Revenue Recognition - Revised Proposals Issued

The development of a new standard for revenue recognition was discussed in the summer 2011 edition of Financial reporting. Since then the IASB has issued a revised exposure draft in response to feedback received on their original proposals.

The IASB decided to revise its proposals after receiving over a thousand comment letters on the original exposure draft (ED), many of which expressed concern that it was not clear how to apply the proposed core principles in practice, particularly to contracts for services and construction contracts.

Proposals in the revised ED

The core principle set out in the revised ED is consistent with the original ED, that "an entity shall recognise revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled to in exchange for those goods and services".

The ED outlines the five steps any entity needs to consider in order 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 performance obligations.

Step 5: Recognise revenue when a performance obligation is satisfied.

For many companies, step 5 will be the most important in determining the amount of revenue to be recognised in each accounting period.

Smith & Williamson commentary

For many contracts, such as straightforward retail transactions, the proposals will have little, if any, effect on the timing and amount of revenue recognised. However, in other circumstances, for example long-term service contracts, contracts that contain multiple deliverables (e.g. mobile phone contracts) or contracts for services, the proposed new standard could result in changes to both the timing and amount of revenue recognised.

Revenue should be recognised when an entity satisfies its performance obligations by transferring control of the goods or service to the customer. If control is clearly transferred at a point in time, for example in a retail transaction when the customer pays for and obtains custody of the item, revenue should be recognised at that point. If control is obtained over a period of time, then revenue should be recognised over that period of time.

The proposals in the original ED would have prohibited the recognition of revenue over time for many construction and service contracts where the...