By Steve Rizer
The International Accounting Standards Board (IASB) and the Financial Accounting Standards Board (FASB) have issued for public comment a revised draft standard to change the financial reporting requirements of International Financial Reporting Standards (IFRSs) and U.S. Generally Accepted Accounting Principles (U.S. GAAP) for revenue and some related costs from contracts with customers. The proposal, which would replace IAS 18 Revenue, IAS 11 Construction Contracts and related interpretations, and, in U.S. GAAP, guidance on revenue recognition in Topic 605 of FASB’s Accounting Standards Codification, is expected to become a final standard late this year.
IASB and FASB believe that the new standard would improve IFRSs and U.S. GAAP by doing the following:
- Providing a more robust framework for addressing revenue-recognition issues.
- Removing inconsistencies from existing requirements.
- Improving comparability across companies, industries, and capital markets.
- Providing more useful information to users of financial statements through improved disclosure requirements.
- Simplifying the preparation of financial statements by streamlining the volume of accounting guidance.
The organizations explained that the following core principle of the revised proposed standard mirrors the 2010 Proposed Accounting Standards Update Exposure Draft: that an entity would recognize revenue from contracts with customers when it transfers promised goods or services to a customer. The amount of revenue recognized would be the amount of consideration promised by the customer in exchange for the transferred goods or services.
However, in response to feedback received from approximately 1,000 comment letters on the 2010 exposure draft and outreach activities, IASB and FASB further refined their original proposals for the recently released revised draft standard. Specifically, the boards did the following:
- Added guidance on how to determine when a good or service is transferred over time.
- Simplified the proposals on warranties.
- Simplified how an entity would determine a transaction price (including collectibility, time value of money, and variable consideration).
- Modified the scope of the onerous test to apply to long-term services only.
- Added a practical expedient that permits an entity to recognize as an expense costs of obtaining a contract (if one year or less).
- Provided exemption from some disclosures for non-public entities that apply U.S. GAAP.
“This revised exposure draft on revenue recognition is based on the same underlying principles as the original draft, but we have simplified and clarified several aspects of the guidance in response to feedback we received,” FASB Chairperson Leslie Seidman said. “Because this proposed standard would affect companies across a wide range of industries, we are taking this additional quality-control step to ensure that the final standard is well understood by companies, auditors, and investors before it is issued as a final standard. We plan to conduct additional outreach with interested parties during the comment period to help people understand the proposed guidance and to listen to any remaining concerns.”
Added IASB Chairperson Hans Hoogervorst: “Our proposals will give analysts and investors the confidence that revenue is being presented on a consistent basis, across industries and continents.”
Financial Accounting Foundation Official Provides Additional Details to CPC/BIM
In an email interview with Construction Project Controls and BIM Report (CPC/BIM), Financial Accounting Foundation spokesperson Christine Klimek provided the following additional information:
CPC/BIM: What is the expected timeline for reviewing comments after the comment period closes March 13, making any additional changes to the draft standard, and finalizing the standard? If the standard is to be issued late this year, when specifically will it probably be finalized?
Klimek: The boards expect to finalize the revenue standard by the end of 2012 or early 2013. At this point, it is difficult to predict exactly when, since the comment period on the revised Exposure Draft does not end until March 13, 2012, and we expect many comments will be received on or around that deadline. The number and complexity of the issues raised by our stakeholders during the comment period will influence how long it takes the boards to redeliberate and refine or revise, if necessary, the final standard.
CPC/BIM: Approximately how many organizations/individuals within the construction industry are expected to use this standard after it is finalized? What estimates, if any, do you have about how widely the current standard is used within the construction industry?
Klimek: As proposed in the Exposure Draft, the revenue standard would apply to all construction companies that currently follow U.S. GAAP -- specifically, Topic 605-35 of the FASB Accounting Standards Codification (formerly SOP 81-1). This includes both public companies and private companies. It should be noted, too, that FASB has proposed to grant most private companies exceptions from applying most of the proposed quantitative disclosure requirements. In addition, the standard would become effective at least one year later than for public companies.
CPC/BIM: The boards stated that the proposed standard would affect companies across a wide range of industries. Why not have a new standard that is specific to the construction industry? Why isn’t each industry addressed through a separate standard?
Klimek: A major goal of the revenue recognition project has been to replace industry-specific guidance with a single and comprehensive framework for recognizing, measuring, and disclosing revenue and some contract costs. That single framework would apply across companies, industries, and capital markets. The problem that has arisen with industry-specific guidance is that the different sets of requirements that exist in U.S. GAAP (and IFRSs) can result in economically similar transactions being accounted for differently. That makes it difficult for users of financial statements to compare the financial statements of different companies, especially if they have operations in other industries.
An additional explanation that might be relevant is provided in paragraph BC43 of the basis for conclusions which accompanies the revenue proposals: BC43 -- Many respondents expressed concerns about how the revenue model would apply to construction-type contracts and asked the boards to retain existing requirements for those contracts. The boards discussed those concerns on various occasions with representatives from the construction industry and observed that the concerns were partly attributable to a misperception that the proposals would require completed contract accounting for contracts currently within the scope of IAS 11 Construction Contracts or ASC Subtopic 605-35 on construction-type and production-type contracts. In addition, many in the construction industry were concerned about the costs of accounting for a single construction contract as many performance obligations. In the 2010 exposure draft, the boards clarified that not all construction contracts would result in an entity recognizing revenue only at completion of the contract. Furthermore, as discussed below, the proposed requirements provide further clarity on identifying separate performance obligations in construction contracts and determining when those performance obligations are satisfied over time. Hence, the boards affirmed their view that the proposed requirements should apply to construction contracts.
CPC/BIM: In your opinion, what is the most important proposed change, as it relates to the construction industry, to the original draft?
Klimek: Based on comments received on the original (2010) Exposure Draft, the boards have added clarifying guidance about identifying separate performance obligations in a contract. Specifically, the boards added this guidance to address concerns that applying the proposed criteria for identifying separate performance obligations to a construction contract could result in separate performance obligations being identified for each activity that could be subcontracted (which could include supplying construction materials to the customer and the provision of various construction services) even though those materials and services are highly interrelated and the company is integrating them to construct the asset that the customer has contracted for. Under the revised 2011 Exposure Draft, it is likely that many construction contracts would have only a single performance obligation. (Example 5 of the illustrative examples that accompany the revenue proposals provides an example of the application of those criteria to a construction contract.)
CPC/BIM: The boards stated that the proposed standard would remove inconsistencies from existing requirements. What are examples of such inconsistencies, and how would they be dealt with?
Klimek: Inconsistencies typically arise because the existing requirements are a collection of industry-specific guidance. Such inconsistencies have reduced comparability because economically similar transactions may be accounted for differently. One example is that Topic 605-35 includes estimated amounts in revenue (such as awards and incentive payments) when those amounts are probable to be received and can be estimated reliably whereas other parts of U.S. GAAP only permits revenue to be recognized for amounts that are ‘fixed or determinable.’
CPC/BIM: The boards also reported that they intend to conduct additional outreach and listen to remaining concerns. What remaining concerns have been raised, and how are they being dealt with?
Klimek: As you point out, the boards are currently focused on outreach. Between now and the end of the comment period on March 13, the boards will conduct additional outreach with preparers, users, and auditors of financial statements to get their input on the proposals. This will include educational speeches and field visits with preparers and auditors in targeted industries, including the construction industry. In early December, we also hosted a joint webcast with the IASB to explain and respond to questions about the 2011 Exposure Draft. At this point, the boards are still collecting feedback, so it’s too early to discuss what, if any, concerns will need to be addressed. When this outreach is completed, the boards will discuss any concerns that have been raised as part of their redeliberations.
CPC/BIM: Other comments?
Klimek: We encourage your readers to become part of the process by reviewing the revised Exposure Draft, available at www.fasb.org, and providing comments on its proposals. Their feedback is essential to the boards’ success in developing a standard that improves how revenue is recognized in financial reporting.
[The exposure draft is open for comment until March 13 and can be accessed via the “Comment on a Proposal” section of http://www.iasb.org/ or on http://www.fasb.org/.]