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With this summary and the following evaluation of an illustrative case, internal auditors can improve their understanding of revenue recognition compliance under FASB ASC 606.
In May 2014, the Financial Accounting Standards Board (FASB) and the International Accounting Standards Board (IASB) issued sweeping changes for revenue recognition from contracts with customers. This article will help internal auditors ensure financial reporting compliance by summarizing the major changes required under Accounting Standards Update (ASU) No. 2014-09, codified into the U.S. Generally Accepted Accounting Principles (GAAP) as FASB ASC 606.1 It also provides an illustrative case to demons t rate the new revenue recognition process.
Revenue is typically the largest item in the income statement and has long been an area susceptible to improper financial reporting. Former SEC chief accountant Lynn Turner stated in a letter to the chairman of the IASB, "A majority of the fraudulent financial reporting cases investigated by the SEC involve improper revenue recognition."2
The long-anticipated new standards were issued as the result of a joint project between the FASB and the IASB. Because existing revenue recognition standards contain significant weaknesses and implementation problems, the updated rules aim to narrow the differences between FASB ASC 606 and its international counterpart, International Financial Reporting Standard (IFRS) 15. U.S. GAAP for revenue recognition are currently scattered across multiple guidance sources and are based on broad concepts, with many unique except ions for particular industries (e.g., software) and transaction types (e.g., real estate).3 Existing IFRS revenue recognition standards provide limited implementation guidance, leading to difficult and inconsistent application for complex transactions. As a result, economically similar transactions are frequently accounted for in different ways. The new standards are expected to reduce accounting inconsistencies and improve comparability across entities and industries. James Schnurr, chief accountant for the SEC, commented on the importance of the new guidance: "Successful implementation of the new standard will be critical to ensuring comparable, high-quality financial reporting for investors."4 Financial statement preparations should be simplified because the amount of guidance available for reference has been reduced. The new standard will also improve revenue recognition disclosures.
The standard broadly applies to any reporting organization that enters into contracts with customers to transfer goods or services - but not to contracts that are within...