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IFRS Principal of GAAP and IFRS

IFRS Principal of GAAP and IFRS

IFRS Principal of GAAP and IFRS: GAAP- Revenue recognition guidance is extensive and includes a significant volume of litera- ture issued by various US standard setters.

  • Generally, the guidance focuses on revenue being (1) either realized or real- izable and (2) earned. Revenue recogni- tion is considered to involve an exchange transaction; that is, revenue should not be recognized until an exchange transaction has occurred.
  • These rather straightforward concepts are augmented with detailed rules.
  • A detailed discussion of industry-specific differences is beyond the scope of this publication. For illustrative purposes only, we note that highly specialized guidance exists for software revenue recognition.
  • One aspect of that guidance focuses on the need to demonstrate VSOE of fair value in order to separate different soft- ware elements in a contract. This require- ment goes beyond the general fair value requirement of US  GAAP.

IFRS Principal of GAAP and IFRS

General guidance associated with contin- gencies around consideration is addressed within SEC Staff Accounting Bulletin (SAB) Topic 13 and the concept of the seller’s price to the buyer being fixed or determinable.

Even when delivery clearly has occurred (or services clearly have been rendered), the SEC has emphasized that revenue related to contingent consideration should not be recognized until the contingency is resolved. It would not be appropriate to recognize revenue based upon the prob- ability of a factor being achieved.

IFRS Principal of GAAP and IFRS

Revenue arrangements with multiple deliverables are separated into different units of accounting if the deliverables in the arrangement meet all of the speci- fied criteria outlined in the  guidance.

Revenue recognition is then evaluated independently for each separate unit of accounting.

US GAAP includes a hierarchy for deter- mining the selling price of a deliverable. The hierarchy requires the selling price to be based on VSOE if available, third-party evidence (TPE) if VSOE is not available,  or estimated selling price if neither VSOE nor TPE is available. An entity must make its best estimate of selling price (BESP) in a manner consistent with that used to determine the price to sell the deliver- able on a standalone basis. No estima- tion methods are prescribed; however, examples include the use of cost plus a reasonable margin.

Given the requirement to use BESP if neither VSOE nor TPE is available, arrangement consideration will be allocated at the inception of the arrange- ment to all deliverables using the relative selling price method.

The residual method is precluded. The reverse-residual method (when objective and reliable evidence of the fair value of an undelivered item or items does not exist) is also precluded unless other US GAAP guidance specifically requires the delivered unit of accounting to be recorded at fair value and marked to market each reporting period thereafter.

IFRS Principal of GAAP and IFRS

US GAAP prohibits the use of the cost- to-cost revenue recognition method for service arrangements unless the contract is within the scope of specific guidance for construction or certain production-type contracts.

Generally, companies would apply the proportional-performance model or the completed-performance model. In circumstances where output measures do not exist, input measures (other than cost-to-cost), which approximate progression toward completion, may be used. Revenue is recognized based on a discernible pattern and, if none exists, then the straight-line approach may be appropriate.

Revenue is deferred if a service transac- tion cannot be measured reliably.

IFRS Principal of GAAP and IFRS

A right of refund may preclude recogni- tion of revenue from a service arrange- ment until the right of refund expires.

In certain circumstances, companies may be able to recognize revenue over the service period—net of an allowance—if certain criteria within the guidance are satisfied.

IFRS Principal of GAAP and IFRS

The guidance generally applies to accounting for performance of contracts for which specifications are provided by the customer for the construction of facilities, the production of goods, or the provision of related services.

The scope of this guidance generally has been limited to specific industries and types of contracts.

IFRS Principal of GAAP and IFRS: -contract method

Although the percentage-of-completion method is preferred, the completed- contract method is required in certain situations, such as when management is unable to make reliable estimates.

For circumstances in which reliable estimates cannot be made, but there is an assurance that no loss will be incurred on a contract (e.g., when the scope of the contract is ill-defined but the contractor is protected from an overall loss), the percentage-of-completion method based on a zero-profit margin, rather than the completed-contract method, is used until more-precise estimates can be made.

IFRS Principal of GAAP and IFRS

IFRS

Two primary revenue standards capture all revenue transactions within one of four broad categories:

•    Sale of goods

•    Rendering of services

•    Others’ use of an entity’s assets (yielding interest, royalties, etc.)

•    Construction  contracts

Revenue recognition criteria for each of these categories include the probability that the economic benefits associated with the transaction will flow to the entity and that the revenue and costs can be measured reliably. Additional recognition criteria apply within each broad category.

The principles laid out within each of the categories are generally to be applied without significant further rules and or exceptions.

The concept of VSOE of fair value does not exist under IFRS, thereby resulting in more elements likely meeting the separa- tion criteria under IFRS.

Although the price that is regularly charged by an entity when an item is sold separately is the best evidence of the item’s fair value, IFRS acknowl- edges that reasonable estimates of fair value (such as cost plus a reasonable margin) may, in certain circumstances, be acceptable alternatives.

For the sale of goods, one looks to the general recognition criteria as follows:

•    The entity has transferred to the buyer the significant risks and rewards of ownership;

•    The entity retains neither continuing managerial involvement to the degree usually associated with ownership nor effective control over the goods sold;

•    The amount of revenue can be measured reliably;

•    It is probable that the economic bene- fits associated with the transaction will flow to the entity; and

•    The costs incurred or to be incurred with respect to the transaction can be measured reliably.

IFRS specifically calls for consideration of the probability of the benefits flowing to the entity as well as the ability to reli- ably measure the associated revenue. If it were probable that the economic benefits would flow to the entity and the amount of revenue could be reliably measured, contingent consideration would be recog- nized assuming that the other revenue recognition criteria are met. If either

of these criteria were not met, revenue would be postponed until all of the criteria are met.

IFRS Principal of GAAP and IFRS

The revenue recognition criteria usually are applied separately to each transac- tion. In certain circumstances, however, it is necessary to separate a transaction

into identifiable components to reflect the substance of the transaction.

At the same time, two or more transac- tions may need to be grouped together when they are linked in such a way that the commercial effect cannot be under- stood without reference to the series of transactions as a whole.

The price that is regularly charged when an item is sold separately is the best evidence of the item’s fair value.

At the same time, under certain circum- stances, a cost-plus-reasonable-margin approach to estimating fair value would be appropriate under IFRS. The use of the residual method and, under rare circumstances, the reverse residual method may be acceptable to allocate arrangement consideration.

IFRS Principal of GAAP and IFRS

IFRS requires that service transactions be accounted for by reference to the stage

of completion of the transaction (the percentage-of-completion method). The stage of completion may be determined by a variety of methods, including the cost-to-cost method. Revenue may be recognized on a straight-line basis if the services are performed by an indeter- minate number of acts over a specified period and no other method better repre- sents the stage of completion.

When the outcome of a service trans- action cannot be measured reliably, revenue may be recognized to the extent of recoverable expenses incurred. That is, a zero-profit model would be utilized, as opposed to a completed-performance model. If the outcome of the transaction is so uncertain that recovery of costs is not probable, revenue would need to be deferred until a more accurate estimate could be made.

Revenue may have to be deferred in instances where a specific act is much more significant than any other acts.

IFRS Principal of GAAP and IFRS

Service arrangements that contain a right of refund must be considered to deter- mine whether the outcome of the contract can be estimated reliably and whether

it is probable that the company would receive the economic benefit related to the services provided.

When reliable estimation is not possible, revenue is recognized only to the extent of the costs incurred that are probable of recover.

IFRS Principal of GAAP and IFRS

The guidance applies to contracts specifi- cally negotiated for the construction of a single asset or a combination of assets that are interrelated or interdependent in terms of their design, technology, and function, or their ultimate purpose or use. The guid- ance is not limited to certain industries and includes fixed-price and cost-plus construc- tion contracts.

Assessing whether a contract is within the scope of the construction contract standard or the broader revenue standard continues to be an area of focus. A buyer’s ability to specify the major structural elements of

the design (either before and/or during construction) is a key indicator (although not, in and of itself, determinative) of construction contract accounting.

Construction accounting guidance is gener- ally not applied to the recurring production of goods.

IFRS Principal of GAAP and IFRS

Completed-contract method

The completed-contract method is prohibited

IFRS Principal of GAAP and IFRS

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