The latest revenue standard proposes a single, complete revenue recognition model
applicable to all contracts with customers.
The International Accounting Standards Board (IASB) and the United States Financial Accounting Standards Board (FASB) indicated that the new revenue standard will be issued in the third quarter of 2013.
BACKGROUND
The process of compiling a new revenue standard started in 2010 with issuing Exposure Draft (ED) 2010/6 Revenue from Contracts with Customers to supersede virtually all existing revenue standards and interpretations under IFRS and US GAAP. Based on comments on ED/2010/6 received, significant changes were made to the proposed model, and on 14 November 2011 ED/2011/6 was published.
The IASB and FASB designed the proposed standard to streamline accounting for revenue across all industries and to correct inconsistencies in existing standards and practices. The proposed standard is intended to replace IAS 11 Construction Contracts, IAS 18 Revenue, IFRIC 13 Customer Loyalty Programmes, IFRIC 15 Agreements for the Construction of Real Estate, IFRIC 18 Transfers of Assets from Customers, and SIC 31 Revenue – Barter Transactions Involving Advertising Services.
After two rounds of public consultation on the ED Revenue from contracts with customers, the new revenue standard will in all probability be in line with the current ED/2011/6. Peter Margaritas, an IFRS expert, commented that it appears as if the boards have tried to address all comments in the 2011 ED, and that it is unlikely that there will be many significant changes between the present proposed model and the final standard.
FIVE-STEP PROCESS
The ED/2011/6 proposes that a single comprehensive revenue recognition model would apply to all contracts with customers, and it therefore affects all entities that enter into contracts to provide goods or services to their customers. The ED states that the core principle for revenue recognition is that an “entity shall recognise revenue to depict the transfer of promised goods and services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services”.
This core principle is achieved by the application of the following five sequential steps to recognise revenue:
Step 1: Identify the contract with a customer.
Step 2: Identify the separate performance obligations in the contract.
Step 3: Determine the transaction price.
Step 4: Allocate the transaction price to the separate performance obligations.
Step 5: Recognise revenue when (or as) the entity satisfies a performance obligation.
These five steps will assist entities in determining when to recognise revenue and at what amount. Entities are required to exercise a high degree of judgement in applying the five steps. The terms of the contract(s) and all surrounding facts and circumstances must be considered, including any implied contractual terms. An entity will also have to consistently apply the requirements of the proposed model to contracts with similar characteristics and in similar circumstances.
The model proposes the following two ways to recognise revenue: revenue may be recognised 1) over time (similar to current stage of completion accounting), or 2) at a point in time (similar to current sales of goods accounting).
Each step of applying the model to a contract is discussed individually below.
Step 1: Identify the contract with a customer
The aim of step 1 is to identify the contractual rights and obligations to which the revenue recognition model would be applied. ED/2011/6 defines a contract as an agreement between two or more parties that creates legally enforceable rights and obligations.
Entities can combine two or more contracts that are entered into at or near the same time with the same customer, and account for them as a single contract, if one or more of the following criteria are met:
• The contracts are negotiated as a package with a single commercial objective.
• The amount of consideration in one contract depends on the price or performance of the other contract.
• The goods or services promised in the contracts are a single performance obligation.
Step 2: Identify the separate performance obligations in the contract
The aim of the second step is to identify promised goods or services that are distinct and therefore would be accounted for separately. The proposed new model requires an entity to evaluate the terms of the contract and its customary business practice to identify the promised goods or services that are distinct, and hence, accounted for separately.
Step 3: Determine the transaction price
The transaction price is the amount of consideration that an entity expects to be entitled to in exchange for transferring promised goods or services to a customer. Current IFRS requires revenue to be measured at the fair value of the consideration received or receivable. For some entities, the change in the measurement objective may result in a change to their current practice.
Factors to consider when determining the transaction price include:
• Variable consideration
• The time value of money
• Non-cash consideration
• Consideration payable to a customer.
Step 4: Allocate the transaction price to the separate performance obligations.
An entity must allocate the transaction price to each of the identified performance obligations based on the relative standalone selling prices of the underlying goods and services. The stand-alone selling price is the price at which an entity would sell a promised good or service separately to a customer, for example the list price of the goods or services. If stand-alone selling prices are not directly observable, an entity will need to use estimates, based on reasonably available information. Suitable estimation techniques include the adjusted market assessment approach, expected cost plus a margin approach, and the residual approach.
Step 5: Recognise revenue when (or as) the entity satisfies a performance obligation
An entity must recognise revenue when or as it satisfies performance obligations by transferring control of a good or a service to a customer. The entity must also determine if the performance obligations are satisfied over time or at a point in time.
EFFECTIVE DATE
The Boards tentatively decided to require an entity to apply the revenue standard for reporting periods beginning on or after 1 January 2017.
Author: Sophia Brink CA(SA), MCom (Taxation), is a lecturer in the Department of Accounting, Stellenbosch University.
