The number of FASB’s revenue-recognition rules has grown to more than 100 standards, plus rule exceptions addressing over 20 different industries. Although IFRS contain fewer standards on revenue recognition, its standards have conflicting principles, and can be difficult to understand and apply beyond simple transactions. Both bodies of standards have led to diversity in practical application and a skewing of economic reality.

 

The boards’ objective is to develop a single revenue model that can be applied consistently, regardless of industry. Under the proposed standard a company would recognise revenue when it satisfies a performance obligation by transferring goods and services to a customer as contractually agreed. This principle is similar to many existing requirements and the boards expect that most transactions would remain unaffected. Revenue recognition is an area susceptible to a range of errors and possibly fraud. The proposed model applies to contracts with customers.

 

The discussion paper defines a contract as ‘an agreement between two or more parties that creates enforceable obligations’. A customer is defined as ‘a party that has contracted with an entity to obtain an asset (such as a good or service) that represents an output of the entity’s ordinary activities.’ Agreements do not have to be in writing to be a contract.

 

In principle the model could apply to all contracts, but there is uncertainty about whether it is appropriate for some financial instruments; insurance contracts; and leasing contracts.

 

In a contract, an entity receives consideration (rights) from, and promises to transfer assets (performance obligations) to, a customer. Under the proposed model, the rights and obligations give rise to a net contract position and revenue is recognised when a contract asset increases or a contract liability decreases as an entity satisfies its performance obligations.

 

The key change from the current model is that revenue will be based on the changes in contract assets and liabilities. All contracts (with the possible exception of the above) would be analysed into contract assets and contract liabilities. Revenue would only be recognised when either the net contract liability is reduced or the net contract asset has increased, both as a result of the entity discharging its contract liabilities by performance.

 

Revenue should only be recognised on the fulfilment of a performance obligation under a contract. The transfer of control evidences fulfilment.

 

Entity A agrees to sell Entity B a product for £30,000, which is ‘the transaction price’. Entity A has an obligation (and therefore a liability) to provide a product worth £30,000 and a right to receive payment (and an asset of £30,000). The net position is zero.