Time to Test-Drive the Revenue Recognition Proposal

December 9, 2011

GE’s global technical controller said a new standard on revenue is close enough to reality that he is instructing business managers to keep the likely new regulations in mind as they draw up contracts.

“To the extent you’re entering into five-, 10-, 15-year contracts today, you really need to think about how they’re going to be affected by the standard, because it looks like it’s fairly imminent,” the controller, Russell Hodge, said.

Hodge was one of four speakers on the AICPA Conference on Current SEC and PCAOB Developments panel on revenue recognition on Wednesday. Panelists discussed the revenue standard that’s being jointly formed by FASB and the IASB in a convergence project. They said it could significantly change the way revenue is reported in the United States.

An initial exposure document was issued in June 2010. After comments led to revisions, a second ED was released in November. The comment period on the proposed changes will end March 13.

“We have heard some concerns about the cost to preparers of providing this information and the transition to a new model,” said panelist Kenny Bement, the lead FASB staff member on the project. “But I think this is an area where the boards have focused, again, on their customer and users of financial statements. And users have long complained about disclosures, that they’re inadequate, they’re boilerplate. So the disclosures are significantly enhanced.”

The core principle of the model is that revenue should depict the transfer of promised goods or services to customers in an amount that the company expects to be entitled to receive in exchange for those goods and services.

A five-step process is proposed to identify that amount:

  • Step 1: Identify the contract with a customer
  • Step 2: Identify the separate performance obligations in the contract
  • Step 3: Determine the transaction price
  • Step 4: Allocate the transaction price to the separate performance
    obligations in the contract
  • Step 5: Recognize revenue when (or as) the entity satisfies a performance obligation


The proposed regulations include a time value of money consideration that Hodge said could challenge businesses that frequently deal in long-term contracts with vendors.

“The one takeaway that I think is important that we’re trying to focus our businesses on is, given that this is going to be effective within the next few years and we’re entering into long-term contracts every day, what we’re asking them to go out and do is to think about how they would change the way they would contract today if they knew the standard was going to be effective,” Hodge said.

Panelist Liesl Nebel, accounting policy controller for Intel, said her concerns are the operational challenges triggered by the proposed rules. She said the new model would require Intel to recognize revenue earlier than it currently does.

Intel currently doesn’t recognize revenue on sales to its distributors until they sell on to the end users, Nebel said. This is because Intel offers price protection and other incentives, and doesn’t consider its price to be fixed and determinable until the distributors sell to the end user.

But the new revenue model would require companies to estimate the price at which the good or service would be sold to the consumer.

“It’s not bad,” Nebel said. “But it does bring operational concerns. So your concerns are, your control environment, what message are you sending to your salespeople who have historically been compensated on a sales-out basis and now they’ll get earlier recognition? So it’s really, how do you operationalize all these changes?”

Step 2 of the process, which requires identification of the separate performance obligations in the contract, can be difficult because it requires intuition, Bement said. The principle for separating obligations is the notion of goods or services that are distinct.

In order to be treated separately, goods or services must regularly be sold separately, or the customer must benefit from the good or service on its own or with other resources that are readily available to the customer. Goods or services bundled with other goods or services are not distinct if the goods or services in the bundle are highly interrelated and transferring them to the customer requires that the entity also provides a significant service of integrating the goods or services into the combined items for which the customer has contracts, and the bundle of goods or services is significantly modified or customized to fulfill the contract.

“You focus not only on the nature of that good or service, but you also think about how it’s been integrated with other goods or services within that same contract,” Bement said. “Because the goods and services may have been integrated in a way in a bundle that it results in just one performance obligation.”

One of Hodge’s main concerns relates to the model’s treatment of the time value of money, which he said is a new concept with regard to revenue recognition. When contracts are settled within one year, time value doesn’t apply.

Where a financing component is significant to a contract, revenues have to be adjusted effectively. But Hodge said costs aren’t similarly adjusted in the model, and he said that  could distort operating results in areas such as supplier arrangements.

Panelist Paul Munter, a partner in the Department of Professional Practice-Audit & Advisory at KPMG, asked Hodge if that meant that on the back end of a contract, the margins could be skewed significantly because the revenue side is being discounted and the cost side is not.

“Absolutely,” Hodge said. “And early on in the contract, to the extent that you’re providing financing,  … you’re actually going to take a hit and it’s going to be distorted quite significantly.”

Hodge also is concerned about the disclosure requirements. He said companies such as GE will be challenged to report the proper amount of disaggregation of revenue from contracts with customers in a way that’s meaningful but doesn’t overwhelm the users.

He said scheduling performance obligations and the associated revenue over time also could be difficult.

“A lot of people are concerned about the forward-looking nature of the disclosure,” Hodge said. “So I think that one is going to get a lot of attention. I would encourage everyone to start field-testing this particular aspect of the model and try and get some feedback to the FASB as soon as possible.”

Just reading the proposed regulations isn’t enough, Hodge said. He encouraged accountants to actually take their companies’ contracts and transactions and run them through the model, focusing intently on the wording.

That will help them provide good feedback, Hodge said.

With that input, Bement said, FASB is looking to continue to improve the model over the next year or so. The earliest the standard could take effect would be the reporting period that begins Jan. 1, 2015.

“The board is trying to achieve our objective, which is to get good information into the hands of those who make decisions using financial statements,” he said. “And to get a standard that achieves that objective, we really need good input.”

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