New Revenue Guidance: Just Different, or Better?

By Aarthi Rayapura November 6, 2014

In previous posts, we discussed the release of the long-awaited new accounting principles and the ensuing reactions to it from industry experts. Now, as the new guidelines have been put under the spotlight by industry owners, it is fair for them to wonder just how exactly do the main principles of the new update differ from current U.S. Generally Accepted Accounting Principles (GAAP). If they are indeed different, then why are these new guidelines already considered an improvement?

To answer these questions, we spent some time thoroughly researching existing literature on the new provisions. The main provisions of the new revenue recognition model do, in fact, differ greatly from the current US GAAP.

While setting up the project objectives, the board observed that revenue is commonly looked at as a critical number to users of financial statements, which helps in assessing the entity’s financial performance and position.

Additionally, it was noted that revenue recognition requirements in U.S. GAAP differ from those in International Financial Reporting Standards (IFRS). The introduction of a comprehensive and converged standard on revenue recognition will empower users to understand and consistently analyze an entities revenue across industries, transactions, and geographies.

The US GAAP guidance on revenue recognition was initially limited to the general guidance statement in concepts statement No. 5, Recognition and Measurement in Financial Statements of Business Enterprises. Concepts Statement Five specifies that an entity should recognize revenue only when realized or realizable and earned. Additionally, FASB Concepts Statement No. 6, Elements of Financial Statements, defines revenues as inflows or other enhancements of assets of an entity or settlements of its liabilities (or a combination of both) from delivering or producing goods, rendering services, or other activities that constitute the entities ongoing major or central operations.

In 1999, the Securities and Exchange Commission (SEC) issued a Staff Accounting bulletin on Revenue Recognition, which helped and provided guidance on how a public entity should apply the realized or realizable.

Additional guidance for recognizing revenue in U.S. GAAP consists of numerous industry-specific and transaction-specific standards (for example, Subtopic 985-605, Software—Revenue Recognition, Subtopic 605-35, Revenue Recognition—Construction-Type). Those requirements were developed by various standard setters often to address narrow issues or transactions without reference to a common framework. Consequently, issues about recognizing revenue were often difficult to resolve, and economically similar transactions sometimes yielded differing revenue recognition.

The guidance for recognizing revenue in IFRS was comparatively limited and was based on different fundamental principles.

IFRS lacked guidance on particular topics that were challenging to address in practice (for example, multiple-element arrangements). Consequently, the guidance for recognizing revenue under IFRS was difficult to apply to many complex transactions, and many times in the absence of specific guidance an entity may use, or analogize, to U.S. GAAP.

Under current U.S. GAAP, the required disclosures about revenue were limited and lacked cohesion. General disclosure requirements about revenue recognition were limited to descriptions of an entity’s related accounting policies and the effect on revenue of those policies, including rights of return, the entity’s role as a principal or an agent, and customer payments and incentives. Some industry-specific or transaction-specific revenue recognition guidance required more extensive disclosures; however, investors and other users of financial statements indicated that the previous disclosure requirements about revenue in both U.S. GAAP and IFRS were insufficient for analyzing an entity’s revenue.

The Board considered the existing guidance on revenue recognition and concluded that the new revenue recognition guidance in this update will provide an improvement to financial reporting.

As compared to existing guidance on revenue recognition, this update will significantly enhance comparability of revenue recognition practices across entities, industries, jurisdictions and capital markets. The largely principles-based guidance in this update provides a framework for addressing revenue recognition issues comprehensively for entities that apply U.S. GAAP in addition to those that apply IFRS. Because the guidance in this update is principles-based, it can be applied to all contracts with customers regardless of industry-specific or transaction-specific fact patterns.

The guidance in this update also improves U.S. GAAP by reducing the number of requirements to which an entity must consider in recognizing revenue. For example, prior to this update, an entity would have potentially considered industry-specific revenue guidance for some transactions, in addition to general revenue guidance and other relevant guidance which commonly affects revenue transactions. As a result of the update, the board concluded the guidance for recognizing revenue in U.S. GAAP should be less complex.

The comprehensive disclosure package will improve the understandability of revenue, which is a critical part of the analysis of an entity’s performance and prospects.

Furthermore, the new framework provides guidance for transactions not addressed comprehensively (for example, service revenue, contract modifications and licenses of intellectual property). Finally, the new guidance will apply to all entities, including non-public entities, for which extensive guidance didn’t exist previously.