They say once you’ve seen sausage made, you’ll never eat it again. In this sense, sausage and accounting principles may have something in common. Since 2004, the Financial Accounting Standards Board (FASB) and International Accounting Standards Board (IASB) have been jointly engaged in an effort to create an accounting version of what physicists might call a “revenue theory of everything.”
Arguably, revenue is the single most-watched line item in company financial statements. You’d think it would have received lots of standard-setting attention in the past, but it hasn’t. We might call it U.S. GAAP’s “missing link”. For all of its pretensions to “quality” and “rigor,” U.S. GAAP has no general standard for recognizing or measuring company revenue. Hard to believe? Not if you knew how accounting sausage is made. But revenue is one important chunk of sausage and its getting lots of attention nowadays from both IASB and FASB.
When they started four years ago, it was with visions of grandeur. FASB and IASB were going to rescue the world of finance from the cold-war-era “earnings process,” now enshrined in the SEC’s SAB 104, and carry us off to a nirvana of fair-value measurement. Auditors and analysts would frolic in ever-mounting series of highly relevant but largely unverifiable assets and liability values perpetually “marked to market”. I think we can now safely say, “Alas! It was not to be.”
I may be the only person in the world to know how it really happened, but only because it is unlikely that any other independent observer has spent as much time listening to audio recordings of IASB and FASB meetings dedicated to this kind of accounting esoterica.
Without getting too detailed, revenue recognition appears to be circling back to its roots — the earnings process — because too many cooks from too many culinary schools are crowding the GAAP kitchen. It’s one thing to ask a single international standards-setting group like the IASB to craft a new standard. It’s another thing to overlay, in addition, a national standards-setter like the FASB. The project was doomed from its inception.
At this point, the “Boards,” as they like to call themselves, are orbiting ever more closely around the so-called “customer consideration model.” It’s really just warmed over SAB 104 with what IASB Board member Jim Leisenring and I agree is a strange “onerous contact” adjustment. This adjustment would kick in when the obligations associated with a revenue-generating contract become sufficiently high in cost as to require a downward revenue adjustment.
Speaking of Leisenring (pic, right), one of my favorite audio segments is transcribed below, roughly verbatim, from the recording of the IASB’s May 21 meeting:
[1:04:36] [Jim Leisenring] Would this [fair value] model allow me to sign a construction contract where the contractor-seller says to the customer, “Ya know, this would be a lot better for me if you would only let me say that the specific consideration for buildin’ this skyscraper, that of the $20M it’s gonna cost, $15M was in the design phase.”
Do I get to do that, or not? Yes or no? ‘Cause [the] contract’s gonna say that. And I’m actually gonna say, “I’m gonna give you a million-dollar discount if you’ll do that because then I’m gonna get one gawdawful lotta stuff up front in revenue and I’ll be better off.” . . .
. . . back to the sweater, I have no problems with saying that if that contract’s for a sweater at a hundred, the revenue line oughta have a hundred in it. I also don’t care, particularly, about deciding in the revenue recognition project – if I was gonna be customer consideration – about remeasuring anything unless it was remeasuring the hunerd [sic]. But I don’t see why I’d remeasure the cost side just because it got onerous. I understand why I’d do that under the provision standard, [IAS] 37, but I don’t understand why I would in the revenue standard. Different issue. But there are questions unanswered . . .
[1:06:33] and while this structure [of the draft discussion paper on revenue recognition] may be fine, its content is vacuous in terms of trying to apply it to most commercial endeavors that are problematic. I agree that it’s set out the right way, by issue. But when I read the approaches, I don’t know what I’d do.
[1:06:50] [Unidentified] Maybe we should get Jim to develop the hybrid model. . . you’ve been sitting on both the groups . . .
[Jim] I’ve already asked the questions and neither group will answer, including you, MacGregor.
[Unidentified] Why don’t you answer them?
[Jim] So, if you’re not gonna answer . . . and I wanna for example wanna know why when I signed on to sell Suzy the $100 sweater, if I can sell that damn contract for $3 in the marketplace this afternoon, you’re gonna tell me I don’t have an asset.
[Mary Barth] MacGregor’s not going to tell you that, so ask somebody else.
[1:07:35] [Jim] I just don’t understand it. Ya know. And, if that means what I oughta do … maybe what we oughta be thinking about’s the day I signed that I got a $3 contract asset I could have sold . . . but I do not know your definition of an asset. And I think we absolutely should not support an approach or even publish an approach unless it’s candid as to whether we’ve changed the definition of an asset and a liability.
. . .
[1:10:34] . . . [Jim] . . . because I’ve been trying for three years to get them to respond but they haven’t . . . I do wanna make clear that if that’s the right answer to things we should not be getting day one profit recognition on financial instruments just because there’s an observable price in another market. Because that’s what we’re doing now and we find that perfectly comfortable but we don’t find it comfortable . . . for sweater contracts. . . .
[Philippe Danjou] Unintelligible interjection.
[Jim] Fine, then do the same thing to the banks [that we do to the sweater seller] . . . I’m only trying to figure out your principle. And I don’t think you have one. . .
Of such exchanges are accounting principles made. So much for the revenue theory of everything. Enjoy the sausage! Next year, in London!