaction price allocation methods and
assumptions
8. Remaining performance obligations
Telecommunications Industry Example
The telecommunication industry appears
to be one of the industries most affected
by the Standard. Under current U.S. GAAP,
most telecommunication companies report
revenues and costs associated with a subsidized
equipment sale when the equipment is
transferred to the customer, and subsequently
recognize revenue as they perform the relevant
services (e.g., generally based on monthly
attribution). This accounting treatment
results in a loss when subsidized equipment
is sold, even though the contract overall is
profitable due to the recognition of additional
revenues over the duration of the contract.
IFRS does not have detailed guidance to
account for such transactions. Most European
telecommunication companies have therefore
analogized to U.S. GAAP in practice (Citi
Research, 2014). The boards acknowledged
that the current standards do not reflect
the underlying economic substance of the
transaction described above.
Summary of the New FASB and IASB Revenue Recognition Standards 13
In comparison, the Standard requires the
allocation of the contract’s transaction price
to the handset and service performance
obligations. Specifically, the Standard requires
an entity to allocate a discount proportionately
to all performance obligations in the contract
unless the entity has observable evidence
that the entire discount belongs to only some
performance obligations in the contract.
Because the entity in our example (Company
T) does not have observable evidence that the
entire discount belongs to only some of the
performance obligations in the contract, the
discount would be allocated proportionately
to Company T’s two performance obligations
based on the stand-alone selling prices of
the equipment and the service contract,
respectively.
We have used an example from the
telecommunications industry to illustrate
how revenue would be recognized under
the Standard. The example included in this
article has been made relatively simple in
order to illustrate how an entity would apply
the principles of the Accounting Standards
Update. Contracts with customers entered
into by companies in the telecommunications
industry may include a large range of devices,
voice and data service options, pricing plans,
financing options, early-termination or opt-out
features and penalties, as well as many other
variables not contemplated in this example.
Entities will be required to use judgment in
applying the Standard to contracts containing
these elements and will be required to apply
forthcoming interpretive guidance that will be
released by standard setters such as the FASB
or its implementation groups and regulators
such as the SEC.
The telecommunication industry
is likely to be significantly affected
by the adoption of the new revenue
standard due to [its] widespread
use of bundled contracts that
include … equipment (i.e., a
phone) and a service (i.e., voice
and data service).
Example
Assume the following facts:
1. Company T sells its standard handset for $150 to customers who concurrently enter into a 2-year
service contract with the entity.
2. The cost of a handset to Company T is $500.
3. Company T sells its standard handset on a stand-alone basis for $600.
4. Company T’s wireless contract is non-cancellable and has a duration of two years.
5. Company T charges a service fee of $75 per month for unlimited voice and data service over the
two year duration of its service contracts.
14
Analysis:
Table 1 illustrates that the average subsidy for
each handset sale is $350. The total revenue
earned by Company T over the two year
contract period, inclusive of the handset and
service revenue, is $1,950 (the “transaction
price”).
If a handset and a two year service contract
were sold separately, total revenue would be
$2,400, of which handset revenue and service
revenue represent 25% and 75%, respectively.
Under the Standard, the allocation of total
revenue is based on the stand-alone selling
prices of the handset and service contracts.
Therefore, Company T would allocate 25% of
the transaction price to the handset element
and recognize revenue of $487.50 (=25% *
$1,950) when control of the handset transfers
to the customer, and allocate $1,462.50 (=75%
Table 1
Row Formula Company T 20X3 Data
Handset Selling Price (1) $150.00
Handset Cost (2) $500.00
Subsidy (3) =(1) - (2) $(350.00)
Service Fee per Month (4) $75.00
Contract Length (Months) (5) 24
Revenue Over Contract (6) =(4) * (5) $1,800.00
Total Revenue with 2-year
Contract
(7) =(1) + (6) $1,950.00
Stand-alone Handset Price (8) $600.00
Stand-alone Handset plus Average
Service Revenue
(9) =(8) + (6) $2,400.00
% Handset Price of Total (10) =(8) / (9) 25%
% Service Price of Total (11) =(6) / (9) 75%
Revenue Allocated to Handset (12) =(7) * (10) $487.50
$ Increase from Current
Standards
(13) =(12) - (1) $337.50
% Increase from Current
Standards
(14) =(12) / (1) - 1 225%
Service Revenue Allocation (15) =(7) * (11) $1,462.50
Monthly Service Revenue
Allocation
(16) =(15) / (5) $60.94
$ Decrease from Current
Standards
(17) =(16) - (4) $(14.06)
% Decrease from Current
Standards
(18) =(16) / (4) - 1 (19%)
Summary of the New FASB and IASB Revenue Recognition Standards 15
* $1,950) to the voice and data service element
which would be recognized as Company T
provides such services to the customer over the
two year service contract.
Under current U.S. GAAP, revenue recognized
upon delivery of the handset would be limited
to the $150 in this example. Subsequently
monthly revenue would be $75 per month. The
Standard would increase revenue recognized at
inception of the contract by 225% and reduce
the revenue recognized over time by 19%.
Accordingly, Company T will realize accelerated
revenue recognition as a result of adopting the
Standard.
Summary
The FASB and IASB issued Exposure Drafts
on the boards’ revenue recognition standard
during 2010 and 2011. The final standard was
issued by the respective boards on May 28th,
2014. The new standard adopts a contract- and
control-based approach. An entity is required to
identify whether a contract exists and allocate
the estimated transaction price to the separate
performance obligations identified in the
contract. The entity is required to recognize
revenue only after it transfers control of the
promised goods and services to its customers
and fulfills its performance obligation.
An industry that is likely to be significantly
affected by the adoption of the new revenue
standard is the telecommunication industry
due to the industry’s widespread use of
bundled contracts that include a promise to
deliver equipment (i.e., a phone) and a service
(i.e., voice and data service). Entities in the
telecommunications industry may be required
to accelerate their recognition of revenue if
they identify separate performance obligations
in bundled contracts. As demonstrated in our
example above, the impact of changes in the
amount and timing of revenue recognition as
a result of adopting the new standard may be
significant to entities and will vary based on
the performance obligations identified in the
contract and the allocation of the transaction
price to those performance obligations.
References
Crowley, M., Young, B., Zimmerman, A., and
McAlister, L. 2013. Heads Up — Boards
preparing to issue final standard on revenue
recognition
http://www.iasplus.com/en-us/publications/us/
heads-up/2013/hu-rev-rec
Deans, S. and Fisher, T. 2014. The Standards IFRS
2014: An Investor’s Annual Guide to IFRS
Accounting. Citi Research.
FASB Accounting Standards Update No. 2014-09.
Revenue from Contracts with Customers
(Topics 606).
IFRS 15, Revenue from Contracts with Customers
FASB Revenue Recognition Project Update
http://www.fasb.org/cs/ContentServer?site=FA
SB&c=FASBContent_C&pagename=FASB%2FF
ASBContent_C%2FProjectUpdatePage&cid=11
75801890084#summary
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