Revenue Recognition: an IFRS "Hot Spot"

- RevenueRecognition.com

Revenue Recognition processes, long considered "extreme" accounting under US GAAP, will be equally difficult under IFRS. The IFRS standard looks much simpler, but is it? What are the implications for accounting processes and systems if it’s not?

The Myth of IFRS – Debunked

The impending adoption of IFRS in the US, viewed with varying degrees of dread by those who have to do the actual adopting, carried one small potential for hope–perhaps IFRS Revenue Recognition will greatly simplify the revenue accounting process. However, a recent survey by RevenueRecognition.com found that in countries where IFRS is required, survey respondents reported by an even wider margin than US GAAP respondents, that Revenue Recognition is more complex, more error-prone and more material than other key finance processes

Rules versus Principles

The hopes of a kinder gentler approach to revenue recognition in IFRS are pinned to the substantial difference in the amount of text that supports each standard. IFRS, which is principles-based, provides orders of magnitude less guidance on revenue recognition than US GAAP – a rules-based standard stuffed with industry-specific examples. Ironically the big difference that we can expect is that under IFRS, interpretation of the principles will be more difficult — and more subject to variation, to personal judgment and even to local culture. The actual revenue processes necessary once the judgments are made will have the same degree of difficulty and require the same information system support.

IFRS and US GAAP: Revenue Recognition Compared

Let’s peel that onion a little. The revenue recognition for US GAAP consists of a multitude of guidance and rules. IFRS in contrast , does not spell out specific rules and practice aids on how to implement revenue recognition accounting. However in both, the revenue recognition fundamentals are the same: revenue is recognizable when it is (1) realized or realizable and (2) when it is earned, regardless of whether any money has actually changed hands. Both cover revenue for essentially the same business activities, namely the sale of goods, services and for assets and royalties.

Under US GAAP revenue recognition accounting is largely built on the following four "Pillars": (1) persuasive evidence of an arrangement exists, (2) delivery has occurred or services have been rendered, (3) the seller’s price is fixed or determinable, (4) and collectability is reasonably assured. Until each and every one of them is met, revenue must be deferred and can not be recognized. This means that criteria must be established (pretty much dictated by US GAAP) to determine what evidence constitutes a green light for each of these conditions and that evidence must be tracked to completion for all four conditions before any deferred revenue can be moved to the general ledger as revenue. When one considers that this process must take place for every element of accounting in a transaction, it’s easy to understand why it’s complicated AND error-prone — especially if it’s being done manually.

IFRS doesn’t simplify this process. It actually has five conditions that must be met in order for the sale of goods to be recognized and four for services. For goods, (1) the significant risks and rewards of ownership have transferred from seller to buyer;(2) the seller does not retain continuing involvement or control over the goods; (3) the amount of revenue can be measured reliably; (4) it is probable that economic benefits will transfer to the seller; and (5) costs incurred or to be incurred can be measured reliably. IFRS, as with US GAAP, includes a "right of return" for goods that also requires a carve-out. For the sale of services the revenue recognition conditions include the 3rd, 4th and 5th above with the addition of a fourth condition related to completion: the stage of completion can be measured reliably.

It’s important to drill home this point: where IFRS differs significantly from US GAAP is that there is little guidance and much judgment involved in determining the "evidence" of completion of this process, but once a determination is made, the process of tracking each of these many conditions to conclusion is the same. It’s hard to find an "easier" anywhere in this scenario.

There are some concepts in US GAAP without precise parallel in IFRS: the international standard does not dictate different principles for different industries – it’s "all for one," (with the exception of Construction, detailed in IAS 11) and as a consequence there is no such thing as a multiple-element arrangement or Vendor Specific Objective Evidence (VSOE). However, the application of "Fair Value" is very much in play within IFRS as is the requirement to break out elements of accounting for separate revenue recognition treatment in certain kinds of transactions. Whether under IFRS or US standards, these similar concepts are among the most difficult processes in accounting to manage and track. FASB and the International Accounting Standards Board (IASB) have been working on a joint project to reconcile or merge the two standards. This project could eliminate VSOE but would not be likely to eliminate other forms of Fair Value requirements.

And just as there are concepts in US GAAP without precise parallel in IFRS, the reverse is also true in that IFRS has significant disclosure requirements around accounting methods and controls and exact amounts of revenue in every category for every reporting period. Systems will require depositories and the ability to capture information automatically to meet these requirements.

A Comparison of US GAAP and IFRS Revenue Recognition Rules
US GAAP Goods/Services		IFRS Services		IFRS Goods
1	Persuasive evidence of an arrangement exists	1	The amount of revenue can be measured reliably	1	The significant risks and rewards of ownership have transferred from seller to buyer
2	Delivery has occurred or services have been rendered	2	It is probable that economic benefits will transfer to the seller	2	The seller does not retain continuing involvement or control over the goods
3	Price is fixed or determinable	3	Costs incurred or to be incurred can be measured reliably.	3	The amount of revenue can be measured reliably
4	Collectability is reasonably assured.	4	Stage of completion can be measured reliably.	4	It is probable that economic benefits will transfer to the seller
				5	Costs incurred or to be incurred can be measured reliably. (IFRS, as with US GAAP, includes a “right of return” for goods that also requires a carve-out.)