The Board continued its discussion of the 'Measurement Model', begun in November 2007 (see IASPlus Meeting Notes for November 2007). The measurement model is one of two that are being considered for inclusion in the forthcoming FASB/ IASB discussion paper on revenue recognition. This session was intended to ensure that issues to be raised with respondents were identified and included in the discussion paper.
The staff reminded the meeting that, under the measurement model, revenue is not defined. Rather, revenue reflects the change in the exit price of the contract asset or contract liability from providing goods and services at the date the goods and services are provided. The Board discussed four possible approaches. Briefly, those approaches were:
- All contract revenue would be reported in the revenue line. Any losses on the contract would be reported in a separate line item. Total revenue recognised could be greater than contract consideration.
- Report the effects of price changes as revenue - revenue and changes in the exit price of the customer contract would be reported in the same line. Total revenue recognised would be equal to contract consideration; however in any one period revenue could be negative.
- Report the effects of price changes outside revenue - in this presentation, all changes in the exit price would be presented separately from revenue as contract gains and losses. Total revenue recognised would be equal to the contract consideration.
- Report the effects of price changes as an adjustment of revenue - within 'revenue', there would be an analysis of gains and losses on contract, coming to a total of 'contract revenue' that would be equal to the contract consideration.
Board members suggested that remeasurement would be required either when the exit price changed or when the entity did something under the contract.
A Board member thought that the analysis was useful for complex, infrequent transactions (such as building a nuclear power station). However, the market for such transactions does not exist and it would be very difficult to determine exit prices (as currently understood). In addition, he challenged the staff and other Board members whether and how this information was useful in forecasting the entity's future cash flows. Another Board member shared this concern and asked whether analysts would find this approach useful.
A Board member expressed the view that analysts are more interested in margin rather than revenue; revenue is important but it is not overriding. Other Board members noted that if margin analysis was to be useful and consistent, all the components of gross margin would have to reflect current fair value (at least one Board member objected, noting that the project was restricted to revenue). They noted that, while the information provided by the measurement model might be useful for benchmarking purposes, it would not assist in predicting future cash flows or margin analysis. It was also noted that the Standards Advisory Council had asked the Board to justify changes, especially radical ones like this, on the basis of decision usefulness and utility in predicting future cash flows.
A Board member noted that own costs are important to estimating future cash flows and that neither the measurement model nor the customer consideration model (to be discussed later) solved the problem. However, the measurement model potentially made all prepaid contracts into IAS 39 derivatives (such as by eliminating the notion of 'normal purchase and sale' contracts). In addition, the right to cancel or the right to return with full refund also challenged the measurement model. Another Board member noted that the 'hard issues', such as these last two, were common to both the measurement model and the customer consideration model and were solved by neither.
One Board member asked the staff whether they had consulted with any of the entities that use a similar approach already. He noted in particular some non-life insurance companies in Australia and gold mining and similar commodity companies. Many gold producers sell their production forward; what interests analysts most is how well those companies manage the forward/spot price spread (there is a unified and active market for such transactions). For this to work, such companies re-price their delivery contracts on an ongoing basis (minute-by-minute essentially). For the measurement model to be truly useful, the Board member thought that the re-pricing of the contract must be done on a daily basis.
Measurement model - should the model account for a broader set of assets and liabilities?
The Board then turned to question whether a focus on the contract asset or liability would be too narrow to represent faithfully an entity's economic circumstances. In considering this question, the staff noted the following consequences about the measurement model:
- Measuring only the contract asset and liability at current exit price could result in accounting mismatches arising in profit or loss that may not faithfully depict economic mismatches.
- Profit or loss would depict changes in a narrow set of assets and liabilities that may give an incomplete depiction of the changes in the entity's assets and liabilities throughout the contract.
The Board used the example of a house builder who builds a house 'off plan'. The example highlighted that in addition to the building activity, revenue under the measurement model is driven by the value of the house itself. This suggests that, to reflect the whole of the transaction properly, revenue might be analysed between 'contracting' revenue and 'production' revenue; or that gross margin would reflect the net of revenue, production margin and expenses.
The staff noted that the FASB/IASB group working on the measurement model wants to go beyond the narrow confines of contracts but are undecided about whether to revise the definition of revenue or treat the additional items as other components of income. Board members noted the similarity between where the staff would like to go and the presentation that results from recognising biological transformation in IAS 41. Board members also noted that the discussions highlighted that recognition and measurement were the primary challenges rather than measurement.