Shock of Recognition

A new rule for revenue recognition could raise thorny challenges for CFOs.
Kathy HoffelderDecember 6, 2013

Like a lot of CFOs, Neal Fenwick of Acco Brands, a $1.8 billion global supplier of branded office products, generally likes to defer taking an expense as long as possible. That will become more difficult under a new revenue-recognition standard slated for release by U.S. and global accounting standard-setters in early 2014.

Indeed, says Fenwick, the new standard will be among the most prominent accounting issues affecting Acco’s business next year. The standard is not scheduled to take effect until 2017, but Acco is among many multinational retail, software and telecommunications companies that are already adjusting their accounting and IT systems to accommodate the change and plan to be early adopters of the new standard.

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Among the 148 senior finance executives surveyed by CFO in September, 50% expect to expend “a great deal of” or “moderate” effort on understanding the converged revenue-recognition rules from the Financial Accounting Standards Board and the International Accounting Standards Board.

About 37% of survey respondents said they anticipate devoting at least moderate effort to a particular aspect of the new standard: adapting accounting practices for contingent revenue (when refunds are agreed on in case a vendor does not perform, for example), contract costs or sales commissions.

The new rules are certainly not all bad. U.S. generally accepted accounting principles have long required companies to recognize revenue from customer contracts at the time they transfer goods or services to customers. Now FASB and the IASB plan to give companies more flexibility in estimating and booking revenue and in determining when the control of a good or service is transferred. Corporations will still be able to recognize revenue at a specific time, but they’ll also be allowed to recognize it over a period of time.

13Dec_Outlook_p30Hard Questions
But other elements of the accounting change may prove bothersome. One big challenge is factoring in a product’s performance obligation under customer contracts, particularly when a contract is modified after product is shipped (for example, lowering the contract value to reflect a shortfall in the sales volume specified in the contract).

Manufacturers often change contract terms in such cases. Under the new revenue-recognition standard, however, when a contract modification comes after goods are shipped, the manufacturer must take a one-time charge to reflect the sales shortfall. Under the existing revenue-recognition standard, that can be amortized over the contract period. Fenwick would rather keep doing that.

The current heightened regulatory climate “is driving rules that don’t beget value,” he says. “What difference does it make whether I recognize sales when I ship product or after the customer receives it, as long as I do it consistently?”

Sellers of software services, which currently are subject to industry-specific accounting standards, could be significantly affected by the changed revenue-recognition rules, according to an August report from PricewaterhouseCoopers and [email protected] Such companies often sell product licenses that cover future periods and usually recognize revenue ratably over contract-delivery periods.

At Carena, a telemedicine solutions firm, doctors deliver online services, and the company also delivers software tools and integrates them with customers’ information-technology systems, notes Matt Thorne, the company’s vice president of finance and administration.

“What portion of the fees that we are getting is for the software we are delivering, and what portion is for the services that we are delivering?” asks Thorne. The new rules do not provide sufficient practical guidelines for making that distinction, he says.

Other industries that the new standards could affect include real estate, construction and telecommunications. “This isn’t just a financial-reporting issue,” notes Myles Corson, partner and markets leader for Ernst & Young’s financial accounting advisory services practice. Revenue recognition, he says, has “fundamental commercial consequences for the business. It impacts the ability to forecast when you are going to need resources.”

Still, some finance chiefs are on board with the concept that bringing GAAP and international financial reporting standards more in line with one another is a positive development for the ever-developing global marketplace.

For example, new IFRS standards for contract-acquisition costs, known in the United States as slotting fees for store shelf space, should help manufacturers that scramble for such space. That’s because the fees will now be amortized over the period during which the goods are sold, which is similar to GAAP standards. The IASB is also eliminating a tough IFRS amortization requirement, “which will make it easier for retailers to recognize all the income in one go,” Fenwick says.

FASB and the IASB, for their part, are gearing up for any implementation difficulties the new standard may bring. The boards created a joint transition resource group so companies and other stakeholders can discuss the application of the requirements before 2017.