IMPORTANCE OF THE TIMING OF REVENUE RECOGNITION 12
Importanceof the Timing of Revenue Recognition
Moreoften than not, businesses may receive cash for products that are yetto be delivered. When a company lacks the matching principle and therecognition guidelines, it is likely to record revenues whenreceived. In such a scenario, misrepresentation of a company’sincome statement and portrayal of a picture that the said company isdoing better or worse than it is in the actual case occurs. Throughaligning revenues to the accomplishment of the sales, the incomestatement will be in a better position to reveal what happenedconcerning revenue generating activities during the accountingperiod. The timing of revenue recognition is a vital aspect in theindustrial set up. On that note, the goal of the paper will narrowdown its scope to ascertain the importance of timing of revenuerecognition in the telecommunication sector while exploiting theunique situation in the industry, and to test the impact of revenuerecognition on the characteristics of the income reported.
Importanceof the Timing of the Revenue Recognition
Revenueis perceived to be the biggest aspect presented in any organization’sfinancial statements. Considering the bottom line income, the topline revenues are radical measures not only in monetary terms but canbe used by investors to foster viable decision-making process, themovements and growths of revenue can also be used to gauge a firm’sperformance and future undertakings (McConnell,2014).Accordingly, recognition of revenue has been one of the most criticalconcerns challenging standard developers as well as accountants.According to the US GAAP, the standard of revenue recognitionproposes that earnings must be acknowledged at that time when theyare earned and realizable. In simple terms, it implies that a buyerand seller enter into an agreement to transfer goods or assets andcash payment is received in exchange. One of the most importantissues concerning revenue recognition is the timing aspect which isregarded as the appropriate theme in the sale sequence when revenuesare recognized. In the real sense, the timing of recognizing revenuesis relatively complicated for the reason that there is multiplicityin the causal revenue making trades. Businesses often have theopening to hasten revenues through primary acknowledgment, forinstance, through recognizing revenues before shipment or transfer ofthe title of the manufactured goods or at the stage when thepurchaser has the preference to delay, dismiss, or consider thetransaction to be void. Despite the increased importance to recognizerevenue in financial reporting, there is limited research inassessing recognition of revenue and its timing to be precise.According to Kasztelnik(2015), theprimary cause of the scarcity of continuous exploration in this fieldis due to the challenges that exist in procuring sufficientinformation regarding the guidelines for the recognition of incomes.Kasztelnik(2015) conductedresearch in an attempt to contribute to the literature on recognitionof incomes and the extent in which timing and the valuation error asthe key ingredients to reliability and relevance in financialaccounting.
In2014, the Financial Accounting Standard Board together with theInternational Accounting Standard Board published a new model on therevenue from the contract with customers. The guideline which iscodified as Topic 606 in the FASB and postulated under the IFRS 15 bythe IASB defines the sole broad standard for organizations to applyas an accounting treatment for revenues emanating from agreementswith customers and surpasses the most recent revenue recognitionstandard. An analysis by Deloitte to the telecommunication industryconcentrated on the proposed revenues recognition standard and alsopoints out the fundamental accounting problems and possiblecomplications for the telecom organizations. Telecom organizationswill be forced to explore whether applying portfolio approach willminimize some of the complexities of using the new standard (KPMG,2016). Since introducing the new revenue model, the IASB and the FASBhave proposed numerous amendments to the standard. PWC offers that anin-depth supplement has not been restructured to mirror every likelychange. An article by Grant Thornton (2015) sought to analyze theimpact of the new revenue recognition model on telecommunicationindustry. The article further summarized the new requirement and whatthey are intended for in the telecom sector. In yet another research,Steele (2012) focused on the convergence of revenue recognition whichwas introduced in 2010 and has since been subjected to improvementsusing the due process procedure to a finished product.
Issuesaround the Importance of Revenue Recognition
Revenuerecognition is one of the most complicated concerns that developersand accountants have to deal with on a regular basis. The prevailingGAAP standard provides industries with specific guidelines that havebeen established on ad hoc basis which is not dependable. Theaforementioned model allows revenue to be recognized when earned andrealized. The concept statement under the FASB holds that anorganization’s revenue-generating activities include producingproducts and providing services that constitute an ongoing operation.Revenues are deemed earned when the organization accomplishes what itmust do to be given the benefits represented by the income.Previously, the accounting literature failed to provide specificguidelines on the proper timing for revenue recognition fromretailing, renting, and accrediting. Additionally, there has been anincreased diversity in recognition of revenue in thetelecommunication industry. Coming 2017 may set numerous issues forthe telecommunication sector. This may include allocation of revenueto various products and services, contract modification, time valueof money, capitalization of contract costs, and disclosures (KPMG,2015).
Therevenue recognition timing may be substantially affected by theproposed model. Previously due to lack of specific guidelinesprovided under the IAS, there was more room for judgment to recognizegoods and services and their allocation to revenues. IFRS 15 proposesthat income from an agreement must be allocated to distinct productsand service on a separate selling price base. The primary challenge,therefore, would be to divide the bundled deal into specificperformance obligation and to book the contract price. According toIAS 18, telecommunication agents may offer free hardware to customersand then booked them as marketing expenses. In contrast, provisionsin IFRS 15 require that telecom agents must apportion the transactioncontract amount between incomes from the sale of the hardware and themonthly plan trade (IFRS,2016).In the end, there may be movement in the timing of revenuerecognition which implies that recognition of revenues when thecontract commences and becomes reduced as the deal progresses whetheror not it is replicated in the Billings arrangement. This can bechallenging since the implementation process will demand substantialalterations in the systems in a manner to routinely calculate andraise amounts of revenue identified on a monthly basis (Deloitte,2014).
Inthe telecommunication sector, it is not uncommon to allow customersto modify their contract to either add or get rid of services or toincrease or decline minutes. Previously, IAS standards provided onlylimited guidelines on whether a contract modification can beaccounted for in retrospect or prospectively. This results in thechange of practice for some organizations and may pose a challengefor the sector. The new guideline establishes an explicit principlefor assessing if to profit from costs, distinguish between thosecharges linked with finding a contract and those associated withfulfilling a contract (Steele,2012).IFRS 15 describes the financial component and necessitates thataccounting for these elements should be separate from the revenues.This relates to the payments made in advance as well as those inarrears. Entities may be required to integrate the time value ofmoney into permanent fees paid or earned or contracts settled beyondone year. IFRS 15 stresses the volume of disclosures in companies’interim and yearly financial statements. Telecommunicationorganizations may need to increase their efforts when preparingrequired disclosures. The telecommunication firms must ensure thatsuitable systems, policies, procedures, and internal control are inplace to report and make required disclosures (Kasztelnik,2015).
Afteryears of numerous discussions, the FASB has formulated new financialguidelines on revenue recognition. These new guidelines are meant tosupersede the longstanding organization-specific regulations.Interestingly, for many telecommunication companies, these newstandards will accelerate the timing of revenues recognition setagainst the current GAAP guidelines (Pwc,2014).Revenues can be realized at a particular point in time or in a givenperiod, which highly depends on when obligation performance is met inan agreement. The ASC (Accounting Standards Codification) the 606guideline holds that when an organization transfers its control ofproducts and services to another party over a given period, then itis presumed that the firm has met the performance obligation and atthe same time can recognize revenues over time. Thus, before anyrevenues are recognized, the firm should be able to ascertain whenthe control of products is transferred to consumers at a point intime or over a specific period. ASC 606 provides that companies mustsatisfy at least one of the three criteria just to prove that goodsand services are transferred over a certain period.
Whena criterion is satisfied, only then should the firm recognize revenueover time. In the first criteria, FASB proposes that the customerconcurrently purchases and consumes the benefits offered by thecompany`s performance as the firm engages in daily activities. Incriterion 2, the company`s performance enhances its work in processthat the consumer controls as the good are being created(AICPA, 2016).Under the third criterion, the organization’s performance fails tocreate a good and service with an alternative use to the company. Assuch, the company has an applicable right to payment. These threecriteria have the capacity to change the timing of revenuerecognition for telecommunication companies. Additionally, the mostrecommended method for recognizing revenue in telecommunicationindustry would be the proportional performance method. The method isconsidered as an adjustment of the percentage of completion approachwhere expenses utilized are allowed for estimations to recognizerevenues rather than be allotted to specific parts of the amountaccomplished(Pwc, 2014).Revenue recognized is computed by multiplying direct costs oftransactions and the total revenue from completed transaction toobtain the direct cost of individual performance.
Themost important aspect of the new standards is that it willsignificantly affect the financial reporting. As such, companies willbe obliged to begin sharing product roadmaps with their clientsbecause it will not delay revenue recognition until new attributesare made commercially accessible. Given the importance that the newrevenue recognition guidelines present on recognizing customercontracts, organizations will be required to consider whether thelegitimate requirements can be adapted to mirror the existingbusiness practices better. Likewise, with the new set of guidelines,companies will be forced to update their systems, internal controls,processes, as well as policies (Deloitte,2014).
Steele(2012) identified that the proposed revenue recognition model wouldsignificantly affect the current standards in many ways. Steeleconducted research on two firms i.e. the AT & T and Verizoncompanies. In the wireless category, Verizon earns its revenues byoffering access and usage of its system services. The access incomeis to be paid one month prior and is acknowledged when received. Itsusage revenues are to be paid in debts and are accepted when servicesare facilitated. On the other hand, AT & T collects incomes fromthe data, video, telephone, long distance, wireless services whichare recognized when services are rendered. This is based on theperiod, usage, and other proven fee programs. Studies were made onthe before and after IFRS operating income to derive comparisons. Inthe research, the assessment of the performance of the before andafter IFRS operating revenues were carried out to address the effectsof accounting treatment for revenue recognition upon implementing thenew proposed model. The means for the before and after IFRS revenuesfor both companies were found to be at p < 0.05. The calculated thypothesis was reported to exceed the critical value for the Verizoncompany, at 4.14 > 2.78. Also, the calculated t for the AT & TCompany was found to exceed the critical value at 71.06 > 2.78.For both cases, it can be deduced that the means are dissimilarcentered on the key values table for a two-tailed test.
Thenew revenue recognition guideline details relevant procedures invarious areas concerning the reporting of revenues (KPMG,2016).It is in high hopes that the proposed model will be reliable andconsistent for not only the telecommunication entities but for everyother organization. The manner in which changes in mobile phone salesand contracts are to be reported is one of the fundamental reasonswhy telecommunication companies were the verbal commenters for thenew revenue recognition guideline. According to provisions under theASC 606, revenue recognition over a specific period is stated to bedifferent. With the introduction of the three criteria, contributesto significant impact on the timing of recognition of revenues. Forcompanies relying on industry-specific guidance, the three criteriamay be deemed more inclusive of such entities. Additionally, someorganizations may begin recognizing revenue earlier while others maydelay recognizing revenues over time. As a result, the three criteriaare designed to offer more direction on revenue recognition in pointof time and to fuse isolated industry-specific guidance in onesetting(AICPA, 2016).While applying the proportional performance method, identification ofthe overall direct costs to prompt the commencement of the servicesto be provided must be enhanced. The original revenue recognized isthen calculated by evaluating the proportion of beginning costs tothe projected expenses for project completion.
RE:FINDINGS ON THE IMPORTANCE OF THE TIMING OF REVENUE RECOGNITION
Itis high time to conduct an analysis of the nitty-gritty detailsregarding the importance of timing in recognizing revenue at thismoment. Virtually, every organization may be subjected to changes intheir daily practices due to the new financial reporting standard ofrecognition of revenue. I find that early recognition of revenueswill result to the conveyance of timely information on incomes as itis demonstrated by high simultaneous connection, with data stored ininventory returns. In general, the results generated show that earlyrecognition of revenue makes revenue reporting to be both timely andreliable.
Thenew guidelines are set to follow a five-step approach for the newrevenue recognition standard, which will be founded on the controlprinciple. Companies will transfer control over the goods andservices to the customer as the firm meets performance obligations.In the search to assist the telecom companies to conclude thatcontrol over the products is transferred, the first criterion will befor entities to use a theoretical approach to identify whether thecustomer has received benefits as the goods and services are beingprovided. The proportional performance method, which is considered asbeing the most accurate and appropriate revenue recognition methodmust be implemented. This method allows for numerous similaractivities to be completed as part of the service contract.Similarly, where services rendered are identical, revenue isrecognized within the projected number of service events.
Inconclusion, companies need to hasten their pace, in the hunt toaddress change management, which is linked to the proposed rules,despite the fact that the reporting period commences after January2017.
Withthe above in mind, it is imperative that the consideration of thetiming of revenue recognition is vital.
Iam looking forward to your input regarding the acknowledgment of thetopic at hand.
AICPA.(2016). New Revenue Recognition Accounting Standard-Learning andImplementation Plan. Retrieved fromhttp://www.aicpa.org/InterestAreas/FRC/AccountingFinancialReporting/RevenueRecognition/DownloadableDocuments/2014-09_LIPlan.pdf
Deloitte.(2014). IFRS industry insights: Telecommunication sector. New revenueStandard may require system changes and could have a significantimpact on the profile of revenue and profit recognition. Retrievedfrom deloitte.com.
FASB.(2016). Technical Corrections and Improvements to Topic 606: Revenuefrom Contract with Customers.Retrieved fromhttp://fasb.org/jsp/FASB/Document_C/DocumentPage?cid=1176168723765&acceptedDisclaimer=true
GrantThornton (2015). The impact of the new revenue recognition standardon telecommunication companies. Retrieved fromhttps://www.grantthornton.com/issues/library/articles/technology/2015/01-Telecom-revenue-recognition.aspx
IFRS.(2016). Revenue Recognition. Retrieved fromhttp://www.ifrs.org/Current-Projects/IASB-Projects/Revenue-Recognition/Pages/Revenue-Recognition.aspx
Kasztelnik,K. (2015). The Value Relevance of Revenue Recognition underInternational Financial Reporting Standards. Accountingand Finance Research,4(3),p88.
KPMG.(2016). Accounting for revenue is changing: What’sthe impact on telecommunication companies?Retrieved from KPMG.com
McConnell,P. (2014). Revenues recognition: Finally, a Standard approach forall.Investor perspectives.
Pwc.(2014). Revenue from a contract with customers. The standard is final– A comprehensive look at the new revenue model. Communicationsindustry supplement.Retrieved from PWC.com
Steele,C. A. (2012). The Convergence of US GAAP and IFRS: RevenueRecognition.