So far, no one has responded to my questions about the importance of contracts for revenue recognition. So, let me venture to ask a few more questions that occurred to me while reading the FASC’s comment letter on the revenue recognition discussion paper.

In their response to Q9, the authors state:

The traditional “income statement” approach suggests that if a company does half the work on a long-term construction project during the current period, they should recognize half of the revenue during that period. To use language that seems to have passed “out of vogue,” it matches revenues with costs incurred during that period to complete the performance obligation.

I’ll admit that the word matching seems to have passed “out of vogue” among standard setters in recent decades. In my work on the revenue recognition project, board members bristled when anyone mentioned the idea of matching. But to be fair, there is a good reason why the principle of matching expenses to revenue (note the direction) is problematic. Unless you have a clear definition of revenue and when it should be recognized, the idea of matching expenses to revenue is much like trying to pin the tail on a moving donkey. This is one of the primary reasons why the boards added revenue recognition to its agenda—to define revenue more carefully and to identify the circumstances (i.e., which changes in assets or liabilities) that would lead to the recognition of revenue.

Interestingly, the FASC letter describes an example of matching revenue to expenses, just the opposite direction of expenses being matched to revenue. Unfortunately, the same tail-and-moving-donkey situation exists here as well.

  • To what expenses would the revenues be matched?
  • Should revenue be recognized when cash expenditures are made to obtain framing and roofing materials in a long-term construction project? Is this an expense?
  • Should revenue be recognized only when these materials are incorporated into the building or ship? Is this an expense? Would it depend on whether the building or ship in progress is the company’s or the customer’s asset?
  • Should revenue be recognized when a construction company transfers the building to the customer?  Is this an expense?
  • Which expense should drive the recognition of revenue based on the matching principle?

My point here is that both ideas of matching expenses to revenues or matching revenues to expenses are equally vacuous without careful definition and recognition criteria for revenues (in the first case) or expenses (in the second case).

What did the authors have in mind? I am not sure. But this is one example of why comment letters to the boards are sometimes not as useful as they could be. Sometimes they come across as mere opinion without careful analysis. Believing these authors to be smart and careful researchers, I suspect they had something good in mind. So, I would invite them (or anyone else) to respond to my questions. I look forward to reading your comments.