Converged Accounting Standards for Revenue Recognition

In May 2014, the IASB and FASB issued converged accounting standards which aim to provide a principles-based approach to revenue recognition. The core principle behind these converged standards is that revenue is to be recognized in order 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 in an exchange for those goods or services.”

Revenue Recognition Steps

There are five steps involved in recognizing revenue:

1. Identify the contract(s) pertaining to a customer;
2. Identify performance obligations in each contract;
3. Determine the transaction price(s);
4. Allocate the transaction price(s) to the performance obligations in each contract; and
5. Recognize revenue whenever the entity satisfies a performance obligation.

Key Aspects of the Converged Accounting Standards

The key aspects of the converged accounting standards for revenue recognition issued by the IASB in May 2014 include the following:

• A contract is an agreement and commitment between two or more parties which establishes each party’s obligations and rights, including payment terms, and which exists only if collectability is probable. Under US GAAP, “probable” means “likely to occur”, while under IFRS, it means “more likely than not”. This may result in economically similar contracts being treated differently under US GAAP and IFRS.

• Performance obligations within contracts represent promises to transfer distinct goods or services. A good or service is considered to be “distinct” if the customer can benefit from it on its own or in combination with readily available resources and if the promise to transfer it can be separated from other promises in the contract. Each performance obligation that is identified is to be accounted for separately.

• The transaction price is the seller’s estimate of the amount that will be received in exchange for the transfer of goods or services identified in the contract and is allocated to each identified performance obligation.

• Revenue will be recognized whenever a performance obligation is fulfilled. Once revenue is recognized, a contract asset is presented on the balance sheet.

• A receivable will appear on the seller’s balance sheet when all performance obligations have been met except for payment. A contract liability will be presented on the balance sheet if consideration is received in advance of transferring goods or services.

• The incremental costs for obtaining a contract and other costs incurred to fulfill a contract must be capitalized or reported as an asset on the balance sheet rather than as an expense on the income statement. The profitability of companies which had previously expensed these incremental costs in the years prior to adopting the converged standard will initially appear to be higher under the converged standards.

• At the end of their financial year, companies are required to disclose information about their contracts with customers disaggregated into different categories of contracts. These categories may be based on the type of product, the geographic region, the type of customer or sales channel, the type of contract pricing terms, the contract duration, or the timing of transfers. Companies must also disclose the balances of any contract-related assets and liabilities and significant changes in those balances, as well as remaining performance obligations and transaction price allocated to those obligations, and any significant judgments and changes in judgments that are related to revenue recognition. Significant judgments are those used in determining the timing and amounts of revenue to be recognized.

Question

Which of the following accurately describes a distinct good?

A. A good is distinct if the customer can benefit from it on its own or in combination with readily available resources and if the promise to transfer it can be separated from other promises in the contract.

B. A good is distinct only if the customer can benefit from it on its own.

C. A good is distinct only if the promise to transfer it can be separated from other promises in the contract.

Solution

The correct answer is A.

A good is regarded as being distinct if the customer can benefit from it on its own or in combination with readily available resources and if the promise to transfer it can be separated from other promises in the contract. Options B and C partially describe the requirements for a good to be classified as distinct.

Reading 23 LOS 23d:

Describe key aspects of the converged accounting standards for revenue recognition issued by the International Accounting Standards Board and Financial Accounting Standards Board in May 2014