Revised IASB proposals could affect the way income is recognised, writes Nick Randall.
The International Accounting Standards Board (IASB) has issued a revised exposure draft (ED) in response to feedback on its original proposals. If finalised, it could affect how professional practices recognise their income and, therefore, pay tax. The IASB received more than 1,000 comment letters on the original ED. Many felt it was unclear how to apply the proposed core principles in practice, to both service and construction contracts.
Revised ED proposals
The core principle set out in the revised ED is consistent with the original draft. It says: "an entity shall recognise revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled to in exchange for those goods and services."
The revised ED outlines five steps an entity needs to consider to recognise revenue.
- Identify the contract with a customer.
- Identify the separate performance obligations in the contract.
- Determine the transaction price.
- Allocate the transaction price to the performance obligations.
- Recognise revenue when a performance obligation is satisfied.
For many firms, step five will be the most important in determining revenue to be recognised in each accounting period. For contracts such as straightforward advisory transactions, this will have little, if any, effect on the timing and amount of revenue recognised. However, the proposed new standard could mean significant changes for long-term contracts, those containing multiple deliverables or contracts for services.
Step five says that revenue should be recognised when an entity satisfies its performance obligations by transferring control to the customer. If clearly transferred at a specific time then revenue should be recognised from then. If transferred over a period of time, then it should be recognised over the period.
The original ED proposals would have prohibited the recognition of revenue over time for many service and construction contracts where the asset created by the seller's performance, i.e. the work in progress of professional practices, was not controlled by the customer until the end of the contract.
In the revised ED, revenue can be recognised even if the customer does not have control of the work in progress, provided that it does not have an alternative use to the seller and other criteria are met (including a right to payment for partial completion). It means that more transactions will be accounted for over time than under the original ED.
Presentation
A key change from the original ED and from current practice is the proposed treatment of credit losses. The revised ED requires the amount of any expected credit losses and any subsequent adjustments, i.e. any bad and doubtful debt expense, to be presented in a separate line item within the statement of comprehensive income (profit and loss account) next to the revenue line.
Disclosure
The revised ED proposes a fuller set of disclosures that require both qualitative and quantitative information about revenue and cashflows. Apart from some minor amendments they are unchanged from the original ED.
Effective date
The final standard is expected to be issued by the end of 2012. The IASB has indicated that the earliest date by which the new standard will be mandatorily effective is for periods beginning on or after 1 January 2015.
Although the new standard will not apply for a few years, the impact on some firms could be significant. Early efforts to consider how this could change the firm's accounting policies are recommended.
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