The Financial Accounting Standards Board (FASB) issued a new set of standards for revenue recognition along with the International Accounting Standards Board (IASB) on Wednesday. These standards are the result of several years of work between the two entities to converge their standards, reduce the number of industry-specific differences, and make the standards less proscriptive and more principles-based.
At a basic level, this new standard seeks to replace the large number of industry-specific revenue recognition rules in the U.S. (over 100 of which exist) with a basic 5-step framework:
Step 1: Identify the contract(s) with a customer.
Step 2: Identify the performance obligations in the contract.
Step 3: Determine the transaction price.
Step 4: Allocate the transaction price to the performance obligations in the contract.
Step 5: Recognize revenue when (or as) the entity satisfies a performance obligation.
That all sounds straightforward in principle, but of course achieving those goals is not always so simple. The full standard runs 700 pages long with all the amendments and background information presented. These amendments give guidance on specific issues related to revenue recognition and outline the increased disclosure that will be required from companies under the new rules.
Ideally, the new rules should lead to a more principles-based system that allows companies to better reflect the underlying economics of transactions. Former FASB chairman Bob Herz expressed a desire for standards to move in this direction when I spoke with him last year.
“I favor more objectives-oriented or outcomes-based standards, with enough explanation and education so you can then understand how to apply it and leave it up to people’s judgments without having to write prescriptive rules and guides on every possible thing you can think of,†Herz said.
The length and complexity of this standard means that its effectiveness will depend largely on the ability of FASB and IASB to communicate with companies and make sure the standard is applied and enforced appropriately and equally.
