The International Accounting Standards Board (IASB) and Financial Accounting Standards Board (FASB) will commence revising the proposals on Revenue and Lease Accounting after receiving comments from the public on how to converge and redesign the two standards.
Feedbacks came from the technology and construction sectors. Some companies also are concerned about whether the “percentage of completion” method would disappear under the new standard. For leases, most of the concerns points on how the standard addresses lease terms that tend to create uncertainty about the ultimate life or cost of the lease – especially options to renew a lease, contingent rentals, and residual value guarantees.
Companies can expect significant changes next year as the two boards set June 2011 to finalize the two standards. The two proposals will impact the current standards on revenue recognition (Topic 605 and IAS 11 & 18) and lease accounting (Topic 840 and IAS 17).
Impact on the US GAAP and IFRS
Revenue Recognition
The Exposure Draft states that “…However, the proposed guidance would differ from current practice in the following ways:
a. Recognition of revenue only from the transfer of goods or services - Contracts for the development of an asset (for example, constructing, manufacturing, and customized software) would result in continuous revenue recognition only if the customer controls the asset as it is developed.
b. Identification of separate performance obligations – an entity would be required to divide a contract into separate performance obligations for goods or services that are distinct. As a result of those requirements, an entity might separate contract into units of accounting that differ from those identified in current practice.
c. Licensing and right to use – an entity would be required to evaluate whether a license to use the entity’s intellectual property (for less than the property’s economic life) is granted on an exclusive or nonexclusive basis, an entity would be required to recognize revenue over the term of the license. That pattern of revenue recognition might differ from current practice.
d. Effect of credit risk – in contrast to some existing standards and practices, the effect of a customer’s credit risk (that is, collectability) would affect how much revenue an entity recognizes rather than whether an entity recognizes revenue.
e. Use of estimates – in determining the transaction price (for example, estimating variable consideration) and allocating the transaction price on the basis of standalone selling prices, an entity would be required to use estimates more extensively than in applying existing standards.
f. Accounting for costs – the proposed guidance specifies which contract costs an entity would recognize as expenses when incurred and which costs would be capitalized because they give rise to an asset. Applying that cost guidance might change how an entity would account for some costs.
g. Disclosure – the proposed guidance specifies disclosures to help users of financial statements understand the amount, timing, and uncertainty of revenue and cash flows arising from contracts with customers. An entity would be required to disclose more information about its contracts with customers than is currently required, including more disaggregated information about recognized revenue and more information about its performance obligations remaining at the end of the reporting period.
Leases
The proposals in this exposure draft would, in confirmed, result in significant changes to the accounting requirements for both lessees and lessors.
Changes to lessee accounting
US GAAP and IFRSs classify leases into two categories: capital leases and operating leases. Lessees would be most affected if they have a significant portfolio of assets held under operating leases, especially those with leases of property. At present, US GAAP and IFRSs account for the lease payments arising from operating leases by recognizing them in the period in which they occur. The proposals would require lessees to recognize the assets and liabilities arising from those leases.
Although the proposed changes may be less fundamental for leases currently classified as capital assets, they would result in significant changes in the measurement of the assets and liabilities arising from those leases because of the way this exposure draft proposes to account for options and contingent rentals. In addition, the pattern of income and expense recognition in the income statement would change significantly.
Changes to lessor accounting
The proposed approach to lessor accounting would differ significantly from existing US GAAP and IFRSs. Depending on the extent to which a lessor retains exposure to risks or benefits associated with the underlying asset, a lessor would apply either a performance obligation approach or a derecognition approach. There would be no separate proposed approach for leveraged leases.
If a lessor retains exposure to significant risks or benefits associated with the underlying asset, the lessor would continue to recognize the underlying asset and in addition recognize a right to receive lease payments and a lease liability. The lessor would be viewed as satisfying the lease liability continuously over the lease term, and therefore would recognize lease income continuously over the lease term.
If a lessor does not retain exposure to significant risks or benefits associated with the underlying asset, the lease would be accounted for in away similar to the current accounting for capital leases. That pattern of income recognition is similar to the pattern of revenue recognition currently required for manufacturer/dealer lessors. However, there would be significant changes in the measurement of the right to receive lease payments, the recognition of lease income and the recognition and measurement of residual assets. For such leases, the lessor would satisfy the lease liability at the date of commencement of the lease by delivering the right-of-use asset to the lessee and, thus, would recognize lease income representing the sale of the right to use the underlying asset."
Click link to download the FASB drafts
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