Audit, Compliance and Risk Blog

On February 20, 2013, the U.S. Financial Accounting Standards Board (FASB) and its international counterpart, the International Accounting Standards Board (IASB), completed their “substantive deliberations” on the joint project to issue a comprehensive new standard on accounting for revenue. The changes in this standard will affect almost all companies in one way or another. While minor “tweaks” might occur over the next few weeks, the major decisions have been reached.

No, you can’t yet obtain a copy of the new standard and begin to learn exactly how it will affect your company when reporting revenue in financial statements. The boards must still translate their final conclusions into a final standard—a process expected to take several months. Their goal is to issue the “real thing” by June 30, 2013. As discussed in my prior blog article, “Expected Developments Affecting Accountants in 2013—Part 2, FASB-IASB,” this timeframe is optimistic in view of the lack of implementation guidance developed so far, but issuance of the final standard is now in sight.

Existing Standards for Revenue Recognition

Over the years, generally accepted accounting principles in the United States (U.S. GAAP) for revenue recognition has generally been developed for specific industries or sectors such as real estate, construction, and casinos. Whenever a new standard was issued, it was typically interpreted and (or) amended over the course of many years, often by the FASB itself or its interpretive body, the Emerging Issues Task Force (EITF).

To use a specific example, the guidance for real estate transactions was formalized in 1982 with the issuance of FASB Statement No. 66, Accounting for Sales of Real Estate, and Statement No. 67, Accounting for Costs and Initial Rental Operations of Real Estate Projects. These standards have now been incorporated into the FASB’s Codification, primarily in Topic 605, Revenue Recognition, and industry topics 970 through 978. Since 1982, these standards have been amended or interpreted nearly 50 different times.

Outside the United States, the IASB has existing revenue accounting standards in the form of International Accounting Standards (IAS)—it now issues its standards as International Financial Reporting Standards (IFRS). The IASB has an interpretive group, the IFRS Interpretations Committee or “IFRIC,” which is similar to the FASB’s EITF and can amend these standards.

Specifically, the IASB has revenue standards in IAS 18, Revenue, and IAS 11, Construction Contracts. However, many believe that these standards can be difficult to understand and apply. In addition, IAS 18 provides only limited guidance on important topics such as revenue recognition for multiple-element arrangements.

Efforts toward Improving Revenue Standards

For some time, the FASB and IASB have been striving for convergence of accounting principles with reasonably good success but also some bumps along the way, as discussed in my prior blog article, “Convergence of International and U.S. Accounting Principles Hits Snag.”

One of the projects on this journey toward convergence has been to develop new parallel standards for revenue recognition, because revenue is such a key figure for anyone using financial statements to assess an entity’s financial performance. Many believe that existing accounting rules issued by the FASB and the IASB are incomplete and that accounting principles should not be focused on any specific industry.

The two boards decided to fix this “problem” initially by seeking broad feedback on a joint “discussion paper” that was issued on December 19, 2008. After considering feedback received on the discussion paper, the boards jointly published on June 24, 2010, an exposure draft titled Revenue from Contracts with Customers. This exposure draft had a four-month public comment period, and reaction by users was less than enthusiastic. Nearly 1,000 comment letters were received, and almost all respondents believed that more clarification of the fundamental principles of revenue recognition was needed. The respondents were equally concerned about the practical application of many of the proposed rules.

In view of the less than full support for finalizing the guidance proposed in the 2010 exposure draft, the boards decided to address the concerns commenters raised and try another “bite-at-the-apple.” They issued another exposure draft, Revenue from Contracts with Customers, on November 14, 2011, for another four-month exposure period. This time, fewer than 400 comment letters were received by the two boards, indicating that the proposal was less controversial and less disliked—and meaning a new standard might actually get finalized.

As is typical in such an undertaking to revamp a major accounting principle, the boards conducted many “roundtable” discussions and other “outreach” forums to ensure that users and preparers could voice their opinions on the proposed changes.

FASB-IASB Decisions Reached on February 20, 2013

The FASB and IASB concluded deliberations on their joint project on revenue on February 20, 2013, and directed their staffs to finalize the new standard. Several months of “authoring and editing” will be necessary to ensure that the final published guidance matches the decisions the boards have made over the years of deliberations. The target date for issuing the final standard is June 30, 2013, although formal voting by the members of the two boards needs to occur—which at this stage should be perfunctory, as long as the voting occurs before June 30.

The final decisions reached at the February 20 meeting deal mainly with effective dates and related disclosures. They include the following:

• Assuming the standard is issued by June 30, 2013, a public company will be required to adopt the new standard beginning with annual periods beginning on or after January 1, 2017. This means that a public company with a December 31 year end would have to apply the new rules beginning with its first quarter financial statements of 2017, that is, its financial statements for March 31, 2017.

• The boards also clarified the required disclosures in interim periods.

• A company will be required to retrospectively apply the rules to all periods presented unless the company decides to use the “practical expedient” concept that was outlined in the 2011 exposure draft (modified slightly for decisions made on February 20, 2013) when applying the standard, or an “alternative transition method” developed at the February 20 meeting.

• Companies will be prohibited from implementing the new rules early.

The boards also did not “reopen” their prior decisions on revenue recognition, made over many months of deliberations. While it is hard to briefly summarize in a meaningful way the conclusions the boards have reached as to what is to be included in the forthcoming standard, suffice it to say, clarifications on when and how revenue should be recognized will be set forth.

It should be noted that the question of whether nonpublic companies will have to adopt the forthcoming standard as scheduled above has not been answered by the FASB (the IASB will not participate in this decision); however, the 2011 exposure draft states that “[t]he effective date for nonpublic entities will be a minimum of one year after the effective date for public entities.”

Preparing for the New Standard

Companies must await issuance of the new rules before they can begin to prepare for the changes, but now is the time to begin assessing the “right people” in a company’s financial reporting group to develop a plan for adopting the forthcoming standard. Obviously, once the standard has been issued, it will have to be studied, a timetable developed, and an initial determination made as to how the new standard might apply to the company and each of its consolidated subsidiaries. In the meantime, a review of the FASB decisions to date on the revenue project may also be useful to ensure the “right people” can make a preliminary assessment or “best guess” as to the eventual likely impact of the new standard.

Immediate Disclosure by Public Companies

Companies subject to Securities and Exchange Commission (SEC) oversight will have an immediate disclosure obligation in financial statements filed with the SEC once the final standard is issued. Assuming that the FASB and IASB achieve their timing goal and issue the final standard on June 30, 2013, an SEC registrant would have to disclose the existence of the new revenue standard in any financial statements filed with the SEC after that date.

This SEC disclosure requirement is set forth in Staff Accounting Bulletin (SAB) No. 74, which has now been codified into SAB Topic 11M, “Disclosure Of The Impact That Recently Issued Accounting Standards Will Have On The Financial Statements Of The Registrant When Adopted In a Future Period.” The SEC staff has determined that disclosure is required in Management’s Discussion and Analysis of Financial Condition and Results of Operations (MD&A) and should be considered in the financial statement footnotes as well. Specifically, MD&A disclosure is required of (a) the existence of the new standard; (b) the date the registrant is required to adopt and the date the registrant plans to adopt the new standard, if earlier; (c) a discussion of the methods of adoption allowed and the method elected to be used by the registrant, if different; (d) a discussion the effects that adoption will have on the financial statements unless not known or reasonably estimable—which requires a statement to that effect; and (e) disclosure of the potential impact on other significant matters—loan covenants, business practices, etc. A public company that believes the disclosure is important in its financial statement footnotes typically makes a short statement in the footnotes to that effect, and then refers readers to a more detailed discussion in its MD&A.

Once the standard is issued, the disclosure SEC registrants will make to comply with SAB Topic 11M, will likely be short and sweet. It will probably be something like the following:

“The FASB has issued a new accounting standard on revenue recognition. The company is studying the new rules that were issued on June XX, 2013, and the likely effect they will have on its financial statements. The new FASB rules are required to be implemented in annual periods beginning after January 1, 2017, and are to be applied retrospectively unless the company elects to use the defined “practical expediency” or an “alternative transition method” as described in the new standard. The company has not decided how it will adopt the standard and has not determined what effect, if any, the new rules will have on how the company has historically accounted for its revenue or effect on its business practices, or loan agreements.”