Peeling away financial reporting issues one layer at a time

The Big Revenue Recognition Fizzle

“The new, converged revenue recognition standard will include substantially less industry-specific, “bright-line” guidance than many U.S. companies are accustomed to.” [italics added]

That understatement is brought to you by the Journal of Accountancy.  It’s the lede for a story on a presentation by McGladrey partner Brian Marshall in which he identified six broad areas of the proposed revenue recognition standard where issuers will have to exercise judgment, on things that were straight from the cookbook of existing US GAAP.

Maybe I’m still carrying a grudge against the Accounting Establishment for their incessant ‘IFRS is inevitable’ chanting, which may have been the cause of my tinnitus; but I don’t think I’m overly sensitive to be peeved by JofA’s use of  “will include” in the forgoing when “would include” is patently the more appropriate tense. The fact remains that the FASB is still only in the exposure draft stage, and consequential changes are surely in the works before a final standard is put to a vote by both the FASB and the IASB. It has become painfully obvious to all, including JofA’s editorial staff, that the proposal is highly controversial; and that a great many stakeholders would prefer for this convergence project to fade away, as so many others have before it.

Having once again been forced to lament that JofA is no longer the respected “journal” it once was, and is now merely a house organ for the AICPA leadership (padded with some nerdy tips on using Excel), I do welcome the coverage of thought-provoking remarks by Mr. Marshall.   But, the unasked $64K question on the revenue recognition project, is whether expected future costs will exceed benefits.

Unlike the other two major projects the Boards are grappling with – leasing and financial instruments – the revenue recognition standards work pretty well, and issuers are used to working with them.  It’s long past the time for the FASB to explain why users of financial statements can expect any benefit to come from a completely revamped approach to revenue recognition.

But, if I am going to rant over the appropriate verb tense, I should at least give JofA some credit where it is due.  It seems that with the death of “IFRS is inevitable,” the myth that “IFRS is principles-based” remains deep in the bosoms of the loyalists.  So, props to JofA for at least not comparing the “bright lines” in current GAAP to non-existent principles in the proposed replacement.

The irony, though, is that only a principles-based revenue recognition standard might constitute a real improvement to US GAAP.  If finalized in whatever form, however, the proposed standard will be trumpeted on high as the crown jewel of the last 12 years of IASB-FASB joint standard setting.  But, it will effectively have only accomplished one highly questionable thing for U.S. GAAP:  the FASB and the IASB will have adopted the same set of lousy rules – that could turn out to be a whole lot worse than current US GAAP.  But, whatever the ultimate effect on accounting quality, the injection of advisory fees that the Big Four (plus McGladrey and a few others) stand to collect will be a windfall for them.

An even sadder irony is that the FASB did start at the right place when this project was initiated more than 12 years ago.  The Board correctly and perspicuously identified how the revenue recognition rules currently in force could be improved: (1) they are not consistent with the principled ‘asset and liability’ approach the FASB has looked to for other major standards (e.g., hedge accounting); (2) they are not consistent with related topics such as leasing and insurance; (3) the guidance for recognizing revenues in the construction industry was inconsistent with other construction-like contracts and other services provided over time; and (4) there are inconsistencies in the current guidance due to a hodgepodge of industry-specific rules that were difficult to justify or to apply without being an expert on the topic.

Setting aside the reasons why the IASB needed a new approach to revenue recognition much more than the FASB did, each of these laudable objectives from the US perspective were cast aside as the FASB defended itself from wave after wave of special (i.e., non-investor) interests.  As best as I can tell, the concept of a “performance obligation” in the proposed revenue recognition standard is anything an issuer wants it to be – so as not to disrupt business as usual when it comes to revenue recognition, and so as not to encroach on accounting by lessors and insurers.  The quaintly European notion of “constructive obligations” only exists in the proposed standard for one purpose: to grant preparers with a right, but not the obligation, to smooth their earnings. Do you remember the conceptual framework project, and the goal to re-define liabilities? How about the project to distinguish liabilities from equity?  The former sits dead in the water, and the latter is plain ole dead from failure of the IASB to agree with the FASB’s principles-based proposal.

Technically, I suppose, we would be achieving a single standard (albeit with numerous scope limitations), but it’s going to require a lot of judgment to make the journal entries.  So much so, that we’re going to need a whole new “transition resource group,” ostensibly to advise both the FASB and IASB about implementation issues as they arise.  But, cynical me, senses a hidden agenda: if the Boards have invested all this time on a converged standard, no matter how bereft of principles, they’re going to make darn sure that it stays converged.  (The most important thing in that regard is to pre-empt the SEC from providing its own “interpretive guidance” that non-US issuers would have to cope with.)

What common revenue recognition rules really mean is that the the answers to the tough revenue recognition questions under that new standard, are not the best answers for the U.S. capital markets.  At most, they are the best the FASB could negotiate without having the IASB threaten to jump ship.

I suppose that from a pragmatic viewpoint, JofA’s “will” versus “would” may be splitting hairs, even though I hope that I have at least made the point that it is poor journalistic form.  Although one can always hope for the best, the likelihood is remote that the FASB could concede yet again that a convergence project has been a deplorable waste of time and effort, and must be abandoned.

For such a conspicuous failure on such a fundamental topic will get more people to question whether the FASB should continue to be recognized as the U.S. accounting standard setter for investors in public companies.


  1. Reply Jake Chazan October 17, 2013

    There are a couple of papers that you may want to look at that look at the question of rule based or principles based accounting standards form a number of different perspectives:
    Rules-Based Accounting Standards and Litigation Risk

    Principles-Based versus Rules-Based Accounting Standards and
    Extreme Cases of Earnings Management

    • Reply Tom Selling October 17, 2013


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