The Financial Accounting Standards Board (FASB) and International Accounting Standards Board (IASB) are working together to improve revenue recognition standards by eliminating the differences in revenue recognition between industries and transactions and enhancing disclosures. The core principle of the new proposed standard is that an entity should recognize revenue to depict the transfer or promised (contracted) goods or services to customers in an amount reflecting the consideration the entity will receive in exchange for the goods or services. In order to achieve this recognition, five steps must be performed:
1. Identify the contract with a customer,
2. Identify separate performance obligations,
3. Determine the transaction price,
4. Allocate the transaction price to the separate performance obligations, and
5. Recognize revenue when (or as) the performance obligation is satisfied.
It’s important to note that a contract can be written, oral or implied, as long as it has commercial substance, it has been approved by the parties, each party’s rights are identifiable and the payment terms are identifiable. If both parties to the contract can walk away without compensating the other party prior to performance, the contract does not actually exist.
A performance obligation is defined as “a promise to transfer a good or service to a customer.” Performance obligations are only to be accounted for separately if they are distinct, which is determined to be a good or service the entity regularly sells separately or a good or service the customer can benefit from on its own.
Transaction price represents the amount of consideration the seller expects to be entitled to in exchange for promised goods or services, and does not include amounts collected on behalf of third parties or effects of customers’ credit risk.
The entity would then allocate consideration to each performance obligation based on standalone selling prices of goods or services at inception of the contract. If standalone prices aren’t known, they should be estimated. An exception allows for the allocation of consideration that is contingent solely on a particular performance obligation to be allocated entirely to that performance obligation.
Finally, revenue should be recognized when the performance obligation is satisfied. Satisfaction has occurred when the customer obtains control of the promised good or service, being able to direct the use of and obtain substantially all of the remaining benefits of the asset.
Additionally, under the proposed standard, bad debt expense should be netted against revenue for presentation purposes.
The revised proposal is out for comment until March 13, 2012, and indicates that the Boards expect adoption no earlier than for annual reporting periods beginning on or after January 1, 2015. The IASB allows for early adoption, but FASB does not.
Our next e-newsletter will discuss the implications of this proposed standard on mining companies.
If you have any questions about how this proposed standard will affect your company, please contact Amanda Hall (ahall@ddafcpa.com) or Morgan Daulton (mdaulton@ddafcpa.com) and we’ll gladly discuss your particular situation.