The bodies that establish US and international accounting standards have released new guidance on the timing of companies’ revenue recognition. The new guidance from the Financial Accounting Standards Board (FASB) and the International Accounting Standards Board (IASB) has been in development for more than a decade and is intended to enhance comparability of revenue recognition practices across companies, industries, jurisdictions, and capital markets. It applies to both public and private companies.
FASB’s version of the guidance, which will significantly change US Generally Accepted Accounting Principles (GAAP), was published in Accounting Standards Update (ASU) No. 2014-09, Revenue from Contracts with Customers. Existing GAAP contains numerous standards regarding the recognition of revenue from customer contracts, including a variety of specialized standards applicable only to certain industries or transactions. The ASU adopts a single process for all companies and transactions. Some companies will end up with different timing for revenue recognition — reporting revenue on financial statements earlier or later — which could affect investors’ perceptions of their performance. Companies will also need to make more sweeping disclosures related to their contracts with customers.
Background of the new converged standards
GAAP and International Financial Reporting Standards (IFRS) have applied divergent rules for revenue recognition, but both sets have been the subject of criticism. As FASB noted in its guidance, GAAP has comprised broad, general recognition concepts together with numerous recognition requirements for particular industries (for example, software and construction) or transactions (for example, multiple-element arrangements). This mishmash of rules sometimes led to different accounting for economically similar transactions. IFRS, on the other hand, provided only limited guidance and required inadequate detail. Moreover, it reflected different fundamental principles.
Both the new GAAP guidance and the new corresponding IFRS rule are founded on a core principle — that companies should recognize revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration (payment) that it expects to be entitled to in exchange for the goods or services.
5-step recognition framework
To accomplish that core principle, the new guidance specifies five steps a company must follow to determine when and how to properly recognize revenue on its financial statements: