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1 July 2016 Position Paper

Top-Line Watch: Investor Considerations in Run-up to 2018

Long-Term Contract Revenue Recognition Changes

  1. Vincent Papa, PhD, CPA, CFA

It is approximately 18 months to 2018. And the clock ticks away towards a new world where there could be potentially significant revenue recognition changes due to the revised International Accounting Standards Board (IASB) and US Financial Accounting Standards Board (FASB) guidance, which will be effective from 2018. Pronounced changes in the amount and timing of revenue recognized could arise for companies whose business models depend on long-term customer contracts (e.g., engineering, aerospace, defense, infrastructure, and real estate development).

This paper highlights key areas within the revised guidance that could affect reporting outcomes for long-term contracts and need to be at the forefront of investors’ attention. These areas include criteria for recognizing revenue over time in a fashion similar to the current percentage-of-completion (POC) method; significant financing components; additional cost recognition and disclosures requirements; and transition considerations.

This paper extends the analysis of our April white paper (Watching the Top Line: Areas for Investor Scrutiny on Revenue Recognition Changes) that reviewed transition requirements, multiple deliverables within a contract, license revenue, gross versus net presentation of revenue, and customer credit risk. A further follow white paper, will review uncertain revenue, contract definition issues (e.g. modification) and presentation of revenue related lines on the financial statements.
Top-Line Watch: Investor Considerations in Run-up to 2018 View the full article (PDF)
Footnote(s)

  1. The IASB and FASB first issued this guidance in 2014, and both standard setters have since had clarification guidance.

  2. https://www.sec.gov/news/speech/speech-bricker-05-05-16.html

  3. http://ww2.cfo.com/financial-reporting-2/2015/09/accounting-rife-estimates-haunted-toshiba/

  4. http://247wallst.com/aerospace-defense/2016/02/11/sec-said-to-question-boeing-accounting-method-shares-dive-10/

  5. Unit cost accounting expenses contract costs as incurred. In contrast, the program accounting method takes more of a contract life-cycle (income–expense matching) approach—for instance, a contract for the entire 747 aircraft production program.

  6. The newly issued revenue recognition guidance is often described as a “five-step model”: (1) Identify the contract. (2) Identify separate performance obligations. (3) Determine the transaction price. (4) Allocate the transaction price. (5) Recognize revenue as (or when) the performance obligations are satisfied.

  7. That said, one cannot generalize the eligibility for revenue recognition over time for real estate, as it will be crucially dependent on the contract terms and also local property laws, which are highly jurisdiction specific.

  8. www.rolls-royce.com/~/media/Files/R/Rolls-Royce/documents/investors/results/presentations-and-briefings/2014-investor-briefing-totalcare-accounting-mark-morris-tcm92-57736.pdf

  9. Current IFRS requirements are silent on the need to recognize interest expense for customer payments that are received in advance. Under US GAAP, customer advances (e.g. deposits or progress payments on construction contracts, advance payments for resources and raw materials, and advances to encourage exploration in extractive industries) are excluded from requirement to impute interest (KPMG, 2014).

  10. An exception to this split will be companies where interest income is part of operating income streams (e.g. banks).

  11. A reporting company recognizes an impairment loss to the extent that the carrying amount of the asset exceeds the recoverable amount. The recoverable amount is defined as:

    • The remaining expected amount of consideration to be received in exchange for goods or services to which the asset relates; less

    • The costs that relate directly to providing those goods or services and that have not been recognized as expenses.

  12. The revised guidance allows preparers to choose among providing retrospective transition (i.e., 2018 and all prior years presented for comparison in 2018 financial statements), retrospective transition with practical expedients, and cumulative catch-up transition (2018, no prior year, a cumulative catch-up in opening equity, and disclosure of what current-year revenue would have been under the old guidance).

  13. Capitalization normally occurs when costs are incurred and not several reporting periods later.

References
  • Financial Reporting Council 2015 2015. Corporate Reporting Review, Annual Report
  • Mulford, C.W., and D. Austin 2015 Percentage-of-Completion Accounting and the New Accounting Standard: A Look at the Aerospace and Defense Industry Working paper Georgia Tech Financial Analysis Lab
  • KPMG 2014 Issues In-Depth: Revenue from Contracts with Customers
  • PwC 2014 Revenue from Contracts with Customers
  • --- 2014 In-Depth: A Look at Current Financial Reporting Issues Supplement to Revenue from Contracts with Customers 18 Jun June
  • Shamrock, E.S. 2012 FRS and US GAAP: A Comprehensive Comparison Edison, NJ John Wiley & Sons.
  • Pakaluk, J. 2016 Is Contract Accounting Under the Microscope?
  • Papa, V. 2016 Watching the Top Line: Areas for Investor Scrutiny on Revenue Recognition Changes CFA Institute Codes, Standards and Position Papers Vol. 3 No. 2 CFA Institute
Publisher Information
CFA Institute 18 pages doi.org/10.2469/ccb.v2016.n10.1

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