The International Accounting Standards

Introduction

Accounting is referred to as the language of business. Through accounting, all financial communication of a bossiness is channeled. The scope of accounting as a discipline is so wide that it has been divided into many subgroups. These include cost accounting, management accounting, financial accounting, and so on. All these branches of accounting play different roles but all are aimed at providing the business entity with the much-needed information to make decisions.

Cost accounting is a branch of accounting that as its name indicates, is concerned with the cost management of an entity (William & Milton 99). It is concerned with providing the entity with information such as cost ascertainment, cost allocation, and so on. It is a useful branch in accounting since it helps in providing cost-related information to make such decisions as budgeting etc.

Financial accounting is the branch that is concerned about giving financial information about the historical activities of an entity (Clyde 145). It is the branch that is often responsible for the preparation of the financial statement which is then used by the external stakeholders such as the investors, shareholders, the government to make decisions. It is more concerned with the money as a measure of value economically rather than a measure of the cost of production (Wendy and Colin 203).

Since an organization has various stakeholders, there arises a need to address all the interests of these stakeholders according to their area of interest in the organization. The various stakeholders include the shareholders, the government, the potential investors, the employees, the management, the society, and many other stakeholders. Since accounting is regarded as the language of business, it needs to communicate to all these stakeholders seeking to address their various concerns.

The management of the organization would be more interested in making decisions that would propel the organization towards achieving its goals and objective. In effect, management accounting is most suited for management. The government, the potential investors, and the creditors would be interested in the financial performance of the company and as such, financial accounting would effectively address their interests (Clyde 121). It should, therefore, be noted that there is a difference between financial accounting, cost, and management accounting.

Of all these accounting branches, financial accounting tops as the most important and the most relevant to almost all the stakeholders. There are several reasons for this. One is that the auditors use financial accounting to do make reports on the financial position of the company and since they are regarded as the independent watchdogs, audited financial accounts are the most reliable of all other accounting statements. One of the elements of the financial statements is the income statement. This is a statement that records the revenues and the expenses that the company has incurred. The difference between the revenue and the expenses is what is reported as the profit or loss. One important constituent of the income statement is the revenue.

This paper discusses revenue recognition about two international accounting standards setters bodies; the US Generally Accepted Accounting Principles (GAAP) standards and the International Financial Reporting Standard (IFRS). It discusses the scope of revenue recognition as provided by these two standard setters and then compares and contrasts their provisions for the same. In the end, a discussion of the current treatment of the revenue recognition under the US GAAP and the IFRS, an evaluation of the key areas of revenue recognition within the accounting conceptual framework, and a discussion on the convergence prospects between the GAAP and the IFRS will be extensively presented. Some recommendations are also put forward in the conclusion part of the paper.

Accounting Standards Analysis of revenue recognition

The various accounting standards setters have different provisions that define and govern revenue recognition. In basic terms, revenue is referred to as the economic benefits that flow into an entity due to revenue-generating activity (Belverd and Marian112). Revenue comes from the cash received from business activities on the condition that that cash inflow results in an increase in equity. This indicates that there must be an aspect of an increase in equity for a cash inflow to be recognized as revenue. This is an important aspect of determining revenue since many other cash inflows do not constitute revenue.

A practical example of a cash inflow that does not constitute revenue is the capital injection from a shareholder of a business. These cash flows include investment cash flows such as receipts from the issue of shares, financing cash flows such as receipts from bank loans, and so on.

Revenue is, therefore, a significant part of any business undertaking and as such, its recognition is as important. There has been a worldwide concern among many business executives about revenue recognition due to its complexity. Most revenue transactions are fairly straightforward and do not pose a problem with regards to when to recognize the revenue. This is because these transactions happen at the point of sale and as such, the revenue is recognized at the point where the cash is received and the goods and/ or services are transferred to the purchaser.

However, there are other cases where recognition of revenue becomes a little bit more complicated because there is a timing difference between the transfer of goods and/ or services and the receiving of the revenue. There are various scenarios where the two world standards for revenue recognition will be studied to establish the difference in the treatment of revenue recognition. These scenarios include revenue recognition at point of sale, for services, for long-term contracts, and multiple deliverable arrangements.

Revenue recognition under GAAP

GAAP usually referred to as the United States Generally Accepted Accounting Principles, is an accounting standard-setting board whose jurisdiction is in the United States of America. This body provides guidelines under which the various financial statements are prepared in their jurisdiction. Under the GAAP there are various provisions and requirements for recognition of revenue.

GAAP defines revenue as the “…inflows pr other enhancements of an entity’s or settlements of its liabilities which emanate from delivering of goods, producing goods, rendering services, or other activities that regard an entity’s operational activities.” From this definition, it can be seen that several requirements ought to be fulfilled, under the GAAP for revenue to be recognized.

These requirements ought to be attained to recognize the revenue under the guidelines of GAAP. They include an increase in assets, reduction of liabilities owed by other companies, or both, and these must be a result of the entity’s operational activities. There are two tiers of guidance under the GAAP on revenue recognition (Clyde 70). These are Level one guidance that entails concept statements, which defines the criteria for revenue recognition, and level two guidance which provides the guidelines for various industries and economically different transactions (International Financial Reporting Group 103).

The Financial Accounting Standards Board (FASB) has a concept statement No. 5 that defines the revenue recognition and measurement of the same in financial terms of a business entity. Under GAAP, revenue is not realized until earned (International Financial Reporting Group 122). Businesses are required to recognize revenue where they have performed a bigger part of their deliverable geared towards performing their part of the contract. Once this is achieved, revenue may be recognized by such a firm.

This means, for instance, if an entity is engaged in a construction contract, the entity will be allowed to recognize revenue if and when a substantial work has been done and completed in the cases of the percentage of completion, the entity has verifiably completed the construction of a significant portion of the work. In such cases, the revenue is recognized as a percentage of the total revenue to be accrued to the project depending on the valuation criteria used.

The Securities and Exchange Commission (SEC) has in effect, adopted many of the above-named principle requirements in SAB No. 104. Three major components embody these principles. These will be discussed in succession in the ensuing text. The first one is the bill-and-hold arrangement which is a situation where a customer receives an invoice from a supplier but the products remain undelivered and under the custody of the supplier (Belverd and Marian 103). As a rule of thumb, the supplier is required not to recognize the revenue associated with the undelivered goods unless the parties establish a fixed schedule for the delivery of the said goods and/or services.

SAB 104 provides for the recognition method under such an arrangement. The only condition under which the entities will be required to recognize revenue in this arrangement is where there is an express and upfront written agreement that states that they are doing so for business and that it is reasonable to do so under the prevailing circumstances. However, it is paramount that all these arrangements be in adherence to all other accounting and financial reporting principles.

The SAB 104 also provides guidelines for revenue recognition under immaterial obligations. Immaterial obligations are the deliverables that a company is yet to honor. However, these deliverables are insignificant and immaterial relative to the portion of the work done. In effect, SAB No. 104 provides that a firm may recognize the revenues from the immaterial obligations since they are of insignificant effect to the values appearing on the financial reports. The recognition of the immaterial revenue should be accompanied by the reorganization of the associated costs through an accrual basis.

SAB No. 104 also provides for the recognition of the revenue when dealing with the nonrefundable upfront payments. Nonrefundable upfront payments are the payments that are received instead of service delivery or a sale of goods contract which are paid before or after the delivery of the services. Under SAB 104, there must be a complete transaction, and the earning process will be deemed to be complete only after such requirements are fulfilled. However, there are quite a several inconsistencies under GAAP about different industries. This is because there are over one hundred different industries in which the application of this broad guideline would bring material inconsistencies. The GAAP has as result, provided for over one hundred different industry-specific revenue recognition standards.

The major conflict under GAAP arises as to when the entity ought to recognize the revenue in the cases where the contract of sales has more than one deliverable. For instance, when an individual enters into a contract to sell a certain item, and when the cash inflows happen more than once, there is a need for a standard to address this conflict since the revenue may be recognized at the first inflow, at the middle or the last installment (Peterson 92). The revenue, in this case, ought to be recognized separately if the delivered item has a standalone value to the customer, or when the seller is in control of the undelivered portion of the remaining deliverable. This means that a portion of the deliverable, which is measured by the delivered portion is accounted for and the revenue apportioned to that part recognized (Belverd and Marian112).

Revenue recognition under IFRS

Under IFRS, the definition of revenue includes both the income and the gains. This is unlike the GAAP where there is a separate definition between the income and the gains. IFRS is more comprehensive with the definitions of income. It provides an outline of inflows and gains which constitute revenue.

Under IFRS, an entity is required to recognize revenue when there is a high level of assurance that the expected cash inflows will be realized. Under IFRS, revenue can be defined as the inflow of economic benefits if those benefits increase equity. The only exception to this is when the increase does not come from the cash received from shareholders of the company (International Financial Reporting Group 112).

Revenue is constituted by various economic benefits which in most cases are denominated in monetary terms and include cash inflows from goods and services sales, interest income, and other gains such as royalties and dividends associated with the business activities of the entity. There is also another provision under IAS/IFRS for revenue recognition. This is the revenue recognition of long-term contracts. IAS 11 gives the provisions for revenue recognition of long-term contracts.

This is a special area of revenue recognition under the IAS. This is because of the nature of long-term contracts. These are contracts that their occurrence and performance are spread over more than one accounting period. As such, there is a need to match the costs incurred in each period and also match them with the revenues to be recognized in the same period. This gives rise to the accrual basis of accounting where the revenues and costs are spread over different accounting periods.

According to the IAS/IFRS, revenue comprises the initial contract price agreed upon at the point of entering the contract and the variations that arise in the course of the contract on the condition that the variation will result in revenue (International Financial Reporting Group 127). There are, on the other hand, contract costs. These are the costs that are directly incurred by the specific project operations such as direct materials, direct labor, and so on (William and Milton 89). Other costs which are not direct costs may also be allocated to the project using the various cost allocation techniques available to the cost accountants (Belverd and Marian 132).

Under the IAS, costs are recognized in the periods in which they are incurred. During the performance of the contract, it is provided that the revenues be recognized. They should also be matched with the accompanying costs. It should be noted that the revenue is not recognized based on the costs incurred matched with the markup factor and not the payments received.

Differences between the GAAP and the IFRS/ IAS revenue recognition

The comparison between these two standards can be noted on almost all financial reporting frontiers. There are, however, several provisions of revenue recognition where the GAAP and the IFRS are either similar or result in the same outcome even though there is a different approach of both.

The basic difference between the two starts with the criterion for revenue recognition. Under the GAAP, for revenue to be recognized, it must be either realized or realizable. it must also be earned. On the other hand, under IFRS, revenue is recognized when it’s probable and it can be reliably measured that a firm will enjoy future economic benefits as a result of an operational undertaking (International Financial Reporting Group, 2012).

The other major difference arises in the treatment of deferred payments. Accordingly to the GAAP, there is not a requirement for discounting of the deferred payment to reflect the present value. A discounting technique where the present value of future cash flows is calculated is recommended by IFRS in calculating deferred payment revenue values (International Financial Reporting Group 145).

There is also a different provision between the GAAP and the IFRS about the services rendered right of refund. Under the GAAP, the right of refund prohibits the recognition revenue associated with the services rendered (Belverd and Marian 118). However, this is only allowed until that particular right has expired (Clyde 78). On the other hand, the IFRS requires that services be put into consideration to determine whether the contract can be reliably measured. If the estimation is impossible the costs incurred must be used to measure the portion of the service rendered to recognize the revenue.

There are quite a several advantages and disadvantages of the provisions of revenue recognition under the GAAP and the IFRS. The setting out of the rules and regulations to be followed when making the financial statements is usually the main advantage of GAAP reporting standards. The advantage of this is that the set of rules provides clarity in reporting and helps reduce the risk of such vices as fraud and other issues including the ability of companies to carry out comparisons among the companies in the same industry applying the same standards. The main disadvantage of GAAP as a reporting standard comes as a result of the nature of the standards which is rule-based.

This means that there is a strict requirement of the reporting entity’s stick to the rule even if adherence to these rules leads to undesirable effects such as material misstatement of revenues. It may also bring undesirable effects where the rules are not followed.

The main advantage of the IFRS as a standard is the fact that it is based on principles rather than rules and regulations. This means that the provisions set out by IFRS are consistent with the underlying reasons of the provisions. This is desirable since the accountants are allowed to defend their assumptions. The main disadvantage of IFRS is the fact that due to the principle-based approach, there is a possibility of transactions manipulation.

The main advantage of IFRS over GAAP is that the IFRS is recognized in over 120 different countries whereas the GAAP is only accepted in one.

International Standards main convergence

It has been thus far, been notably seen that there are major differences between these two accounting standards-setting boards. Financial analysts and accountants, therefore, spend time doing reconciliations between the two whenever the reporting yields different results. This usually happens whenever companies are operating under different jurisdiction that allows one of the two standards to be used separately from the jurisdiction of the parent company.

The IFRS and the US GAAP began the process of converging both standards to come up with one standard that provides a worldwide provision for financial reporting. This process was to take time and to date, the process is still incomplete. The main way of achieving this convergence was the elimination of the differences between the two standards’ provisions as well as consultations with regional and national standards bodies.

It has, therefore, become of increasing need that these two standards be converged to ensure a consistent approach to the provisions that govern the accounting profession. During a meeting held in Pennsylvania in 2009, there was a commitment made by the G-20 summit reps to complete the convergence of IFRS and the GAAP. This commitment was reached and had a two-year timeline, meaning that by the end of the year 2011, the process of convergence would be complete and that the two standards would be consistent with each other.

International convergence of accounting standards is meant to give birth to one single set of accounting standards that companies would adopt in preparing financial reports, both domestic and foreign and cross-border reporting. The commitment to convergence was boosted when in 2006 both bodies issued a joint statement reiterating their commitment and set up milestones to be achieved by the year 2008.

Currently, the progress of the convergence of the US GAAP and the IFRS has been productive and joint cooperation between the two bodies continues to yield desirable results. The progress receive positive feedback when in 2007, the SEC abolished the requirement of all companies operating in the US though not from US parents to file their financial reports under the provisions of the GAAP.

By April 2012, the joint update on the progress of the convergence indicated that there has been a substantial degree of achievement of the convergence prospects between the IFRS and the GAAP. Their convergence of the standards was divided into many projects which were supposed to be carried out separately and upon conclusion, a completion report is issued on the results. As a result, many projects have been achieved the milestone of completion. This means that the convergence is headed for success.

To date, Revenue recognition is one of the three main projects that remain in the process of convergence (International Financial Reporting Group). The IASB and the FASB however, remain committed to the completion of these three main priority projects. Ensuing is a discussion of the progress of the revenue recognition projects through the issuance of new standards and by both the IASB and the FASB.

The boards have together published three documents about the revenue recognition principle project of FASB and IASB convergence. These were issued in 2008, June 2010, and November 2011. The most recent document to be issued by the boards was November 2011 which was the revised exposure draft. It was meant to give comprehensive guidance on when and how revenue should be recognized (International Financial Reporting Group).

Since the issuance of the revised draft paper, there has not been another issuance about the revenue recognition project. However, there was a 120 day feedback period given about the revised exposure draft. In the second quarter of 2012, the boards began joint deliberations seeking to address the main issues arising from the concerns raised by the comments received from the revised exposure draft of 2011. The revenue recognition project is expected to be completed in 2013 when the final standards will be published by mid-2013.

The current standards are problematic because of the different provisions for the industry-specific activities. This is seen for instance where the provisions applicable in one industry conflict with the provisions required for another industry. This has however been addressed and the boards expect by mid-2013 to publish the revenue recognition standards that will apply to all industries except the contracts with customers on leases, financial instruments, and insurance contracts. It is expected to be a major milestone towards achieving the revenue recognition convergence project.

The new standards improved tremendously in trying to remove the inconsistencies that come about by these different standards. The standards convergence has brought about various achievements. These can be looked at on standards by a standard approach where the various standards are already completed successfully with both IAS and GAAP providing similar guidelines for the particular standards. They can also be looked at as a broad view where the accounting profession can now apply the same standards in the broad reporting perspective.

Some standards have been improved from their original provisions, others have been converged, other standards have remained the way they were due to disagreements between the two bodies. Other principles such as revenue recognition are in the process of being converged and they will soon be completed and converged. the main aim of all these convergence efforts is financial reporting.

For most firms, however, the proposed changes in the standards and the provisions of revenue recognition may not materially change the manner in how revenue recognition is recorded. However, various industries will experience major changes as a result of the FASB and the IAS convergence. These industries include the real estate/ construction industries and the technology companies. This is because the scope under which the reporting of the revenue under these industries is materially different from the other industries where the organizations operating in those industries usually experience different patterns in terms of revenue revenues.

Different industries have different ways of accounting for contractual promises (Peterson 87). In effect, there is a conflict of reporting where a firm has such a contractual promise as a revenue stream and as such, the need to recognize it separately from the other revenues whose recognition and subsequent reporting does not conflict on the basis of the two major accounting standards setting boards.

There are some limitations on the extent of the use of estimates in recognizing revenue under GAAP. This is usually seen in the technology industry. In technology industry, for instance the selling of software, the standards require that the companies provide for objective and reliable measurement of revenues before the revenue can be recognized. This is essence means that the companies trading in software sales are not allowed to provide for an estimate of the separate price of an element component of the contract. The new and revised standards will provide for separate recording and reporting of contract components prices which are stand alone by nature (International Financial Reporting Group).

Finally, there is a standard revision on dealing with the capitalization of capitalization of contract costs. This treatment will change allowing for the capitalization on condition that the capitalization is consistent with other standards. This simply means that the such costs as the sales commissions will now be recognized upfront and not accrued over time as initially were (International Financial Reporting Group, 2012).

The results of the convergence

The outcome of these standards convergence has brought in effects which are reaching far and wide. While for most firms the revised standards may have minimal effects on their reporting patterns, there are some industries that will be effected significantly. The model so proposed does not exclude any contract and as such, a few challenges will need to be addressed. The main challenge is the relevance of the of the model in terms of providing information useful for making decisions when presenting the financial statements when reporting on insurance contracts, leasing contracts, or financial instruments.

This will of course depend on the number of exceptions provided under these provisions. This is because there are different scenarios which cannot be wholesomely summed up in one provision and thus, the need for the exceptions. These exception once harmonized, will provide a consistent guideline for revenue recognition and as such, the need for the convergence of the revenue recognition provisions of the FASB and the IASB will be quenched.

Recommendation and conclusions

As seen and mentioned in the preceding discussion, the two main accounting standards setting boards; IFRS and the US GAAP ought to complete their convergence which is already in progress. Accounting is always regarded as the language for business and it is therefore, an important player in the financial reporting of a business entity. This is because it communicates the most important information to the stakeholder of the business entity. It is therefore, important that the information so communicated be reliable and relevant to the users.

The relevance and the reliability of the accounting information comes in where the different provisions are provident in order to govern the reporting and the presentation of the financial statements. The provisions of such principles as revenue recognition which differ depending on the standards being used ought therefore, to be harmonized in order to be consistent across all the industries and across the globe. The convergence of these standards will be a great milestone in the financial reporting profession since the entities will have one guideline which will either be principle based or regulatory in nature (International Financial Reporting Group, 2012).

The various means of converging these standards have been adopted and are applied accordingly. These have thus far been successful though there are some which have stalled and remain unchanged due to disagreements between the two boards. Some other standards such as the revenue recognition are still in the process of being converged. This though it is expected to take some time, will yield desirable results since the reporting in the financial statements will be uniform across the globe and the various exception will also be explained well (International Financial Reporting Group 139).

The important thing however, is that there is a continuous commitment by both the GAAP and the IFRS to ultimately converge the two standards and come up with a single financial reporting standards that will be used worldwide. This commitment is reiterated by both the FASB and the IFRS whenever there is a meeting to deliberate on the progress and issue a joint status report. It is expected that in the mid 2013 that the converged provisions for revenue recognition will be published. Then the standards of both the IFRS and the GAAP will be considered converged with regards to the principle of revenue recognition.

Works Cited

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Clyde, P. Stickney. Financial Accounting : An Introduction to Concepts, Methods, and Uses. Mason: Cengage Learning, 2010. Print.

International Financial Reporting Group. International GAAP 2012 : Generally Accepted Accounting Practice under International Financial Reporting Standards. Chichester: John Wiley & Sons, 2012. Print.

Peterson, H. Accounting for Fixed Assets. New York: John Wiley & Sons, 2002. Print.

Wendy, Carlin and Meyer Colin. “Financial Feporting under GAAP and IFRS Convergence.” Journal of Financial Economics 93.3 (2003): 12-23. Print.

William, K. and F. MIlton. Cost Accounting. Houston : Dame Publications, 1999. Print.