Revenue recognition standards are changing, and the move will certainly affect organizations. But before we know the ‘how’ and ‘why’, it is very crucial to learn about the fundamentals.
What do you generally understand by ‘recognizing revenue’?
Generally, a company’s performance is assessed by its revenue.
Revenue recognition is an accounting principle under GAAP, where the revenue is accounted only under specific conditions.
When companies prepare financial statements they have to follow a set of accounting principles.
Accounting principles differ for each country and the GAAP is the standard accounting principle for the companies based in the United States.
Significance of Revenue Recognition Policy
A company is revenue-rich, but cash-poor.
What does this exactly points at?
Revenue recognition policies protect investors from such scenarios. Most of the time companies to cover themselves from bad sales report fake revenues. Without earning cash, the company is establishing that it has earned revenue, which is opposed in revenue recognition policy.
To fake a company’s performance before investors, most of the time revenue would be mentioned without the actual income. But when financial statements are prepared through the accounting principles it is not possible to mislead the investors.
For instance, let’s say a company has earned a business of some ‘X’ million dollars (annual), but the company cannot straightaway declare that amount as revenue, and the account for each month is to be taken into consideration before the revenue is recognized.
Deconstructing the GAAP
Generally accepted accounting principle (GAAP) is based on three set of important rules,
The basic accounting principles and guidelines.
The generally accepted industry practices.
And the detailed rules as issued by the Financial Accounting Standards Board (FASB) and the Accounting Principles Board (APB).
Similarly, IFRS (International financial reporting standards) is accounting standards developed by an independent organization called IASB (International Accounting Standards Board) for non-US or other international companies.
Irregularities were witnessed across industries concerning revenue recognition.
Also, there was a need to clarify the differences between US GAAP and IFRS standards.
In order to recognize the common principles between GAAP and IFRS, FASB and IASB together brought in a new update in the accounting standard, which was ASC 606.
Model of ASC 606
Identify a contract with a customer.
Identify commitments and performance obligations in the contract.
Determine the transaction price.
Allocating the transaction price.
Revenue recognition in the event when the company completes its contract with the customer.
The Convergence of US GAAP & IFRS Standards: What is the Impact of Single Revenue Recognition Model?
The new update came out back in 2014 and 2018 is the deadline set for organizations across the globe to implement the new financial accounting model.
Investors or shareholders will be clearly benefitted through this model, but the impact can be seen across every organization and every industry including the accounting professionals, accounting standard setters, corporate management, and stock markets.
The comforting prospect:
Increase in the inflow of international capital.
Consistency & transparency in accounting practices.
Implementing international standards will be smoother.
More global investment opportunities.
It can be either US GAAP or IFRS, but the purpose of accounting principles was to promote transparency in the financial market. With the convergence of standards, the purpose has been increased manifolds, which will foster better financial ecosystem across the globe.