ADMS 4510 term project Q1
We agree with most proposals in paragraph 35 and 36. However, some requirements are ambiguous and further clarifications are required. When reviewing the exposure draft, we have several major concerns with satisfaction of performance obligations. There should be persuasive evidence to show the existence of an agreement. Delivery of goods should have been occurred and services should have been rendered for revenue recognition. Sufficient evidence should support for the proposal to result in revenue being recognized over time. Also, there is chance that revenue could be recognized without the entity being reasonably assured to have a right to consideration. As is explained below, we have some disagreements. For 35(a), customer controls asset as it is created or enhanced. We partially agree with the concept of recognizing revenue over time when the entity creates or enhances an assets that the customer controls is consistent with the principle of recognizing revenue with transfer of goods and services. It follows the core principle in paragraph 31. However, this assumption may be problematic, controls may not be transferred over time but at a point in time. Hence, the proposal could hardly be applied to the situation where a customer has obtained control of goods in advance of the entity satisfying the performance obligation. In some cases, they fall into the performance obligation satisfied at a point in time rather than over time. Customers could recognize an asset in various bases, so it may or may not reflect a continuous transfer of control. Based on the requirements in paragraph 31­33 and 37, they only determined performance and control transferred at a point in time, so the board should clarify that how exactly control is transferred over time. Also, as percentage­of completion was used in previous cases before the ED, the board has to clarify that whether the percentage­of­completion method is still acceptable based on the requirements in 35(a). As is supported by paragraph 36, paragraph 35(b) is limited by the proposal that entity’s performance should not create or enhance an asset with an alternative use to the entity. It also states that entities should consider whether the entity is unable to readily direct the asset to another customer. The guidance may be too broad here and lead to financial manipulation especially for company with financial problems. They may want to manipulate the contract and create an alternative use of their asset without notifying the customers and investors. It would raise reliability problems. On the other hand, even if the entity has an option to sell the products to another customer, it does not mean that the entity is sure to exercise it. To solve the problem, the contract could carefully include a clause prevent the entity from transferring assets to another party. With the contractual limitations regarding the alternative use, as long as the customer simultaneously receives and consumes the benefits of the entity’s performance as the entity performs or the entity has a right to payment for performance completed to date and it

expects to fulfill the contract as promised, that revenue should be recognized over time. We suggest that the board could remove the preclusion of alternative use requirement Furthermore, paragraph 35(b)(ii) does not seem to provide a necessary and appropriate separate criterion. 35(b)(ii) states that another entity would not need to substantially re­perform the work the entity has completed to date if other entity were to fulfill the remaining obligation. It implies that another entity would not have to substantially re­perform the work if the customer has simultaneously received and consumed the benefits of the entity’s performance as 35(b)(i) indicated. In that case, we suggest removing 35(b)(ii) or combine the standards with 35(b)(i). Lastly, in 35(b)(iii), it states that the entity must have a right to payment for performance completed to date and expect to fulfill the contract as promised. The draft is ambiguous, as an arrangement would meet the requirement only if the payment the entity was entitled to receive correlated with the entity’s performance to date. Assessment is required to consider whether the right to payment existed throughout the entire period of performance. We recommend that further interpretation is needed to clarify the concept of “right to payment for performance”. Q2
We agree with the proposal. We believe that collectability is part of revenue recognition standard and uncollectible amount should be reduction of revenue. Implication of new standard which bad debt expense should be represented next to revenue will increase relevance and reliability of income statement. As revenue is the lifeblood of the company, incorporate bad debt expense in the separate line in the revenue item will help investors to predict future earning of the company increasing relevance by estimating the amount of bad debt expense in the future.
Reliability information faithfully represent what is intend to represent which is complete, free from error and bias. As it is difficult to predict the cash collection in the early revenue recognition stage, estimating the reasonable amount of revenue will increase the reliability of the information. In the new standard, revenue is presented net of bad debt expense, which has less bias, and complete to present what extend the revenue should be collected hence there is greater reliability. That is also increase the main diagonal probabilities of information system by improving the informativeness of financial statement to help investors to make more useful decision. Investors could rely on useful information to revise their probabilities to make buy or sell decisions. Besides, by disclosure detailed information is a way to inform company’s integrity in the market which will less misleading investor and make them have more confidence about the company. In addition, provide separate line with discretionary accrual which

improves the transparency of the financial statement could increase ability to evaluate fair value of the debt. Investors and could rely specifically company’s financial statement instead solely on credit rating agencies to evaluate risk to make investment. What’s more, according to the positive accounting policy, investors demand timely recognition if they are risk averse. In the new proposal, it is a kind of conservative accounting which recognize many revenue and expense until reasonable reliability is attained. Thus, it reduced dividend and contract cost, increase the cash stays in the company to repay debt.
Therefore, it is less likely that the value of the company turn out to be overstated. That will also prevent company from lawsuits because investors will lose less by understate value rather than overstate. For the significant transaction in the revenue recognition item, more detailed revenue and losses provided could have economic consequences even though changing accounting policy may not affect cash flow. Increasing the concern about credit risk, the value of the company will increase as well. Managers could minimize contract cost by identify the credit risk of the customers. Customers who has high credit risk, the contract should not exist. However, we should concern that bad debt is fundamentally different from cost of good sold and including it which understates revenue will distort gross margin and mislead readers. Investors focus on the operating revenue and expense to revise their probabilities of firm’s future performance. If Bad debt expense is not significant and it is discretionary accrual amount, it is not material to predict the future cash flow. If it is located in the separate line of the revenue item, investors would consider the expense which could mislead their decision making process. Secondly, time value of money should also be concerned. Change location which is not change the measurement and recognition approach for revenue will not effect much. In the long­term contract, the current estimation of bad debt expense is not accurate. Managers may abuse accounting policy by overstate the revenue in current year and understate it for the future year. Managers could take advantage of it to make him more profit this year without consider future cash flow of the company. Thus, investors may have over confidence for the firm’s future performance.
Finally the collectability is hard to determine due to market uncertainty it may be the better way to estimate base on historical data. Q3 partially agree with the proposed constraint on the amount of revenue that an entity
: We would recognize for satisfied performance obligations, but, regarding to the first three points in
Par. 82, we disagree. Since revenue recognition can help investors predict a company’s future financial performance and revenue growth, therefore, the information collected to determine revenue recognition should be a trade off between relevance and reliability. Also, we look at this problem in perspective of earnings persistence.

Firstly, information should be faithfully represented. In the draft provided, paragraph 81 stated that if the consideration is not in a fixed amount, two criteria has to be met to recognize revenue.
The one is “The entity has experience with similar types of performance obligations (or has other evidence such as access to the experience of other entities)”, which means consideration obtained from services rendered or goods sold has to be measurable. Goods and services usually have fixed prices, however, prices may change due to different sales agreement or various types of services. For example, when DQ (an ice cream chain store) orders a great amount of milk from a milk supplier, the price must not be as same as those sold to a small grocery store in York
University. Instead, the milk supplier would provide more discount, because more milk is ordered. At this time, the supplier may refer to past similar transactions to determine how much discounts to give to evaluate a fair price of the final deal. In this situation, fewer estimates are made and it increases the reliability of revenue recognition. The other one criteria is “The entity’s experience is predictive of the amount of consideration to which the entity will be entitled in exchange for satisfying those performance obligations.” Therefore, a company is able to recognize revenue as soon as possible, if they could reasonably predict the consideration amount. Since rational investors are primarily interested in predicting future firm performance, and will respond quickly to new, publicly available information that is useful in updating their predictions, therefore, the earlier revenue is recognized in the firm’s operating cycle, the more relevant is revenue growth information. The second criterion increases relevance of revenue recognition. Secondly, based on par.81, par.82 provided precise indicators that what are not predictive amount of considerations and it seems this paragraph follows a conservative approach. However, we believe that the first three points put too much emphasis on reliability with lowering the relevance of information, which may mislead investor’s prediction. In part a, some factors, such as weather conditions, are possible to change without warnings or indicators. So, predictions involve uncertain portions impacting actual amount of transactions. If we wait until all uncertainties are eliminated, relevance of information would be reduced a lot. In part b, the proposal suggested not to recognize the revenue if the uncertainty is not expected to be resolved for a very long time. Since uncertainty is a pervasive impact of each transaction, we should divided into material and immaterial. If the uncertainty is a key element in determining the consideration, then we could say it is not measurable. In contrary, if the uncertainty is not material, the consideration would not be influenced by that, so should be still predictive. For (c), especially for service providing industry, new service agreements may not be exactly the same as past experience, because changes are necessary to tailor the customer’s needs. Besides, external environment, such as economic conditions, is changing at the same time, but we believe the consideration is predictive referring to similar transaction and reasonable assumptions. We agree with the last point. Since when a contract has a large number and broad range of

possible considerations, it means it is hard to measure the revenue at some point of the range. In order to recognize revenue, the management has to make estimates to determine the amount, which increases relevance with sacrificing reliability. As a result, we recommend to properly disclosing the revenue recognition method the company engaged in and policies for contingency. In addition, from the perspective of earnings persistence, we agree with par.81. Current earnings provide better indications if the more the good or bad news in current earnings are expected to persist into the future. Good assumptions and similar past experience indicate the earnings persistence. Good assumptions include both measurable consideration amount and reasonable cost, so the net income is more accurate and highly persistent. Past experience is evidence that the firm generates the net income from their daily operating activities, not unanticipated gain or loss. In this situation, earnings have higher quality. In conclusion, we agree with par.81 and the last point in par.82 by arguing information relevance and reliability and earnings persistence. However, for the first 3 points in par.82, we think those indicators are too conservative and restrictive in defining predictable amount of consideration.
By following this approach, we are not able to achieve a trade off between relevance and reliability. Our recommendation is to properly disclose revenue recognition policy and accounting treatment for contingency. Question 4: We do not agree with the proposed scope of the onerous test. According to paragraph 86 and
87, an entity should recognize an accrued liability for an onerous performance obligation when certain proposed requirements are met over time. This onerous test said that an onerous obligation would occur if the lowest cost of settling the performance obligation exceeds the amount of the transaction price allocated to that performance obligation. The lowest cost of settling the performance obligation is the lower of a) the costs that relate directly to satisfying the performance obligation by transferring the promised goods and services, and b) the amounts that the entity would be permitted to pay to exit the performance obligation. The onerous test acts as an application of accounting conservatism, requires recognizing all probable losses as they are discovered and deferring revenue until it is verified, in revenue recognition model. However, some respondents argued that the onerous test on performance obligation should not be included in the scope of revenue. Revenue is an increase in economic benefits defined in Appendix A in
Exposure Draft. An onerous contract is a net outflow of economic resources as an expense, not revenue. Therefore, it may be more appropriate exclude the onerous contract in revenue recognition (This factor implies that onerous test is not a remeasurement issue). As mentioned in BC204 of 2011 Exposure Draft, The entity expects at contract inception to satisfy over a period of time greater than one year, which indicates that the onerous test is limited to long­term performance obligations other than recognizing material short­term onerous

performance obligations that are shorter than one year. This limitation of onerous test would create incentives for the management to avoid accrued liability and related expenses by contracting short­term performance obligations to get compensations or bonuses based on the net income or maintain their required debt covenants, which based on the opportunistic form of positive accounting theory. At the same time, the management can also use the onerous test, based on the positive accounting theory, to create unnecessary income smoothing by overstating the estimation of accrued liability and lowest expense to lower current period’s income, and then decrease previous overstated estimation to increase net income for the next period. Moreover, the entity updates the measurement of liability for this onerous performance obligation to provide users with important information by, in effect, remeasuring performance obligations to reflect significant adverse changes in circumstances on a timely basis, the onerous test increases the relevance because the estimated loss on performance obligation is recognized early on the financial statement to users to predict their future benefits. However, the financial statement information may not fully faithfully represent what it is intended to present, which implies that onerous test decreases reliability. Firstly, the early loss the onerous test recognized might not represent the whole contract as some respondents disagreed about. Paragraph BC206 of 2011 ED said that applying the onerous test to individual performance obligations may not always generate meaningful information, in particular, because the onerous test often require the recognition of a loss at contract inception for loss­making performance obligations even though the contract as whole is expected to be profit”. According to paragraph 23 to 30 of the Exposure draft, an entity needs to identify goods or services that are distinct under a contract and account for them as a separate performance obligations, which will not impact the revenue recognition.
Onerous test carries out a separate performance obligation and recognizes the loss as an expense on a specific performance obligation whose allocated revenue is less than the lowest settling cost
(This factor also implies that onerous test is not a remeasurement issue). By measuring the loss of the contract instead of recognizing overall profitability of the contract will not reflect the accurate economic reality. Secondly, the entity needs to make estimates on the lowest cost of settling the performance obligation and the potential mistakes may be made during the estimation in the onerous test process, which will distort the true nature of the performance of the contract and trigger the liability and expense that is not a faithful representation. The last reason for our disagreement is that the onerous test does not include certain types of contracts such as leasing contracts, labour contracts and insurance contracts. This factor produces difficulties of matching obligations in different type of contract because criteria of liability recognition is not same and not comparable. Therefore, the information provide to the financial statement users are inconsistent and misleading. Also as we mentioned before, the management may also use this factor to choose the contracts not applying the onerous test to avoid the accrued liability and expense to maximize their benefits, such as signing leasing contracts instead of selling contracts to make their profits, based on the positive accounting theory. All in all, we are not in favor in this proposed scope of onerous test based on the analysis

above. However, there are some recommendations that we can give. One is, if the contract is overall profitable, the entity could recognize and measure the loss in the onerous performance obligation as an expense emerged with the revenue it gathers from other profitable obligations under the same contract, which ensures the overall economic reality and nature performance of the contract. Another alternative recommendation is that if the contract is overall unprofitable, total loss can be recognized as an extra expense in the current period, which is different from the proposal in Exposure Draft as the onerous liability is evaluated at the contract level. These methods can also be consistent with the earning approach used for long­term contracts, which are more one year. Question 5:
We agree entities should be required to provide of these disclosures in the interim that some financial statements, but not each of them. The proposal requires too many disclosures in the interim statement that seem excessively detailed and could fail to provide useful information to users. Additionally, they will impose extra costs on the entities. Therefore the cost­benefit ratio for including the disclosures is not favourable.
First Point:
We do not agree with that disaggregate revenue in financial statement. As investors focus on the cash flow of a company in the future mainly based on operating activities, revenue has been provided in the income statement which is appropriately reflect the future cash flow. disaggregation of revenue given more details of the revenue which might help revenue recognition and measurement in the future. However, separate revenue in different categories is not actually provide further information about future cash flow which is time consuming and may duplicate information that has already exists in the financial statement. Thus, the cost is overweight the benefits for us to implement the proposal.
Second point:
The implementation of a disclosure such as tabular reconciliations for instance has will have an unfavourable cost to benefit ratio. This is primarily because management does not consider the tabular reconciliations to be of importance for decision making, therefore users would follow suit. The complex disclosures might not be understood by the user, which in turn may dissuade them from the entity. This would deem these disclosures irrelevant and creates a seemingly non­beneficial situation for both the users and the preparers. The reporting of additional disclosures will change the nature of what interim financial statements are used for and will make them seem like an annual financial statement.
Third point:
Paragraph 119­221 states to disclose the aggregate amount of the transaction price allocated to remaining performance obligation and an explanation of when the entity expects to recognize that amount as revenue. It does not seem to provide decision­useful information for the users.
The guidance requires management prediction for the company’s future performance. The

estimation of forward­looking information would reduce the reliability of the financial statement and would affect the investors’ decisions. We suggest removing this part of the disclosure. Fourth point:
We do not agree with this disclosure procedure. According paragraph 122 and 123, the disclosure of both the amount and tabular reconciliation of the accrued liability for onerous performance obligations are very detailed and useful to external users. The more information external investors get, the more confidence they have in their investment in the firms. However, there is a potential abuse of leaking inside information to the outside competitors, such as operation strategies that could be valuable yet vulnerable to exposure, leading the entities losing opportunities and money. Moreover, interim reports are not generally audited as the annual report, there may exist inaccurate information misused by internal management to achieve their earnings. Therefore, we recommend that just disclose basic amounts of onerous obligation liability by following the accounting policies instead of giving too much details reveal to the public to avoid potential risk of unnecessary cost and leak of inside information. This will ensure the tradeoff between entities costs and users benefits. The last point:
We think that disclosing a tabular reconciliation of “Assets recognised from the costs to obtain or fulfil a contract with a customer” is reasonable. Since revenue recognized should match the costs incurred. Recording and disclosing asset change from the costs could help the company keep track of the progress of a contract and these information helps investors predict the firm’s future performance. The more information disclosed, the more confidence of investors working in the securities market, because there is less inside information to worry about.
Recommendations:
The proposed interim disclosures also conflicts with the IAS principle that only significant changes since the last annual reporting period should be reported. Also this proposal would decrease the timeliness of the reports. The principles in IAS 34 and ASC 270 should be re­considered to determine the extent of revenue disclosures for interim financial statements. Important disclosures that should be included in interim financial statements are: A quantitative analysis of the revenue derived from each source, disaggregated to depict how the amount, timing, and uncertainties of revenue and cash flows are affected by economic factors.
A description of the principal sources of revenue and the accounting policies applied to each significant revenue stream.
The extent to which revenue in the current period is affected by changes in estimates, if changes are material in nature.