Measuring Value-Added as a Revenue Recognition Approach
I’ve been thinking about something Jeff Wilks said during this week’s FASRI Roundtable and something that occurred to me during the conference. In short, it is the notion that it might be useful to consider perspectives other than the customer consideration model for revenue recognition. (Forgive me, Jeff, if I misunderstood your comments Wednesday, and of course feel free to correct me.)
One alternative perspective that I believe is consistent with the conjecture that Jeff made is the idea that maybe what we should be trying to measure is value-added activities. This seems consistent to me with what equity investors are really after in thinking about performance during a period: How much value did the firm create during the period? Such a definition of revenue is, I think, consistent with the conceptual framework, in that it embraces the notion that revenue is equal to the non-owner-related increase in net assets during the period. I believe it is also consistent with the revenue recognition methods currently employed in the agriculture industry, as well as in the application of the percentage of completion method used for long-term contracts.
This approach is not inconsistent with the customer-consideration/performance obligation approach, in that satisfaction of a performance obligation, which is the trigger for revenue recognition in the proposed model, would also be considered a value-adding activity. But it seems that the value-added approach might be more general, in that it would not necessarily require a customer relationship to recognize revenue.
One simple example that occurs to me is that of a retailer, who buys merchandise from a supplier at “wholesale” prices. By the act of locating such goods and “re-locating” those goods to a specific retail location, the retailer has created value that its customers could not readily do (i.e., they do not have access to wholesale prices). Abstracting from errors in judgment as to how many items to acquire, spoilage, etc., one could argue that once the goods are in the store, offered for sale, the value-creating activity has been completed, even before any customers actually purchase the goods. The retailer could conceptually recognize revenue under this approach upon the act of putting the items on display in the store. This would make retail accounting similar to that of the timber or farming industries under current practice, where the sale to the customer is considered less critical than the production of the saleable items.
There are serious measurement issues, and non-trivial issues about the prospect of recording “sales” revenue prior to a sale taking place, but I’m wondering if the “value-added model” might overall have more or fewer complicated issues overall than the customer consideration model. I’m also wondering what sorts of approaches taxing authorities use in jurisdictions where there are value-added taxes. Might those approaches be used as a means of building a revenue recognition model for financial reporting purposes?