Remi Forgeas

Revenue Recognition Project Nears End

Instead of cutting corners to meet the initial deadline, how two Boards dedicated enough time to revisit controversial paragraphs and find the right solutions.

May 23, 2011
by Remi Forgeas, CPA

In June 2010, as part of its joint project with the Financial Accounting Standards Board (FASB), the International Accounting Standards Board (IASB) published an Exposure Draft (ED) on revenue recognition (Revenue From Contracts With Customers). Almost 1,000 comment letters were received (view on the FASB website) and after a thorough analysis of these comments, the two Boards decided that some points needed a redrafting.

The project update was issued last April and it is likely that this document provides a significant foundation for the final standard. The tentative decisions taken in previous months substantially amended the definitions and principles that had been proposed in the ED, bringing them closer to current revenue recognition practice.

The issuance date for the new standard is expected to be during the last quarter of 2011.

During their meeting in April, the Boards addressed the following aspects:

  • Determining the transaction price;
  • Allocating the transaction price;
  • Sales with a repurchase clause;
  • Licenses and rights to use;
  • Costs incurred in fulfilling a contract.

Determining the Transaction Price

The revenue recognized under a contract with a customer should correspond to the transaction price (discounted where appropriate). The credit risk (i.e. risk on the collectability of the receivable) should not be reflected in the measurement of the revenue (in contrast to the initial position of the Boards).

When the customer promises an amount of consideration that is uncertain, the Boards believe that an entity should estimate either of the following amounts depending on which is most predictive of the amount of consideration to which the entity will be entitled:

  • The probability-weighted amount or
  • The most likely amount.

However, the sale should be recognized as revenue only if it is reasonably assured that the seller is entitled to the sale consideration. The Boards consider that a seller is not reasonably assured to be entitled to an amount in each of the following circumstances:

  • The customer could avoid paying an additional amount of consideration without breaching the contract;
  • The entity has no experience with similar types of contracts;
  • The entity has experience of similar contracts, but that experience is not predictive of the outcome of the contract.

Allocating the Transaction Price

The contract transaction price would be allocated between each performance obligation on the basis of the relative selling prices of the goods or services related to each performance obligation. The Boards decided that if the stand-alone selling price of a good or a service related to a separate performance obligation is highly variable (i.e. when there are different market prices for a similar performance obligation) a residual technique may be the most appropriate. In such a situation, the entity would determine the selling price of this performance obligation by reference to the total transaction price, less the stand-alone selling prices of other goods or services that are easily quantified. This tentative decision represents a significant change from the position in the ED, and is close to existing practice.

The Boards also addressed the issue of the recognition of a change in contract price, such as additional payments not covered by the initial contract. A change in the transaction price should be allocated to a specific performance obligation if both of the following conditions are met:

  • The contingent payment terms of the contract relate specifically to the entity’s efforts to satisfy that performance obligation; and
  • The amount allocated to that particular performance obligation is reasonably relative to all of the performance obligations and payment terms in the contract.

This tentative decision also marks a significant change from the ED, which required the change in price to be allocated to all performance obligations.

Sales With a Repurchase Clause

The Boards decided to amend the ED regarding sales with a repurchase clause. As we understand it, this decision is largely  because the Boards have decided to reintroduce the notion of “risks and rewards of ownership” as an indicator of the transfer of control (and hence as a criterion for revenue recognition). Sales with a repurchase clause include sales with an automatic repurchase clause and transactions that give the customer the right to sell the asset back to the seller at a price below the original sales price. The Boards decided that if the customer has a significant economic incentive to exercise that right, this would be the case if the option exercise price is significantly higher than the market price of the asset at the time the option is exercised, the customer effectively pays the entity for the right to use the asset for a period of time. In this case, the contract would be analyzed as a lease (and not as a sale).

These decisions, once again, are close to existing practice.

Licenses and Rights to Use

The Boards seem to have abandoned the ED’s proposals for the accounting treatment of licenses and rights to use, which were based on the concept of the exclusivity of rights granted to the customer. According to the Boards, the promised rights give rise to a performance obligation that the entity satisfies at a point in time when the customer obtains control (i.e. the use and benefit) of the rights. If there are several performance obligations in the contract (an example might be the sale of the right to use software and an obligation to update the software throughout the term of the right to use), the seller should determine whether these rights give rise to separate performance obligations or a single performance obligation.

Costs Incurred in Fulfilling a Contract

The ED also contained proposals for accounting for costs of fulfilling a contract with a customer:

  • The scope of the proposed guidance on fulfillment costs was not modified;
  • The costs that relate directly to a contract include costs that were incurred before the contract was obtained if those costs related specifically to an anticipated contract;
  • The costs of abnormal amounts of wasted materials, labor or other resources that were not considered in the price of the contract were recognized as an expense when incurred.

Therefore, with the exception of costs due to wastage, the costs would be capitalized:

  • If they meet the definition of an asset (e.g. inventory, tangible or intangible assets); or
  • If they generate or enhance resources of the entity that will be used in satisfying performance obligations in the future, if they relate directly to a contract (or future contract) and if they are expected to be recovered.


Overall, the process is longer than anticipated, however it shows that the two Boards took the comments received seriously. Instead of cutting corners to meet the initial deadline, the decision was to dedicate enough time to revisit controversial paragraphs and to find the right solution. We can applaud the two Boards for their efforts to find solutions that ensure sound principles and practical feasibility.

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Remi Forgeas, CPA, is an audit and assurance partner for WeiserMazars LLP US and provides his views on international convergence of GAAP and whether progress is really being made in light of recent developments. For U.K. IFRS, you can contact, Steven Brice who is a technical partner in the financial reporting advisory group for WeiserMazars LLP UK and provides his views on international convergence of GAAP and whether progress is really being made in light of recent developments.

* The views expressed in this article are the author’s own and do not necessarily reflect the views of the AICPA or AICPA CPA Insider.