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Transcript of Lexis Nexus Complexus: Comparative Contract Law and ... · PDF file See John H. Matheson,...

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    Lexis Nexus Complexus: Comparative Contract Law and International Accounting Collide in the IASB–FASB Revenue Recognition Exposure Draft

    Kurt S. Schulzke* Gerlinde Berger-Walliser**

    Pier Luigi Marchini***

    ABSTRACT

    U.S. and international accounting-standard setters plan to launch a new, global revenue accounting standard, Revenue from Contracts with Customers, in 2013. Poised at the nexus of comparative contract law and international accounting, the proposal’s contract-based revenue recognition model creates new legal risks and opportunities for accountants, lawyers, clients, and financial statement users. Despite its focus on legally enforceable contracts, the proposed standard was drafted

    * Associate Professor of Accounting & Business Law, Director of Law, Ethics & Regulation, Corporate Governance Center, Kennesaw State University. Professor Schulzke represents corporate whistleblowers as Of Counsel at Slappey & Sadd LLC, Atlanta, Georgia. J.D., cum laude, Georgia State University College of Law; M.Acc. & B.S., Brigham Young University. 1000 Chastain Road, Stop 0402, Kennesaw, Georgia 30144, [email protected], tel. +1770.423.6379. ** Assistant Professor of Business Law, School of Business, University of Connecticut. Dr. jur., University of Bielefeld (Germany); 2. Staatsexamen, Landgericht Heidelberg; 1. Staatsexamen, University of Bielefeld (Germany). 2100 Hillside Road, U 1041 Storrs, CT 06269, [email protected], tel. +1860-486- 4133. *** Professore Aggregato, Dipartimento di Economia, Università Degli Studi di Parma. Professor Marchini teaches international accounting and governance, and publishes on corporate social responsibility disclosures and the process of disclosing economic and financial information, particularly with respect to consolidated financial statements, business economic groups, income and equity representation schemes, and international accounting convergence toward International Financial Reporting Standards. Via Kennedy, 6 - 43125 Parma, Italy, [email protected], tel. +390521032389. The authors express sincere gratitude to their spouses and children for their unfailing support during the drafting process; Catalina Castaño for her research and commentary on Colombian law; Can Mugan (Middle East Technical University), Thomas Rautenstrauch (HWZ Zurich), Marisa Pagnattaro (University of Georgia), and a host of generous Academy of Legal Studies in Business colleagues for their insights and comments on earlier drafts.

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    without input from the legal community. This Article models the proposal’s complex contract-analysis process, demonstrating that its revenue outcomes may vary materially because of seemingly minor interjurisdictional differences in law applicable to “open-price” contracts; offers practice pointers for attorneys, accountants, and auditors; recommends changes to the proposal, including the substitution of self-enforcing Nash equilibria for legally enforceable contracts; and encourages more collaboration between the legal and accounting professions in the joint deployment of legal and accounting expertise for better value creation, value allocation, and risk mitigation.

    TABLE OF CONTENTS I. INTRODUCTION .............................................................. 517

    A. Revenue Primer ................................................... 520 B. Related Research and Commentary ................... 527

    1. Comparative Contract Law ......................... 527 2. Accounting and Revenue Recognition ........ 528

    II. REVENUE RECOGNITION PROCESS ................................. 534 A. Overview .............................................................. 534 B. Stage 1: Contract Analysis ................................. 535

    1. Contract Analysis Overview ........................ 535 2. Contract Existence ....................................... 536 3. Implied and Noncontract Obligations ........ 542

    C. Stage 2: Recognition and Measurement ............ 546 III. ED APPLIED TO PRATT & WHITNEY–MALEV ................. 549

    A. Fact Scenario: Jet Engine Transaction ............. 549 B. Contract Analysis: Legal Enforceability ............ 551

    1. European Union ........................................... 554 a. France ..................................................... 555 b. Germany ................................................. 557 c. Italy ........................................................ 559

    2. North America: United States .................... 562 3. South America: Colombia ............................ 567 4. International Law: UN Convention on Contracts for the International Sale of Goods ................................................ 568 5. Legal Analysis Summary ............................ 572

    C. Contract Analysis: ED Paragraphs 14 and 15 .. 573 1. Paragraph 14(a): Commercial Substance ... 573 2. Paragraph 14(b): Parties’ Commitment ..... 574 3. Paragraph 14(c): Parties’ Rights ................. 574 4. Paragraph 14(d): Terms and Manner of Payment .................................................... 574

  • 2013] Lexis Nexus Complexus: Law and Revenue Accounting Collide 517

    5. Paragraph 15: Termination Compensation ............................................... 574

    D. Recognition: ED paragraphs 23–80 ................... 576 IV. CONCLUSIONS AND RECOMMENDATIONS ....................... 577

    I. INTRODUCTION

    The wheels of commerce would turn more smoothly if lawyers better understood accounting and accountants better understood the law. Exhibit A in support of this proposition is the international revenue accounting exposure draft (ED), Revenue from Contracts With Customers, 1 now under final review by the U.S. Financial Accounting Standards Board 2 (FASB) and the International Accounting Standards Board 3 (IASB) in preparation for global implementation.

    1. The ED is available in International Accouting Standards Board (IASB) and Financial Accounting Standards Board (FASB) versions. See Exposure DRAFT: REVENUE FROM CONTRACTS WITH CUSTOMERS, ED/2011/6 (Int’l Acct. Standards Bd. 2011) (Proposed Exposure Draft 2011) [hereinafter EXPOSURE DRAFT] (IASB version), available at http://www.ifrs.org/Current-Projects/IASB-Projects/Revenue-Recognition/ EDNov11/Documents/RevRec_EDII_Standard.pdf; EXPOSURE DRAFT: REVENUE FROM CONTRACTS WITH CUSTOMERS, ED/2011/6 (Fin. Accounting Standards Bd. 2011) (Proposed Exposure Draft 2011) (FASB version), available at http://www.fasb.org/cs/ BlobServer?blobkey=id&blobwhere=1175823559369&blobheader=application%2Fpdf& blobcol=urldata&blobtable=MungoBlobs. Hereinafter, unless otherwise noted, citations to ED paragraphs will be to the IASB version. The original ED/2010/6 will be referred to hereinafter as ED 2010. 2. Effective September 15, 2009, the FASB promulgates U.S. generally accepted accounting principles (U.S. GAAP) exclusively in the ACCOUNTING STANDARDS CODIFICATION, subtopic 105-10-05 (Fin. Accounting Standards Bd. 2012) [hereinafter FASB CODIFICATION], available at http://asc.fasb.org, which must be followed in the preparation and auditing of U.S. GAAP-compliant financial statements of all for-profit companies. The Codification and Securities Exchange Commission (SEC) regulations, issued by the SEC under its rule-making authority, comprise the accounting principles binding on publicly traded, U.S.-headquartered companies. Id. Prior to September 15, 2009, U.S. GAAP was found in materials promulgated by the FASB and the American Institute of Certified Public Accountants archived at Pre-Codification Standards, FIN. ACCT. STANDARDS BOARD, http://www.fasb.org/jsp/FASB/Page/PreCodSectionPage& cid=1218220137031 (last visited Feb. 15, 2013). These materials were ranked hierarchically, in terms of their relative authoritative force. STATEMENT OF FINANCIAL ACCOUNTING STANDARDS NO. 162: THE HIERARCHY OF GENERALLY ACCEPTED ACCOUNTING PRINCIPLES ¶ 3 (Fin. Accounting Standards Bd. 2008) [hereinafter SFAS 162], available at http://www.fasb.org/pdf/fas162.pdf. 3. The IASB promulgates International Financial Reporting Standards (IFRS). Preface to INTERNATIONAL FINANCIAL REPORTING STANDARDS ¶¶ 5, 7 (Int’l Accounting Standards Bd. 2010), available at http://eifrs.iasb.org/eifrs/ bnstandards/en/preface.pdf. Prior to January 1, 2001, the IASB’s predecessor, the International Accounting Standards Committee, issued IAS, which continue in force unless superseded by subsequently issued IFRS. INTERNATIONAL ACCOUNTING

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    Hovering at the nexus of comparative contract law and international accounting, the ED’s contract-based revenue recognition model offers a prime context for accountants and lawyers to work together. Legal and management scholars in Europe and the United States have previously encouraged lawyers and other professionals to apply their expertise collaboratively to maximize business success.4 So far, however, little, if any, collaboration has occurred in connection with the ED. Despite its singular focus on legally enforceable contracts, the ED was drafted largely without input from the legal community, which plays a leading role in the negotiation, drafting, interpretation, and enforcement of