Convergence Milestone

Revenue recognition among proposals released as FASB, IASB commit to new timeline.

BY MATTHEW G. LAMOREAUX AND KIM NILSEN
August 1, 2010

FASB and the IASB wrapped up the first of three rounds of issuing proposed standards in their final push toward U.S. GAAP-IFRS convergence, even as they gave themselves an extra six months to complete the ambitious project.

 

In what is potentially their most far-reaching joint proposal to date, the boards unanimously recommended an approach to revenue recognition that would create one standard across all industries and would require greater disclosures, among other changes.

 

The revenue recognition proposal came a month after FASB issued its own proposal on accounting for financial instruments. The two boards are currently pursuing their own approaches to financial instruments but have pledged to try to reconcile this fall.

 

The boards consider revenue recognition, financial instruments and two projects closely related to financial instruments—fair value measurement and the presentation of other comprehensive income—to be urgent projects in the larger IFRS-U.S. GAAP convergence effort, and they said they remain committed to completing them by their self-imposed June 2011 deadline. Other priority projects scheduled for June include insurance contracts, leases, consolidations and derecognition. But the boards extended their deadline to December 2011 for less-urgent projects on financial statement presentation and financial instruments with characteristics of equity.

 

REVENUE RECOGNITION

The proposed revenue recognition standard, released June 24, is designed to streamline accounting for revenue across industries and correct inconsistencies in existing standards and practices.

 

“I think it will make accountants’ jobs easier when new types of business arrangements emerge because they’ll have one standard to look to on how to recognize revenue for the arrangement,” FASB board member Leslie Seidman said in a podcast outlining the proposed changes. In the U.S., revenue issues have been dealt with on an ad hoc basis over the years, creating a “very complex, inconsistent and incomplete set of standards,” Seidman said. Meanwhile IFRS offers very little guidance on revenue recognition.

 

The joint standard “would make it absolutely clear when revenue is recognized—and why,” IASB Chairman Sir David Tweedie said in a news release.

 

The core principle of the 170-page exposure draft “is that a company should recognize revenue when it transfers goods or services to a customer in the amount of consideration the company expects to receive from the customer,” according to an overview released by the boards.

 

In the overview, FASB points to four differences between current practice and the proposal. The first is that revenue would be recognized only from the transfer of goods or services to a customer. That change would affect some long-term contracts, the standard setters said. For example, percentage-of-completion revenue recognition would be allowed but only if the customer owns the work-in-progress as it is built or developed.

 

In addition, a company would be required to account for all distinct goods or services, which could require it to separate a contract into different units of accounting from those identified in current practice. Another change would be that collectability would affect how much revenue is recognized, rather than whether revenue is recognized. And greater use of estimates would be required in determining both the amount to allocate and the basis for that allocation, which would better reflect the economics of a transaction.

 

FASB also created a chart showing the five steps a company would follow to apply the new revenue recognition proposals (see Exhibit 1).

 

The proposal would be applied to all contracts to provide goods or services to customers, except leases, insurance contracts, certain contractual rights and obligations, guarantees (other than product warranties) and certain nonmonetary exchanges. Companies would be required under the standard to disclose qualitative and quantitative information about contracts with customers, including a maturity analysis for contracts extending beyond a year, and the significant judgments and changes in judgments made in applying the proposed standard to those contracts.

 

The effective date for the potential changes has not been set. The deadline for comments on the proposal is Oct. 22. The final standard is expected in the second quarter of 2011 if the boards are able to respond to feedback received through comment letters, round-table meetings and other outreach, Seidman said in her June podcast. She noted in the podcast that the proposal has unanimous support from both boards.

 

“That is a far cry from where we were a couple years ago on this project, where we really did have very divided views on the basic proposal,” Seidman said. “But we were able to work through those and come to a proposal where we’re all on board.”

 

NEW CONVERGENCE TIMELINE

Also on June 24, a day ahead of the G-20 Summit in Toronto, FASB and the IASB released a joint progress report and revised work plan that extended by six months their June 2011 deadline for completing convergence projects.

 

Last September the leaders of the G-20 called on “international accounting bodies to redouble their efforts to achieve a single set of high quality, global accounting standards within the context of their independent standard setting process, and complete their convergence project by June 2011.”

 

In a letter to the G-20, the boards explained that additional time was requested by stakeholders to deal with the volume of proposed changes and emphasized a shared commitment to improving IFRS and U.S. GAAP and achieving their convergence.

 

“We are limiting to four the number of significant or complex exposure drafts issued in any one quarter,” the progress report said. “This change is intended to address stakeholder concerns about their capacity to respond. It also reduces the number of major proposals we are re-deliberating at the same time, improving our ability to focus on the input received and reconcile differences in views in ways that produce improved and more internationally comparable financial reporting.”

 

The modified convergence timeline keeps the June 2011 target end date for projects that have the “most urgent” needs, according to the joint report. “Projects we believe are a relatively lower priority or for which further research and analysis is necessary are now targeted for completion after the original June 2011 target date,” the boards said.

 

The new schedule features three rounds of exposure drafts with revenue recognition, financial instruments, the reporting of comprehensive income and fair value measurement comprising the now-completed first round (see Exhibit 2).

 

 

FINANCIAL INSTRUMENTS

FASB launched the first round of convergence EDs on May 26 when it issued a much anticipated exposure draft intended to improve accounting for financial instruments (see Exhibit 3). The FASB financial instruments ED was issued separately from the IASB’s proposals, which contain significant differences.

 

Among other changes under the proposed Accounting Standards Update (ASU), financial statements would incorporate both amortized cost and fair value information about financial instruments held for collection or payment of cash flows (see Exhibit 4).

 

 

The proposal also aims at providing more timely information on anticipated credit losses to financial statement users by removing the “probable” threshold for recognizing credit losses. It seeks to better portray the results of asset-liability management activities at financial institutions.

 

FASB said other potential improvements addressed by its proposed ASU, Accounting for Financial Instruments and Revisions to the Accounting for Derivative Instruments and Hedging ActivitiesFinancial Instruments (Topic 825) and Derivatives and Hedging (Topic 815), include a single credit impairment model for both loans and debt securities and simplified criteria for hedge accounting.

 

“Today, there also is arguably too high a threshold before an entity is required to record credit impairments resulting in a delayed recognition of losses, while complex hedging requirements produce reported results that lack transparency and consistency,” FASB said in a briefing document accompanying the ASU’s release.

 

FASB also noted that the impact the proposals would have on a given entity would depend on how great an extent financial instruments play in the entity’s operations and financial position. “For example, a large bank that presents a large number of financial assets at amortized cost will be the most affected,” the briefing paper said. “Non-banks likely will be least impacted.”

 

FASB is projecting that the new rules would take effect no earlier than 2013. To minimize the impact of the changes on smaller and community banks, nonpublic entities with less than $1 billion in total consolidated assets would be allowed a four-year deferral beyond the effective date from certain requirements relating to loans and core deposits. This deferral would apply to nearly 90% of all U.S. banks that hold just 10% of the country’s financial assets, FASB said. Also, some financial instruments, including pension obligations and leases, are entirely exempt, FASB said.

 

In December, the AICPA’s Accounting Standards Executive Committee (AcSEC), now known as the Financial Reporting Executive Committee (FinREC), weighed in on FASB’s discussion of when fair value should be used to measure and record financial instruments on the balance sheet.

 

In a letter, FinREC Chairman Jay Hanson said the committee favors an approach that would measure many but not all financial instruments on the balance sheet at fair value.

 

FinREC said in the letter that “a one-size-fits-all balance sheet measurement approach for financial instruments will not result in useful information across all user categories (for example, equity analysts, private company lenders, credit rating agencies, sureties, venture capital investors, and donors to [not-for-profit entities.]”

 

FinREC “believes that the nature of a financial instrument, along with its established use in an entity’s business model, should impact the determination of whether that instrument should be measured and recorded on the balance sheet at fair value,” the letter states. “In addition, [FinREC] believes that the needs of the primary financial statement users, which may vary by the type of entity (meaning public company, private company, or not-for-profit organization), should be an important factor in determining the most meaningful measurement of financial instruments.”

 

The committee cited a 30-year fixed-rate mortgage loan held to maturity as an example of a financial instrument that should not be measured and recorded on the balance sheet at fair value. The committee suggested FASB should perform a user needs assessment as it moves forward.

 

Following the Sept. 30 comment deadline, FASB says it plans to hold public round-table meetings during October to collect additional input.

 

STATEMENT OF COMPREHENSIVE INCOME AND FAIR VALUE MEASUREMENT

On the same day it issued its proposed ASU on financial instruments, FASB also issued for public comment a separate, but related, proposed ASU, Comprehensive Income (Topic 220): Statement of Comprehensive Income, that would require total comprehensive income and its components in two parts—net income and other comprehensive income—be displayed in a continuous statement of financial performance.

 

On June 29 the boards issued separate EDs on fair value measurements. Under the EDs, U.S. GAAP and IFRS measurement and disclosure requirements would be the same except for minor differences in wording and style, the boards said.

 

The most significant amendments in FASB’s ED focus on subsequent measurement and disclosures. Under the ED, ASC 820-10-35, Subsequent Measurement, would:

 

  • Reflect that the highest and best use and valuation premise concepts are only relevant for nonfinancial assets;
  • Add guidance for measuring financial assets and financial liabilities when a reporting entity has offsetting positions in market risks or counterparty credit risk;
  • Add guidance for measuring an instrument classified in a reporting entity’s stockholders’ equity; and
  • Be amended related to the application of blockage factors and other premiums and discounts in a fair value measurement.

 

ASC 820-10-50, Disclosure, would:

 

  • Be amended related to disclosure requirements for recurring and nonrecurring measurements;
  • Disclose uncertainty analysis for measurements categorized within Level 3 of the fair value hierarchy; and
  • Disclose when a reporting entity uses an asset in a way that differs from the asset’s highest and best use when that asset is recognized at fair value in the balance sheet on the basis of its highest and best use.

 

DIFFERENCES ON FINANCIAL INSTRUMENTS

Unlike the situation with revenue recognition, FASB and the IASB are not in agreement on financial instruments. In a move that was not followed by FASB, the IASB split its project to replace IAS 39, Financial Instruments: Recognition and Measurement, into three parts to deal separately with classification and measurement; impairment; and hedging. FASB decided to deal with all three aspects of financial instruments in a single project.

 

FASB and the IASB have been unable to agree on a common approach for classification and measurement. The IASB published its approach on Nov. 12, 2009, with the release of IFRS 9, Financial Instruments. IFRS 9 may be adopted early but is not effective until Jan. 1, 2013.

 

But both boards are asking for comments on both approaches and pledge to work through the differences this fall.

 

Tweedie, the IASB chairman, said in a JofA interview that the divergent approaches were caused by mismatched timing between the boards’ work and the inherent problem of having two major standard setters rather than one. The key, according to Tweedie, is that “both of us are asking the others’ constituents to look at the opposite model. So this fall, we can say the world in balance thinks this is the best approach.”

 

FASB spokesman Neal McGarity expressed similar sentiments. “Although our approach in the AFI proposal is different than that of the IASB’s, we share the same goal of reaching a converged set of answers,” said McGarity. “When the feedback from both boards are collected and shared, we will work together with the IASB to come up with converged answers for financial instruments later in the year.”

 

 

EXECUTIVE SUMMARY

 

 FASB and the IASB have completed the first of three expected rounds of releasing exposure drafts in their effort to converge U.S. GAAP and IFRS.

 

 The boards released a revised work plan that extended by six months their self-imposed June 2011 deadline for completing convergence projects. The new plan limits to four the number of significant or complex exposure drafts issued in any one quarter, with revenue recognition, financial instruments, the reporting of other comprehensive income and fair value measurement comprising the first round.

 

 The joint revenue recognition proposal is built around the principle that a company should recognize revenue when it transfers goods or services to a customer in the amount of consideration the company expects to receive from the customer.

 

 Under the proposal, a company would be required to account for all distinct goods or services, which could require it to separate a contract into different units of accounting from those identified in current practice. And collectability would affect how much revenue is recognized, rather than whether revenue is recognized.

 

 FASB separately issued an exposure draft intended to improve accounting for financial instruments. The IASB, which is releasing its own set of proposals on financial instruments, asked its constituents to comment on the FASB plan. The boards plan to jointly consider the comments received on both models.

 

 Under the FASB proposal, financial statements would incorporate both amortized cost and fair value information about financial instruments held for collection or payment of cash flows. It also aims at providing more timely information on anticipated credit losses to financial statement users.

 

Matthew G. Lamoreaux (mlamoreaux@aicpa.org) is a JofA senior editor. Kim Nilsen (knilsen@aicpa.org) is the JofA’s editorial director.

 

To comment on this article or to suggest an idea for another article, contact Matthew G. Lamoreaux, senior editor, at mlamoreaux@aicpa.org or 919-402-4435.

 

 

AICPA RESOURCES

 

JofA articles

 

Convergence

Countdown to Convergence,” March 2010, page 24

 

Revenue Recognition

 

Financial Instruments

 

Consolidation and Derecognition

 

Financial Statement Presentation

Shaking Up Financial Statement Presentation,” Nov. 2008, page 56

 

Use journalofaccountancy.com to find past articles. In the search box, click “Open Advanced Search” and then search by title.

 

Website

IFRS.com offers resources related to IFRS for accounting professionals, financial managers, audit committees, boards, investors and other users of financial statements.

 

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For more information or to make a purchase, go to cpa2biz.com or call the Institute at 888-777-7077.

 

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To access On-Site Training courses, go to aicpalearning.org and click on “On-Site Training” then search by “Acronym Index.” If you need assistance, please contact a training representative at 800-634-6780 (option 1).

 

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