Revenue Recognition

Answer

1.             Revenue Recognition

   Revenue recognition includes two basic and interrelated decisions of how much revenue to recognize and when to recognize. Under the traditional approaches of net asset and income determination, the two methods that are in application include the asset-liability and revenue-expense approach (Zeff, 2012). The revenue-expense approach entails measurement of assets and liabilities at historical cost. The recognition and measurement of contract liabilities and assets determine revenue recognition. The IFRS borrow elements from these approaches. The IAS 18 and IAS 11 standards are closer to the revenue-expense approach (Haslam, Tsitsianis, Andersson, & Gleadle, 2015). The asset-liability approach provides a more objective anchor for the revenue recognition than the matching principles under the revenue-expense approach. Under the revenue-expense approach, revenue is recognized when it is earned and realized. It captures the idea that earnings cycle must be adequately definite to trigger recognition.

   Revenue recognition that is directly payments received by customers while decoupling income recognition completely from revenue recognition is another importance of the old revenue recognition standard. This approach focuses on what the customer can do for the company as opposed to what the company can do to satisfy the contract (Zeff, 2012). This approach is observable and verifiable and it is able to eliminate deferrals of revenue. From an information economics view, the principle to recognize revenue based on customer payments offers no incremental information over the information conveyed under the statement of cash flows (Haslam, Tsitsianis, Andersson, & Gleadle, 2015).

   Measurement under the old revenue recognition standard includes conservative features. In this case, a contract with a customer is onerous if the unavoidable expected cost in settlement of the performance obligation exceeds expected considerations. This kind of conservatism is labeled conditional conservatism owing to its contingent nature on the occurrence of a specific event that brings about unexpected loss. This way, it is easy to recognize loss immediately when it is expected. Conservatism is particularly valuable in stewardship settings (Haslam, Tsitsianis, Andersson, & Gleadle, 2015). Because earnings are a basic component in executive compensation contracts and management decisions, early recognition of losses by managers enables them to internalize expected losses from projects and in so doing reduce an incentive to invest in short-term positive projects with long-term negative consequences. In addition, it induces companies to abandon projects that generate losses earlier and managers to reveal unfavorable events. This complements the inherent incentive to reveal favorable events voluntarily (Zeff, 2012).

   The need for a single comprehensive standard that would be used in revenue recognition forms the basis for the development of the IAS 18 and IAS 11 by the FASB and the IASB. This effort was predominantly steered by the fact that firms developed business models with specific and highly complex contracts with their customers (Zeff, 2012). They included a number of variable considerations, variables, and bundling of a variety of goods into a single customer contract. The old revenue recognition standard offered a principles-guided standard setting approach that has only two standards IAS 18 and IAS 11 accompanied by a few interpretations. The two standards can be traced to 1993 when IFRS developed a full set of standards to foster its acceptance (Haslam, Tsitsianis, Andersson, & Gleadle, 2015). In 2008, the board issued a joint discussion paper in which they developed an asset-liability approach for revenue recognition that is based on the origination of rights to consideration and performance obligations using a contract with a customer. The concept of revenue and related IAS 18 and IAS 11 is rooted in the financial reporting period when the focus was on profit. The performance focus formed the cornerstone of financial reporting in the old revenue recognition standard.