Revenue Recognition and Customer Credit Risk

On June 24, the U.S. Financial Accounting Standards Board and the International Accounting Standards Board issued a proposed new joint standard for revenue recognition.

The core principle would require an entity to recognize revenue to depict the transfer of goods or services to customers in an amount that reflects the consideration that it receives, or expects to receive, in exchange for those goods or services.

To apply that principle, an entity would:

(a) identify the contract(s) with a customer;
(b) identify the separate performance obligations in the contract;
(c) determine the transaction price;
(d) allocate the transaction price to the separate performance obligations; and
(e) recognize revenue when the entity satisfies each performance obligation.

The proposals in this exposure draft are far reaching.  A lot of discussion has centered on industries that will be significantly impacted like construction, software and telecom.  However, all companies will be affected to some degree. 

One area that will be different is how the issue of collectibility is handled.  In determining the transaction price, an entity would be required to reduce the amount of promised consideration to reflect the customer’s credit risk.

Currently, SEC Codification of Staff Accounting Bulletins Topic 13, Revenue Recognition, requires collectibility to be reasonably assured before revenue is realized.  Under the new exposure draft, collectibility would not directly affect the timing of revenue recognition but is considered in determining the transaction price, thus affecting how much can be recognized. 

The requirement to reduce the amount of revenue recognized for the estimated portion that may be uncollectible includes situations in which an entity enters into contracts with customers and expects a proportion of them to default, but does not know which specific customers will default.

Implementation guidance in the exposure draft explains that if the entity enters into a group of similar contracts in which the promised consideration is required to be adjusted to reflect the customer’s credit risk, the entity might recognize revenue on an individual contract basis in the amount of the invoiced amount. The entity would then adjust the initial measurement of the receivables and recognize a corresponding reduction of revenue for the group of contracts.

How credit risk is handled is just one example of important changes proposed in this exposure draft.  Accounting for warranties, sales with right of return, bill and hold arrangements, construction contracts, contract costs and licensing arrangements are some other examples.

Have you had a chance to study the Exposure Draft Revenue Recognition (Topic 605): Revenue from Contracts with Customers?  What do you think about the proposals?

- Paul Parks | www.IFRS.com

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