Accounting - ASB turns over a few ideas

Readers will doubtless be fascinated to know that the Williams’ family is buying a new car. This is a humble enough transaction, but it warrants mention because it coincides with the Accounting Standards Board’s discussion paper on revenue recognition.

The written order confirmation from the garage with a detailed breakdown of the price of the car demonstrates why revenue recognition is now seen through a glass darkly. The nub of the problem is illustrated by the way in which there are two prices for the car stated, one of which includes a #1,500 cash back. This is essentially an incentive provided to the dealer by the manufacturer which is ‘passed on’ to the customer.

I wondered how the sale would be recognised in the dealer’s books: would the top line figure be the final, final price (the figure we see as the cost of our vehicle) or would the accounts reflect the pre-cashback price and the #1,500 incentive be shown as a marketing cost? In this case, the dealer and the manufacturer are one and the same, but it affects how gross margins are reported. But what about the accounting for independent dealerships?

The scenario could be further confused by way the transaction is financed.

Should the recognition of the revenue from the sale alter depending on whether the vehicle is purchased for cash or on tick? Answers, please, on an email to Financial Director – or the ASB.

If such a straightforward transaction as the purchase of a car can offer a fistful of alternative accounting treatments, it is easy to see the possibility for wide variation of treatments in complex deals. The discussion paper on revenue recognition is attempting to plug a gap in UK accounting guidance by giving an insight into the thoughts of the ASB on the main principles of this issue. Until now, there has been no guidance in the UK on revenue recognition and accountants have been using their judgement as to what GAAP should be, or turning to the international or US standards.

The paper follows the same approach as the UK Statement of Principles.

It starts by looking for a definition of “revenue” and develops proposals consistent with other recent accounting standards, such as: discounting amounts receivable or payable in the future – a theme already found in FRS19 (deferred tax) and FRS12 (provisions); and regarding the issue of customers’ rights to return and the need for an entity to adopt the most appropriate accounting policy, a subject picked up mainly by FRS18 on accounting policies.

There are already standards and rules on revenue recognition in the US and under International Accounting Standards (IAS18). The US rules are – surprise, surprise – highly prescriptive and have led to anomalies in certain industries. The proposals within the discussion paper are broadly in line with IAS18, requiring revenue to be recognised on performance of the seller’s obligations under the contract.

Two events demonstrate why some rules on revenue may be timely: first the Financial Reporting Review Panel – sister body to the ASB – has recently been chatting to the directors of vehicle leasing group Northgate plc about its reports and accounts for the year ended 30 April 2000. The FRRP was unhappy about the treatment in the consolidated financial statements of the credit relating to vehicle-related bonuses. The company’s policy was to record such bonuses as deferred income and release them to turnover over the anticipated holding period of the vehicle category to which they related. The FRRP took the view that, to conform with FRS15, the bonuses should have been credited to the purchase price of the vehicles which triggered the bonuses, not recorded as deferred income nor released to turnover. Northgate has now accepted this.

Secondly, the discussion paper follows thoughts from the Auditing Practices Board on aggressive earnings management (see this column, last month).

The APB and the ASB have always pursued separate agendas, but they are now talking about issues of mutual interest.

FDs may find that once the discussion over industry-specific policies starts, practices which they have been employing for recognising revenue are questioned. The industries identified so far are software licensing and product rights, and long-term service contracts. But once this sort of back-to-basics exercise is undertaken the list of industries affected is bound to grow.