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Revenue from
Performance obligations for contracts with
“revenue from contracts with customers

customers” principle in the

shipping industry 211
Okan Duru Received 20 February 2017
Revised 1 June 2017
Nanyang Technological University, Nanyang, Singapore Accepted 25 October 2017

Joan P. Mileski
Department of Maritime Administration,
Texas A&M University at Galveston, Galveston, Texas, USA, and
Ergun Gunes
Essex Shipping Services Ltd, Essex, UK and Institute of Chartered Shipbrokers,
London, UK

Abstract
Purpose – The aim of this paper is to investigate the gap between cost-based and time-based revenue
recognition schemes in the accounting of ship-owning corporations, and to propose cost-based
revenue recognition (as in general accounting practice) in connection with the performance
obligations.
Design/methodology/approach – For a comparative analysis of time-based (traditional approach) and
cost-based schemes, a sample of dry bulk ships is selected and voyage estimations are performed by certified
professional shipbrokers (Fellow of the Institute of Chartered Shipbrokers) (data collection and voyage
estimation by practitioner). Performance obligations are also defined by certified shipbrokers (i.e. survey and
expert opinion) and certified public accountant based on common shipping business practice and accounting
practice in general.
Findings – Empirical results indicate the significant gap between two alternative schemes. Cost-based
revenue recognition accelerates the revenue recognition (benefit of shipowner), and it enables comparability
among other industries since cost-based allocation is the common practice in accounting (matching principle,
Generally Accepted Accounting Principles).
Research limitations/implications – It is obviously impossible to observe all kinds of freight market
transactions for all different kinds of vessel particulars. The sample size does not undervalue the current
study since the central idea of this paper is not the verification of the cost-based recognition in all possible
transactions.
Practical implications – The proposed approach debiases the existing recognition practice as well as
improving the speed of revenue recognition. In the existing practice, time-based recognition is still based on
voyage estimations (time estimation). Voyage estimations conventionally answer two questions: “What is the
cost of the voyage?” and “What is the duration of the voyage?” Therefore, the proposed approach does not
require any additional work done. Common practice also clarifies the cost-based schedule for revenue
recognition.

© Pacific Star Group Education Foundation Maritime Business Review

Vol. 2 No. 3, 2017
Authors gratefully acknowledge two anonymous reviewers as well as Essex Shipping Services pp. 211-223
Ltd. for providing representative voyage charter data used for comparative analysis of service Emerald Publishing Limited
2397-3757
component valuation. DOI 10.1108/MABR-02-2017-0009
MABR Originality/value – This paper addresses the unconventional accounting practice and its incomparability
problem for the first time. To the best of the authors’ knowledge, this paper is also the first study on
2,3 accounting economics of the shipping business. This paper proposes a practical solution to the debate raised
by Financial Accounting Standards Board 2014-09 regulation on accounting standards by utilizing a staging
approach and cost-based revenue allocation.
Keywords Accounting economics, Accounting standards, Performance obligations,
Revenue recognition
212 Paper type Conceptual paper

1. Introduction
The basic objective of financial reporting is to provide financial information about the
reporting entity that is useful to present and potential equity investors, lenders and other
creditors in making decisions (Kieso et al., 2012). Information must be relevant and
faithfully represent what really happened or existed. Furthermore, there are basic
concepts on how to recognize, measure and report financial statement elements and
events.
The governing bodies for the accounting practices, known as generally accepted
accounting principles (GAAP) or international financial reporting standards (IFRS), include
the Financial Accounting Standards Board (FASB) and the International Accounting
Standards Board (IASB). The accounting practices for shipping firms (particularly vessel
owning and operating firms) are unique to the character of the maritime business. Although
the FASB and the IASB promulgate the way a transaction should be recorded, managers
have some discretion in applying the standards.
The FASB and the IASB have initiated a joint project to clarify the principles for
recognizing revenue and to develop a common revenue standard for US GAAP and IFRS.
The FASB amends the FASB Accounting Standards Codification and creates Topic 606,
Revenue from Contracts with Customers while the IASB issues IFRS 15 (also Revenue from
Contracts with Customers). Both regulate the revenue recognition mechanism and provide
principles for reporting relevant information about the nature, amount, timing and
uncertainty of revenue and cash flows arising from an entity’s contracts with customers (e.g.
charter parties). The standard replaces International Accounting Standard (IAS) 18
“Revenue” and IAS 11 “Construction contracts”, and it is effective since January 1, 2017
(earlier application is voluntary) (IFRS, 2014).
We ask the following research questions: What does this new standard mean for the
maritime industry? How does this standard impact financial and operational management
of shipping firms?
A critical component of the new requirement is the establishment of performance
obligations to determine when revenue is earned. Shipping companies and their customers,
through their contracts, will need to define “objective” milestones to clarify the degree of
completion of service. These milestones, also known as performance obligations, will
determine the timing for recognizing revenues through the period of service. Difficulty in
applying this new standard for financial reporting arises when a shipping contract covers
many services, each of which may not be separately delineated as to revenue earned under
the contract. Further, the portion of the revenue related to each service must be recognized
only when the service is complete.
This paper addresses the challenges maritime firms face in adopting these new
standards. Further it adds to the current literature in that there is a paucity of accounting
standards and revenue recognition papers for shipping companies. The paper is organized
as follows: Section 2 reviews the current and proposed accounting practices. Section 3 Revenue from
discusses current maritime practices in financial reporting. Section 4 addresses the methods contracts with
and strategies proposed for shipping firm adoption. Section 5 reviews implication for
managers and the conclusion.
customers

2. Current and proposed accounting practices

There is a paucity of academic literature addressing revenue recognition from an 213
accounting standards perspective in the shipping industry. Whereas economics is
frequently studied, the accounting rules for shipping transactions are not well
addressed in the maritime literature. This may be because the maritime industry to date
has been allowed to account for revenue in a way that is unique from other industries.
This uniqueness is the focus on time for revenue recognition rather than on the
performance of a task or transaction. Why this focus dominates is due to the length of
time of a ship’s voyage and the lack of understanding of the tasks that occur aboard
ship with the handling of cargo.
Further, the shipping industry is global with differing accounting bodies controlling
the accounting rules. As the accounting bodies converge on common methodologies
globally, the shipping industry is now uniquely impacted by any accounting changes.
There is a fair amount of literature on the new revenue recognition rules in the
accounting academic literature. For example, Wall (2014) notes that the new rules will
cause banks to recognize loan losses sooner. Yeaton (2015) shows how research and
development partnerships will be impacted by this accounting standard. Bloom and
Kamm (2014) and Holzmann and Munter (2014) both project the impact on publicly and
non-publicly traded firms. Rick et al. (2016) address how the new rules may lead to a
more aggressive revenue recognition for software companies. Finally, Dyson (2015)
applies the rules to various industry-based scenarios.
This current unique accounting makes the industry not comparable to other industries.
As the amount of investment dollars has dwindled, competition for investment has
intensified. However, a few studies do address accounting for revenue in shipping. Ting and
Tzeng (2004) address revenue recognition from a cash flow revenue management
perspective. Barnes and Oloruntoba (2005) review revenue recognition from the perspective
of assurance of security in maritime supply chains. Others focus on port and distribution
center revenue recognition methodology (Bichou and Gray, 2004; Lu, 2004). Still others
address the flux in shipping revenue as a result of the institutional and economic
environments (Heaver, 1973). This paper will focus on the issues related to implementing the
new revenue recognition requirement from the FASB and IASB as they pertain to a shipping
company.
There are three conceptual frameworks under which the FASB and IASB standards
under which accounting rules are set and financial reporting controversies resolved. The
first is the basic objective of financial reporting which is to provide useful financial
information about a firm to current and potential investors, lenders and other creditors in
making decision about providing resources to the entity (Kieso et al., 2012). There are
fundamental concepts which include two qualitative fundamentals or characteristics that
distinguish better information from less useful. One is relevance meaning accounting
information must be capable of making a difference in a decision such as reporting details
on transactions over a certain size or importance. The other is faithful representation
meaning that the numbers and descriptions match what really happened or existed (Kieso
et al., 2012).
MABR For purposes of this paper, it is the third conceptual framework of the recognition and
2,3 measurement concepts that we will focus. There are four basic assumptions under this
framework, economic entity, going concern, monetary unit and periodicity. Economic entity
refers to the assumption that economic activity can be identified with a particular unit of
accountability. Going concern assumption relies on the perspective that a firm will have a
long and continuing life. The monetary unit assumption means that money is the common
214 denominator of economic activity and provides an appropriate basis for accounting
measurement. Finally, the periodicity assumption implies that a company can divide its
economic activities into artificial time periods (Kieso et al., 2012). This periodicity
assumption determines in timing of revenue and expenses recognition important to the
change in standards explored in this research.
There are also four basic principles of accounting under the third conceptual framework.
They are the measurement principle, the revenue recognition principle, the expense principle
and the full disclosure principle. The measurement principle means that transactions are
most commonly measured either by historical cost or fair market value. The full disclosure
rule strives for sufficient detail to disclose matters that make a difference to users in an
understandable and cost-effective way. The expense recognition principle states that
expenses follow the recognition of revenue (Kieso et al., 2012). Finally, the revenue
recognition principle is the overarching principle we explore for this research.
Under the general principles of revenue recognition under the FASB Statement of
Financial Accounting Concepts 5, Recognition and Measurement in Financial
Statements of Business Enterprises and the US Security Exchange Commission Staff
Accounting Bulletin 104, Revenue Recognition, revenue must be “earned” and either
“realized” or be “realizable” before it can be recognized in the financial statements.
Revenue is considered “earned” if the entity has substantially accomplished what it
must do to be entitled to the contractual benefits. Now, FASB has adopted an
amendment to the FASB Accounting Standard Codification on the recognition of
revenue from contracts with customers (Topic 606) effective May 2014. The purpose of
the amendment is to align the FASB and the IASB (IFRS 15) and to clarify the principles
of recognizing revenue. Further, this amendment provides comparability of revenue
recognition across entities, industries, jurisdictions and capital markets (Financial
Accounting Standards Board (FASB), 2014-09).
There are, however, two other elements that companies must consider that constrain
reporting on financial statements. There are the cost–benefit relationship and industry
practices. Cost–benefit relationship refers to the cost of providing information verses the
benefits derived from the information. Industry practices refer to the need for industries to
depart from basic theory due to their peculiar nature (Kieso et al., 2012). These two
constraints will become important in our strategies for shipping company compliance with
the new [Financial Accounting Standards Board (FASB), 2014-09] in Section 4.
The aim of the new [Financial Accounting Standards Board (FASB), 2014-09] is to make
entities recognize revenue more consistently regardless of the industry in which they
operate. Further, it purports to improve comparability of revenue recognition practices
across entities, industries, jurisdictions and capital markets. It hopes to also remove
inconsistencies and weaknesses in revenue requirements and reduce the number standards
on revenue recognition.
The change impacts entities that either enter into contracts with customers to transfer
goods or services or enters into contracts for the transfer of nonfinancial assets unless those
contracts are within the scope of other standards [Financial Accounting Standards Board
(FASB), 2014-09]. For the purpose of the maritime/shipping industries, this new FASB/IASB
will impact entities which enter into multi-element (services) arrangements with customers Revenue from
to provide bundled solutions to transportation and logistics solutions under one service contracts with
contract. Accounting for these multi-element arrangements may be significantly different
under this new standard. Revenue from each element of the sale (known as performance
customers
obligations) will now be accounted for separately based on the relative fair market value
(KPMG, 2010). This method is drawn from the customer consideration model of revenue
recognition (Schipper et al., 2008). The new revenue recognition standard eliminates the
215
transaction- and industry-specific revenue recognition guidance under current GAAP/IFRS
and replaces it with a principle-based approach for determining revenue recognition. So, the
application of the new revenue recognition rule may now deviate from previous recognition
departures for purposes of industry standards.

3. Current Maritime practices in financial reporting

Challenges for the shipping firms to comply with this new revenue recognition rules
primarily relate to the timing of revenue recognition. Companies that currently use the
percentage-of-completion approach for the recognition of revenue or that enter into contracts
that contain multiple elements will be significantly impacted (KPMG, 2010). The percentage-
of-completion method will no longer exist as a separate and distinct revenue recognition
model.
Currently, shipping companies prefer the percentage-of-completion method of revenue
recognition. However, shipping companies can continue to use the percentage of completion
method only if it matches the timing of the completed service. So, a firm may recognize
revenue consistent with the percentage of completion method when those activities
concurrently satisfy performance obligations through the transfer of the control of assets
(goods or services) to the customer such as in the case where the customer controls the
product or where this is a continuous transfer of assets to the customer (KPMG, 2010). This
means that the percentage of completion method is not appropriate for the recognition of the
amount and timing of revenue if the control of an asset (service) is transferred at a time that
is different from the transfer of risk and rewards or the stage of completion of the service.
For example, currently time charter parties establish a proportion of revenue recognized for
each day (daily T/C freight rate is earned) while voyage charter parties usually define an
instant payment deadline for freight to be paid to ship owner.
So, recognition of revenue occurs upon satisfaction of performance obligations within the
contract. This generally occurs when the control of an asset (a good or service) transfers to
the customer. The criteria used to determine whether a performance obligation is satisfied
are somewhat complex. However, the key concepts include whether the assets have an
alternative use to the company and whether the company has a right to payment (IFRS,
2014).
What this means for shipping companies is they will need to identify all performance
obligations, including those embodied in the terms and conditions of the arrangement
including any constructive or statutory obligations. Further, if the shipping company enters
into a contract with multiple elements (e.g. where goods and services are sold together but
delivered at different times), then revenue must be assigned to each element and recognized
when the performance is completed. The price under the contract must be allocated to each
good and service under the contract based on a standalone selling price of each associated
good or service. This means, however, that each good or service must be “distinct” (IFRS,
2014). Further, these prices may vary but must be able to be measured reliably (KPMG,
2010).
MABR The challenge to adoption of this new accounting standard is due to the particular
2,3 processes for loading and unloading of a ship. Ships need to arrive at a particular time at the
loading port for loading operations, and freight revenue is rarely paid before cargo is loaded
securely. So, when is the revenue now recognized? Under voyage charter arrangements, is
control continuously passed to customers over the course of the voyage or only at the
completion of the contract? Further, there are “breach of charter party” codicils in shipping
216 contracts that state that even when the freight rate is paid in advance, a ship owner is liable
for any damages caused by failure to complete a safe cargo shipment service. Impairment
losses can also complicate revenue recognition (IFRS, 2014).
This new promulgation can also impact recognition of revenue for obligations under
the contract that are not usually sold separately such as bundled services which are
provided at different times throughout the contract. For example, the dry bulk business
spot revenues are currently recognized proportionally over time which may include
several months of voyage (usually before steaming to a cargo discharge port). An
industry acronym connected with this principle of revenue recognition is
FDEDANRSAOCLONL – Freight Deemed Earned, Discount less And Non-Returnable
Ship And Or Cargo Lost or Not Lost. The current practice of the industry recognizes
revenue either at the completion of voyage or daily and proportionally distributed
between either two discharge ports (Discharge-to-Discharge, D-D) or two loading ports
(Load-to-Load, L-L). Since details and estimations for the next voyage are usually
available at the discharge port of previous contract service, D-D approach is frequently
preferred. D-D (e.g. Eagle Bulk Shipping Inc., National Association of Securities Dealers:
EGLE) or recognizing rateably over the estimated transit time of each voyage (e.g. Navios
Maritime Partners L.P., New York Stock Exchange [NYSE]: NMM) will now not be
appropriate unless control of a good or service can be continuously passed to the
customer. In other words, the timing of revenue recognition must comply with completed
performance obligations under the contract.

3.1 Methodologies of current revenue recognition

Although this paper explores conceptually the issues for shipping companies under the new
accounting promulgation, this paper collects data on the current methodologies of revenue
recognition by global shipping companies. We review the annual reports of these shipping
companies for the methodology used to recognize revenue using the latest (usually 2015)
annual financial statements. We select these companies because they represent large
publicly traded companies or large companies with publicly available financial statements.
The authors review the notes in the annual reports for revenue recognition and report the
findings in Table I.
Table I shows the various revenue recognition methods declared in the annual reports of
the various shipping companies. A legend is provided below the table. As indicated on the
table, there are various methods of revenue recognition across companies and market
segments. The selection of a method must be consistent with generally accepted accounting
standards but is at the discretion of management. Under general accounting rules, once a
firm selects a revenue recognition method, it may not change without a significant event
occurring. Otherwise, financial statements would be inconsistent across time periods
confusing the results for investors. The percentage of completion approach at daily basis is
the most common method used in the industry. The Japanese shipping groups (Nippon
Yusen Kaisha, MOL, Kawasaki Line) and Bahri Chemical Tankers (The National Shipping
Company of Saudi Arabia [Bahri]) prefer the completion of voyage method (an instant
recognition) while cruising firms particularly utilize the per-voyage (by completing 10 days
 Revenue recognition
Revenue from
method declared in contracts with
Company Segment Stock exchange annual reports
customers
Maersk Container CSE D/P
Carnival Cruise NYSE P.V.
MISC Diversified KLSE D/P
Royal Caribbean Cruise NYSE P.V.
Mitsui O.S.K. Diversified TSE C/V 217
NYK Diversified TSE C/V
K-Line Diversified TSE C/V
Tidewater Offshore Vessels NYSE D/P
NSCSA Chemical Tanker SSEX C/V
Teekay Tanker NYSE D/P
Hyundai Merchant Marine Container KSE D/P
Frontline Tanker OSE D/P
OOCL-OOIL Container HKEX D/P
Seacor Holdings Offshore Vessels NYSE D/P
Alexander & Baldwin Container NASDAQ D/P
NOL Container SGX D/P
Hanjin Shipping Container KSE Not declared
Cosco Singapore Dry Bulk SGX D/P
OSG Tanker NYSE D/P
Evergreen Container TAIX D/P
Bergesen World Wide Gas Diversified OSE D/P
Stolt-Nielsen Chemical Tanker OSE D/P to “Budgeted voyage legs
ACL Barge NASDAQ D/P to distance sailed
Torm Product Tanker CSE D/P
Qatar Shipping Tanker QSE D/P
Euronav Tanker EB D/P D-D
Yang Ming Container TAIX D/P
OMI (acquired by Teekay and TORM) Tanker NYSE D/P D-D
Wan Hai Container TAIX D/P
Wilh. Wilhelmsen ASA Car Carrier OSE D/P
China Cosco Holdings Container HKEX D/P
Norden Dry Bulk CSE D/P D-D
Great Eastern Tanker NSE D/P
CMB Dry Bulk EB D/P
Odfjell Chemical Tanker OSE D/P
Iino Kaiun Tanker TSE D/P

Source: Compiled from annual reports and many other sources by authors. Abbreviations for Stock
Exchanges: CSE: Copenhagen Stock Exchange; EB: Brussels Stock Exchange (EURONEXT); HKEX: Hong
Kong Stock Exchange; KLSE: Kuala Lumpur Stock Exchange; KSE: Korea Stock Exchange, Seoul;
NASDAQ: National Association of Securities Dealers; Automated Quotations, New York; NSE: National
Stock Exchange of India; NYSE: New York Stock Exchange; OSE: Oslo Stock Exchange; QSE: Qatar Stock
Exchange; SGX: Singapore Stock Exchange; SSEX: Saudi Arabia Stock Exchange, Riyadh; TAIX: Taipei
Stock Exchange; TSE: Tokyo Stock Exchange. Some abbreviations used in the table: MISC: Malaysia
International Shipping Corporation (Berhad); Mitsui O.S.K.: Mitsui Osaka Shosen Kaisha (also MOL); NYK: Table I.
Nippon Yusen Kaisha; K-Line: Kawasaki Line; NSCSA: The National Shipping Company of Saudi Arabia
A Sample of publicly
(Bahri); OOCL-OOIL: Orient Overseas Container Line and Orient Overseas International Limited; NOL:
Neptune Orient Lines Ltd; OSG: Overseas Shipholding Group; ACL: American Commercial Barge Line; traded shipping
OMI: Ogden Marine Inc.; CMB: Compagnie Maritime Belge (also Bocimar & Delphis); D/P: Daily and/or companies and their
Proportionally, Percentage of Completion; D-D: Discharge-to-Discharge schedule for revenue recognition; C/ revenue (charter)
V: Completion of Voyage; P.V.: Per Voyage (10 days) recognition methods
MABR at each voyage) method in a similar way of completion of voyage. Percentage of completion
2,3 method is always applied based on time spent for the shipping service (a few exceptions
with distance-based staging). The choice of methodology is determined by management.
Some companies particularly emphasize that percentage of completion approach is
performed for the period between two discharging ports (discharging previous and
subsequent cargo), which is called D-D distribution of revenues. Utilizing D-D approach
218 instead of L-L has a number of advantages such as availability of details on the next charter.
For some shipping services, making an estimation of a voyage is a complicated problem.
For example, chemical tankers usually carry parcel cargoes which are carried for several
different terminals and owned by several shippers. In addition to that, these tankers can
charter a single tank space even before discharging all cargoes completely. Therefore, Stolt-
Nielsen (Oslo Stock Exchange: SNI) prefers “budgeted voyage legs” approach which is
based on estimations of fixtures for each parcel cargo (each freight revenue payment is
proportionally distributed for its own service period).

3.2 Performance obligations in the shipping business practice

According to the new revenue recognition approach, charterers and shipowners are required
to define certain performance obligations so they may assign particular amounts of freight
revenue to each of these obligations. Freight revenue is recognized when services are
delivered and revenues realized. In the current practice, this means that the lump-sum
amount of freight revenue is usually distributed over the duration of voyage (daily basis)
based on the voyage estimations prior to the intended voyage charter. However, it is obvious
that if a ship sailed half of its entire route between a loading port and discharging port (ship
sails to discharge its cargo), it will not be paid in a half of agreed freight revenue unless the
shipowner terminates the contract.
There are a number of common industry practices such as Before Break Bulk (BBB), i.e.
before discharging, arrival to discharge port, or FDEDANRSAOCLONL. In case of conflicts,
jurisdictions and insurance companies handle cases based on the breach of charter party,
general average and other common legal regulations. Currently, freight revenue is paid with
a single payment at the time of departing the loading port (before steaming) or arriving the
discharge port (before delivering cargo), and that the single payment practice causes
oscillations of cash flow recognition.
Distribution of freight revenue (or recognition of revenue) through the shipping service is
needed for establishing a proper financial reporting practice. That is also needed to ensure
comparability across different industries. In current shipping practice, freight revenue may
be deemed earned before a complete delivery. Freight revenue is recorded as deferred
revenue (as liability) when paid. The liability is then reversed to recognize revenue
gradually in exchange of shipping service.
Key question behind the staging of shipping services is the definition of performance
obligations (milestones) for relevant timing of revenue recognition. In the ship broking and
operation practice, there are four major services delivered through a voyage charter:
(1) Ballast voyage before loading (arriving a loading port);
(2) Loading a cargo (completion of cargo loading);
(3) Steaming (sea route); and
(4) Cargo discharging (final delivery of cargo).

FDEDANRSAOCLONL refers to advance payment at the second stage (cargo loading),

while BBB refers to the third-stage payment (before discharging, arrival to discharge port).
In this four-stage classification system, ballast voyage and complete delivery of cargo are Revenue from
usually not considered as a point of freight payment. However, the four-stage approach may contracts with
be utilized as performance obligations to recognize revenues earned from a voyage charter
party. With the proposed staging approach, valuation of each stage is required, and fair
customers
market value of these stages cannot be estimated directly since there are no independent
markets for these stages themselves. In many other industries, cost-based valuation is
frequently used, while time spent for each stage may be an alternative (similar to time
charter basis). For illustrating the differences between these valuation methods, a number of
219
representative dry bulk voyage contracts are selected from transaction database of Essex.
Shipping Services (Table II) and both cost-based and time-based value of stages
(percentage of entire freight revenue) are estimated by given average numbers (Table III).
For representative route and tonnages, the length of each stage (days) and total expenses
are estimated based on the industry practices as well as average cost items recorded in the
database. Steaming periods are estimated by using average speed of representative tonnage
(economic steaming speed) and average time spent at given ports in the past few years
(excluding extraordinary cases). Bunker expenses [both Intermediate Fuel Oil (IFO) and
Marine Gas Oil (MGO)] are based on the current market prices, while port disbursement
accounts are based on average of invoices paid in the past few years for given ports.
According to the market value estimations, there is a significant gap between time-based
and cost-based approaches (Table III). Time-based approach (current practice of the
industry) emphasizes the period spent for steaming between loading and discharging ports,
which is usually the major section of the entire voyage, while cost-based approach (current
practice of other industries) highlights port expenses for Handymax and Supramax
tonnages. Panamax bulkers usually spend a long time at steaming between ports, and
therefore, cost of steaming is still the major portion of the entire cost of shipping service.
The gross averages of cost-based valuation indicate that one-third of lump-sum freight
revenue (roughly) must be recognized in the last three stages (one-third for each stage) of

Representative route
Type Size (dwt) Loading Discharging
Table II.
Handysize 29,000 Odessa Rotterdam
Supramax 58,000 New Orleans Gijon
Representative
Panamax 82,000 Houston Kandla routes for valuation
of performance
Source: Essex Shipping Services Ltd obligations

Time basis Cost basis

Ballast Loading Steaming Discharging Ballast Loading Steaming Discharging
Tonnage (%) (%) (%) (%) (%) (%) (%) (%)

Handysize 4.52 24.16 45.30 26.02 2.32 40.13 23.23 34.32

Supramax 3.24 27.75 41.26 27.75 1.85 45.09 23.52 29.55
Panamax 2.08 11.57 72.63 13.72 1.18 29.27 41.13 28.42 Table III.
Gross Time and cost basis
average 3.28 21.16 53.06 22.50 1.78 38.16 29.30 30.76
assessments for
Sources: Essex Shipping Services Ltd.; authors’ calculation based on the data representative routes
MABR completing cargo loading, completing the sea voyage and completing cargo unloading. The
2,3 practical meaning of cost-based approach is the current industry practice (percentage of
completion at daily basis) causes delayed recognition of revenues.
Underlying reason behind the D-D basis approach is usually accounted for the
availability of voyage details (fixture) before discharging previous cargo. Having details of
the next charter enables to estimate the length of entire service and distribute freight
220 revenue through the shipping service at daily basis (similar to time charters). Ship operators
are also able to estimate the cost of the service, and it is even conducted before fixture to find
a breakeven value for negotiations (e.g. for almost all ports, port dues and invoices are well
known before a fixture.) Therefore, cost-based recognition of revenues does not require an
additional work, but actually rationalizes earlier recognition of revenues than the time-based
approach.
Currently the percentage of completion method is most often used by shipping
companies to recognize revenue. Since this methodology is no longer allowed under the new
accounting standards, it must now be abandoned. When costs are incurred may be a good
substitute and have similar results to the percentage of completion. Further, these data on
the various methods currently employed by shipping companies to recognized revenue
show that cost is a good proxy, under the new accounting rules, for revenue recognition
when each service provided in a voyage has a similar profit margin or revenue/cost ratio.
Further, this methodology is an efficient way in line with industry operations to recognize
revenue in the appropriate accounting period.

4. Methods and strategies for shipping firm adoption

The stock price of a company is impacted by the results of operations. Since the financial
statements report the results of operations, how transactions are reported affect the stock
price. Further, this information can have a significant impact on several external decisions
such as ratings, credit opportunities or attracting new equity investors. So, a change in the
way a transaction is reported can have the effect of changing the stock price and making the
reported results not comparable over several reporting periods (Ferraro and Mcpeak, 2000).
Consistency across periods prevents stock price volatility and manipulation.
In addition to non-comparability of results from period to period for a given firm caused
by a change in accounting for the same type of transaction, comparability is needed across
firms in the same industry for similar transactions. Ship valuation is made with reference to
the current market price of the ship or long-term asset value (LTAV) derived from
discounted cash flow method. So, a loss to the ship’s value from any impairment is
calculated with reference to this current market across all firms. After the financial crisis of
2008, ship valuation has become a hot topic of ship finance and LTAV became the preferred
method of valuation due to the sudden decline in current market prices of ships. If there were
differences in accounting between periods for revenues and costs used to derive the
discounted cash flows, whether a ship loan was in default would have been further
impacted.
Managers have to use their discretion regarding assumptions made in financial
reporting. However, consistency between companies and between periods is important. The
IFRS does not have a required mandatory restatement retrospectively across periods (IFRS,
2014).
To appropriately adopt the new revenue recognition rules, there are five steps a firm
should consider in how it presents revenue. These five steps appear in the academic
accounting literature (Wall, 2014; Bloom and Kamm, 2014; Holzmann and Munter, 2014;
Dyson, 2015; Gallagher, 2016). We attempt to apply the steps to the shipping industry. The
first step is to identify the contract with a customer. This means the essential agreement Revenue from
between the firm and the customer that creates enforceable rights and obligations. Further contracts with
collectability must be reasonably assured to recognize revenue.
The second step is to identify the performance obligations in the contract. The contract
customers
may contain more than one distinct good or service and, if so, the related revenue streams
must have accounted for separately. Under Financial Accounting Standards Board (FASB)
(2014-09), separate performance obligations may be implied through customary business
practices or valid expectations. Inconsequential items or administrative activities may be 221
excluded.
For Step 2, a staging approach given in Section 3.2 may be utilized independently to
ensure the new regime of FASB and IASB. On the other hand, a more structural
revolution, a revision of standard voyage charter parties, is thought to be needed for
establishing more consistent solution. If carrier and charterer define performance
obligations and make valuations at the time of fixture, accounting for these contracts
would be much easier and straightforward. For example, GENCON 94 standard voyage
charter party form may be revised to include performance obligations.
In Step 3, the transaction price is determined. Under GAAP, having variable elements,
the revenue is recognized only when the related contingency is resolved. Under Financial
Accounting Standards Board (FASB) (2014-09) now, all variable consideration that is likely
to occur should be included in the transaction price and the inception of the contract. “Likely
to occur” does not mean the customer’s credit risk is considered. Up-front fees will have to be
reviewed under this step.
Step 4 discusses the most contentious part of the new promulgation for shipping
companies. The transaction price must be allocated to performance obligations using the
relative standalone selling price of good service. If standalone prices are unknown, they
must be estimated. A process and documentation on how these prices are estimated must be
developed.
Step 5 addresses satisfying performance obligations. The timing of revenue recognition
is determined in this step. Revenue is recognized when or as control of the asset or service is
transferred to the customer. This differs from previous rules where revenue was recognized
when the risks and rewards of ownership have transferred. Timing of revenue may change
for shipping companies as it is evaluated separately for each identified performance
obligation. There is no guidance under this rule on transfer as a point in time or over a
period of time.
However, in addition to these revenue recognition rules, there is a FASB and IFRS
standard that is known as the matching principle. Under the matching principle,
revenue earned and the expenses incurred to earn the revenue should generally be
recognized in the same period. So, the percentage of completion method can be
calculated based on expenses incurred through delivering services (e.g. Manitowoc Co.,
MTW: NYSE). Considering the matching principle, cost-based revenue recognition may
be more suitable and fair to the shipping industry as the standard for the timing of
revenue recognition. Therefore, costs incurred may be a good proxy for revenue
recognition provided that each service has a similar margin (Figure 1).

5. Implication for managers and the conclusion

In conclusion, shipping company managers should be able to identify the various
performance obligations under each contract. If the margins earned on each obligation
under the contract are similar, the use of costs when incurred as a proxy for the timing
of revenue recognition may provide a simpler solution to adoption of this new FASB/
MABR IASB standard. Costs, it can be argued, are only incurred when performance occurs.
2,3 Thus, the matching of cost and revenues is the best satisfaction of a performance
obligation.
Managers should also consider the requirements of this standard before negotiating
contracts (IFRS, 2014). Tax implications not addressed here should be reviewed.
Further, they may wish to unbundle contracts. However, this may be considered
222 difficult since shipping customers traditionally have seen the contract as a single
package, the services are performed as a continuous sequence and the risk associated
with delivering each element are similar (KPMG, 2010).
Further, judgment by management is needed when defining voyage under a contract.
Consideration should be given to whether a round trip or leg-to-leg basis is more
appropriate. The actual number of days it takes to complete a voyage when a large
proportion of ocean freight is delivered late should be used rather than an estimate. Also,
the voyage definition should consider contracts that contain several destination ports
(KPMG, 2010).
Renegotiations of charter contracts as markets change will provide further
challenges. Also swap or sharing arrangement as well as leveraging embedded in the
contracts will need to be carefully reviewed. These items will impact revenue
recognition such as when the actual service is deliver (not when the swap is sold) or
treated as a separate contract.
The methodologies, assumptions and decisions used regarding revenue recognition
by shipping companies must be disclosed in the financial statements. This includes
methods used to determine contract revenue and the methods used to determine the
stage of completion (KPMG, 2010). The five-step approach to contract analysis may
help to resolve questions regarding the timing of revenue recognition for the shipping
industry.
How revenue is recognized in financial statements impacts a shipping company’s ability
to obtain financing whether it is through the stock price or from debt instruments. This
paper presents a cogent argument for a cost-based revenue recognition approach for
shipping companies under the new accounting rules. The argument reiterates that cost is a
good proxy for revenue recognition when each service provided in a voyage has a similar
profit margin or revenue/cost ratio. Accounting methods are required to fairly present the
results of operations of companies and this suggested methodology follows how the
industry does business.
Further research is needed when shipping companies begin to show the results of
operations using the new revenue recognition rules. Questions will remain on the impact of
this accounting rule on contract negotiations, voyage practices and cost as a proxy for
revenue recognition.

Identify the contract Revenue recognized

with the customer when performance met

Figure 1.
Revenue recognition
process with
Identify
performance Performance
Determine the Allocate transaction price to
transaction price performance
obligations Obligations
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Corresponding author
Okan Duru can be contacted at: [email protected]

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