Fasb Ongoing Project for Revenue Recognition Research Paper

Introduction

The FASB project was prepared for the purpose of acting as an update and is summary of the project activities and the decisions that have been made by the international accounting standards board and the financial accounting standards board. This project was prepared by the board to provide information and convenience of the elements of the Boards. The Boards made tentative decisions that would make changes in the future meetings. However, these decisions do not have any changing effect to the current accounting as well reporting requirements. Revenue is considered to be an important measure to the users of financial statements (FASB, 2008).

The people who use financial statements make use of revenue to determine the progress in the performance and prospects of a company. The revenue recognition requirements given in the generally accepted accounting principles are different from those in the international financial reporting standards. These two are usually put into consideration when an improvement is needed (FASB, 2008). The requirement found in generally accepted accounting principles are seen to compromise a number of standards some of which are industry specific. These principles can result to answers that conflict each other in similar transactions. The international financial reporting standards contain fewer standards that discuss about revenue recognition. There are two different standards in the international financial reporting standards that have different principles that are hard to understand and apply in complicated transaction.

This paper is being done for the purpose of explaining the proposed model as well as it’s the implications of the model. The paper is also looking for decisions from parties who have interest in assisting the boards with further development of the model to a summary for both the international financial reporting standards and the generally accepted accounting principles. The paper is aimed at providing a single revenue model that can be applied consistently in the various industries and countries. The paper is also aimed at improving the comparability of solutions in the financial statements. The guide is said to have become increasingly complex with scores of authoritative literature in the generally accepted accounting principles. The project will also act as a simplifying guidance to the existing one since it provides clear principle that can be used to recognize revenue in different industries (FASB, 2008).

Objectives of the project

The proposed model gives clarity in the principles that are used in the recognition of revenue and to create a joint revenue recognition standard for both the international financial reporting standards and the generally accepted accounting principles. The joint revenue recognition standard can be applied consistently in different industries and transactions.

The objective of this project was to clarify the principles for the purpose of recognizing revenue as well as creating a joint revenue recognition standard fir IFRS and US general accepted accounting principles that could be used by apply consistently in various industries and transactions. Through the development of a common standard that assists in the clarification of the revenue recognition revenue the board aims at; removing inconsistencies and weaknesses that are existing in the revenue recognition standards and practices. This would also help in providing a more robust framework that would address the issues of revenue recognition. The project would make it simple to prepare financial statements by reducing the number of standards that companies are required to refer when making their financial statements. It would improve the comparability of revenue among different companies as well as along geographical boundaries (Kieso, 2007).

The FASB History, background of the project and its current status

From the year 1973, the body that has been designated in the establishment of standards for both financial accounting as well as reporting is the financial accounting standards board. The standards produced by this body govern the preparation of financial statements. The Securities and Exchange Commission and the American institute of certified public accountants as more superior to the other standards also formally recognize these standards. They can be used to determine the efficiency of the economy since investors, creditors, auditors and other financial statement users rely on reliable, clear and similar financial information (Cangem, 2008).

Revenue is an essential part of an entities financial statement. This is evident because capital providers usually use the revenue of an entity to analyze its financial position and performance as a basis for making economic decisions. It is important for the provision of data to the people who prepare financial statements, auditors and regulators. The revenue recognition project was initiated by U.S. Financial accounting standards board international accounting standards board (IASB). This was for the purpose of providing clarity of the principles for recognizing revenue. The two principles that underlie the main revenue recognition standards are inconsistent and vague. They include IAS 18, for Revenue and IAS 11, for Construction Contracts (FASB, 2008).

The Scope

This project would apply to contracts with customers where agreements will be made between two or more parties to enforce obligations. The agreement does not need to be in a written form to be considered as a contract. The customers are a party that would contract with an entity for the purpose of obtaining an asset that represents an output of the entity’s ordinary activities. On the proposed model, the Boards do not exclude any particular contracts with customers. However, due to the broad scope of the a standard on contracts with customers, the board has considered if the proposed model specifically the measurement approach, would provide information that is useful for making decisions on the following contracts (FASB, 2009).

The board views that the proposed revenue recognition model may not always provide useful information that would be used in making decisions about those contracts.

1. Other contracts relating to insurance that are in the scope of FASB statement No.60, “Accounting and reporting by insurance enterprises and other related GAAP,” and IFRS4, “Insurance contracts.” There is an active project regarding the insurance contracts to be undertaken by the board. This is because; the proposed revenue recognition model might provide information that is useful for decision making for some of the insurance contracts.
2. In the proposed project leasing contracts will also be dealt with. These contracts are usually in the scope of Financial Accounting Standards Board statement No. 13, which deals with Accounting for leases and IAS 17, which deals with Leases. A joint project is on the boards’ agenda for lease accounting. The board has made a decision of concentrating on the development of an improved lease accounting model. However, the board has not yet decided ways in which the proposed revenue recognition model would apply to lessor accounting.

In future consideration, the boards will take the inference of the proposed model for entities that are recognizing revenue r gains when there is no available contract. The project decision by the boards has no intention of changing the way that the entities use to measure inventory. On the other hand, the board will take into consideration if the entities should be precluded from presenting increases in inventory as revenue. These increases should instead be presented as another component of comprehensive income. There is also a plan to consider if the contracts with the customers need to be excluded from the proposed model after the review of comments (Hodgdon et al 2008).

The proposed change and the reasons for the change

The board made a proposal that revenue to be recognized based on the increases of the net position of the entity in a contract with the customer. The consideration here is that, when a contract is made between an entity and customer, the rights and obligations combined in that contract should lead to a net contract position. The net contract position in all contracts will depend on the measurement of the remaining rights and obligations in the contract. These contracts can either be a contract asset, a net nil position or a contract liability. Revenue recognition in the proposed model is recognized when there is an increase in a contract asset. It can be recognized when there is a decrease in a contract liability or a combination of increase in asset or a decrease in liability (FASB, 2008).

The boards have proposed that, after the start of a contract, the updating of performance obligation measurement should not be done unless it is believed to be complicated. According to the boards’ decision, a difficult performance obligation is one that the expected cost of satisfying the performance obligation goes beyond the carrying capacity mount of that performance obligation. The proposed model will use a contract based revenue recognition principle to enable change to happen. The recognition of revenue by an entity would be done after an increase in its net position in a contract with a customer is realized. This will help in the satisfaction of a performance obligation. When there is an increase in other assets like cash and inventory with he absence of a contract with the customer, the inventory in the contract with a customer would not lead to revenue recognition (Payne, 2008).

The proposed model will also bring change through the use of identification of performance obligations. It accounts for some warranties and other post delivery services as cost accruals as an alternative of deliverables or elements of a contract. Estimates are also used in the proposed model although the use if estimates is limited in the existing standards than by the Board. In this proposed model, entities are allowed to estimate the separate selling prices of goods and services that have not yet been delivered to the customer. Capitalization of costs in the proposed model is used where costs are capitalized after qualifying for capitalization in agreement with other standards. For example, commission disbursement to a sales person to obtain a contract with a customer cannot lead to established grounds for an asset to be qualified for recognition in agreement with other standards. An entity will be required to recognize such costs as expenses incurred that may be a different period from which revenue was recognized (Tarca, 2008).

Problems that are encountered due to the use of the U.S GAPP

The generally accepted accounting principles contain numerous standards that define an earnings process in an unpredictable way. This is evident since the application of the approach in the earning process has brought up more than a hundred standards on revenue and gain recognition in the generally accepted accounting principles. A big number of these standards are industry specific and be able to generate results that are inconsistent with transactions that are similar. This happens because people view the earning process as not well defined hence tends to disagree on its application to particular situations. The example given in the proposed model is of a cable television provider where the question is, does his earnings process involved only cable signal provision to the customer over the period of subscription or does the service of connecting the customer to the network cable considered to be an additional earning process (FASB, 2008).

To answer the above question the FASB statement No. 51, “Financial Reporting by cable television companies” is used. It states that an entity should account for connection services to be a separate earning process and recognize revenue for them when rendered. In addition, the earning process approach is considered sometimes as leading to a misrepresentation of contractual rights and obligations in financial statements of an entity. In the U.S GAPP, there are gaps in guidance and conflicts with the asset and liability definitions. In the U.S GAAP, a general standard on recognition of revenues for services does not exist. There is a continued need for more guidance in the generally accepted accounting principles (Kieso, 2007).

Problems that are involved with the use of IFRS_S

IFRS_S are considered to have fewer standards on revenue recognition but they also need improvements. The standards in the IFRS are found to be inconsistent with asset and liability definitions. Entities that apply these standards tend to recognize amounts in the financial statements that cannot be considered as faithful representation of economic phenomena. The possibility of this happening is that revenue recognition for the sale of a good depends largely on the time that the risks and rewards of ownership of the good are transferred to the customer. Hence, the recognition of a good by an entity can be done the time when the customer has obtained inventory since the customer is still taking control over the goods. This outcome is believed to be contradictory to the international accounting standards boards’ asset definition. An asset is defined as that which relies on control of goods instead of the risks and rewards that comes with the possession of goods (Kieso, 2007).

The view of risks and rewards in IAS 18 can pose problems when transactions are involved with both goods and services that are related to the goods. In determining the time of transferring the risks and rewards of the ownership of the goods, the entity takes into consideration the transaction as a whole. This can lead to an entity to recognize all the revenue during the delivery of the good, although it has contractual obligations remaining for the services that are related to the good. The outcome is that, revenue does not give clear representation of the pattern for transferring to the customer of all of the goods and services involved with the contract. An entity may also recognize all the revenue in a contract before the entity has fulfilled all of its obligations depending on ways in which accruals for the services are measured (FASB, 2008).

IFRS_S is found to have the deficiency of lacking guidance for transactions that are involved with the delivery of more than one good or service. The guidance for multiple element arrangements given in IAS 18 illustrates this. The international accounting standard 18 states that, elements that can be identified separately on a single transaction can be applied in definite situations using the principle for revenue recognition.. This will help in reflecting the substance of the transaction. This standard also does not give clear dimensions on when or how an entity should deal with the separation of a single transaction into components. The interpretation of paragraphs 17 and 18 tend to be different for different people. The same paragraphs have been interpreted as requiring deferral of revenue for all the elements until delivery of the final element (Payne, 2008).

IFRS_S is also seen to lack guidance on the ways of measuring the elements in a multiple element arrangement. Entities are considered to apply different measurement approaches to similar transactions without a specified measurement objective I elements that are remaining in such an arrangement. This reduces the possibility of revenue to be compared among different entities. The problem of not being able to distinguish between goods and services is experienced when using IFRSs. When accounting for some items such as when accounting for real estate, there is no clear distinction between goods and services. Here there is lack of clear distinction between goods and services hence reducing the comparability of revenue across entities (FASB, 2008).

There is inconsistency between IAS 11 and IAS 18 because there is no clear principle to apply to ever changing and increasingly complex transactions. Principles IAS 11 applies only to construction contracts that meet specified requirements. It appears that an entity should recognize revenue as the activities that are required to complete a contract has taken place. This does not matter even if the customer cannot control and then faced with the risks and rewards of ownership of the item under construction. Principle IAS 18 contrasts with this because it advocates that revenue recognition should be done only when an entity has made transfers on control and the risks and rewards of ownership of the goods to the customer (Kieso, 2007).

My Opinion/Thoughts

According to my own opinion I would prefer an approach that would measure the performance obligations of an entity at each financial statement date rather than only when the entity has deemed a performance obligation to be onerous. This favors the explicit measurement approach rather than an allocated transaction price approach that re-measures only when a performance obligation is deemed onerous by exception. An explicit measurement at each financial statement date should be used for the purpose of capturing both unfavorable and favorable changes in prices and circumstances that occur after the start of a contract. In addition, an explicit measurement would result to a more timely recognition of changes in an entity’s net position in a contract. There are approaches that can be used for the purpose of measuring performance obligations. This includes the current exit approach, transaction price approach and building block approach (FASB, 2008).

In the current exit approach an entity measures its bundle of remaining performance obligations at any financial statement date at the amount that the entity would be required to pay to transfer those performance obligations to a third party on that date. It would capture any change in circumstances that affect the current exit approach. This will help an entity in recognizing the changes in the period in which they arise. Another approach that can be used for the purpose of measuring performance obligations would be current transaction price approach. This approach would be consistent with the Boards view on measuring performance obligations at the beginning of a contract (Tarca, 2008).

It is evident that entity should satisfy a performance obligation and hence recognizes revenue after the transfer of a promised asset to a customer. The proposed model by the board has taken into consideration that transfer of a promised asset takes place when the customer obtains control over it. In addition, I suggest that for a service, a performance obligation is satisfied when the service is the customer’s asset. This happens when a customer has received the promised service. However, when a service is consumed immediately it should not be recognized as an asset. Consequently, activities that are carried out in the fulfillment of a contract by an entity results to revenue recognition only if there is concurrent transfer of assets to the customer.

Before the recognition of a contract, it is important for an entity to measure its rights and performance obligations related to the contract. The proposed model by the board did not articulate an examination in the beginning on the ways in which an entity can measure the rights and performance obligations that are related to the contract. They had proposed the use of transaction price to be used for the purpose of measuring performance obligation that is the promised consideration of the customer. In addition, the subsequent measurement of performance obligations should be followed by the depiction of the obligation of an entity in transferring goods and services to the customer. The main theme here is that, the amount of the transaction price allocated to the satisfied performance obligation at the beginning inception, is considered as the amount of revenue recognized in the satisfaction of a performance obligation.

On my own opinion the proposed model will provide a clear guidance for determining when revenue should be recognized. In contract based revenue recognition, an entity is required to specify the relevant assets or liabilities since revenue recognition is dependent on the increases in assets and decreases in liabilities. Revenue is defines as the change in assets and liabilities that arise in the connection with the provision of goods or services that constitute an entity’s ordinary or ongoing major or central activities. An increase in an asset leads to revenue recognition in a model that focuses solely on cash. This model ignores the possibility that the entity transfers the product to the customer since its only focus is on one asset cash.

An asset may be considered to be the product that the entity manufactures. An increase in a product would lead to revenue recognition in a model that focuses on the product being manufactured which is the inventory. The model ignores the possibility of another asset to have increased. Here, enhancement in the value of the product being manufactured would be the basis in which revenue will be recognized. Liabilities occur when the entity is under an obligation to deliver the product on a specific date. Where there is a decrease in liability leads to revenue recognition in a model that focuses on the settlement of such liabilities. The model ignores the increase in assets whether it has occurred.

Annotated Bibliography

Closing the GAAP. (2007). Wall Street journal- Eastern Edition 250, no. 138

This article is seen to have discussed the GAAP together with some of its problems. Highlights on how the SEC is pulling for a change in standards are also captured in the author. This article showed a different perspective since it considered mostly the SEC side of things. It is definitely bias against the GAAP and the SEC. It is a newspaper article and not a scholarly journal hence not containing the entire factual information and it only expresses the main opinions of the author. It is very pertinent to the GAAP topic and the issues that are happening to recover the issues. It is a recent article hence making it useful in showing exactly what is gong on at present

Cangemi, Michael P. “Warning U.S. GAAP likely headed for Extinction.” Financial Executive 24, No. 2 (2008): 6-6.

Cangemi wrote about the possibility of GAAP being replaced in future by IFRS in U.S. The article discusses the SEC’S stance on this replacement and the required adjustments for the replacement. It includes many facts that are hard, although some bias is evident in the fact that the author was strongly supporting the international side of things. The information presented is important to the issue of convergence of standards and articulates in details what happens between the IAS and GAAP. However, more information from the FASB side of things would have been helpful.

Edwards, James Don and John B. Barrack. “Reaching international accounting standards.” Economic reform Today 1, (1999): 20-21.

These two writers give brief background information on what international accounting standards are and the reason for using them as well as the approaches for achieving them. The information contained here is a little bit different in the sense that it takes into consideration small countries as well as big ones. This is a beneficial view that is not found in many other sources. The authors are experts’ professors on the topic and they have also cited other articles. The article is bias since it agrees with the opinion of adopting IAS. Their definitions are accurate and easily understandable and this is helpful. It is found to be n old article but it has a good representation of information on IASB. The representation is seen to provide a nice contrast to many other resources, which generally present only the side of FASB.

FASB. Convergence with the international accounting standards board. FASB.

This article is seen to have discussed the six steps that FASB has taken toward converging U.S. and international Accounting Standards. It introduces the reader on to the topic and presents a brief outline of efforts until the date published 2007.

Hodgdon, Christopher, Rasoul H. Tondkar, David W. Harless, and Ajay Adhikari. Compliance with IFRS Disclosure Requirements and Individual Analysts’ Forecast Errors. Journal of International Accounting, Auditing & Taxation (2008): 1-13.

This article has an in depth discussion of the IFRS. It did a meticulous investigation using a disclosure index. This study supports the use of IFRS and states that it can deliver financial forecasts more accurately.

Payne, Wendy M. and Julia E. Ranagan. To Converge Or Not to Converge?, Journal of Government Financial Management 57, no. 1 (2008): 14-20.

The main discussion in this article is on whether the U.S should switch to IAS or merge the two together. It has facts from both sides of view and is impartial. Its language is not hard and its engaging.

Tarca, Ann. “The International Accounting Standards Committee: A Political History.” Accounting Review 83, no. 2 (2008): 554-556.

The article offers a complete background review of the international Accounting Standards Committee, its history, creation and politics. It is highly informative and shows the many different aspects of the organization.

References

1. FASB. (2008). Financial accounting series: preliminary views on revenue recognition with customers.
2. Kieso, D. E., Weggadt, J.J. (2007). Word field intermediate accounting. FASB update.
3. Closing the GAAP. (2007). Wall street journal- Eastern Edition 250, no. 138
4. Cangemi, M. P. (2008). Warning U.S. GAAP likely headed for Extinction: Financial Executive 24, No. 2. 6-6.
5. Don, E. J. and Barrack, J. B. (1999). Reaching international accounting standards: Economic reform Today 1, 20-21.
6. FASB. Convergence with the international accounting standards board.” FASB.
7. Hodgdon, C., Rasoul H. Tondkar, D. W. Harless, and Adhikari, A. (2008). Compliance with IFRS Disclosure Requirements and Individual Analysts’ Forecast Errors. Journal of International Accounting, Auditing & Taxation. 1-13.
8. Payne, Wendy M. and Julia E. Ranagan. (2008).To Converge Or Not to Converge? Journal of Government Financial Management 57, no.1. 14-20.
9. Tarca, A. (2008). The International Accounting Standards Committee: A Political History.” Accounting Review 83, no. 2. 554-556.