Accounting: The Language of Business - Vol. 2 (Intermediate: Part 134)

As part of the tradition of learned monks conducting high-level scientific and philosophical research in the 15th century, Italian monk Luca Pacioli revamped the common bookkeeping structure and laid the groundwork for modern accounting. Pacioli, who is commonly known as “the father of accounting,” published a textbook called “Summa de Arithmetica, Geometria, Proportioni et Proportionalita” in 1494, which showed the benefits of a double-entry system for bookkeeping.

The idea was to list an entity’s resources separately from any claims on those resources by other entities. In the simplest form, this meant creating a balance sheet with separate debits and credits. This innovation made bookkeeping more efficient and provided a clearer picture of a company’s overall strength. This record, however, was only for the owner who hired the bookkeeper. The general public had no access to such records—at least not yet.

*Investopedia*

Revenue Recognition (Part U)

by

Charles Lamson

Interview

MICHAEL HALL

PARTNER, KPMG

 Michael Hall 

Michael is a partner in KPMG’s Department of Professional Practice (DPP) in New York. Previously, he led KPMG’s On-Call Technical Accounting Advisory Services. He provided financial statement audits in KPMG’s Northeast Financial Services practice for 10 years, focusing on banks and mortgage banks. He has more than 28 years of experience in accounting, financial reporting, and auditing with KPMG (kpmg.com).

Revenue is an important measure of a company's success and trends and performance over time. Investment analysts measure revenue based on different indicators for each industry they follow. Over time, there has been give and take in the analysts and financial statement preparers to arrive at a revenue recognition method understandable to the analysts.

Prior to this project, there was no comprehensive revenue recognition standard adaptable across entities, industries, and capital markets. Prior U.S. GAAP was an amalgamation of revenue recognition standards adopted over time and as industries developed. Individual entities may have chosen accounting policies and approaches that differed from their industry peers. For example, applications of revenue recognition guidelines can vary among large aerospace companies because each can make different judgments on when revenue is recognizable.

Industries also formed their own accounting the practices. The original principles of revenue recognition were written well before there was a software industry. Software companies had to promote industry-specific standards. Other industries that developed industry-specific standards over time include building and construction, real estate, telecommunications, and asset management. Thus, the FASB and IASB jointly issued new revenue standards that include a five-step model to remove inconsistencies across entities, industries, and capital markets, replacing almost all existing U.S. GAAP and IFRS guidance.

The objectives of the standard include (1) removing inconsistency and weaknesses in the existing requirements to improve comparability, (2) providing more useful information through disclosure requirements, (3) providing a more robust framework for addressing revenue issues, and (4) simplifying financial statements by providing one revenue framework. The new standard provides a logical set of steps to determine whether revenue should be recognized. The lens of control, under the new rules, is intended to be a precise means of evaluating whether revenue is realized (or realizable) or earned.

Revenue is a common place for fraud because it is a significant measure of a company's success. Fraud relating to revenue recognition can come in two forms— intentional, improper revenue recognition methodology or intentional, improper recording of the transactions. Furthermore, management is often compensated based on the level of sales revenue, which can create an incentive for overstatement.

The intention of the five-step process is to allow companies to use the same framework when making judgments. The new standards don't eliminate all disparities, and we will still have differences in judgments and circumstances. Companies, even in the same industry, have different types of contracts and contract terms.

For example, assume that Company A sells widgets to Company B. Company A charges one price for both the widgets and shipping and handling. Company A generally provides replacements for widgets damaged during the shipping process. A question arises as to how many performance obligations Company A would have relating to this contract. Judgment would be applied because the potential performance obligations would be sales of widget, delivery, and potential risk of loss coverage. Then Company A would need to determine whether such performance obligations are separate and distinct or could be bundled together for purposes of allocating the transaction price. 

*GORDON, RAEDY, SANNELLA, 2019, INTERMEDIATE ACCOUNTING, 2ND ED., P. 417*

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