Monday, January 10, 2011

The Revenue Recognition Project: Death by a Thousand Comments

Via The Accounting Onion. 
One of the recurring themes of this blog is that exit prices (as opposed to entry prices) create accounting problems literally from Day One. Expensing transaction costs to acquire financial instruments is just one example the boards have had to cope with, but the even more vexing problem has turned out to be Day One gains from being able to settle performance obligations for less than what was received from the customer. For example, a company that sells an extended warranty on an automobile for $1,000 might be able to immediately subrogate their liability to some other company for a payment of $800. Thus, the fair value of the warranty is only $800, and the Day One gain is $200. The obvious (to me, at least) solution is to measure a performance obligation by the customer's replacement cost of its asset to receive warranty services over the extended period (still $1,000). But the boards traveled too quickly and too far down the fair value road to admit their errors without significant loss of face.
Consequently, in a desperate attempt to save their revenue recognition project (an integral element of convergence) from destruction, the boards pivoted away from fair value measurement and eventually settled on the time-worn notion of allocating the total arrangement consideration amongst the performance obligations in proportion to their respective fair values.
As with any allocation process in accounting, such an approach to measuring performance obligations has raised a whole host of ineffable questions. When is more than one contract an arrangement? When is one contract more than one arrangement? How to measure arrangement consideration? Most fundamentally, what attribute of the performance obligation is being measured?
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