Academic journal article Management Accounting Quarterly

Convergence Collaboration: Revising Revenue Recognition

Academic journal article Management Accounting Quarterly

Convergence Collaboration: Revising Revenue Recognition

Article excerpt

The "revenues" line often is the single biggest number in the income statement. It is one of the most crucial financial measures investors will ponder, and it is often the focus of management mischief. Think of the accounting chicanery, for example, to which investors have been subjected in the last decade:

* "Round-tripping" of contracts to increase revenue and add to investor appeal,

* "Buy-and-hold" transactions where early customer purchases were not really sales at all, and

* "Principal vs. agent" transactions where transactions were reported on a gross basis for, say, a ticket price, when the real revenue earned only amounted to a commission on that gross price.

To deal with the many different types of revenue transactions, the U.S. accounting standards for revenue recognition have multiplied. The section of the U.S. Accounting Standards Codification[R] covering revenue recognition is composed of more than 140 pronouncements issued over the years. Some of it is very specific to certain kinds of transactions; some of it is very specific to certain industries. Oddly, none of it contains general guidance on revenue recognition for services. Revenue recognition issues have been frequent agenda items for the Emerging Issues Task Force of the Financial Accounting Standards Board (FASB), indicating that the current standards are themselves inadequate.

Since 2002, the FASB has worked with the International Accounting Standards Board (IASB) on a joint project to improve revenue recognition standards. On the FASB side, the greatest improvement would be a comprehensive set of revenue recognition principles that do not require constant repair and maintenance. On the IASB side, the greatest improvement would be more consistent principles that could be applied in more specific situations. For example, there is little guidance on revenue accounting for arrangements containing multiple elements. Both sides have something to gain from this project, and developing a joint standard is a meaningful standards convergence step. The basic objectives of the new standards include:

* Remove the many inconsistencies and weaknesses in existing standards;

* Provide a more robust framework for addressing revenue recognition issues;

* Improve comparability of practices across entities, industries, and capital markets; and

* Simplify the preparation of financial statements.

Here is how the joint proposal will work--in its current form--and how it could affect current revenue recognition practices in various industries.


The current revenue recognition standards are best described as the result of a long-term ad hoc approach. There has never been a comprehensive revenue recognition standard that presented a framework for working out unmapped issues. Instead, revenue recognition standards have often been developed in response to a request from a particular industry that views itself as somehow different from others in the way that revenues get recognized. U.S. standards setters have thus built a towering mound of rules around revenues--more than 140 standards--with no guiding principles running through them. Without a central theme, the continued issuance of more narrow-range accounting standards is a certainty. The new standard should also help address the many common revenue fraud techniques that have negatively impacted the capital markets. Such frauds have included sham sales, premature revenue recognition before all the terms of the sale have been completed, conditional sales, improper cutoff of sales, improper use of the percentage-of-completion accounting, and consignment sales.

The IASB standards, on the other hand, are the polar opposite of the FASB standards. There are two chief IASB revenue standards--International Accounting Standard (IAS) 11, "Construction Contracts," and IAS 18, "Revenue"--and they are not complementary. …

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