Revenue Recognition – EFRAG presentation on PAAinE discussion paper
The Joint Board meeting welcomed representatives from Europe's Pro-active Accounting Activities in Europe (PAAinE) initiative to present an overview of the discussion paper Revenue Recognition- A European Contribution. The paper was published in July 2007 jointly by European Financial Reporting Advisory Group (EFRAG) and the German and French accounting standards boards. Its objective is to stimulate debate on revenue recognition in Europe and to develop European views to be considered by the IASB and FASB in their joint revenue recognition project.
The PAAinE representatives introduced the paper by noting that it was prepared based on the revenue recognition project currently being undertaken by the IASB and FASB. The representatives noted that the IASB and FASB's proposal that revenue should be recognised as the legal layoff amount (the amount the recipient of the revenue would have to pay a third party to fulfill the obligation to deliver goods or services) made many constituents in Europe uncomfortable. PAAinE believe that there is a need for new principles based on existing standards, but indicated that they do not believe that this necessarily means that fair value is the appropriate answer.
The PAAinE paper received 70 comment letters with quite mixed responses.
The representatives highlighted that the PAAinE paper:
- Develops an asset/liability approach starting from the question 'what shall revenue reflect' (revenue being the top line of the income statement).
- Discusses different possible meanings of the revenue number.
- Discusses when revenue arises under different approaches (recognition).
The paper does not discuss measurement issues in depth. The representatives highlighted that it does not discuss defining revenue as changes in the fair value (legal layoff amount) of performance obligations.
The representatives then moved on to discuss what the revenue number should reflect. In this discussion, it was noted that the paper indicated that a binding contract is a necessary precondition for revenue to exist. One Board member queried the emphasis on a binding contract. The Board member was not sure that the boards have a notion of a binding contract. He went on to ask whether the PAAinE representatives believe that a right of return was a binding contract - because, if you can return a good for a refund it is not very binding. The Board member concluded by stating that this was fundamental to the notion of revenue.
The representatives moved on to provide an overview of the models discussed in the PAAinE paper (diagrammed below):
The representatives noted that there is a grey area between the 'critical events approach' and the 'continuous approach' and that, rather than being separate models, the two actually merge into each other.
The discussion then focussed on Approach C. One Board member asked whether the term 'substantively' in Approach C was important. The representatives responded by saying that it wasn't and that the model could be read without the term included.
Some Board members queried how this approach was consistent with the assets and liabilities approach. It was noted that the approach seemed to be more in line with an earnings process.
The representatives moved on to discuss the critical events approaches (A-C). The critical events approaches require that revenue should reflect that the company has completed a defined part or all of a contract.
- Approach A: complete contract fulfilment
- Approach B: fulfilment of part contract as defined by contract itself
- Approach C: fulfilment of part contracts as defined by economic measures
In explaining Approach C it was highlighted that for revenue to be recognised under this approach, the paper says that the customer can use the product for its intended purpose. The representatives clarified that this meant that, for example, if a customer is delivered a computer monitor, they are able to use that monitor as a monitor, rather than for some other purpose (for example, as an ashtray). Some Board members were concerned that this would involve understanding customer intention. Given how difficult it was to determine management intention, Board members queried how customer intention might be determined. One Board member also queried whether revenue could be recognised differently for the sale of the same item to different customers depending on customer intention.
The representatives noted that this was a good point and was not addressed in the paper.
Following general discussion on the models, the representatives then moved on to discuss the continuous approach (Approach D). Under Approach D, revenue reflects the activity of the company under a binding contract in a way that mirrors progress under a contract. The progress of the contract could be measured in a number of different ways, for example:
- as the supplier incurs the costs inherent in the contract;
- as the risks inherent in the transaction decrease or are eliminated by the supplier;
- as the value of the goods created under the contract increases; or
- with the passage of time.
It was clarified that these are not intended to be measurement options.
One Board member queried whether the representatives thought this would be a choice as to which option to take. The representatives did not think so.
Finally, the representatives very briefly highlighted that the paper outlines the differences between the two approaches. In sale of goods scenarios (for example, buying produce at a supermarket) little difference to existing practice is expected. However, for services, more difference are expected to arise.
The representatives said that a summary of comments will be released in early April; however, no decision has yet been made on what, if any, further work will be done on the project.
The IASB Chairman thanked the representatives for their efforts.