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New Revenue Recognition Standards May Affect International Business

By Megan Doyle

New revenue recognition standards that experts expect to vastly change the international business landscape became effective in January 2018, based on rules implemented jointly by the U.S. Financial Accounting Standards Board (FASB) and the global International Accounting Standards Board (IASB). The updates, FASB's Accounting Standards Update (ASU) 606 and IASB's International Financial Reporting Standard (IFRS) 15, both titled Revenue From Contracts with Customers, join forces to promote comparability of financial reporting between different countries by alleviating existing conflicts and complexities associated with different international business practices; they are implemented through a series of amendments that create global accounting standards for revenue recognition.1

Announced in 2014, the new standards are based on a single overarching principle: domestic and international businesses must recognize revenue when goods and services are transferred to the customer, in an amount that is proportionate to what has been delivered so far.2 The new approach is set to create a single revenue recognition model followed by industries internationally.3

 

Despite having three years to prepare for the change, many companies put planning on the backburner. According to a year-old PriceWaterhouseCoopers (PwC) survey, just over half of the companies they surveyed had "not even chosen a method of adoption" yet.4

 

What is a Revenue Recognition Performance Obligation?

 

 

The major amendment to the financial reporting standards is that revenue should no longer be recognized when cash is received. Instead, domestic and international businesses must recognize revenue when performance obligations are met.5 A performance obligation is defined as "the selling entity's promise to transfer some kind of good(s) or service(s) to its customer."6 In addition to services and goods, performance obligations can include activities like delivery of goods, money back guarantees, and warranties.7 In other words, revenue can only be recognized when "the customer can use or benefit from the good(s) or service(s)" the selling entity has provided.8

 

To help identify performance obligations and realize their satisfaction, ASC 606 and IFRS 15 enforce a five-step model:

 

  • Identify the contract with a customer,
  • Identify the performance obligations in the contract,
  • Determine the transaction price,
  • Allocate the transaction price to each of the performance obligations in the contract, and
  • Recognize revenue when the entity satisfies a performance obligation.9

 

The five separate steps focus on the "nature, amount, timing, and uncertainty of revenue and cash flows from contracts with customers."10 In other words, transparency becomes much more granular, and more accurate disclosures are expected to help prevent future economic meltdowns.11

 

International Business May Feel Most Impact

 

Any entity that enters into contracts with customers to transfer goods or services in exchange for payment will be affected by the new regulations.12 The convergence of ASC 606 and IFRS 15 impact accounting and reporting standards at a global scale, affecting investors, accounting professionals, stock markets, corporate management, and more.13 Domestic and international businesses that often change terms of a customer contract will likely feel the greatest effects. Whenever a customer contract is altered, the standards require businesses to reassess performance obligations and reallocate revenue or defer recognition, if necessary.14

 

Otherwise, international business will feel the bulk of the changes, considering the change is meant to establish a global standard for revenue recognition. To further reduce the complexity of doing international business, U.S. buyers familiar with GAAP may wish to gain an understanding of IFRS reporting, and vice versa.15

 

For example, different international shipping terms with their own characteristics, such as Free on Board (FOB) and Cost Insurance and Freight (CIF), have varying standards for recognizing when a performance obligation has been met.16 Knowing exactly at what point in the supply chain to recognize the sale of goods is a crucial aspect of the new revenue recognition standards. The International Commerce Terms (Incoterms), published by the International Chamber of Commerce (ICC), provide clear guidance on costs and risks associated with delivery and transportation of goods to the international community.17 Understanding the differences in arrangements may be useful to accurately recognize revenue in international transactions.

 

What It Means for International Businesses

 

The convergence of ASC 606 and IFRS 15 is predicted to promote clarity, transparency, and comparability of financial reporting between different countries. With more international understanding and a closer alignment of global accounting standards when doing business, the possibility for increased capital flow and international investments could increase.18 Ease of reporting revenue may also enhance efficiency, making uniform information more readily available.19

 

But the benefits may not be noticeable quickly. According to Financial Executives International's news publication, it will take experienced accounting professionals about nine months of active use to "get up to speed" on the new standard, and twice as long for the average company to fully adapt to the new standards.20

 

And despite the shrinking differences between the U.S. GAAP and the IFRS, there are still differences in their respective methodologies to take into account when adopting either set of standards. U.S. GAAP has more complex and specific guidelines and rules, which aim to create a walkthrough for any possible contingency. On the other hand, the IFRS has fewer detailed rules, opting for a principle-based big picture approach centered around objectives for good reporting.21 According to PwC: "Understanding these differences and their impact on key deal metrics, as well as both short- and long-term financial reporting requirements, will lead to a more informed decision-making process."22

 

With 71 percent of CFOs saying, "revenue recognition programs are not yet complete" as of 2017,23 it is worth nothing that companies that do not comply with or are not fully prepared for the new revenue recognition standards could see fines, loss of investor confidence, or restatements. But there are options to help ease the transition.24 The IFRS offers training materials for international businesses to use, and Deloitte offers a free training e-module.25

 

The

Takeaway:

Adopting the new revenue recognition standards may seem like a major hurdle in the upcoming year for all companies. Small domestic businesses may see an increase in paperwork, but increased transparency could prevent future economic problems. For international business, a more homogenized set of standards may make international trade more feasible than before.

Megan Doyle - The Author

The Author

Megan Doyle

Megan Doyle is a business technology writer and researcher based in Wantagh, NY, whose work focuses primarily on financial services technology.

Sources

1. “The Impact Of Combining The U.S. GAAP And IFRS,” Investopedia; https://www.investopedia.com/articles/economics/12/impact-gaap-ifrs-convergence.asp
2. “ASC 606 is the Biggest News Story You’ve Never Heard: How it Will Affect Your Company,” Zuora; https://www.zuora.com/2017/08/10/asc-606-is-the-biggest-business-story-youve-never-heard-how-it-will-affect-your-company/
3. “A revenue rule change is coming and every company will be affected,” MarketWatch; https://www.marketwatch.com/story/a-revenue-rule-change-is-coming-and-every-company-will-be-affected-2017-07-13
4. 2016 revenue recognition survey, PwC; https://www.pwc.com/us/en/audit-assurance-services/accounting-advisory/assets/2016-PwC-FERF-rev-rec-survey.pdf
5. FASB Accounting Standards Update: Revenue from Contracts with Customers (Topic 606), FASB; https://asc.fasb.org/imageRoot/32/79982032.pdf
6. “What You Need to Know About ASC 606,” Treasury & Risk; http://www.treasuryandrisk.com/2017/11/02/what-you-need-to-know-about-asc-606?ref=hp-featured&slreturn=1511823454
7. “Countdown to IFRS Doomsday: The Road to Revenue Recognition,” FEI Daily; http://daily.financialexecutives.org/countdown-ifrs-doomsday-road-revenue-recognition/
8. “The New Revenue Recognition Standard in Plain English,” Journal of Accountancy; https://www.journalofaccountancy.com/newsletters/2016/mar/revenue-recognition-standard-in-plain-english.html
9. FASB Accounting Standards Update: Revenue from Contracts with Customers (Topic 606), FASB; https://asc.fasb.org/imageRoot/32/79982032.pdf
10. “What You Need to Know About ASC 606,” Treasury & Risk; http://www.treasuryandrisk.com/2017/11/02/what-you-need-to-know-about-asc-606?ref=hp-featured&slreturn=1511823454
11. Ibid.
12. FASB Accounting Standards Update: Revenue from Contracts with Customers (Topic 606), FASB; https://asc.fasb.org/imageRoot/32/79982032.pdf
13. “The Impact of Combining The U.S. GAAP And IFRS,” Investopedia; https://www.investopedia.com/articles/economics/12/impact-gaap-ifrs-convergence.asp
14. “ASC 606 & IFRS 15: What are the changes?”, Sage Intacct; https://www.sageintacct.com/blog/asc-606-ifrs-15-what-are-changes
15. “The Impact of Combining The U.S. GAAP And IFRS,” Investopedia; https://www.investopedia.com/articles/economics/12/impact-gaap-ifrs-convergence.asp
16. “IFRS 15 and INCOTERMS (Revenue Recognition of Export Sale),” LinkedIn; https://www.linkedin.com/pulse/ifrs-15-incoterms-revenue-recognition-export-sale-muhammed-bilal
17. “Understanding the Impact on Revenue Recognition and Inventory Based on International Shipping Terms,” MKS&H; https://mksh.com/impact-revenue-recognition-inventory-based-international-shipping-terms/
18. “The Impact Of Combining The U.S. GAAP And IFRS,” Investopedia; https://www.investopedia.com/articles/economics/12/impact-gaap-ifrs-convergence.asp
19. Ibid.
20. “Countdown to IFRS Doomsday: The Road to Revenue Recognition,” FEI Daily; http://daily.financialexecutives.org/countdown-ifrs-doomsday-road-revenue-recognition/
21. “IFRS FAQs,” IFRS; https://www.ifrs.com/ifrs_faqs.html - q11
22. The importance of being financially bilingual, PwC; https://www.pwc.com/us/en/cfodirect/assets/pdf/the-importance-of-being-financially-bilingual.pdf
23. EY 2017 Revenue Recognition Survey, Ernst & Young; http://www.ey.com/Publication/vwLUAssets/EY-2017-revenue-recognition-survey/$FILE/EY-2017-revenue-recognition-survey.pdf
24. “What You Need to Know About ASC 606,” Treasury & Risk; http://www.treasuryandrisk.com/2017/11/02/what-you-need-to-know-about-asc-606?ref=hp-featured&slreturn=1511823454
25. “Countdown to IFRS Doomsday: The Road to Revenue Recognition,” FEI Daily; http://daily.financialexecutives.org/countdown-ifrs-doomsday-road-revenue-recognition/

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