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Revenue Recognition

Date recorded:

At the October joint meeting between the IASB and the FASB, the staff presented a summary of both the measurement and customer consideration models. The objective of the November meeting is to provide the Board with a more thorough explanation of the measurement model described as the asset and liability approach. The objective of the discussion is for the Board to focus on the measurement model and not compare it with the customer consideration model.

An asset and liability approach

The Board first discussed Agenda Paper 4B, which describes why the Boards did not pursue a revenue recognition model based on notions of realisation and an earnings process. The paper also describes why the Boards have instead pursued a model based on changes in assets and liability and includes the Boards' initial definition of revenue in terms of an entity's contract with a customer.

The staff introduced the paper and noted that although this paper was the basis for a chapter in the forthcoming discussion paper on revenue, it was not intended to be the complete chapter. Any finalised chapter would include additional information explaining the background to the project and why certain decisions were made.

The staff noted the following key points in the paper:

  • The chapter will be common to both the measurement and customer consideration models as both models focus initially on the customer contract.
  • Many constituents believe that the asset and liability approach is 'code' for fair value. Staff does not believe this is the case.
  • Much of the accounting that exists under the existing model will not change as a consequence of adopting an asset and liability approach.
  • Both the measurement model and the customer consideration models focus on the contract. However, it is recognised that in some industries this information may not be the most decision useful information. An example is agriculture. In such industries the focus may be better placed on an asset more generally (the growth of a tree) rather than a contract with a customer.
  • Obligations are satisfied by the transfer of economic resources. Both models need to describe the criteria for transfer.

The Board then discussed the agenda paper, and a number of concerns were raised. One Board member noted that a particular concern is that contract with customers in some jurisdictions may be 'firm' where as in other jurisdictions it may be more behavioural in nature. That is, there is a shared understanding of what will be done under the contract, but no formal terms are agreed until a later point. The Board member queried whether this project was talking only about irrevocable non-cancellable contracts, or something else? The Board discussed the need to clarify the meaning of a contract.

The same Board member also noted that the Board needed to consider the cost-benefits of the models.

The Board discussed the issue of whether the asset and liability approach is requiring fair value. It was noted that not all increases in assets should be referred to as revenue (fir instance, agriculture). It was argued by some that performance should be measured on the same basis regardless of which model is used.

One Board member noted that the section outlining the shortcomings of IAS 18 Revenue in the agenda paper was short and cryptic. It was suggested to staff that the final discussion paper should also include discussion of aspects of IAS 18 that are not flawed, and also include more examples and explanation. Another Board member reminded the Board that IAS 18 was written prior to the conceptual framework.

The Board then moved on to discuss the decision usefulness of information and a tentative definition of revenue. One Board member emphasised that the key issue is whether people are able to understand the information.

In relation to how an asset or liability arises, the issue of 'right of return' and cancellability of contracts was highlighted as critical. One Board member noted that a right of refund is inseparable from cancellability of a contract. This was considered to be a critical point in understanding if and when revenue should be recognised. The staff noted that the papers focussed on enforceable cash flows, which may be contingent on the performance of a supplier; however they have not addressed the issue of any intangible asset that may arise as part of a contract relationship.

Measurement

The Board then moved on to Agenda Paper 4C, which considers how a contract asset or liability should be measured. The staff highlighted the four main reasons why current exit price was selected as the measurement attribute as:

  • The measurement reflects the future cash flows associated with the remaining rights and obligations in the contract.
  • The measurement includes a margin at each measurement date for all of the remaining contractual obligations.
  • The measurement is current.
  • The measurement enhances comparability.

The Board discussed these reasons at length. One Board member noted that the model is not a predictor of cash flows, as it is highly unlikely that the contractor is going to lay off the obligation. The requirement to measure the contract at current exit price was highlighted by the staff as a significant change to current practice. An extensive discussion ensued on issues related to measuring assets at exit price. Some Board members said that they were uncomfortable with the issue that sales price is not remeasured, but cost is.

Accounting for the contract with the customer

The Board then moved on to Agenda Paper 4D, which explores the implications of the proposals for revenue recognition. The Board agreed that revenues cannot arise before a contract with a customer exists. The Board discussed the issue of when revenue should be recognised, and noted that it was not clear from the current papers when this would occur. The issue of contract cancellability was raised again. Some Board members thought that cancellability may be outside the scope of the project. One Board member noted that unless there are legal remedies, all contracts are cancellable - it is just that you may be required to pay your way out of the contract. This issue was referred to staff for further research and consideration.

Following extensive discussion, staff noted that some people disagree with the asset and liability model on a conceptual basis because it gives rise to 'day 1 revenue' whereas others disagree with the model on the basis of measurement difficulties.

It was noted that delivery of the good or service is fundamental to revenue recognition. The links between asset derecognition and obligation satisfaction was agreed by Board members to be critical to both proposed models of revenue recognition. Staff said they would expect the approach to derecognition for purposes of revenue recognition would be consistent with the approach adopted in the financial instruments project. One Board member noted that such consistency should not be limited to derecognition - the revenue project should also be consistent with the current projects on liabilities and insurance.

The Board agreed to continue discussing the model at the December meeting.

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