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The Financial Accounting Standards Board (FASB) and the International Accounting Standards Board (IASB) have proposed new standards for the convergence of U.S. GAAP and IFRS.  The FASB and IASB have nine projects which are considered the major topics which require attention during the convergence process.  The Boards have released exposure drafts on four of the topics and plan to release the remaining five by early 2011.  The most recent draft issued was on revenue recognition Revenue from Contracts with Customers. 

Currently, revenue recognition on a GAAP basis has many requirements that have been developed piece by piece for specific industries and transactions.  The guidance surrounding revenue recognition can be very complex and inconsistent.  IFRS has very little guidance and requires a significant amount of judgment to apply in daily practice. 

FASB and IASB are attempting to create a standard which has much clearer guidance and can be applied across companies, industries, and capital markets.  The objective of the standard is to improve financial reporting by:  removing inconsistencies in existing standards and providing a strong framework for addressing issues, improving comparability, requiring enhanced disclosures, and clarifying the accounting for contract costs.  This proposed standard on revenue recognition would affect all entities that have contracts with customers, including both public and nonpublic companies.

The Boards have created the following five step process on how to apply the proposed standard.  The process includes; identification of the contract(s) with a customer; identification of the performance obligations included in the contract; determination of a total transaction price associated with the contract; allocation of the transaction price to the various performance obligations included in the contract; and recognition of revenue upon satisfaction of the various performance obligations.

Step 1 – Identification of contract(s) with a customer – There are certain instances where two or more contracts could be combined and accounted for as a single contract and other instances where a contract could be segmented for accounting purposes. 

Step 2 – Identification of performance obligations included in the contract – A performance obligation is a contractual obligation to transfer a good or service to a customer.  It is not uncommon for a contract to provide for more than one good or service.  Each distinct promised good or service will be accounted for as a separate performance obligation.

Step 3 – Determination of the transaction price – Generally, in contracts for goods or services, the transaction price will be readily apparent.  However, variably priced contracts may require estimation. Furthermore, the new requirements would require consideration of the customer's credit worthiness, the time value of money, non-cash consideration, and other issues.

Step 4 – Allocation of the transaction price to the various performance obligations included in the contract – Separate measures of pricing will be required for each obligation under the contract. In addition, pricing and obligations must be updated over the life of the contract, based on changes in circumstances.

Step 5 – Recognition of revenue upon satisfaction of a performance obligation – Revenue would be recognized when performance obligations are satisfied by the transfer of a good or service to the customer. Customer control is the appropriate measure of when a good or service is transferred.  There will be various indicators included in the proposed guidance to assist entities in determining when customer control has been achieved.

The Boards are also proposing to enhance the disclosure requirements in order to assist the users of the financial statements in understanding the amount, timing, and uncertainty of revenue and cash flows from contracts with customers.  The disclosures would require amongst other topics, quantitative and qualitative information regarding an entity's contracts and the significant judgments or changes in judgments made in applying the proposed standard to contracts with customers.

For additional information on how the proposed standard might affect your company, please feel free to contact Rubino & McGeehin at 301-564-3636.