At-A-Glance
In this issue, we continue through
the joint FASB, IASB convergence process
with a review of the revenue accounting
project. Like the efforts described last
month to standardize lease accounting
throughout the world, the journey for
revenue accounting has been long and
difficult. In surprising contrast, the
JOBS Act (Jumpstart Our Business
Startups) became law in the United
States relatively quickly, and with rare
bipartisan support, even though heads of
the accounting profession were in
opposition. In our second article, we
cover the accounting-related highlights
that ease the way for the new law, while
raising warning signals as well. Finally
we enter the new frontier of Chinese
accounting standards, and that country�s
challenges to gaining acceptance from
the international financial community.
Editor Gerald E. Herter, CPA
|
|
In This Issue
|
|
Revenue Recognition Accounting
The path to convergence
On March 13, 2012, the comment period closed
on the revised Exposure Draft, Revenue from
Contracts with Customers, which was jointly
issued by the FASB and IASB on November 14,
2011. The road to a new converged standard for
revenue recognition has been even longer than
the one for leases that we covered in our last
issue. Discussions began over ten years ago in
January 2002, initially focusing on a �fair
value� model, and then shifted in 2005 to a
�customer consideration� model that was finally
developed into a Discussion Paper in November,
2008, Revenue Recognition in Contracts with
Customers.
When leases are mentioned in the United
States, FAS 13 (ASC 840) gets the most
attention. But revenue recognition is touched on
in over 100 pronouncements. While construction,
software sales and real estate are prominent in
the revenue measuring literature, a variety of
industries have their own specialized
approaches, leading to inconsistent and
sometimes contradictory methods, when making the
attempt to bring all entities under the same
umbrella. In cases where there are no industry
specific guidelines, the SEC follows four
general revenue recognition concepts: 1)
persuasive evidence of an arrangement, 2)
delivery has occurred or services have been
rendered, 3) price is fixed or determinable, and
4) collectability is reasonably assured.
For IFRS, the focus has been primarily on two
standards, IAS 11 for construction and IAS 18
for sales of goods. Here the difficulties stem
from inconsistencies between the two standards
and how terms are defined, as well as from a
lack of guidance in areas not covered. For
example, IAS 18 stipulates that revenue should
be recognized only when an entity transfers
control and risks and rewards of ownership of
the goods to the customer, while IAS 11 calls
for recognition as the activities required to
complete a contract take place, irrespective of
the transfer of control and risks and rewards of
ownership.
With these challenges, the goal became to
propose a single revenue recognition model that
would encompass all of the disparate approaches.
A daunting task that was, indeed. The general
consensus put forth in the Discussion Paper was
that the overriding concept should be one where
revenue is recognized when there is an increase
in assets, a decrease in liabilities, or both.
The idea of a contract was used, whereby a
company obtains rights to payment from the
customer and assumes obligations to provide
goods and services (the term �performance
obligation� was introduced to describe this
part) to the customer. When a performance
obligation is fulfilled (when a good or service
is transferred to the customer), revenue is
recognized. When multiple goods or services are
involved, the revenue is allocated based on what
the stand alone price of each item would be.
After the start of the contract, a performance
obligation is remeasured and a loss recognized
when it becomes �onerous,� that is when the cost
exceeds the previously determined amount.
After considering comments on the Discussion
Paper, the initial Exposure Draft was issued on
June 24, 2010. The core principle of the
proposed standard was that a company should
recognize revenue when it transfers goods or
services to a customer in the amount of
consideration the company expects to receive
from the customer. A five step process would be
applied:
1. Identify the contract with the customer.
2. Identify the separate performance obligations
in the contract.
3. Determine the transaction price.
4. Allocate the transaction price to the
performance obligations.
5. Recognize revenue when a performance
obligation is satisfied.
The proposal would be applied to all
contracts to provide goods or services to
customers, except for leases, insurance
contracts, and financial instruments..
Almost 1000 comment letters were received,
largely supportive of the core principal and the
all-encompassing nature of the proposal. But
most wanted more practical guidance for certain
items, such as how to determine the transfer of
control for service and construction contracts,
and how to identify individual goods or services
that constituted the measuring point for the
completion of specific performance obligations.
The construction industry was especially
concerned that the percentage of completion
method of recognizing revenue might be
eliminated.
Consequently, the Exposure Draft was revised
and reissued on November 14, 2011, to address
the concerns. Criteria were added for
determining the satisfaction of performance
obligations over time. Criteria were simplified
for identifying individual goods or services in
relation to specific performance obligations.
Collectability was to be treated separately and
discounting was not required when dealing with a
year or less. Estimation of variable
consideration could be done using the concept of
the �most likely amount.� Under the
clarifications, current construction revenue
accounting does not appear to be changed
significantly.
As mentioned, the comment period has ended,
and analysis and meetings are being held prior
to the hoped for issuance of the final
pronouncement, by the end of the year. This time
the comment letters are only about a third of
those received in the first go around. The new
standard would not go into effect before 2015.
For further information, see
Revenue Accounting - Joint Project of the FASB and the IASB
|
JOBS Act Becomes Law
SOX rules weakened to ease startups� access to investors
The Jump Start Our Business Startups Act was signed
into law on April 5, over the strong objections of the
heads of the AICPA, SEC and Financial Accounting
Foundation. While the hoped for result from the
bipartisan action is a stimulation of new business
activity through less burdensome regulatory measures,
the concern relates to the reduction of investor
protections put in place after the collapse of Enron and
others from massive accounting fraud in 2001.
Finding a proper balance between regulation and a
free market has been an ongoing challenge. A mere six
years after the Sarbanes Oxley Act of 2002 was put in
place to address the Enron situation, Lehman Brothers
fell, from even more sophisticated maneuvers that
financial reporting precautions were unable to
forestall. Though the Dodd-Frank Act of 2009 took steps
to deal with this latest financial meltdown, the JOBS
Act has moved the accounting safeguards back in the
other direction, for better or worse. Only time will
tell.
It may seem natural for accountants to have mixed
feelings about the new law. On the one hand, SOX
requirements produced much growth and new employment for
the profession during the first decade of the 21st
century. On the other hand, the costliness and
complexity of regulations were roadblocks to potential
companies that would have needed accountants to staff
and audit their financial functions.
The JOBS Act defines an �Emerging Growth Company�
(EGC) as a new public company that has less than $1
billion in revenue during its most recent year, and less
than $700 million in stock. It can retain this status
for up to its first five years unless it exceeds either
of those benchmarks during that period. The primary
financial reporting benefits for an EGC are:
1. Exemption from the SOX 404(b) requirement to have
internal controls audited.
2. Only two years of audited financial statements are
required in the IPO rather than three years, and
selected financial data from years prior to the two
audited years are not required.
3. Exemption from new PCAOB rules.
4. Compliance with new financial standards is deferred
until the date required for private companies.
5. Opportunity to have the SEC review a draft of the IPO
privately before public disclosure.
6. Various easings of investor community communications
and disclosures.
Other provisions of the Act under certain
circumstances allow exemption from registration for
offerings under $50 million, or for companies with fewer
than 1,000 shareholders. Also, a �crowdfunding�
provision enables up to $1 million to be raised from
individual investors in small amounts.
While the JOBS Act loosens up the rules, examples of
potential pitfalls are in the news as well. Groupon, the
�overnight� internet discount coupon sensation that
recently joined the public ranks, is now the center of
attention with questionable accounting and internal
controls. Also, MF Global, a major securities dealer is
reeling in bankruptcy from Enron-like off-balance sheet
transactions. Of course, these are not the small
companies the JOBS Act appears designed to help. But
considering that the Act can be used by companies with
up to $1 billion in sales, the perils of a Groupon with
$1.6 billion in sales are not that far from where some
companies under the Act may find themselves.
Groupon apparently has not determined an effective
way to estimate an allowance for customer refund claims.
Material weaknesses were also noted in their financial
closing process requiring manual adjustments, and a lack
of detail support and reconciliations to assure complete
and accurate account balances. With these kinds of
shortcomings cropping up in a company going through the
normal IPO process, there is no telling what to expect
from smaller companies that fall under the JOBS Act
exemptions.
As auditors, we know how difficult it can be to
estimate a bad debt allowance for a new company without
a track record. Typically, the company�s experience over
a number of years provides helpful input in what is
basically an informed judgment call. However,
prospective investors cannot be expected to have the
background of an auditor. The challenge in determining
an allowance for customer refunds is akin to that for
bad debts. This area would seem to call for especially
prominent disclosures, so that investors can better
weigh the risks of investment.
A couple other points about SOX 404(b) should be
mentioned. An April, 2011 SEC study required by the
Dodd-Frank Act analyzed the cost and effectiveness of
SOX 404(b) since its enactment in 2002. Academic
research cited in the study found that companies
required to comply with SOX 404(b) reported 45% less
restatements of their financial statements for material
misstatement. And over a six year period, 65% of the
6,000-plus restatements were from companies not required
to have SOX 404(b) audits. So financial reporting has
significantly improved as a result of SOX 404(b).
When SOX 404(b) occurs should be addressed as well.
Even prior to the JOBS Act, companies were not required
to provide an audit of their internal controls until the
first or second annual report after they went public. So
regardless of whether SOX 404(b) is considered
beneficial or not, the timing is of no help to
prospective investors.
For further information, see
JOBS Act becomes law
China Moves Toward IFRS
Major accomplishments and daunting challenges along the
way to international acceptance
When my firm performed an audit in China just over
ten years ago, I felt that our foray into Chinese
accounting standards was akin to roaming America�s �wild
west� of the nineteenth century. Granted, the country
had come a long way since early 1971, the time of my
military service in the Far East, when I gazed over a
fence to the Chinese frontier beyond, forbidden to cross
that border from Hong Kong�s New Territories.
Nevertheless, the hesitance to rely on Chinese
accounting processes and controls underscored the
perceived risk of misstatement, intended or otherwise.
By the start of the twenty-first century, the Chinese
Securities Regulatory Commission (CSRC) had been
established, preceded a couple decades earlier by the
Chinese Institute of Public Accountants (CICPA). But in
a state controlled society, real market reforms don�t
happen overnight, and decades can be required to
overcome the deeply ingrained cultural mores.
However, since that time, China has made great
strides on many fronts to enter the modern world. The
country has recognized, at least in theory, that
credible accounting standards are crucial to gaining
acceptance into the major financial marketplaces.
In 2006, Chinese Accounting Standards (CAS) were put
into effect for public companies, replacing the old
Peoples Republic of China GAAP, and aligning closely
though not completely with IFRS. Some of the differences
include adherence to the historical cost method for
valuations, pooling of interests method for business
combinations, and defined contribution pension
accounting since defined benefit plans are rare. Also,
disclosure requirements can differ, as well as a
prohibition on early adoption of IFRS amendments while
the government agency considers the impact on the
country.
Because of the different influences of regions,
industries and regulatory agencies, the pace and level
of adoption of CAS has been somewhat erratic. In some
cases, private companies will be required to come on
board also. Then in 2008, the Basic Standard for
Enterprise Internal Control was issued to promulgate a
SOX 404(b)-like approach to audited internal control
assessments.
The enormity of the shift required was pointed out by
IASB Chairman Hans Hoogervorst in a July 2011 speech in
Beijing. �Since it began its programme of economic
reform, China has sought to transition its accounting
system from one based on the needs of a planned economy
towards international accounting standards based on
market economic principles.�
Part of the challenge is a shortage of qualified
accountants. The numbers have been growing rapidly,
exemplified by a member of my own CPA staff choosing to
return to her native Shanghai to be part of the dramatic
developments. Audits have been dominated by the Big Four
firms, working on 20-25 year licenses. As these licenses
expire shortly, renewals will call for firms to form
partnerships and have signors of audits carry CICPA
membership. Operating in partnership form will instill
individual liability exposure to the CPAs, an
improvement over the past where only the entity with
limited assets could be held responsible.
Hoogervorst feels that China is well on the way to
having a trustworthy system of accounting standards. But
to overcome the well earned suspicions of the rest of
the world for such a long time, he urges the Chinese to
eliminate all remaining differences from IFRS, devise
ways to promote the understanding of the strong joint
commitment to IFRS between China and the IASB, and to
encourage more involvement by the Chinese in the
standard setting process.
Optimism is understandable from a top-down approach
that looks at the establishment of standards and
professional institutions. However, when considering the
effort required to retrain accountants and restructure
systems at the entity level, experience suggests that
there is still a long way to go. Also, while the
accounting standards put in place in 2006 may have been
closer to IFRS at the time than prior standards, IFRS
has moved on since then, leaving the country further
behind in their goal of full adoption.
Thanks to the foresight of Integra�s Global Board and
Board member Steve Austin�s multiple fact finding trips
during the past decade, Integra International is well
placed in China with three accomplished member firms and
over 300 CPAs well suited to serve the needs of our
member�s clients: .K. Cheung (CPA) Co., Limited in Hong
Kong, Shanghai Perfect CPA Partnership in Shanghai, and
Dezan Shira & Associates, a multi-national firm with
offices in those cities, as well as Beijing and cities
across China and Asia.
For further information see
China Accounting Standards
Additional A&A News
The following links provide a selection of current articles
devoted to highlighting other A&A topics currently making
news.
-
FASB, IASB tentatively agree on two financial
instrument items
-
IFAC Urges G-20 to Stop Inconsistent, Unreliable
Public Sector Financial Reporting
-
CPAs as Market Leaders for Reporting on Service
Organization Controls
-
Microsoft's Laux: Multiple Challenges Face
Accounting Profession
-
Auditors �Monkeying Around with Documents,� Top
PCAOB Cop Says
-
FASB makes decision on qualitative going-concern
disclosures
|
