Accounting

A report that outlines the key differences in the point of views of the boards
and determines whose view is sounder

Introduction
Revenue recognition is the most critical of the accounting issues since the policy related to revenue recognition can turn the financial results upside down and it is the greatest tool used by companies engaging in earnings management. Due to the risky nature of revenues, its accounting needs to be tougher. However, it is not the case there is a great deal of inconsistences in the accounting principles set for revenue.

There is a need for reconsideration of principles related to accounting for revenues not only in the US but also globally. This is why the US standard-setting body FASB and the international standard setter IASB have signed to MoU to develop a single set of guidance related to revenues. In 2002 the boards initiated the project. In this report we aim at identifying the point of view of each standard setter, compare them, find out the differences, discuss the relative strengths and weaknesses and come out with a recommendation as to which of the views should be adopted in the new global standard on accounting for revenues.

Main Problems in Revenue Recognition
The main problem in accounting for revenue recognition is the diversity which is hard to capture by a single guidance. The diversity comes from the diverse environment and varying underlying economics of transactions in each industry. Although the basic logic presented by the standard setters regarding revenue is simple recognize revenue when there is a transfer of risks and rewards, the complex nature of transactions has made accounting for revenues complex. In US for example, there are 140 authoritative statements related to revenue recognition (Bragg, 2007) and still we see new questions still arising related to revenues indicating a lack of guidance.

ATT A Case Study
In order to understand the accounting for revenues and related complexities lets consider the ATT note to the financial statements on accounting policy for revenue recognition in its annual report for the financial year 2008. The company has three major categories of revenue each with a different revenue recognition policy

The simplest category as regards accounting complexity is revenue from communications services provided such wireless, landline, data transfer, etc. This type of revenue is recognized either instantly (on the basis of usage of airtime), on the basis of period of time (in case of monthly fees) or on any other suitable schedule.

Another category for revenue recognition is revenue from upfront setup and activation fees. Within this category there are further two types

If the contract for provision of setup and activation doesnt include any other contract for the provision of services, the fees and related expenses are recognized when the service is activated and

If the transaction also involves some related other contract for provision of services besides the activation services, the revenue from additional services is deferred and recognized over the period of the service contract.

Third category of revenue includes revenue from sales of equipment to the customers. In this situation too there are further categories
Situations where ATT is the primary obligor in such cases the revenue is recognized at gross out when there is a contract and the customer accepts the equipment.

Situations where a third party is the primary obligor in such cases revenue is recognized for the net benefit is recognized as revenue not the gross amount.

Besides this the company has revenue from publishing directories too which is amortized over a period typically twelve months.

Some other questions asked by ATT include
What to do with the regulatory duty collected on behalf of the government
How to recognize revenue in case of bundled services For example sale of cell phone with an airtime package, etc.

What to do in case of resale of third party services in which ATT is not the primary obligor
ATT is just one company and it has so many questions related to revenue recognition. Different companies, different industries and different underlying economics have to be sorted out with concise yet comprehensive standards.

FASB Point of View and its Weaknesses
According to the SFAC 5 (CON 5) Recognition and Measurement in Financial Statements of Business Enterprises, revenue should be recognized when the entity has completed the activities entitling it to the benefits represented by the revenues. Further guidance is provided by SAB 104, which states that revenue is recognized where all of the following conditions are met
an arrangement and understanding exists for the transfer of goods or provision of services,
delivery of goods or provision of service has occurred,
the amount of revenue is determinable and
the revenue is realizable i.e. collectible.

However, the problems with US GAAP are
Numerous standards that define an earnings process inconsistently. It is difficult to handle so many standards on a same topic. Further there are inherent conflicts within those standards.

The accounting for revenue recognition conflicts with the asset and liability definitions in the framework. A receivable, an asset arises as a result of the contract coupled by a corresponding liability for provision of goods or services, but no revenue, asset and liability is recognized until we have not recognized until we have delivered the goods or provided the service
IASB Point of View and its Weaknesses

The IASB portfolio of standards has two standards IAS 11 Construction Contracts and IAS 18 Revenue Recognition dealing with the issue of revenues. While US GAAP stresses for point of delivery IASB looks for the point of transfer of risks and reward to be the trigger point for recognition of revenue. But here again similar to US GAAP, the revenue recognition principles dont sit well with the conceptual framework. According to the IFRS revenue is recognized when the risks and rewards incidental to ownership transfers. Due to this rule a company may keep a sold item in an inventory because the risks and rewards were not transferred even where the control has passed on. According to the framework, since control is an element of asset and it is lacking here so keeping inventory as an asset is not precisely in accordance with the framework.

Whose View is Appropriate
Although both the views have some limitation, the view adopted under US GAAP seems more appropriate since it also emphasizes on control besides existence of arrangement and delivery. But since focus is shifting against towards a balance sheet driven accounting, standard setters are likely to explain things with this approach. The same is the case with accounting for revenues. FASB and IASB intend to issue a common standard for revenue recognition which also considers the legal status of a transaction besides the underlying substance. The approach is contract driven whereby entities will be required to record revenue when the entity has a legally enforceable right to receive the consideration for the transfer of goods or provision of services and a corresponding obligation to deliver the goods or perform the service. Revenue will be recognized as the movement in the assets and liabilities. This approach will be helpful in making it difficult to engage in earnings management by manipulation of revenues.

Current Situation
The final product of IASB-FASB revenue recognition project is expected in 2011. The boards have issued proposed a contract-centered balance sheet approach for revenue recognition.