Steve Collings gets to grips with the exposure draft for a new international standard on revenue recognition. Sooner or later, you will need to do so as well, he warns.
On 14 November 2011, the International Accounting Standards Board (IASB) issued a revised proposal for revenue recognition. A hot issue for several years, any revenue recognition changes are likely to filter through to UK GAAP as our standards converge towards IFRS.
The project was carried out in collaboration with the American standard-setters – the Financial Accounting Standards Board (FASB) and if adopted the standard would replace IAS 18 Revenue and IAS 11 Construction Contracts. It would also replace the guidance on revenue recognition in Topic 605 Revenue Recognition in US GAAP.
Why Change Now?
Revenue, in all countries, is the headline figure in a set of financial statements. It plays a pretty important part in not only the calculation of profits, but also affects external stakeholders such as banks, other financiers, tax authorities, suppliers and credit rating agencies. In a nutshell, the IASB reintroduced proposals it originally proposed in 2010 in order to give analysts and investors more confidence that revenue is being recognised on a consistent basis and across all industries and continents that adopt IFRS. Indeed these proposals are likely to affect certain listed companies in the UK that report under EU-adopted IFRS.
The IFRS proposals aim to:
- improve the comparability of revenue recognition policies
- reduce the number of accounting requirements to which a company must refer
- simplify the interpretation of emerging revenue recognition issues on a case-by-case basis; and
- improve the content of financial statements prepared under IFRS.
IAS 18 and IAS 11 weaknesses
The existing IAS 18 Revenue deals with revenue arising from:
- Sales of goods
- Rendering of services
IAS 11 encompasses, among other things, the revenue recognition requirements relating to construction contracts in a similar fashion to the UK’s SSAP 9 Stocks and Long-Term Contracts. IAS 11 uses the “stage of completion” method, also known as the “percentage of completion method”. Essentially, contract revenue and costs are recognised as revenue and expenses in profit or loss in the period in which the work is performed. When losses are foreseen they are immediately recognised, which is consistent with SSAP 9 requirements.
IAS 11 is fairly complicated because a construction company has to be able to make reliable estimates of its income and costs to recognise revenue. This is easier to do once the contracting parties have drawn up an enforceable contract that stipulates the contract consideration and the terms of settlement. As is often the case in such matters, the company has to have the ability to review and, where necessary, revise its estimates of revenue and costs during the life of the contract. The company needs to have an effective system of internal financial budgets and reporting systems.
The IASB acknowledged that simply amending the existing IASs would not resolve the fundamental weaknesses in those standards. So what are these “fundamental weaknesses”? Because the standards are entirely different, a company reporting under IFRS regime could recognise and report significantly different levels of revenue depending on which standard it applies. IFRS does not clearly distinguish between goods and services, so some companies may not be entirely sure whether to account for some transactions under IAS 18 or IAS 11.
The exposure draft is open for comment until 31 March 2012 and the IASB plans to issue a revised standard for revenue recognition in 2012.
Steve Collings is the audit and technical partner at Leavitt Walmsley Associates and the author of ‘The Interpretation and Application of International Standards on Auditing’ (Wiley March 2011) and ‘The AccountingWEB Guide to IFRS’ (Sift Media May 2011).