Differences between GAAP and IFRS on Revenue Recognition

GAAP vs IFRS on Revenue Recognition

In recent years, the overall market has tremendously evolved and many companies begin to have stakeholders from around the world. These stakeholders may require the financial information to be prepared under local accounting standards. This improves reliability and relevance of financial statements of the company and strengthens the trust of stakeholders. There are many countries in the world that currently permit or require IFRS for the purpose of statutory financial reporting, while many other countries have already incorporated IFRS into their local framework of accounting. This has been very successful for companies that are entering into the international market and are expanding globally.

Secondly, transactions related to mergers and acquisitions are on the rise. Companies are looking outside their borders to look for the potential targets and buyers and therefore, understanding of IFRS is crucial. Various accounting bodies from around the world are making continuous effort to bring uniformity in accounting standards and make the financial statements more comparable and reliable. Despite these efforts, there are certain differences that exist between IFRS and GAAP. The biggest difference is that fewer detailed rules and limited industry-specific guidance is provided by IFRS when it is compared to GAAP. One of the widely discussed topics is the difference of recognizing revenue under GAAP and IFRS.

Revenue is an important element of financial statement. Revenue recognition guidance under GAAP is extensive and highly detailed. It is based on a significant number of standards issued by the Emerging Issues Task Force (EITF), the Financial Accounting Standard Board (FASB), the US Securities and Exchange Commission (SEC), and the American Institute of Certified Public Accountants (AICPA). On the other hand, revenue recognition under IFRS is covered by two revenue standards and four revenue-focused interpretations. These accounting standards and interpretations are based on general principles without any exception for specific industry and without further guidance.

Following are the major differences between IFRS and GAAP for Revenue Recognition:

Recognition Criteria

GAAP – Under GAAP, the revenue recognition guidance focuses on being (a) either realizable or realized and (b) earned. According to the recognition criteria, no revenue will be recognized until exchange transaction occurs.

IFRS – All revenue transactions related to rendering of services, sales of goods, construction contracts, and others’ use of entity asset (royalties, yielding interest, etc.) are covered by two accounting standards (IAS 11 and IAS 18). The recognition criteria for each of these categories include the probable inflow of economic benefits to the entity, transfer of significant risks and rewards of ownership to the buyer, and that revenue and cost can be reliably measured. The principles related to these categories are generally applied without significant exceptions or rules.

VSOE

Vendor Specific Objective Evidence (VSOE) is a method of recognizing revenue under US GAAP that allows companies to recognize revenue of specific items on multi-item sale. The recognition criterion is based on company specific evidence that the product has been delivered.
GAAP – A Highly specialized guidance is available for recognizing software revenue and one of its aspects focuses on the requirement to demonstrate VSOE of fair value so that different software elements can be separated for accounting purpose. It is actually beyond the general requirement of fair value of GAAP.

IFRS – There is no concept of VSOE of fair value under IFRS, which makes more and more elements to meet the separation criteria under IFRS. The price of an item that is separately sold on a regular basis is considered a best evidence of the fair value of that item. However, in certain circumstances, a reasonable estimate of fair value, i.e., reasonable margin plus cost, is also an acceptable alternative under IFRS.

Contingent Consideration

GAAP – The guidance related to contingent consideration is addressed within SEC Staff Accounting Bulletin (SAB) and according to that guidance, no revenue related to contingent consideration should be recognized until the contingency is resolved as it is not appropriate to recognize revenue on the basis of probability of factors achieved. For example, no revenue will be recognized even when the services have clearly been rendered or delivery has occurred.

IFRS – If there is a probable inflow of economic benefits to the entity and revenue can be reliably measured, contingent consideration will be recognized assuming other revenue recognition criteria is met. In case any of the criteria is not met, no revenue will be recognized until all the criteria are satisfied.

Multiple Element Arrangements

GAAP – Where there are multiple deliverables in revenue arrangements, the arrangements are divided into separate unit of accounting provided deliverables meet all of the specified criteria defined under GAAP. A recognition criterion for revenue is then evaluated separately for each specific unit of accounting.

Two models are currently used to account for customer loyalty program, a multiple element accounting model and incremental cost model. The multiple element accounting model is used where revenue is allocated to the award credits on the basis of relative fair value and the incremental cost model is used when cost of fulfillment is treated as an expense and is accrued as ‘cost to fulfill’.

IFRS – The revenue is usually recognized on the basis of each transaction, but in certain circumstances, it is important to separate a transaction into identifiable components so that the substance of the transaction can be reflected. Also, at the same time, it may be required to combine two or more transactions when they are linked in such a way that a commercial nature of a transaction cannot be understood without referring to a series of transactions as a whole.

It is a requirement of IFRS that loyalty and other similar programs should be accounted for as multiple element arrangements. The fair value of the award credits, which are earned by customers on purchase of goods and services, should be deferred and recognized separately once all the revenue recognition criteria are met.

Sales of Services

GAAP –

Cost-to-cost method for service arrangements is not allowed under GAAP unless the contract falls under the scope of specific guidance for certain production type contracts or construction contracts. Companies usually apply the completed performance method or proportional performance method for such service transactions that do not qualify for these contracts. Where no output measure is available, input measures other than cost-to-cost may be used that will measure progression toward completion.

Revenue related to the sales of services is recognized on a discernible pattern and if it does not exist, straight line method will be appropriate to use. Revenue can also be deferred if a service transaction cannot be reliably measured.

The revenue cannot be recognized from a service arrangement until the expiry of right of refund. However, companies may be able to recognize revenue over a service period under certain circumstances if certain criteria available in the guidance are met.

IFRS –

Service transactions are accounted for under the stage of completion method, also known as percentage of completion method. The stage of completion can be determined by a number of methods and also include cost to cost method.

Straight line method can be used to recognize revenue if services are rendered based on indeterminate number of acts over a certain period and there is no other method that can represent the stage of completion appropriately. Moreover, revenue can be recognized to the extent of recoverable expenses incurred if the outcome of such transactions cannot be reliably measured and so, a zero profit model will be used instead of completed performance model. If it is not probable to recover cost due to the uncertain outcome of a transaction, revenue is deferred until a more accurate estimate can be made. It may also have to be deferred where the impact of a specific act is more significant than any other acts.
For service arrangements that have a right of refund, it should be considered whether the outcome of the arrangement can be reliably measured and whether it is probable that there will be an inflow of economic benefits related to service rendered. If reliable estimation is not available, the outcome is recognized to the extent of probable recovery cost that was incurred in the service arrangement.

Construction Contract

GAAP –

The guidance provided under GAAP is usually applied to account for the performance of contracts and its specifications are provided by the customer for the production of goods, construction facilities, or the provision of related services.

Percentage of completion method is usually preferred. But a completed contract method is used in a situation when management cannot make a reliable estimate. Within a percentage of completion method, revenue approach and gross profit approach are usually acceptable.
Combining and segmenting contracts are allowed in GAAP subject to certain condition, but is not a requirement so long as the underlying economics related to the transaction is fairly reflected.

IFRS –

IAS 11 deals with the construction contract of a single asset, or a combination of assets that are interdependent or interrelated in terms of design, technology, function, purpose and use, and their scope is not limited to certain industries. IAS 11 includes both cost-plus construction contracts and fixed price construction contracts.

In order to establish whether the contract is within the scope of IAS 11 or other accounting standard (IAS 18), the ability of a buyer to specify the major structural elements of design is a key indicator. The buyer’s ability to decide the structural elements of design during or before construction indicates that it is a construction contract accounting. It is not applied to the recurring nature of production of goods.

The completed contract method is not allowed in a construction contract. This IFRS applies a percentage of completion method. But when no reliable estimation is available for the final outcome, zero profit method is used. However, the gross profit method is not allowed.

Combining and segmented contracts are permitted if certain set of criteria is met.

Sale of Goods (Continuous Transfer)

GAAP – Other than the accounting of construction contracts, US GAAP does not have any specific method that is equivalent to the continuous transfer method for the sale of goods.

IFRS – When the contract for sale of goods is outside the scope of IAS 11, entity consider whether the recognition criteria for the sale of goods are being met continuously throughout the contract. If so, an entity recognizes revenue with respect to the stage of completion by using a percentage of completion model. However, it is rare in practice that revenue recognition criteria are continually met for sale of goods as the contract progresses.

Barter Transaction

GAAP –

In case of non advertising barter transactions, it is allowed to use the fair value of goods and services received if the value surrendered cannot be clearly estimated.

In case of advertising barter transactions, the carrying amount of advertising surrendered (that is likely to be zero) will be used to record a transaction if the fair value of the asset surrendered cannot be determined.

In a barter credit transaction, it is presumed that the fair value of the barter credit received is not as clear as the fair value of non-monetary assets exchanged. It is also presumed that the fair value of nonmonetary assets cannot be in excess of the carrying value unless a higher value is supported by persuasive evidence. However, fair value of the barter credit can be taken in rare circumstances where an entity can convert such credits into cash in the near term. This practice was usually found in the historical practice.

IFRS –

If the fair value received as a result of non advertising barter transactions cannot be reliably determined, it is allowed to measure the transaction by using the fair value of goods and services surrendered.

In advertising barter transactions, revenue cannot be reliably measured at a fair value that was received for advertising services. However, a seller can reliably measure the revenue generated from such transactions at a fair value of advertising services is certain criteria are satisfied.
No guidance is given in terms of barter credit transactions and the principles discussed above should be applied, where necessary.

Extended Warranties

GAAP – Revenue generated from separately valued extended warranty or product maintenance contracts should generally be deferred and recognized as income on a straight line basis over the life of a contract. However, an exception to this rule is where the cost of performing services is incurred on other than straight line basis.

IFRS – The revenue generated from the sale of extended warranty should be deferred and recognized over the period, which is covered by the warranty. Where extended warranty is an integral part of the sale, i.e., it is combined into a single transaction, the entity should assign value on the basis of relative fair value to each of its components.

Discounting of Revenue

GAAP – Discounting of revenue is generally required when receivables are involved with payment terms exceeding one financial year, and in industry specific situations, such as, license agreements for television programs or motion pictures. The interest rate used for discounting should be based on the stated rate of interest in the instrument, or a market interest rate if it is considered that the stated rate is unreasonable.

IFRS – Revenue is discounted to present value where cash or cash equivalent inflow is deferred. In such cases, the imputed rate of interest is used for determining the amount of revenue that should be recognized and a separate interest income should be recorded over time.

The standard setting bodies are making continuous effort to develop a converged revenue recognition standard. On November 2011, International Accounting Standard Board (IASB) and Financial Accounting Standard Board (FASB) jointly released a revised Exposure Draft (ED). The ED is called Revenue from Contracts with Customers. The proposal was re-deliberated by these boards during 2012 and 2013 and a final standard was expected by the end of 2013 or at the start of 2014. However, this standard is likely to be effective in 2017 but the effective year for non-public entities that are following US GAAP is 2018. It is expected that the new model will impact the revenue recognition criteria under both IFRS and GAAP and Industries that fall under the scope of this standard will see pervasive changes.

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