232 SECTION 1 The Role of Accounting as an Information System R evenue recognition accounting standards help ensure that the appropriate amount of revenue appears in each period’s income statement. That guidance has changed recently. Revenue recognition previously was based on the “realization principle,” which required that we recognize revenue when both the earnings process is virtually complete and there is reasonable certainty as to the collectibility of the assets to be received. That approach to revenue recognition created some problems. Revenue recognition was poorly tied to the FASB’s conceptual framework, which stresses a balance sheet focus that places more emphasis on recognizing assets and liabilities rather than on the earnings process. The focus on the earnings process led to similar transactions being treated differently in different industries. And, the realization principle was difficult to apply to complex arrangements that involved multiple goods or services. To address these concerns, the FASB and IASB worked together to develop a new revenue recognition standard, which the FASB issued as Accounting Standards Update (ASU) No. 2014–09, “Revenue from Contracts with Customers,” on May 28, 2014. 3 The ASU provides a unified approach for revenue recognition that replaces more than 200 different pieces of specialized guidance that had developed over time in U.S. GAAP for revenue recognition under various industries and circumstances. The ASU applies to public companies issuing reports under U.S. GAAP for periods beginning after December 15, 2016. 4 Companies have two options for adopting ASU No 2014–09: they can restate prior years presented in comparative financial statements to appear as if the company had always accounted for revenue under the ASU, or they can leave prior year financial statements unchanged and in the beginning of 2017 record the adjustments necessary to convert to the ASU. Because you need to understand the revenue recognition requirements that will be in effect during your career, we focus in this chapter on the requirements of ASU No. 2014–09. In the chapter appendix, we consider aspects of GAAP that were eliminated by the ASU but that still will appear in practice for public companies until the end of 2016. Introduction to Revenue Recognition Let’s start with the core revenue recognition principle and the key steps we use to apply that principle. These are shown in Illustration 5–1 . Revenue recognition criteria help ensure that an income statement reflects the actual accomplishments of a company for the period. 3 “Revenue from Contracts with Customers (Topic 606)” Accounting Standards Update 2014–09 (Norwalk, Conn: FASB, 2014). 4 The new revenue recognition standard is effective for nonpublic companies for annual reporting periods beginning after December 15, 2017, and for interim periods within annual periods beginning after December 15, 2018. For companies issuing reports under IFRS, the IFRS version of this standard, IFRS 15, is effective for periods beginning January 1, 2017. Early adoption of the standard is permitted for companies reporting under IFRS, but not under U.S. GAAP. PART A 5FASB ASC 606-10-05-4: Revenue from Contracts with Customers—Overall—Overview and Background—General (previously “Revenue from Contracts with Customers (Topic 606)” Accounting Standards Update 2014–09 (Norwalk, Conn: FASB, 2014)). ● LO5–1 Illustration 5–1 Core Revenue Recognition Principle and the Five Steps Used to Apply the Principle Core Revenue Recognition Principle5 Companies recognize revenue when goods or services are transferred to customers for the amount the company expects to be entitled to receive in exchange for those goods or services. Five Steps Used to Apply the Principle Step 1 Step 2 Step 3 Step 4 Step 5
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