In business, financial statements are critical because they are used to keep track of business finances. There are different financial statements, which play different roles in business. The financial statements include cash flow statements, balance sheets, income statements, and statement of owners’ equity. Revenue is a vital element of a financial statement, which shows the stakeholders’ performance index of a company and help them make investment evaluations and judgments. Outsiders ponder revenue the most while managers consider it the most despite being the most notable numbers that appear in financial statements and receive the least explanation. The United States Generally Accepted Accounting Principles (U.S. GAAP) and Financial Reporting Standards (IFRS) has merits and demerits in acquiring and instructing revenue reporting. However, none of the two bodies has a single complete set of revenue recognition. As a result, there has been a working together in unison between International Accounting Standard Board (IASB) and Financial Accounting Standard Board (FASB) towards convergence: where high quality international financial standards will be developed for companies to use both locally and cross-border financial reporting.
A New World of Revenue Recognition
There has been a working together in unison between the International Accounting Standard Board (IASB) and the Financial Accounting Standard Board (FASB) towards convergence: where high quality international financial standards will be developed for companies to use both locally and cross-border financial reporting (El-Gazzar & Finn, 2017). The reason why FASB and IASB work together is that economic globalization boosts the cross border flow of capital investment. It is difficult and costly to make financial decisions because different countries have different accounting systems (Nobes & Parker, 2016). Therefore, the United States and the European Union alone cannot develop accounting standards while the world’s biggest markets want the two to get involved in the process. After reaching the Norwalk agreement and publication of the Memorandum of understanding, FASB and IASB created a new revenue recognition standard (Banes et al., 2017). The aim of the project is to improve financial reporting through the use of single-based revenue standard for the global users of financial information and the final standard was released in May 2014 (Scott et al., 2017; Tort et al., 2015). Therefore, this paper summarizes and critiques Kathryn Yeadon’s article “A New World of Revenue Recognition: Revenue from contracts with customers.”
Companies ought to start planning now how they are to incorporate the new standards, as well as updating procedures regarding accounting updates on the Financial Accounting Standards Board and on two topics that are very significant: lease accounting and revenue recognition (El-Gazzar & Finn, 2017). In 2014, the International Accounting Standards Board and FASB provided a converged standard for revenue recognition to improve the incompatibility among industries (Maples et al., 2018). The coming of a new standard marked a significant change and aimed to standardize revenue recognition and reduce complexity (Banes et al., 2017). The previous guidance that varied under IFRS and U.S. GAAP were perceived by many as inconsistent and complex among industries (Scott et al., 2017). Under the previous guidance, companies were to meet various requirements depending on the type of transactions or industry.
New guidance of FASB is bound to address weakness and inconsistency that exists in the revenue requirements, improve compatibility across industries and entities, and improve disclosure and provide more information on financial statements. It is also expected to reduce the number of statements to simplify financial statements preparation and come up with a new framework that will address revenue issues (Banes et al., 2017; Tort et al., 2015). The guidelines of the new revenue recognition premises on recognizing revenue principles in a way that depicts the transfer of services or goods to consumers in an amount reflecting consideration in which the exchange of the services or goods is entitled to entity according to Outlook newsletter of FASB (El-Gazzar, S. M., & Finn, 2017).
During the first interim reporting period, public companies had to abide by the rule from the beginning of the fiscal year up to December 15, 2017. For the non-public companies, they had an additional year to December 15, 2018 (El-Gazzar & Finn, 2017). The change is significant and likely to help companies recognize revenue earlier. Adoption and transition of the new standard took companies’ time (Banes et al., 2017). However, many were already in the transition, and the ones who had not begun the process probably run short of time and were not be able to properly complete all the steps as required (Oncioiu, 2017). Below are the revenue recognition steps of FASB:
1. Identifying the contracts with customers. Different standards will account for other arrangements like leases.
2. Performance obligations identification. Performance obligations are contracted deliverables or promises. In case the services or goods are distinct, they are accounted for separately. Consumers benefit from distinct obligations (Banes et al., 2017).
3. Transaction price determination. All the contraction’s separate performance obligations ought to be allocated the transaction price (Nobes & Parker, 2016). The payment amount should be a reflection of what is expected in exchange for goods and services delivered (El-Gazzar & Finn, 2017).
4. Allocation of the transaction price to the contract’s performance obligations. Transaction prices are allocated to all identified obligations in the contracts (Nobes & Parker, 2016).
5. Recognition of revenue as (or when) the performance obligation is satisfied with the reporting.
Implementing the New Revenue Recognition Approach
Implementing the new revenue recognition approach required companies to focus on:
1. Developing and implementing the appropriate controls and processes.
2. Working with information systems to enable adoption of the new standard and changing of processes to reflect the model of the new revenue recognition (Maples et al., 2018).
3. Analyzing all required changes to pricing strategies.
4. Revising measures tied to revenue. For example, debt covenant ratios, sales incentives, or compensation plans.
5. Working together with auditors to review the new processes and controls. Ensure sufficient time for auditor revision and review (Nobes & Parker, 2016). Auditors help in planning on how each step is to be allocated revenue in the recognition process, thus the importance of bringing them in early.
6. Seeking to understand the impacts associated with financial results.
7. Being prepared to communicate about the impact of both externally and internally.
Based on practice, several implications will be part of new rules.
• Likelihood of an unexpected impact of post-transaction statements of a company from implied reduction and valuation of differed revenues.
• Some of the companies will experience more revenue recognition challenges than others.
• Audit staff is likely to challenge and scrutinize the revenue recognition model.
• Some companies may perceive an adoption-year impact of decreased or increased revenues.
Practitioners are free to visit the joint transaction resource group created by FASB and IASB for more learning.
Several Companies have transitioned to the new rules. Leased assets will be included in the companies according to the new standard. Besides, related obligations on the balance sheet and classification changes to the cash flow and income statements (El-Gazzar & Finn, 2017). The new standard is an implementation of FASB aiming to respond to users of financial statement and investors requests for a better representation of transactions and leasing activities of organizations (Flood & O’Reilly, 2017). The new model impacts both the operating leases and financing leases.
The efforts in the adoption of the new leasing standard should have maximum support. Leasing arrangement identification will be a large exercise incorporating robust data collection and judgment (Oncioiu, 2017). Moreover, it is bound to impact financial statements, as well as the way investors analyze operating results and financial conditions of a company. Based on the retroactive application of the past two fiscal years, companies are supposed to have adopted the new standard by January 1, 2019 (Flood, 2017).
For the case of the U.S., the GAAP is made up of three main components. The components include guidelines, rules, and regulations (Maples et al., 2018). It is important when the accounting industry abides by these three components, as well as the standards and rules governing the guidelines as issued and maintained by FASB (Banes et al., 2017). Therefore, AICPA Research Bulletins, FASB Standards, APB Opinions, and related authoritative pronouncements are the key components of GAAP.
GAAP is crucial, as it governs financial reporting in various ways. Firstly, companies with quality financial information have dependent capital markets thus, enabling better decisions by investors. Secondly, using GAAP can help a company expand or become popular in the public (Flood & O’Reilly, 2017). Thirdly, when GAAP and financial report are compliant, then there is the establishment of greater transparency and accountability between the government and her citizens, creditors and investors, and oversight bodies and legislative (Flood, 2017). Lastly, when GAAP is incorporated in nonprofit financial statements, it promotes how users perceive and understand it, besides the general understanding of accrediting bodies, rating agencies, lenders, grantors, donors, and regulators.
Accounting has four qualitative characteristics that include materiality, reliability, consistency, and relevancy. Materiality is a source of qualitative substance during decision-making processes (Tort et al., 2015). Reliability is a crucial characteristic, as its proper use can make production and financial systems provide information “snapshots” that help companies to respond to events quickly (Maples et al., 2018). Consistency is important because to arrive at a value (such as calculation of inventory) accounting information has to abide by the consistent and systematic methods (Oncioiu, 2017). Relevancy is equally important if not most important like other characteristics and its disciplines like timely information and accuracy are very crucial when making decisions. For my case, I think relevancy and reliability are the most important characteristics (Flood, 2017). Dependability and importance are major virtues because they are what make book-keeping information useful for making assessments.
In conclusion, revenue recognition is critical in accounting across different geographies and industries globally. Therefore, convergence has made it easier to compare revenue items under two accounting standards. The convergence between FASB and IASB is imperative and can help improve consistency incomparability of financial statements within industries (Flood, 2017). Also, the asset-liability approach closely compares to the revenue recognition’s economic substance hence the best fit for revenue recognition when determining an entity’s contract performance (Banes et al., 2017). Furthermore, IASB and FASB for more than a decade have shown great steps towards creating a revenue standard that will minimize differences and improve consistency for revenue recognition across industries and geographies (Tort et al., 2015). Organizations across the world have remained supportive and satisfied with the objectives of the board and acknowledged the challenges that result from developing a single model recognition applicable in different transactions and industries (Flood & O’Reilly, 2017). Generally, the board has simplified the complicated accounting rules that were evident in the past across industries easy.
Banes, J. W., Gans, B. J., Von, B. N., & Practising Law Institute. (2017). Sixteenth annual institute on securities regulation in Europe: Practical implications of the U.S. law in EU practice.
El-Gazzar, S. M., & Finn, P. M. (April 10, 2017). Restatements and accounting quality: a comparison between IFRS and US-GAAP. Journal of Financial Reporting and Accounting, 15, 1, 39-58.
Flood, J. M. (2017). Wiley revenue recognition: Understanding and implementing the new standard.
Flood, J., & O’Reilly for Higher Education (Firm). (2017). Wiley Revenue Recognition plus Website.
In Nobes, C., & In Parker, R. H. (2016). Comparative international accounting.
Maples, R. W., Wilson, G. M., & Practising Law Institute. (2018). Implementing the FASB/IASB new revenue recognition standard workshop 2018.
Oncioiu, I. (January 01, 2017). Estimating the Brand Image in the Process of Accounting Convergence.
Scott, A. H., Brown, T., Nelson, M. W., & Jeffrey, W. T. (September 06, 2017). The Effects of Out-of-Regime Guidance on Auditor Judgments About Appropriate Application of Accounting Standards. Contemporary Accounting Research, 34, 2, 1026-1047.
The Need for Global Adoption of International Financial Reporting Standards. (January 01, 2017).Tort, J. R., Kokenge, C. A., & Stallings, D. (2015). The New Revenue Recognition Standard: Assessing Impact and Implementation.
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