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Final Revenue Standard Runs into Last-Minute Hurdles

October 21, 2013

The FASB and IASB want to publish their final revenue recognition standard in early 2014. Before the document can be released, the boards have to reopen discussions on three interrelated topics that have stymied them since July. The issues include the risk that a customer will be unable to pay its bill.

The FASB and IASB have extended the timeline on their much-watched revenue recognition project, and now say they will publish a single, global standard for companies to measure revenue by early 2014.

But before they do so, they must settle three complex issues that have tripped up the boards for the past several months.

The boards plan to hold a videoconference October 30, 2013, to discuss customer credit risk, the concept of “constraint,” and accounting for some license arrangements. IASB Chairman Hans Hoogervorst said at a recent IFRS Advisory Council meeting that the FASB and IASB “solemnly pledge” for this meeting to be the last discussion on the long-running project.

The three issues are somewhat interrelated. The boards thought they had settled all three in July, but several pharmaceutical companies told the standard-setters the decisions would produce counterintuitive accounting for common arrangements, such as a drugmaker selling a drug patent to a manufacturer, and then receiving royalties based on the sales the manufacturer makes to doctors and pharmacies.

Under current U.S. GAAP, drugmakers don’t record revenues until they receive the royalties. But the FASB and IASB’s July decisions would have required them to make estimates about the sales before they happen. The companies said they were nervous that they would then have to do significant backtracking if the estimates were off, or if the drugs faced legal or regulatory hurdles.

In September, the boards put forth ideas without making a decision on adopting the changes. Several board members supported revising the proposal to make it clearer to companies on how to account for deals involving licenses of intellectual property and to apply the concept of constraint.

“Constraint” is a key consideration in determining a revenue figure. A company isn’t supposed to recognize revenue it doesn’t expect to collect, and companies have to consider a variety of factors when they report a final revenue number. The current draft of the standard says a company would always recognize a minimum amount of revenue if the business didn’t expect to perform any significant reversals—another area of concern for several companies.

The boards in September discussed reintroducing a concept from the original November 2011 proposals that required revenue to be recognized in a sale tied to royalties of intellectual property only when the sales occur. They also discussed taking a “predictive value approach,” meaning that if an estimate is a good predictor of the amount the company expects to collect, it would record that number. If the company can’t make the estimate, it would record zero.

For pharmaceutical companies, their first choice would be to reinsert the sales-based royalty wording into the proposal. If the FASB and IASB take the “predictive value approach,” however, they would like to see it worded better so companies have an easier time applying it, said James Barlow, senior vice president and corporate controller of Allergan Inc.

“We’ve got to have something that’s clearly auditable because we know the SEC, even today, challenges any up front recognition of revenue. We get comment letters saying, ‘Why did you recognize revenue here?'” Barlow said. “All this is going to do is create havoc.”

The boards also must discuss the issue of collectability—the odds of a company securing payments from customers. The FASB and IASB in July decided that companies would differentiate between deals that involve financing versus deals that don’t when it comes to transactions with customers with bad credit. Deals with bad customers would be reflected in an impairment calculation, which would be presented separately as an expense in a company’s income statement, the boards decided.

But reviewers of the draft standard told the FASB and IASB research staffs that, at minimum, the boards need to clarify what they mean. If the boards believe rewording won’t help, the staff is suggesting two paths: a threshold to determine the odds of collecting money from risky customers, or a separate, targeted accounting approach for the deals.

The revenue recognition project has been several years in the making. The FASB and IASB in November 2011 released largely converged proposals, with the FASB’s Proposed Accounting Standards Update (ASU) No. 2011-230, Revenue from Contracts with Customers, and the IASB’s Exposure Draft (ED) No. 2011-6, Revenue from Contracts with Customers.

The proposals aim to get rid of the myriad industry-specific revenue standards in U.S. GAAP and provide a single way for all companies to report sales. Under the proposals, businesses would report revenue in the amount they expect to receive. They would follow five steps to determine the amount of revenue they will recognize.

The standard-setters originally said they wanted to publish the final standard by the end of summer, but that deadline got moved to the fourth quarter and now to early 2014.

“It just goes to show you how complex this is,” Barlow said.