Of course, with such a significant change, there are bound to be questions and concerns. Here are a few that have occurred to me.

1. One of the debates we had in the early days of this project was whether to define revenue, or just address how revenue should be recognized. As this exposure draft makes clear (see paragraphs 1-2), the boards ultimately decided not to define revenue, but instead only to address when revenue is recognized in contracts with customers. This made me wonder whether the boards will be happy with revenue being recognized in the absence of contracts with customers. Does revenue recognition require a customer? Apparently not. Revenue is recognized today for changes in the value of some mineral, biological or agricultural assets (IAS 41), even in the absence of a contract with customers. Why do we get a difference for revenue recognition principles across various industries or types of assets? The proposed new standard scopes out non-contractual situations (such as biological and agricultural assets) as well as contractual situations (such as leases, insurance, financial instruments, and guarantees). Conspicuously absent from the exposure draft is any rationale for scoping these areas out of the proposed standard. From experience working on this project, I’m guessing that’s because there was no general agreement about WHY these would be scoped out. There is simply a consensus that they should be scoped out. Wouldn’t it be great if the boards could provide some rationale for scoping out particular types of transactions?
2. The exposure draft states that an entity shall account for each promised good or service as a separate performance obligation only if that good or service is distinct (see paragraph 22). A good or service is distinct if either (a) an entity  sells an identical or similar good or service separately, or (b) the entity could sell the good or service separately because (i) it has a distinct function AND (ii) it has a distinct profit margin. My question–how do you know whether something has a distinct profit margin unless you (or someone else) actually sell that something separately? And if you already sell it separately, then there’s no need for condition (b). The exposure draft states that a distinct profit margin exists if that good or service is subject to distinct risks and the entity can separately identify the resources needed to provide the good or service. This is one area of the proposed new standard that I think people may have some difficulty with—determining whether a potentially separate good or service has distinct risks. If there’s anything our recent past has taught us, it’s that people are pretty bad at identifying and quantifying risks. Who knows, perhaps it won’t be so hard to do for revenue recognition purposes! (By the way, don’t misinterpret my tone here…I actually like the direction the boards have gone with this guidance, but I think it will be a little perplexing at first.)
3. Determining the transaction price in a contract receives lots of attention in the exposure draft. The boards decided that the transaction price should be adjusted based on the time value of money (if financing is a significant component of the arrangement), customer creditworthiness, collectibility, any non-cash consideration received from the customer, and any consideration payable to the customer (such as rebates). I don’t really have a question here, but I do want to highlight how this will be a significant departure from past practice in some situations. Previously, revenue would not be recognized in some situations if certain criteria were not met, for example in real estate sales. If the criteria were met, revenue for the full contract amount would be recognized. Instead of asking whether to recognize revenue, this standard moves more toward asking how much revenue to recognize. So, for instance, if you have sufficient history selling real estate to particular classes of customers, and your history suggests to you that 60% of the time customers follow through with their promises to pay over time, then either through discounting with a high interest rate or through an adjustment due to collectibility, you would recognize the sale of real estate at a drastically reduced amount. Any amount received beyond the original revenue recognized would be treated as a gain or loss. Personally, I think this is an improvement over the criteria approach, but it has its own problems as well, including the estimation process required to determine the amount of revenue to recognize in such a sale.

I’ll stop here for now. I still want to go through the application guidance with a finer tooth comb, but I’m pretty impressed with most of what I’ve read. As much as the project was originally conceived to be a general standard on revenue to replace all other revenue standards, I think the boards have appropriately scaled back their ambitions to focus strictly on settings where a contract with a customer exists. This represents the lion’s share of situations in which revenue is recognized today, and the proposed new guidance will not change most accounting out there. However, what it does change could be pretty significant—including construction contracts, real estate sales, and software revenue recognition. I look forward to reading the comment letters over the next few months!

In summary, the core principle [of revenue recognition] would require an entity to recognize revenue to depict the transfer of goods or services to customers in an amount that reflects the consideration that it receives, or expects to receive, in exchange for those goods or services.

To apply that principle, an entity would:

(a) identify the contract(s) with a customer;

(b) identify the separate performance obligations in the contract;

(c) determine the transaction price;

(d) allocate the transaction price to the separate performance obligations; and

(e) recognize revenue when the entity satisfies each performance obligation.

I haven’t had a chance to look and see if there are many surprises.  For now, let me just remind readers of the new terminology under the Accounting Standards Codification (ASC).  This document is a Proposed Accounting Standards Update (ASU), and when it is approved, it will substantially modify Topic 605 of the ASC, which covers revenue recognition.  But it will also make changes to a host of other Topics — read ‘em and weep!

 340-20 Other Assets and Deferred Costs—Capitalized Advertising Costs

 360-20 Property, Plant, and Equipment—Real Estate Sales

 430-10 Deferred Revenue—Overall

 470-40 Debt—Product Financing Arrangements

 605-15 Revenue Recognition—Products

 605-20 Revenue Recognition—Services

 605-25 Revenue Recognition—Multiple-Element Arrangements

 605-28 Revenue Recognition—Milestone Method

 605-30 Revenue Recognition—Rights to Use

 605-35 Revenue Recognition—Construction-Type and Production-Type Contracts

 605-45 Revenue Recognition—Principal Agent Considerations

 908-605 Airlines—Revenue Recognition

 910-605 Contractors—Construction—Revenue Recognition

 912-210 Contractors—Federal Government—Balance Sheet

 912-275 Contractors—Federal Government—Risks and Uncertainties

 912-605 Contractors—Federal Government—Revenue Recognition

 915-605 Development Stage Entities—Revenue Recognition

 922-430 Entertainment—Cable Television—Deferred Revenue

 926-430 Entertainment—Films—Deferred Revenue

 926-605 Entertainment—Films—Revenue Recognition

 926-845 Entertainment—Films—Nonmonetary Transactions

 928-430 Entertainment—Music—Deferred Revenue

 928-605 Entertainment—Music—Revenue Recognition

 932-605 Extractive Activities—Oil and Gas—Revenue Recognition

 940-605 Financial Services—Brokers and Dealers—Revenue Recognition

948-605 Financial Services—Mortgage Banking—Revenue Recognition

 952-340 Franchisors—Other Assets and Deferred Costs

 952-605 Franchisors—Revenue Recognition

 952-720 Franchisors—Other Expenses

 954-430 Health Care Entities—Deferred Revenue

 970-605 Real Estate—General—Revenue Recognition

 972-430 Real Estate—Common Interest Realty Associations—Deferred Revenue

 972-605 Real Estate—Common Interest Realty Associations—Revenue Recognition

 974-605 Real Estate—Real Estate Investment Trusts—Revenue Recognition

 976-310 Real Estate—Retail Land—Receivables

 976-605 Real Estate—Retail Land—Revenue Recognition

 978-310 Real Estate—Time-Sharing Activities—Receivables

 978-340 Real Estate—Time-Sharing Activities—Other Assets and Deferred Costs

 978-605 Real Estate—Time-Sharing Activities—Revenue Recognition

 980-605 Regulated Operations—Revenue Recognition

 985-605 Software—Revenue Recognition

Also, keep in mind that if this is passed, no one will ever refer to the particular ASU the way we do SFAS 13 or SFAS 157.  Instead, we simply have a revised codification.

“June 30, 2011, is an arbitrary deadline and it’s not one that’s been put in place by the SEC or by our road map,” said Kroeker. Citing FIN 46(R) as an example of an accelerated project that later needed to be reworked, Kroeker said that what’s most important is to ensure through the exposure process that the final standards are a “long term, sustainable solution.”

I suspect the FASB is not all that surprised by Kroeker’s view, given how good the lines of communication typically are between the FASB and the SEC. However, I suspect the IASB and other supporters of a single, global accounting standard will be a little surprised and will interpret Kroeker’s comments as (further) evidence that the US will not be adopting IFRS any time in the near future. They may even increase the volume on their arguments that the IASB should not give so much preferential treatment to the FASB and SEC in its standard setting activities. Should make for some interesting articles over the next few weeks!

As a quick reminder, the IASB reached a tentative decision in the revenue recognition discussion paper that onerous contracts (ie, those for which the expected remaining costs exceed the carrying value of that liability) would be measured at cost. The recently re-exposed IAS 37 proposes that onerous contracts be measured as follows:

36A An entity shall measure a liability at the amount that it would rationally pay at the end of the reporting period to be relieved of the present
obligation.

36B The amount that an entity would rationally pay to be relieved of an obligation is the lowest of: (a) the present value of the resources required to fulfil the obligation, measured in accordance with Appendix B; (b) the amount that the entity would have to pay to cancel the obligation; and (c) the amount that the entity would have to pay to transfer the obligation to a third party.

When I first read this guidance, I thought for sure that the boards had chosen a different measurement approach for onerous contracts in IAS 37 than for onerous contracts in revenue recognition. Specifically, the IAS 37 approach would include a margin that a third party would charge on top of its own costs if the price that third party charged was less than the entity’s own expected costs. In other words, the proposed new IAS 37 approach would be more akin to an exit price for the liability. This definitely would have been at odds with the proposed accounting for onerous contracts under the revenue recognition model. But then I read just a little bit further into the IAS 37 exposure draft appendix B:

B8 Some types of obligation will be fulfilled by undertaking a service at a future date. Subject to the exception in paragraph B9, the relevant outflows for such obligations are the amounts that the entity would rationally pay a contractor at the future date to undertake the service on its behalf: (a) if there is a market for a service, the amount is the price that the entity estimates a contractor would charge at the future date to undertake the service on the entity’s behalf. (b) if there is not a market for the service, the entity estimates the amount it would charge another party at the future date to undertake the service. The estimates shall include the costs the entity expects to incur and the margin it would require to undertake the service for the other party.

B9 If the obligation is an onerous contract arising from a transaction within the scope of IAS 18 Revenue or IFRS 4 Insurance Contracts, the relevant future outflows are the costs the entity expects to incur to fulfil its contractual obligations. 

That last paragraph basically says that if the onerous contract is part of a contract with a customer within the scope of IAS 18 or IFRS 4, then the onerous contract is measured only at cost with no additional margin that a third party or the entity itself would charge for those same services. While I can appreciate the simplicity of this approach for most revenue contracts (and in fact, I tend to agree with that approach), this is yet one more instance in which a liability to perform similar services can potentially be measured in the financial statements at a different amount, depending on whether that service is part of a contract with a customer or outside of a contract with a customer. Although I have no alternative to suggest to this mixed-attribute approach for identical liabilities, I can’t help but feel frustrated with the outcome. Ah, if only the things we want to measure in life would make themselves easier to measure—but then again, the value of accounting would probably be greatly diminished if that were the case.

One alternative perspective that I believe is consistent with the conjecture that Jeff made is the idea that maybe what we should be trying to measure is value-added activities.  This seems consistent to me with what equity investors are really after in thinking about performance during a period:  How much value did the firm create during the period?  Such a definition of revenue is, I think, consistent with the conceptual framework, in that it embraces the notion that revenue is equal to the non-owner-related increase in net assets during the period.  I believe it is also consistent with the revenue recognition methods currently employed in the agriculture industry, as well as in the application of the percentage of completion method used for long-term contracts.

This approach is not inconsistent with the customer-consideration/performance obligation approach, in that satisfaction of a performance obligation, which is the trigger for revenue recognition in the proposed model, would also be considered a value-adding activity.  But it seems that the value-added approach might be more general, in that it would not necessarily require a customer relationship to recognize revenue. 

One simple example that occurs to me is that of a retailer, who buys merchandise from a supplier at “wholesale” prices.  By the act of locating such goods and “re-locating” those goods to a specific retail location, the retailer has created value that its customers could not readily do (i.e., they do not have access to wholesale prices).  Abstracting from errors in judgment as to how many items to acquire, spoilage, etc., one could argue that once the goods are in the store, offered for sale, the value-creating activity has been completed, even before any customers actually purchase the goods.  The retailer could conceptually recognize revenue under this approach upon the act of putting the items on display in the store.  This would make retail accounting similar to that of the timber or farming industries under current practice, where the sale to the customer is considered less critical than the production of the saleable items.

There are serious measurement issues, and non-trivial issues about the prospect of recording “sales” revenue prior to a sale taking place, but I’m wondering if the “value-added model” might overall have more or fewer complicated issues overall than the customer consideration model.  I’m also wondering what sorts of approaches taxing authorities use in jurisdictions where there are value-added taxes.  Might those approaches be used as a means of building a revenue recognition model for financial reporting purposes?

Usually, the only philosophical terms we use are ‘normative’ and ‘positive,’ and I think many of us are pretty comfortable with the notion that standard setters are trying to answer normative questions (what should we do), and that academic researchers can help out by providing positive evidence on what happens, how it happens and why.  (My thoughts on that in this post, called Unabashedly Normative).

Thinking more about the issue leads me to note a different but related distinction between two ways of thinking about the what standard setters should do.  In the philosophy of ethics (the mother of normative questions), people distinguish between deontological and consequentialist methods of answer the question of what people should do.

Deontology (the science of duty) looks to intrinsic definitions of good and bad actions without reference to the consequences of those actions.  For example, arguing that lying is bad because it is forbidden by the 10 commandments would be a deontological argument.  In contrast, consequentialists would argue that lying is bad because it causes bad outcomes (a lack of trust, which leads to the breakdown of society, etc.).

Discussions at the Financial Reporting Issues Conference make me think that standard setters start with a largely deontological view of financial reporting, with the duty imposed by the conceptual framework.  (I understand that IASB members sign a contract agreeing to pass standards that are consistent with the framework.)  The Framework’s asset-liability view imposes quite a bit of discipline on the process of determining standards.  Specifically, it provides a straightforward four-step approach to determine an appropriate accounting treatment for a particular transaction:

1. Determine when assets and liabilities should be recognized and derecognized, according to the Framework’s definitions.
   
2. Determine how to measure those assets and liabilities when they are originally recognized, and when and how to remeasure them.
   
3. Determine how to assign net balance-sheet changes to income statement line items.  Does a change result in revenue or some other gain, or cost of goods sold, operating expense or loss?
   
4. Finally, determine how to present the balance sheet and income statement.  On the balance sheet this often becomes a question of net vs. gross presentation of items that include both a debit and a credit (such as a forward contract, property with accumulated depreciation).  On the income statement, this is often a question of the degree of disaggregation, and the placement of the information.

This process is deontological, because it looks to the intrinsic nature of the transactions to determine what the standard setters should do, without reference to the consequences of the ultimate standard.  To some extent adherence to the deontological argument seems likely to result in good consequences — or at least one can say that deviations from this process might result in very bad consequences.  However, it does not directly address some of the most important consequences of standards.  For example:

1. Will the standard result in better investor decisions?
2. Will the standard distort commercial arrangements as preparers rewrite contracts to get better accounting treatments?
3. Will the standard allow firms too much ability to manage earnings through distortion of unverifiable estimates and judgments?
4. Will the standard result in such complex standards that users won’t understand them?
5. Will similar transactions be treated so differently that users won’t be able to compare across firms?

As Jeffrey Hales pointed out in today’s roundtable discussion, debates over steps 1 and 3 tend to be most deontological because we have reasonably precise definitions of assets, liabilities and many income statement accounts.  However, 2 and 4 don’t currently benefit from definitions.  But that leaves the question:  are the current deontological arguments also leading to good consequences?

That is a job for positivists!

On the other hand, it is hard to see how the proposed revenue model will be implementable without some way of taking account of such ’soft’ considerations.  To see why, consider one of the cases discussed at the Financial Reporting Issues Conference:

A company that sells a one year policy for professional liability insurance for one premium paid at the beginning of the coverage period.  The customer is covered for incidents occurring during the year, but cash outflows for both the claim and related processing costs are most likely to be incurred three or five or even ten years later.

Under the proposed revenue recognition model, the firm would debit cash for the amount of premium as soon as it is received, and credit an equal liability for a ‘performance obligation’ to the customer.    The firm would recognize revenue as they satisfy the performance obligation (debit PO, credit revenue).  The question is whether the performance obligation to the customer includes performing duties arising after the claims period is complete.  One could argue that the obligation to the customer is simply to provide coverage, and at the end of the coverage year, the insurer should have taken all of the PO into revenue.  There is still a liability, of course, for the expected legally obligated payments, but that is created by a separate entry:  debit coverage expenses, credit a reserve (liability) for the expected payout.

An alternative argument goes like this:  part of the performance obligation is to provides the services necessary to settle the claim.   This may not be cheap, especially if the contract requires the insurer to provide an aggressive legal defense to protect the insured’s reputation.  In this case, the customer is buying the insurer’s settlement service as much as they are buying the agreement to cover expenses.

At heart, the question is how preparers are supposed to distinguish obligations to their customers (which are performance obligations and result in revenue) from other obligations.  One could make the case that the distinction actually depends on the intent of the customer.  Did the customer buy the insurance in order to receive post-coverage services?  If so, delay revenue recognition until the customers’ demands for those services are fulfilled.

If you buy this argument, the ‘management approach’ method for segment reporting might be effective.  That approach entails looking at the reporting structures within the firm — who reports to whom, how do internal documents identify segments and business lines — and using those structures to identify segments that should be reported separately for external financial statements. The analogy for revenue recognition would be to look at how the firm presents its value proposition to customers.  In the insurance case, if the firm does not promote post-coverage services, the obligation to pay for such services would not be not a basis for revenue recognition.

The segment reporting guidelines are successful, in my view, because the firm is unlikely to alter reporting structures within the firm in order to change how they can present segments.  If a firm is unlikely to change its marketing materials and sales pitches in order to get desired revenue recognition, the revenue recognition model might well be reasonable.  Otherwise…well, we might have a problem.

An example illustrates the nature of the problem: consider a contract between two parties to provide services or goods that has a fixed term but also a renewal option at the end of the initial term.  At inception, if the provider feels that it is highly likely (and predictable with reasonable accuracy) that there will be a renewal of the contract, at what amount should the provider record the right to receive payments?  The initial period?  Or a period that includes possible renewals?

If we were trying to determine the value to the firm of the contract, we would likely include assessments of probability of various different contract terms and compute the expected value of the payments that would occur (and discount those payments for time value as appropriate).  However, does that computed amount meet the definition of an asset to the provider?

The FASB Conceptual Framework definition of assets (paragraph 25 of Concepts Statement 6) says, “Assets are probable future economic benefits obtained or controlled by a particular entity as a result of past transactions or events.”  If the signing of the agreement is the past transaction or event, clearly that contract conveys to the provider the right to a stream of future payments (probable future economic benefits) during the initial contract term.  But what about payments that might occur during a renewal period, when that renewal is at the option of the customer and has not yet happened?  Information about those payments and their probability of occurrence is likely relevant to financial statement users, but would recording such payments presently violate the definition of an asset?

An alternative view is that this is a measurement issue, not an issue about the definition of an asset.  From that view, the contract conveys to the provider the right to receive a stream of future payments, both during the contract term and probabilistically thereafter.  Anticipating whether or not the customer will choose to renew the contract is done in order to measure the magnitude of the probable future economic benefits, not to evaluate whether the provider has a present economic right to such payments.

At present, I have yet to resolve in my mind whether this is indeed a challenge to the definition of an asset or a measurement issue.  However, resolving this issue is crucial to several of the projects standard-setting projects currently under joint discussion by the FASB and IASB.  In particular, this scenario is representative of revenue recognition in a number of different settings, including lessor’s accounting for leases and accounting for insurance contracts.  The “provider” in the example above could well be a lessor, an insurer, or other seller of goods and/or services.

In some discussions of these issues, the Boards have considered a ‘look-through’ approach where, for example, lessees are directed to determine the effective lease term in the presence of renewal options.  Is looking through the renewal option a tool to estimate/measure uncertain cash flows, or does it represent a potential inconsistency with the definition of an asset?  Or, is it a means of estimating the stand-alone value of options that are embedded in contracts?

I welcome additional thoughts about this to help me resolve this issue for my own edification.

The recent Financial Reporting Issues Conference clarified a number of normative questions that still need to be answered:

• What is the appropriate scope of the revenue recognition standard?  If certain commercial transactions or industries (like insurance or leasing) should be excluded from the scope of revenue recognition, on what basis?
• What are the best ways to distinguish ‘performance obligations’ from other liabilities?  The performance obligation is an obligation to the customer that, when satisfied, results in the recognition of revenue.   Must one identify obligations to customers without reference to management intent or the firm’s business model — and if so, how can that be done?
• How does one distinguish between the sale of a product and the delivery of a service?  This question is closely related to the boundary between the revenue recognition project and the leasing project.
• What is the best operational definition of ‘control’ — a critical issue, since a transfer of control satisfies the performance obligation and results in revenue?

These are just a few of the questions that occur to me, and I am sure other attendees are puzzling over many more.  We are looking for academics (individuals and teams) who are interested in identifying researchable positive questions that will help provide a basis for answering these normative questions.   (See here for my view on positive and normative research.)

Join us at 11am ET on Wednesday, December 09, as we discuss some takeaways from the conference and start a conversation about research directions for revenue recognition.

p.s.  A similar call for research on leasing will be issued soon.

RESEARCH DIRECTIONS
The FASB and IASB have issued Preliminary Views on Revenue Recognition in Contracts with Customers, and expect to publish an exposure draft in 2010.   The revenue recognition model proposed in the document differs from current practice in several ways:  by applying a different model for recognizing and measuring revenue; by applying that model across all industries, rather than providing industry-specific models; and by relying on general principles, rather than detailed rules.  These differences provide opportunities on both the substance of revenue recognition models, and on the guidance for implementation that would need to be provided along with general principles-based standards.

Research on Revenue Recognition Models
A 2003 report by FASB Staff identified four ‘conventions’ appearing in revenue recognition guidance, each basing revenue recognition and measurement on different events:  changes in fair values of assets and liabilities; proportionate performance of production or service; sale and delivery of assets; and collection of proceeds from customers after performance has occurred.   The Preliminary Views propose a model relying heavily on the sale and delivery of assets to customers as part of an enforceable contract.  The proposed model could substantially delay revenue recognition in long-term construction (which can currently recognize revenue for proportionate performance).

Research could examine the decision-usefulness of the proposed model relative to existing practice, especially in industries that are most affected by the proposed changes.  Such research might include:

• Experiments assessing financial statement users’ judgments and decisions
• Surveys examining how expert assessments of appropriate accounting vary across circumstances that are presumed to create the current variation in practice across industries (such as the reliability of fair value estimates, and the timing and certainty of cash inflows and outflows before and after transfer).
• Archival studies examining the variations in the predictive power and value relevance of reported revenue across industries, countries and/or time periods.

All of these studies are likely to be most useful if independent variables can be clearly related to the variables underlying the four revenue recognition conventions (such as market prices, production, cash expenditures and cash collections), as well as variables that play key roles in the proposed model (such as the presence of an enforceable contract and factors indicating a transfer of control).   Such studies might help the FASB determine whether the scope of the general revenue recognition model must be narrowed to exclude certain types of business and transactions.

Research on Implementation Guidance
The FASB also faces challenges in determining what type of implementation guidance to provide as part of any update to revenue recognition standards.  Currently, practitioners can find extensive guidance on revenue recognition in the Accounting Standards Codification (originally developed in Statements of Financial Accounting Standards, FASB Staff Positions, FASB Technical Bulletins, FASB Interpretations, AICPA Industry Audit and Accounting Guides and Statements of Position, and in AICPA and AcSEC Practice Bulletins).  As it prepares to base revenue recognition on a broad model that spans all industries, and replace rules with principles, the FASB could benefit from better understanding how existing guidance is being used, and how new and existing guidance would be used after the passage of a principles-based standard. Research might include:

• Experiments examining how new and existing guidance would be used in different circumstances
• Surveys examining how existing guidance is currently used in different countries and industries
• Archival studies examining the factors that lead to the generation of implementation guidance and rules that clarify principles-based standards

APPLICATION PROCESS
Applicants should submit a letter of interest, along with a CV, to Jeffrey Wilks (FASRI Revenue Recognition Research Coordinator), Robert Bloomfield (FASRI Director) or Jeffrey Hales (FASB Research Fellow) no later than January 4th, 2010.  The letter should demonstrate that the applicant, individually or as part of a team, possesses the research expertise needed to conduct and oversee research of sufficient quality to warrant publication in a peer-reviewed academic outlet, and is willing and able to work with FASRI staff to revise and refine their questions as necessary, as issues under deliberation are clarified.  Evidence of progress on particular research questions on revenue recognition (as described above) is helpful, but not necessary.  The letter should be no more than two pages in length.  Letters will be reviewed by Wilks, Bloomfield, and Hales, with input from the FASRI Editorial Board and FASB staff members from the standard setting project(s) being targeted in the proposal.  The Editorial Board consists of Professors Robert Bloomfield, Jeffrey Hales, Lisa Koonce, Robert Lipe, Ray Pfeiffer and Jeff Wilks.

Researchers are welcome to apply as research teams or as individuals.  At least one member of each team must be employed as a faculty member at an institution accredited by the AACSB or an international equivalent.  Successful applicants will be expected to travel to FASB offices in Norwalk, CT as appropriate.  However, there is no expectation that consulting duties will impinge on time devoted to their current institution any more than other ambitious research projects.

MORE INFORMATION
Potential applicants can find more information from the FASRI website, and from FASRI Round Tables focusing on the targeted FASB projects described above.  Featured speakers have and will include FASB project managers, FASB and IASB constituents, and leading academic researchers. Applicants are strongly encouraged to participate in Round Table discussions on the topic prior to submitting a letter of interest.  These discussions will help in identifying key issues of interest to current standard setting deliberations, and clarifying both the opportunities and the challenges of conducting research in concert with the FASB.  Researchers seeking more information should contact FASRI Director, Professor Robert Bloomfield, Cornell University (rjb9 at cornell.edu) and/or the FASB Research Fellow, Professor Jeffrey Hales, Georgia Institute of Technology (jwhales at fasb.org).

TERMS AND CONDITIONS
At the conclusion of the project, research consultants will submit a report informing the Board about the nature and outcome of the research.  Researchers and research teams will also be strongly encouraged to write their own independent articles for submission to peer-reviewed academic outlets.  We anticipate that researchers will retain complete intellectual property rights over the output of any research they conduct in the capacity of a research consultant, including survey or experimental stimuli created for experiments or surveys, data collected, or other documents.  However, consultants are not permitted to disclose any documents or communications received from FASB employees, unless those are already in the public record, or the researcher has obtained explicit consent allowing disclosure.

I will be writing some posts about the substance of the conference, but for right now I just want to give people the link to the conference website, so you can read the materials for yourself.  The topic, Revenue Recognition, As Applied to Lessors and Insurance Firms, puts an exclamation point on the challenge of the revenue recognition project:  constructing a model that can be applied across industries.  As you read the materials, ask yourself whether revenue recognition standards should be difference for sellers of insurance products and mattresses.  If so, why?

I would encourage you to apply think about revenue recognition standards in terms of the predictive validity framework (a k a ‘Libby Boxes’), as I did in this post:  for each unobservable construct we need to identify an observable proxy variable that can be used to implement the accounting you think is appropriate.  The question then becomes:  why would you want to use industry membership (e.g., “insurance” or “leasing”) as a proxy, instead of directly identifying the features of insurance and leasing companies that make special accounting appropriate.  Is it the fact that insurers are accepting money to bear risk?  If so, why not write standards based on any firm that accepts money to bear risk — and many firms do that in other industries as well.  Is it that accepting money to bear risk is the preponderance of their revenue?  If so, why should that matter?

In a similar fashion, what is the difference between leasing a physical item and licensing the right to use a digital asset?  For that matter, why should leasing be treated differently from a magazine subscription?  What observable variables most directly capture the reason that lessors should account for revenue in a different manner, other than because we want to call their business model by the name “leasing”?

Much more on these topics to come.  Enjoy Thanksgiving, but look for posts even though I am supposed to be on vacation.

One place that seems to need further development was highlighted toward the end of our round table discussion. Stephen had provided a high-level description of a transaction-based framework for financial reporting. My understanding of that framework is that it seeks to recognize amounts in the financial statements that derive directly from transactions, not hypothetical events. We were talking about how a product sold with a warranty usually results in the recognition of a warranty expense and an accrual for anticipated repair costs. Stephen explained that the warranty accrual would be appropriate in a transaction-based framework because you could base that accrual on a history of many previous repair transactions. Because these transactions exist, the warranty accrual can be estimated with some objectivity at the point of sale.

As I was thinking about this example, I started to wonder why the same logic couldn’t be applied to a separately sold extended warranty. In that case, an entity may have just as much history on which to base its expected repair costs as an entity that sales a product with a warranty. If so, why couldn’t the entity recognize the full amount of revenue for the extended warranty at the point of sale and accrue an expense based on the anticipated repair costs for the warranty? Of course, the obvious rebuttal to this idea is that the entity providing the extended warranty has not yet provided any warranty coverage. But the same could be said of the entity that sales a product with a warranty. At the point of sale, no warranty coverage has yet been provided in either case, and yet all of the revenue associated with the sale of a product with a warranty is recognized up front.

My question here is how the transaction-based framework would distinguish between these two types of warranties. In both cases, a history of repair transactions with the customer suggests a reasonable estimate of the expected repair costs. So what in a transaction-based framework tells me to recognize all revenue at the point of sale for a product sold with a warranty but none of the revenue at the point of sale for an extended warranty sold on its own?

Again, let me express my thanks to Stephen for his willingness to share his views in our round table forum and for thinking on the fly about how a transaction-based framework would handle this and other situations. I hope we can have more discussions like this one in future round tables.

This decision for insurance is consistent with the decisions reached by the boards on the general revenue recognition project. However, it poses a significant shift for the insurance industry.  Although in steady state, this change will not affect net income that much, at any given point in time, it means that the acquisition of a new contract with a customer will result in a net negative impact on earnings (because acquisition costs are expensed and no revenue is recognized to offset those costs). This seems counterintuitive given that acquiring a new contract with a customer is usually a positive economic event. At least with the old approach in which acquisition costs were deferred and recognized over the expected coverage period, an insurance entity basically recognized an approximate value of obtaining a contract with the customer. Sure, we didn’t call that a contract asset on the books, but you have to admit that the deferred acquisition costs were probably a pretty good approximation of the value of that contract.

My question–I wonder if this decision for insurance represents yet another instance in which the pressure to achieve a single revenue recognition model sacrificies what is otherwise perceived as decision useful information to investors. We may soon see the same outcome with construction contracts under the proposed new revenue recognition model because the new model will force many construction contracts to delay revenue recognition until the asset is transferred to the customer (essentially a completed-contract approach). But that’s a topic for another day!

On Tuesday, Oct 20th, 4 pm ET, we will be joined by Bin Ke (Penn State University).  Bin will be discussing his recent paper, entitled “Why do cross-listed firms voluntarily adopt Regulation Fair Disclosure?”

The paper is co-authored with Michael Crawley and Yong Yu, both of whom are from the University of Texas at Austin.

The abstract of their paper reads:

We examine why many cross-listed firms voluntarily adopt Regulation Fair Disclosure (REG FD) from which they are explicitly exempt. We hypothesize and find that cross-listed firms’ voluntary REG FD adoption is due to externalities resulting from U.S. firms’ forced adoption of REG FD. First, following REG FD cross-listed firms that continue to use a selective disclosure policy become less attractive than U.S. firms to U.S. investors (especially retail investors) who were previously at a disadvantage in information access to corporate management. Second, U.S. firms’ forced adoption of REG FD creates an information spillover on cross-listed firms whose receipt of information is positively correlated with that of U.S. firms. These two effects induce many cross-listed firms to voluntarily follow REG FD. Relative to non-adopters, REG FD adopters enjoy a significant reduction in the information asymmetry component of cost of capital, suggesting that the voluntary adoption is a credible commitment to increased disclosure transparency.

Please join us on Tuesday!

Remember:  You can attend Round Table Discussions in Second Life (instructions here) or on the web at our LIVE page.