Accounting for Revenue Recognition
The general concepts and principles used for revenue recognition are similar between GAAP and IFRS.
They differ in the details. GAAP provides specific guidelines for revenue recognition for many different industries, whereas IFRS does not.
The International Accounting Standards Board illustrates revenue as including both gains and revenues. When working under GAAP, revenues and gains have completely separate definitions.
Generally, the International Financial Reporting Standards principle for revenue recognition is based on the probability that the economically achievable benefits associated with the transaction will flow through to the company that is selling the goods etc.
The costs and revenues must be capable of being reliably measured. GAAP concepts such as realised, realisable, and earned are a basis for revenue recognition.
The International Financial Reporting Standards has only one basic standard on revenue recognition. It is titled IAS 18. On the other hand, GAAP has many standards related to revenue recognition. Accounting for revenue provides a most fitting contrast between the International Financial Reporting Standards principal and GAAP rules-based approaches.
There are differences on both sides. However, the International Accounting Standards Board and the Financial Accounting Standards Board have identified areas for improvement.
Revenue Recognition as Per IFRS
Revenue is recognised at the fair value of the consideration received or receivable under the International Financial Reporting Standards. GAAP measures revenue by whichever is more evidence out of the fair value of goods and services that have been given up or the fair value of goods and services received.
Under IFRS, revenue from recurring sales and services is recognised in the period in which services or goods are delivered. Revenue is recognised when the goods are transferred to customers in relation to goods. In the case of services, revenue is recognised when services are performed, and the provision for services is provided and rendered available.
Generally, the point of sales accounting is similar between both GAAP and the International Financial Reporting Standards. GAAP provides detailed guidelines. An example is accounting for the right of return and multiple deliverable arrangements. The International Financial Reporting Standards prohibit the completed contract accounting method for long-term contracts.
Percentage of Completion Method for Long-Term Contracts
Under IFRS, companies should use the percentage of completion method to account for long-term contracts. If costs and revenues are difficult to estimate, companies should recognise revenue to the extent of the costs incurred only. This means taking a cost-recovery approach.
When working with the International Financial Reporting Standards, the percentage of completion method and the cost recovery method of accounting for long-term contracts are recognised.
With the percentage of completion method, companies recognise GP and revenues each period based simply on the construction progress or, in other words, the percentage of completion of the project. Construction costs are accumulated, and gross profit earned to date is added to an inventory account. It also accumulates progress billings in a contra inventory account. This method is the same for IFRS and GAAP.
When working with the cost recovery method, contra revenue is sometimes recognised only to the extent of the costs incurred that are expected to be recoverable. Profit is recognised once all costs are recognised. The construction costs, in this case, are accumulated in the Construction in Progress inventory account and progress billings are accumulated in the Billings on Construction in the Progress contra inventory account.
The reason that the percentage of completion method of accounting for long-term contracts is used is that under most contracts, the buyer and seller both have enforceable rights. The buyer’s right is that he can legally require specific performance on the contract. And the seller legally has the right to require progress payments that provide evidence of his ownership. This result is that a continuous sale occurs as the work progresses.
Companies MUST use the percentage of completion method of accounting when the estimates of progress towards completion, revenues, and costs can be reliably estimated and ALL of the following conditions exist:
The contract revenue can be reliably measurable,
- It is probable that the economic benefit associated with the contract will flow to the company,
- The contract costs to complete the contract and the stage of contract completion at the end of the reporting period can both be reliably measured,
- And the contract costs attributable to the contract can be clearly identified and measured, so the actual contract cost incurred can be compared with the prior estimates.
Companies should use the cost recovery method when ONE of the following conditions applies:
- When the conditions for using the percentage of completion cannot be met,
- And when there are inherent hazards in the contract beyond normal business risks.