In reading the FASB’s Discussion Paper on Revenue Recognition with Contracts with Customers, what immediately stands out is the intended breadth of the proposed model.  The Discussion Paper states that the model would apply to “all contracts with customers”, with contract being very broadly defined, although still consistent with IASB and commonly used US legal definitions of the term.  Such broad standardization raises the question: will this standard increase or decrease opportunities for managers to exercise discretion over revenue recognition?

While standard setters seek to increase consistency and comparability in accounting information, research shows us this often comes at the expense of relevance.  One particular instance that comes to mind is the implementation of SOP91-1, the AICPA’s Statement of Position on Software Revenue Recognition, which effectively standardized the requirements for revenue recognition for software sales, limiting managerial discretion.

In a 2001 research paper, Kasznik examines the effect of SOP91-1 on the value relevance of earnings, comparing the originally reported earnings with the restated, more conservative, earnings.  The results suggest that the discretionary portion of earnings (eliminated by SOP91-1) provides information content incremental to the restated earnings numbers, and that after implementing the new standard, the sample firms experienced a decline in the value relevance of reported earnings.  In contrast, firms that did not have to restate (those whose revenue recognition policies were already in compliance with SOP91-1) experienced no such decline.

Due to the reduction of managers’ ability to communicate with investors through accounting discretion, the value relevance of earnings for the sample of software firms declined after SOP91-1 became effective.  To compensate for this, some of the firms in Kasznik’s sample turned to more costly (and unaudited) channels of voluntary disclosure of forward looking information, particularly long horizon forecasts.  Although standardization may have improved the consistency and comparability of software firms’ reported revenue numbers, it also decreased their relevance to investors while imposing additional costs, both explicit and implicit, on firms.

This is only one of many studies that have shown that discretion in accounting is an effective and valuable channel of communication from managers to investors.  If standardizing revenue recognition criterion only within a single industry results in a loss of relevance, we must ask: what would be the effect of standardization across all firms?  Certainly an overall theory, or framework, for revenue recognition criterion is important to accounting, not just as an academic discipline, but in practice, as well.  However, standard setters must continue to strive for a balance between relevance and reliability so that financial statements remain a meaningful tool for investors.