by Glenn Cheney

Norwalk, Conn. - Responding to an increasingly piecemeal jumble of standards relating to revenue recognition, the Financial Accounting Standards Board has taken on a broad-reaching project that aims to clarify the accounting behind one of the most crucial numbers in financial statements.

"This is a big project," said L. Todd Johnson, FASB senior project manager. "Revenue is a big number. Everybody’s got revenue, and it’s usually the biggest number in financial statements. It’s also the single largest category in causes for reasons of restatements. Revenue measures and revenue growth are important things to analysts. It’s an important number that cuts across industries."

Johnson said that the first big concerns over concepts in revenue came during the decline of the dot-com boom. These Internet companies often had little income but substantive revenue. Meanwhile, telecommunications companies were dealing in new kinds of transactions in a complex new economic environment. Bases of generally accepted accounting principles were scattered, incomplete and inconsistent.

Much of the existing GAAP is specific to industrial sectors and to specific kinds of transactions. The principles were developed on an ad hoc basis over the course of many years by various standard-setting organizations that have different levels of authority in the hierarchy of accounting principles.

"When you have a set of standards that are developed [that way], there’s no good set of threads that link it all together," Johnson said. "There are inconsistencies and holes in the existing literature, and that’s where some of the problems are originating."

Bottom-up, top-down

The board plans to develop a standard by working on two simultaneous approaches. In a "bottom-up" approach, the board will attempt to provide an inventory that will help identify inconsistencies and gaps in extant accounting literature. Concurrently, a "top-down" approach will hammer out conceptual guidance.

As it proceeds, the board will test its concepts by applying them to the specific issues that have been identified in the bottom-up half of the project. When FASB proposed the project, comment letters generally supported the idea, though recommendations on scope varied substantially.

Some wanted the board only to clarify and expand on Securities and Exchange Commission Staff Accounting Bulletin 101. Others suggested a much broader proposal that would deal with fundamental concepts and knit together statements that had been issued by the SEC, the American Institute of CPAs and FASB’s Emerging Issues Task Force and Financial Accounting Standards Advisory Council.

The big issue was whether, or to what extent, to include liability recognition within the scope of the project. "We had a number of issues pop up in other projects that concerned liability recognition," Johnson said. "We were thinking about a project just on liability recognition. At the same time, revenue recognition issues were bubbling up through the EITF. There’s a relationship between liability and revenue recognition."

Comment letters expressed no consensus on the inclusion of liability recognition. The most common advice was to avoid the issue for the sake of expediency, though several letters recognized that revenues and liabilities often walk hand-in-hand down a very poorly marked road.

The liability-related comments of PricewaterhouseCoopers were close to what the board ultimately decided. "We don’t feel that the FASB should go back at this point in time and re-address the whole issue of liability recognition, but they’re going to have to touch on liability issues if they address revenue recognition," said James F. Harrington, PricewaterhouseCoopers partner, leader of accounting and SEC technical services, and one of the authors of the firm’s comment letter.

"If they focus on the overall issue of liabilities, it will take a lot longer to get something out with respect to revenue, and there is an important need out there to have a general principles-based standards on revenue recognition that can be applied across many different industries," he added.

In assessing the comment letters, the board decided that the project should focus on revenue recognition but deal with related liability issues when they are necessarily linked to revenues.

Controversies over the project are bound to arise as FASB settles on its scope. The elimination of inconsistencies will inevitably change someone’s accounting practices and shift the curve of their recorded earnings.

One of the thornier issues will be one that the EITF has been grappling with, multiple element revenue arrangement, in which a transaction involves a bundled package of products and services that are delivered over time. Johnson cited long-term cell phone hardware-cum-service deals as a simple example. More complex situations have thrown confusion into equities markets as companies engage in transactions with, apparently, no purpose beyond producing an image of revenues.

The comment letter from Delphi Corp. called for FASB to crank out a statement as expeditiously as possible, and not just because American business can use the guidance. "This issue has been up in the air for a while, so FASB needs to show industry and investors that the board can make a decision quickly," said Cathy Rozanski, Delphi’s director of financial accounting and reporting.

"The accounting industry is under a lot of pressure today, so being an accountant isn’t as cool as it used to be. We don’t want FASB to be regulated by the government, so the board needs to say what it’s going to do and then do it quickly to keep regulators from getting involved," she emphasized.

The EITF will continue to provide guidance on revenue recognition while FASB works through the project, which may become staggeringly complex as it probes into new issues.

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