ASPE Revenue Recognition: The Added Importance of Professional Judgment in a World Without EICs
It’s hard to believe that it has already been more than two years since privately held entities in Canada began applying Accounting Standards for Private Enterprises (ASPE). For most entities, the move towards more principles-based guidance has been a welcome one, as less prescriptive guidance generally means fewer rules to memorize and more opportunity to exercise professional judgment when identifying solutions tailored to specific facts and circumstances. But the beginning of this exciting new era also saw the withdrawal of the Emerging Issues Committee’s abstracts (EICs), many of which dealt with revenue-related topics.
In case you’ve never paused to reflect on the magnitude of this change, consider this: Under the old Part V Generally Accepted Accounting Principles (GAAP), more than 33,000 words of guidance were provided in CICA Handbook section (CICA) 3400 and the five or six significant EICs dealing with revenue-related topics. Under ASPE, this guidance has been reduced to fewer than 3,000 words, all in section 3400—a decrease of over 90%!
So what does this all mean? Well, one thing is clear: With so much less guidance, professional judgment will play an even more critical role whenever companies seek to establish a new policy or change an existing policy in accordance with CICA 1506.06. Despite the fact that the fundamental principles remain unchanged, it is at least conceivable that additional acceptable alternatives may be found under ASPE that would not have been sustainable under the more detailed guidance of Part V, International Financial Reporting (IFRS) or US GAAP. That being said, there are a few important things to keep in mind when recognizing revenue under ASPE.
Avoid a checklist mentality
When it comes to applying CICA 3400, there are no checklists involved. While paragraph 8 provides some examples of factors a company would consider when determining whether persuasive evidence of an arrangement exists, it concludes by stating that “other characteristics may exist” and “judgment is necessary.” Similarly, paragraph 9 lists some of the aspects of delivery that an entity would consider when determining whether delivery has occurred, but tells us nothing about how these aspects should be evaluated, or what additional aspects might need to be considered.
Moreover, paragraph 11 tells us: “… in certain circumstances, it is necessary to apply the recognition criteria to the separately identifiable components of a single transaction in order to reflect the substance of the transaction.” In addition to determining what those “circumstances” are, we must: determine which elements of the arrangement might constitute separately identifiable components; identify the substance of each transaction; and decide which possible treatment is most consistent.
There are many other areas where professional judgment plays a critical role with respect to revenue recognition, including determining whether the significant risks and rewards of ownership have transferred, whether reasonable assurance exists regarding the measurement of consideration, and identifying the “significant acts of performance.” CICA 3400 provides few details on how these questions should be answered, as the answers will depend on circumstances specific to each transaction.
Exercise your professional judgment
Imagine you’re faced with a challenging revenue recognition problem. A customer has approached you wanting to purchase 50 units of product, but doesn’t want to take immediate delivery. They are willing to pay for the product in full when the order is placed, and you almost always carry at least 100 units of finished product at any given time. You know that under CICA 3400, delivery is generally not considered to have occurred until “… the product has been delivered to the customer’s place of business or another site specified by the customer.” But you also know that paragraph 9 says you must consider any “bill and hold” aspects of the arrangement when deciding whether delivery has occurred. ASPE does not provide detailed guidance to help you evaluate whether it may or may not be appropriate to recognize revenue in this situation, so you must rely solely on your understanding of the substance of the arrangement and your professional judgment when determining whether the basic revenue recognition criteria have been met.
When additional guidance is needed to apply CICA 3400 to specific circumstances, the ASPE GAAP hierarchy reminds us in CICA 1100.06 of the need to refer to other sources when selecting policies and disclosures consistent with the primary source. IFRS includes several specific criteria to be met before recognizing revenue on bill and hold transactions. US GAAP includes even more detail, providing important conceptual criteria (still no checklists!), which, in some cases, differ slightly from the corresponding IFRS guidance. But is it necessary to comply with either of these alternative GAAP sources when reporting under ASPE? The short answer is “no.”
Prudent practitioners may consider the insights offered by IFRS and US GAAP on bill and hold transactions when exercising their professional judgment, but they are not required to comply with these insights, as stated in paragraph 20 of CICA 1100: “… it is not necessary to comply with Part I or with pronouncements issued by other bodies in order to comply with accounting standards for private enterprises.”
Consider both your current and future needs
Your company may be privately held today, but will it always be that way? Are you considering an initial public offering in Canada? If you are, then you would do well to consider whether there are any policy and disclosure choices available that meet the requirements of both ASPE and IFRS. Similarly, if you are contemplating becoming an SEC registrant in the next two or three years, you would be wise to determine whether there are choices you can make today under ASPE that will also satisfy the more stringent requirements promulgated by the US Securities and Exchange Commission. I can imagine how disappointed many CEOs and boards of directors might be after launching a strategically timed IPO only to find out that a significant portion of their historical revenues must be reversed in order to comply with the IFRS or US GAAP accounting requirements applicable to bill and hold transactions! In short: Taking your future needs into consideration today may save you considerable stress and effort down the road.
Leverage off your existing professional relationships
Not all privately held entities have a relationship with an audit firm, but for those that do, these firms can act as valuable sounding boards—particularly if their involvement is sought on a timely basis.
I am aware of one particular instance where a company believed they had satisfied all necessary conditions for revenue recognition under ASPE. But while the company considered their remaining obligations to be insignificant, their auditor disagreed. Such is the nature of professional judgment: Two equally qualified individuals with similar experiences may act in good faith and yet still disagree. Ultimately, of course, the financial statements are those of the company, but a protracted disagreement with an auditor can be distracting, unproductive, and costly. In this case, the company should have involved their auditor in the discussion sooner to reap the benefits of their expertise.
The moral of the story
Following the withdrawal of the EICs, there is much less detailed guidance on revenue recognition available today under ASPE than existed previously under old Part V GAAP. This dearth of guidance provides much greater room for practitioners to exercise professional judgment. With a solid understanding of the basic requirements outlined in CICA 3400, an appreciation for the role of other GAAPs and reference sources in the ASPE hierarchy in CICA 1100, awareness of both current and future needs, and a willingness to leverage off the wealth of experience within your professional network, success awaits.
Stephen Miller, member of the Institute of Chartered Accountants of British Columbia