The Joint Project
Revenue recognition requirements in US generally accepted accounting principles (GAAP) differ from those in International Financial Reporting Standards (IFRSs); the former consists of broad concepts whereas IFRSs contain fewer standards, but applying the two main standards to complex transactions were difficult and needed improvement (Australian Accounting Standards Board, 2010). Accordingly, the International Accounting Standards Board (IASB) and the Financial Accounting Standards Board (FASB) initiated a joint project to clarify the revenue recognising principles and to establish a common revenue standard that would:
(a)remove inconsistencies in existing standards;
(b)provide a sturdier framework for addressing revenue recognition issues;
(c)improve comparability across entities, industries, and capital markets; and (d) require enhanced disclosures (IFRS Foundation, 2010). The proposed new standard would clarify recognition, measurement and disclosure of revenue. If adopted, revenue would be recognised when goods or services, or both, are transferred to the customer (IFRS Foundation, 2011). In contrast, current approach to earning revenue is based on the income statement.
Impact of Revenue Recognition
Revenue reporting directly impacts an entity's results of operations and financial position, therefore any changes in the revenue recognition model can have a fundamental consequence on a company’s results. Accordingly, the proposed model could have a significant impact on several industries. For example, the recognition of revenue for the licence of intellectual property is dependant upon the customer obtaining control of the asset. The proposals may result in some entities recognising revenue over the term of the licence instead of upon the granting of it, thereby delaying its recognition (PricewaterhouseCoopers, 2010).
Importance of Revenue
It is widely recognised that revenue is one of the most important items in financial statements and that revenue recognition is one of the toughest issues standard-setters and accountants face. Apart from its monetary importance, users of financial statements attach great value to revenue in making investment decisions on the basis of its trends and growth, evaluating the company's past performance and making predictions about its ability to generate cash flows in the future. Why has revenue been given such significance? Reflecting on this, the work of Hines (1988, 1991) can be considered. Hines stresses a perspective that ‘financial accounting practices are implicated in the construction and reproduction of the social world’, arguing that emphasising particular performance attributes such as profits, or elements like revenue which determine profits, gives legitimacy to organisations. Furthermore, Hines also adopted the view that accountants create the impression that things like revenue only exist once we decide to recognise them, thereby making them real-ised. Essentially it is we who have created revenue to be associated with transactions and events holding such significance and subsequently defining it as crucial in assessing performance.
The Development of Models & Theories
As for revenue recognition models, its development is supposedly grounded in the principles in the existing Conceptual Framework (CF) (Wüstemann & Kierzek, 2005). The CF sets out major accounting objectives with concepts and general principles specified in the standards for particular types of transactions and events. The interaction of these and professional judgement can well be demonstrated in the area of revenue recognition, discussed later below. Although CFs are defined by the FASB as ‘a coherent system of interrelated objectives and fundamentals that can lead to consistent standards’, Hines (1989) suggested CFs are merely ‘a strategic manoeuvre for providing legitimacy...