Custom «ASU on Revenue Recognition» Essay Paper Sample
Table of Contents
Financial Accounting Standards Board is very concerned with the issue of proper revenue recognition as it critically impacts the financial data. In order to facilitate the work according to the international financial reporting standards, it has organized special Transition Resource Group in cooperation with the International Accounting Standards Board. As a result of joint efforts, the revenue standard was updated several times with the latest attempt in March 2016. The goal of the latest ASU 2016-08 is to concretize the difference between the principal and agent revenue recognition principles. Moreover, this ASU followed a range of other updates and the new standard project issued by the Board in 2014. Thus, this paper aims at precise analyzing of the ASU 2016-08 on revenue recognition.
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Summary of the New Rule
A new ASU 2016-08 requires entities to determine whether they provide goods and services as principals or agents. It amends the standard by adding related criteria for such determination. The standard in ASC 606-10-55-36 now defines a principal as an entity that “controls the specified good or service before that good or service is transferred to a customer”. An agent as an entity, in turn, only has to “arrange those goods or services to be provided by the other party” (FASB, 2016).
Furthermore, the added ASC 606-10-55-36A states that entities should identify each provided good or service separately and determine if it controls each identified good or service (FASB, 2016). The recognition of the revenue then depends on the control determination which definition was also slightly changed to conform to the principal/agent issue. If an entity controls the good (as by the control criteria in ASC 606-10-55-39), it recognizes the revenue as a principal of consideration received while being an agent it acknowledges the income in the volume of fees contracted. A new ASU amended paragraphs ASC 606-10-55-36 through ASC 606-10-55-40 and added several more items with clarifications. Moreover, the new examples appeared in the standard to assist the accountants in the practical implementation of the update. The amendments presented in the new ASU take effect along with the new standard on revenue for reporting periods starting on December 15, 2017.
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FASB Reasoning for the Update
A recent update of the income standard is crucial for the proper determination of the revenue figure and, as a result, of the net profit. FASB views this ASU as rather a clarification than a change to the standard. It believes that the ASU should help in avoiding possible inconsistencies in revenue recognitions. Therefore, the update adds a guidance on whether an entity should recognize revenue in the whole amount of consideration obtained or of fees as an agent. Besides, the standard clarified that the consideration should be recognized as income only when the principal has completed or fully transferred all the performance obligations as stipulated by the contract with a customer. FASB also underlines that the ASU assists in decreasing the cost of applying the new revenue standard by reducing complexity and possible differences in understanding the rules.
Difference with the Old Rules
A new revenue standard issued in 2014 did not contain clear differentiation between a principal and an agent and their revenue recognition requirements. Along with the definitions of principal and agent entities, the ASU introduced three types of issues controlled by the principal’s or the agent’s contracts. These kinds of issues include a clear identification of separate goods or services, an existence of the right to provide them, and a combination of the own separate goods or services with those provided by an agent (see ASC 606-10-55-37A). The definition of control was slightly amended to exclude commission as a revenue consideration and credit risk exposure subparagraphs from the control criteria in ASC 606-10-55-39. However, the other old rules mainly remained unchanged (as in 2014 version of the new revenue standard) but enhanced with the principal/agent issues. Evidently, the core principle of recognizing revenue from contracts with the customers involving five steps was not changed but only clarified.
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Industries Impacted by the ASU
ASU 2016-08 influenced merely all the industries and entities that obtain consideration or agent fees from providing goods, services or rights for them. The companies that have contracts with agents providing goods or services to the final customers should pay particular attention to the ASU. In addition, the entities that do not involve third parties to earn revenue or act as agents themselves are less impacted and consider this update mostly informative. Moreover, non-profit organizations and other companies which are not receiving income from the contracts with customers seem to be not impacted by the changes imposed by the ASU 2016-08.
Impact on Financial Statements
As the new ASU influences revenue, it will affect the statement of comprehensive income and net profit of reporting entities. It is possible that revenue and net profit will change for those companies that have agent contracts and use different recognition procedure than required by the update. Consequently, the recognition of revenue might shift for later periods for principal entities due to the need to check full completion of performance obligations both by the entity itself and the contracted agent as well as finalize the transfer of the good or service to the final customer. Additionally, the revenue amount might impact the other financial statements, for example, the statement of financial position which contains an accounts receivable line directly linked to the recognition of income and consideration (or fees) to be obtained by a reporting entity.
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First of all, the ASU influences the accountants who need to reconsider their revenue recognition procedures for contracts having principal/agent relationships or present possible features of either principal or agent control over goods and services. In addition, the auditors and consultants should be aware of the update while checking the revenue line in the financial statements of their clients. The latest update less impacts the investors, creditors, tax inspectors and other parties who need only to be informed that the ASU provides further convergence in revenue recognition among different reporting entities and makes published data more reliable and comparable within the companies.
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Feedback from the Society
As the ASU was issued only a few days ago, there are very few available current opinions in the articles related directly to the introduced changes. For instance, Ernst and Young has fully supported ASU 2016-08 and underlined that it makes a lot to clarify principal and agent relationships (EY, 2016). Besides, the letters and articles on the revenue recognition project and new standard proposed in 2014 addressed the issue. One of such letters was directed to the board by PriceWaterhouseCoopers (2002) and explicitly underlined the need to differentiate between revenue recognition for goods and services as well as principal consideration and agent fees. Currently, PWC continues to discuss the income project actively and has also supported the published ASU.
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To conclude, FASB has made considerable effort to improve the revenue recognition issue. The latest ASU 2016-08 provides enough evidence that the financial reports published by various entities will include much less inconsistency since the effective date of the new revenue standard. However, the work on the revenue recognition project is still continued by the transition resource group, and more ASUs may appear before the year 2017 when the new standard gets first implemented.