Revenue Recognition under IFRS Revisited: Conceptual Models, Current Proposals and Practical Consequences

Abstract

Since 2002, the FASB and the IASB have been undertaking a joint project on the revision and convergence of US GAAP and IFRS revenue recognition. Even though the outcome of the project is still open, the project's course as well as trends in recently published IFRS and other current IASB projects suggest that existing earnings-based and realisation-based IFRS revenue recognition criteria are likely to be replaced by a radically new approach. This paper demonstrates the inconsistencies in current IFRS revenue recognition that have triggered the project and then presents and discusses three conceptually different revenue recognition models that are internationally debated at present. The paper concludes that a major revision of existing IFRS revenue recognition as proposed by the FASB and the IASB is not required. It is argued that the perceived deficiencies should rather be solved on the basis of current transaction-based IFRS revenue criteria.

Acknowledgements

The authors want to express their gratitude for helpful comments on earlier drafts to members of accounting workshops at the Humboldt-Universität zu Berlin, Ruhr-Universität Bochum, Georg-August-Universität Göttingen, Universität Mannheim and Ludwig-Maximilians-Universität München. The authors are members of the working groups on revenue recognition of the European Financial Reporting Advisory Group (EFRAG) and of the German Accounting Standards Board (GASB). The paper benefited from discussions with members of the EFRAG working group on revenue recognition, namely Klaus Pohle (GASB), Mareike Kühne (GASB), Sven Hayn (Ernst & Young, Hamburg), Begoña Giner (University of Valencia), Stig Enevoldsen (EFRAG, Chairman), Reinhard Biebel (EFRAG), Sigvard Heurlin (Redovisningsådet), Andrew Lennard (ASB), Patrick Petit (CNC), Jérôme Chevy (CNC) and Martin Noordzij (CAR). The authors express their own opinion. Financial support from the Ernst & Young Foundation, Stuttgart (Germany), is gratefully acknowledged.

Notes

1. According to Art. 31, par. 1(c)(aa) only profits made at the balance sheet date may be included. As the German version refers to ‘realisierten’ (realised) and the French version to ‘réalisés’ (realised) instead of ‘made’, this requirement is referred to as ‘realisation principle’ in this paper.

2. The definition of the objective of IFRS financial statements which is also mentioned in the IASB Framework, par. 12 was updated in the revision of IAS 1 in 2004 by replacing ‘changes in the financial position’ by ‘cash flows’.

3. We recognise that the presented view was developed by different authors in different periods of time. The main contribution to the revenue and expense view comes from Schmalenbach in the early 20th century, followed by Paton and Littleton in the 1950s. Even though the view is surprisingly consistent, some differences exist. For example, Schmalenbach strictly adheres to the principle of prudence and the realisation principle in the case of long-term construction contracts, whereas other authors such as Paton and Littleton and Bevis accept a deviation in such cases.

4. Schmalenbach (1962) views assets to be ‘Kräftespeicher der Unternehmung’. Similarly Paton and Littleton (1955) describe such assets to be ‘“revenue charges in suspense” awaiting some future matching with revenue as costs or expenses’. See Wüstemann (1999).

5. The approach was, to our knowledge, for the first time consequentially developed by Simon in the late 19th century (Simon, 1886, 1899) out of the idea of the balance sheet as a status of debts coverance.

6. The authors remark that IAS 18.14 contains several other criteria for revenue recognition in the sale of goods which are not discussed in detail.

7. For the example that illustrates the inconsistencies between the sale of goods and construction contracts see Moxter (2004).

8. Whereas the approach was originally referred to as the ‘conceptual model’ by the FASB and the IASB (IASB, 2004d), the FASB now names it the ‘asset and liability fair value approach’ (see FASB, 2005). The description of the asset and liability fair value approach is based on the IASB Information for Observers as well as the IASB Updates between 2002 and 2004 that are all publicly available on the IASB web page. For details see http://www.iasb.org. The revenue recognition and measurement principles as formulated here, however, do not intend to fully correspond with the principles developed by the FASB and the IASB between 2002 and 2004.

9. This example is based on Case Study 1: Long-Term Construction Contract, IASB (2004d).

10. It is assumed that IAS 11.21 does not apply in this case.

11. Services are interpreted broadly based encompassing activities yielding royalties, rent, etc.