Comment on IASB/FASB 2011 ED on Revenues from Contracts with Customers
American Accounting Association, Financial Accounting Standards Committee 2011-2012 Working Paper, Received by Financial Accounting Standards Board (FASB) as 2011-230 Comment Letter No. 94, on 13 March 2012
18 Pages Posted: 8 Jan 2013
Date Written: March 13, 2012
The Committee is concerned with a number of options and exceptions introduced by the 2011 ED. These options and exceptions allow alternative accounting models. Their retention on a contract-by-contract basis may create confusion for both preparers and users of financial reporting. It may leave room for intentional misstatements and structuring opportunities to anticipate profits and delay losses. As a result, the Committee believes that the initial purpose of this project (i.e., creating a comprehensive revenue recognition model that clarifies the principles for recognizing revenue and that can be applied consistently across various transactions, companies, industries, and capital markets) is not achieved and convolution and inconsistency have been introduced.
One of the reasons for preparing this standard was to establish one comprehensive standard for revenue recognition, instead of separate standards concerned with distinctive industries or sectors. However, distinct standards help preparers and users clearly understand and interpret the respective models that are applied, while the ED does not. Methods and problems that are specific to some sectors may then spread to others, involving hazardous changes in accounting practices.
Our Committee has already criticized the revenue recognition project, while arguing for an alternative approach that stresses the need for prudence in revenue and income recognition. The alternative suggested above focuses on the ongoing flow of enterprise activity to determine when a good or service is being transferred to the customer, or by convention on a period-by-period basis. This aspect is clearer under the model already applied in IAS 11. Well-targeted guidance may fix the issues related to specific business models not only for construction contracts, but also sophisticated long-term agreements and continuous service provision. ED involves a number of major and critical options that are included as exceptions and entirely left to preparers’ discretion on a contract-by-contract basis.
This accounting modeling by exception factually leads to a plurality of accounting methods and approaches that are neither clearly defined for preparers nor clearly presented to users. These options include: • Contracts which last less than one year or more than one year; • Variable customer consideration estimated at its expected value or its most likely payment; • Revenue allocation (step4) and recognition (step5) based on transfer of (control over) an asset that occurs “over time” or “at one point in time”; • Updating and unwinding of time value of money.
The ED does not introduce a single model of revenue recognition. It fails to design an understandable and feasible approach to revenue and income recognition. It even fails in providing clearly defined alternative options. The ED may then result in confusion and generate an increased variety of under-identified practices. At the same time, it introduces high complexity for and a burden of high costs on preparers. The Committee recommends the Boards should apply the control model to ordinary sales but not to long-term contracts (construction contracts, continuous service contracts).
If the Boards aim to allow several accounting models, the Committee recommends these models be distinguished under clearly defined alternatives that are to be consistently applied to large categories of contracts with customers, not idiosyncratically, on a contract-by-contract basis. These categories should be presented and disclosed separately in financial statements in a meaningful way.
In conclusion, the ED, in its current form, would not represent an effective improvement over existing IAS 11 and IAS 18 which did not raise major difficulties and shortcomings in the large majority of cases. Instead of issuing a new standard, well-targeted guidance may fix the issues related to business models characterized by sophisticated long-term agreements and continuous service provision.
Keywords: revenue recognition, income to the firm, structuring opportunities
JEL Classification: M42
Suggested Citation: Suggested Citation