Many financial executives have worried about applying the new revenue recognition standards from the Financial Accounting Standards Board (FASB) and the International Accounting Standards Board (IASB). Since they were published in May 2014, these standards have come under attack by companies and trade groups because of the delayed issuance of the new rules, the timing of the proposed changes, the lack of available information technology resources in the workplace and the difficulty of updating internal controls and accounting policies until the rules were finalized.
Despite the complexity of the accounting changes the standards introduced, FASB and IASB representatives believe many questions can be resolved if controllers and CFOs simply focus on the principles involved and avoid getting bogged down in the details.
Diamond in the rough
Accounting Standards Update (ASU) No. 2014-09, Revenue from Contracts with Customers, eliminates reams of tailor-made, industry-specific revenue recognition processes in current U.S. Generally Accepted Accounting Principles (GAAP). But FASB’s proposed clarifications to the standard and the recently approved one-year deferral (see the sidebar “Landmark standard deferred for one year”) are acknowledgments that the converged standards may need ongoing refinement.
The updated standard provides a single, principles-based method by which companies must calculate their revenues from long-term contracts. It’s a significant change for accountants who are accustomed to having a specific book of rules for recognizing revenue under GAAP. The FASB and IASB established a Transition Resource Group (TRG) to handle some of the questions that have arisen since the standards were published, and the panel has handled 73 inquiries to date.
So far, the FASB has tried to answer some of these questions by releasing for public comment clarifications about such issues as:
- How to identify separate promises in a contract,
- How to account for different types of licenses,
- How to report sales tax and noncash consideration, and
- How to determine whether a party in a transaction is a primary supplier of a good or service or merely an agent that recognizes a small fee.
In May, for example, the FASB issued Proposed ASU No. 2015-250, Revenue from Contracts with Customers (Topic 606): Identifying Performance Obligations and Licensing, to resolve questions about performance obligations and licenses, which are some of the more complicated questions that have been put forth about the standards.
In the proposal, the FASB said that immaterial or unimportant parts of a contract — such as a customer service phone number on the side of a bottle of water — don’t represent a separate performance obligation to a customer. Therefore, in the example provided, the bottled water company wouldn’t need to defer revenue.
In terms of the proposed amendment for licenses, the FASB has attempted to more clearly delineate the difference between revenue from licenses of “symbolic intellectual property” that represent a promise to deliver a good or service over time vs. licenses that have “significant standalone functionality” that are satisfied at a point in time.
For example, if franchise rights require ongoing support from the franchisor, licensing revenue from franchises should be accounted for over the life of the contract. However, the licensor of software or film typically must recognize revenue all at once, because the asset doesn’t usually require ongoing support or maintenance.
Work in progress
Several companies have told the FASB that licenses of intellectual property may not perfectly fit into the two categories outlined in Proposed ASU 2015-250. For example, IBM pointed out that an antivirus software license is considered a single performance obligation and functional intellectual property that should be recognized at a point in time. But if the software also comes with updates that are critical to its usefulness, it may be more appropriate to recognize the revenue over time. In this example, the standard isn’t clear on which method to use. IBM suggested that the FASB clarify that a functional license won’t always be recognized at a point in time.
Conversely, pharmaceutical company Eli Lilly took issue with the notion that all licenses of symbolic intellectual property should be accounted for over time. In some cases, a business licenses the brand name of a consumer product to another company and has no obligation to promote the brand or perform other services over the license period.
FASB members weren’t surprised that companies have asked lots of questions about licenses. It’s a part of the guidance that the FASB and IASB tweaked and retweaked up until the last minute of developing their standards.
Keep your eyes on the ball
One year after the publication of the converged revenue recognition standards, former IASB member Prabhakar Kalavacherla cautioned financial executives against hand-wringing over details and to remember that the standards involve using judgment. “Just plow through the standard without getting too worried,” Kalavacherla said at a Financial Executives International conference on revenue recognition in late June. “There is a bit of unrestrained reading of the standard,” he said. “We need to step back and look at the core principle of the standard.”
FASB and IASB members are concerned that companies may become complacent now that implementation of the standards has been deferred. But calendar-year public companies that plan to issue retrospective financial statements will need to be ready to on-board the new standards in early 2016 in order to provide two years of comparative statements by the 2018 effective date. Private companies can follow their lead a year later, although early adoption is encouraged to enable comparability among companies of all sizes and nationalities.
Sidebar: Landmark standard deferred for one year
On July 9, the Financial Accounting Standards Board (FASB) agreed to give companies an extra year to comply with its landmark revenue recognition standard. Now Accounting Standards Update (ASU) No. 2014-09, Revenue from Contracts with Customers, will be effective for public companies with fiscal years that start after December 15, 2017. The standard should be applied to the first financial reports filed in those fiscal years, which for public companies will mean the first quarterly filing for 2018.
Private companies will apply the standard in fiscal years that start after December 15, 2018, and for quarterly and other interim financial statements in fiscal years that start after December 15, 2019. For all companies that have already begun implementing the new standard, the FASB also will permit early adoption in fiscal years that begin after December 15, 2016.
FASB member Marc Siegel, who cast the dissenting vote on the one-year delay, agreed with giving companies extra time. But he opposed the provision that allows companies to adopt the standard as of the original 2017 effective date. “It’s going to be hard enough to understand trends over time when transitioning to the new standard, but to then introduce peer comparisons that will be made difficult by people doing it at different times truly exacerbates the issue,” Siegel said.
FASB member Daryl Buck, who ultimately voted in favor of a one-year delay, said he preferred a two-year deferral. He predicts that the FASB will consider another delay a year from now because companies still won’t be ready to adopt the standard. “I believe we need to ensure an orderly transition here for the system as a whole,” Buck said. “I recognize completely that that may introduce a longer period of noncomparability, but my thought is comparability won’t matter much if we have chaos.”
ASU 2014-09 is largely converged with International Financial Reporting Standard (IFRS) 15, Revenue from Contracts with Customers. On July 22, the International Accounting Standards Board approved a one-year deferral of IFRS 15. But the international board has no plans to consider a two-year deferral.