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1 Picture to be changed EVOLUTION DEMANDS SPEED AND FLEXIBILITY Dolphins are some of the most successful hunters in the animal kingdom. Their speed, intelligence and adaptability give them a crucial edge. F A S B ' S N E W R E V E N U E R E C O G N I T I O N S T A N D A R D A N D T H E P O T E N T I A L I M P A C T S U P O N T H E W A T E R I N D U S T R Y Julie Petit Brian Jones September 19, 2016

2 A G E N D A I. Overview of the new revenue recognition standard A. Background B. Scope C. Effective date D. 5 step approach II. Non-regulated contract services within the water industry III. Regulated utilities within the water industry IV. Implementation and footnotes disclosure V. Conclusions and closing remarks 2

3 O V E R V I E W O F T H E N E W R E V E N U E R E C O G N I T I O N S T A N D A R D A. Background May 2014 FASB issues ASU and the IASB issues IFRS 15, both entitled Revenue from Contracts with Customers Key Impacts Substantially converges U.S. GAAP and IFRS Moves U.S. GAAP to a principles based approach Eliminates transaction and industry based guidance under U.S. GAAP Adds significant guidance and structure to IFRS FASB has issued three clarifying ASUs and has one Exposure Draft outstanding: ASU Principal versus Agent Considerations ASU Identifying Performance Obligations and Licensing ASU Narrow-Scope Improvements and Practical Expedients 3

4 O V E R V I E W O F T H E N E W R E V E N U E R E C O G N I T I O N S T A N D A R D B. Scope It applies to all contracts with customers regardless of industry Specifically excluded Lease contracts Contracts under ASC 944 Financial Services - Insurance, Financial instruments Guarantees (other than product or service warranties) Nonmonetary exchanges between entities in the same line of business to facilitate sales to customers Collaborations where companies work together to develop product/service for sale to third parties 4

5 O V E R V I E W O F T H E N E W R E V E N U E R E C O G N I T I O N S T A N D A R D C. Effective dates U.S. Public Companies Effective for annual reporting periods beginning after December 15, 2017 (December 2018 calendar year end) U.S. Nonpublic Companies Effective for annual reporting periods beginning after December 15, 2018 (December 2019 calendar year end) Early application is permitted, but not before the original effective date (i.e. annual periods beginning after December 15, 2016) Under IFRS Effective for annual periods beginning on or after January 1, Early adoption is permitted 5

6 O V E R V I E W O F T H E N E W R E V E N U E R E C O G N I T I O N S T A N D A R D D. 5 step approach T H E C O R E P R I N C I P L E SINGLE PRINCIPLE FOR REVENUE RECOGNITION regardless of the activity based on the TRANSFER OF CONTROL of the promised goods or services Revenue OVER TIME Transfer of control PROGRESSIVELY Revenue AT A POINT IN TIME Transfer of control AT A PRECISE TIME

7 O V E R V I E W O F T H E N E W R E V E N U E R E C O G N I T I O N S T A N D A R D D. 5 step approach Step 1 Identify the contract(s) with a customer Contract(s) Step 2 Identify the performance obligations (POs) in the contract PO 1 PO 2 Step 3 Determine the transaction price (TP) TP for the contract Step 4 Allocate the TP to the POs in the contract TP allocated to PO 1 TP allocated to PO 2 Step 5 Recognise revenue when (or as) the entity satisfies a PO Revenue on PO 1 Revenue on PO 2 7

8 O V E R V I E W O F T H E N E W R E V E N U E R E C O G N I T I O N S T A N D A R D Step 1: Identify the contract(s) with a customer What is a contract? An agreement between 2 or more parties that creates enforceable rights and obligations The parties have approved the contract and are committed to perform their respective obligations Matter of law Consider local practices It is probable that the entity will collect the consideration to which it will be entitled Account for a contract only when 5 criteria are met The entity can identify each party s rights regarding the goods or services to be transferred The contract has commercial substance The entity can identify the payment terms for the goods or services to be transferred

9 O V E R V I E W O F T H E N E W R E V E N U E R E C O G N I T I O N S T A N D A R D D. 5 step approach (continued) Step 1: Identify the contract(s) with a customer (continued) The following flow chart outlines the criteria for determining when an entity combines two or more contracts and accounts for them as a single contract. No Are the contracts entered into at or near the same time with the same customer or related parties of the customer? Yes Are one or more of the following criteria met? Contracts were negotiated as a single commercial package Consideration in one contract depends on the other contract Goods or services (or some of the goods or services) are a single performance obligation No Account for as separate contracts Yes Account for contracts together as a single contract 9

10 O V E R V I E W O F T H E N E W R E V E N U E R E C O G N I T I O N S T A N D A R D D. 5 step approach (continued) Step 1: Identify the contract(s) with a customer (continued) Change in scope of work and price Are the additional goods or services distinct? Yes No Modification is part of the existing contract, i.e. single partially satisfied PO (1) Adjustment of revenue at the date of contract modification on a cumulative catch-up basis For a price that reflect their stand-alone selling prices? Yes No Some situations are a combination of (1) & (2) Modification is a separate contract Separate accounting Termination of the existing contract and creation of a new contract (2) Prospective accounting

11 O V E R V I E W O F T H E N E W R E V E N U E R E C O G N I T I O N S T A N D A R D D. 5 step approach (continued) Does the contract provide for the transfer of more than one good / service? => Consider both explicit and implicit promises Critical Yes step Are the goods / services distinct? 2 criteria must be met (see next slide) Yes Do those goods / services form part of a series? Are the goods / services substantially the same and do they have the same pattern of transfer (i.e. control is transferred over time and the method for measuring progress is the same)? Yes No No Step 2: Identify the performance obligations (POs) in the contract Recognition of a single PO To be combined with other promised goods / services so as to identify a bundle of goods / services that is distinct (= a single PO) No Recognition of a single PO Each distinct good / service = one PO to be recognized separately 11

12 O V E R V I E W O F T H E N E W R E V E N U E R E C O G N I T I O N S T A N D A R D D. 5 step approach (continued) Step 2: Identify the performance obligations (POs) in the contract (continued) - What does Distinct mean? - A good or service is distinct if BOTH of the following are met: Think stand-alone value as in current standard 12

13 O V E R V I E W O F T H E N E W R E V E N U E R E C O G N I T I O N S T A N D A R D D. 5 step approach (continued) Variable amounts (constraining estimates if need be) Step 3: Determine the transaction price (TP) Consideration payable to the customer Transaction price Significant financing component Interest revenue/expense to be presented separately from revenue Non-cash consideration The transaction price reflects the amount of consideration that an entity expects to be entitled to in exchange for goods or services delivered. 13

14 O V E R V I E W O F T H E N E W R E V E N U E R E C O G N I T I O N S T A N D A R D D. 5 step approach (continued) Step 4: Allocate the transaction price - Allocate the transaction price on a relative stand-alone selling price basis Determine the stand-alone selling price of each performance obligation Yes Existence of an observable selling price? No Best indication of the stand-alone selling price Stand-alone selling price to be estimated Several techniques possible Residual approach if the stand-alone transaction price is highly variable or uncertain 14

15 O V E R V I E W O F T H E N E W R E V E N U E R E C O G N I T I O N S T A N D A R D D. 5 step approach (continued) Step 4: Allocate the transaction price (continued) - Estimating stand-alone selling prices Adjusted Market Assessment Approach Estimated price in relevant markets that a customer would be willing to pay for the good or service. Expected Cost Plus a Margin Approach Forecasted total costs plus an appropriate margin for the good or service. Residual Approach (approach of last resort) Subtract the sum of observable stand-alone selling prices of other goods or services from the total contact price. 15

16 O V E R V I E W O F T H E N E W R E V E N U E R E C O G N I T I O N S T A N D A R D D. 5 step approach (continued) Step 4: Allocate the transaction price (continued) - Allocation of discounts Usually allocated to all POs Allocate to one PO if objective evidence exists that the discount specifically relates to only one or some of the POs - Allocation of variable consideration Usually allocated to all POs Allocate to one PO if:» Terms of variable consideration relate specifically to it» Results in reasonable allocation to other POs 16

17 O V E R V I E W O F T H E N E W R E V E N U E R E C O G N I T I O N S T A N D A R D D. 5 step approach (continued) Step 5: Recognize revenue when / as the entity satisfies the PO Services contracts The customer simultaneously receives and consumes the benefits provided by the entity s performance as the entity performs Yes PO satisfied at a point in time No Construction contracts The entity s performance creates or enhances an asset that the customer controls Yes PO satisfied over time Consultant services, The entity s performance custom products does not create an asset with an alternative use to the entity AND the entity has an enforceable right to payment for performance completed to date Yes 17

18 A G E N D A I. Overview of the new revenue recognition standard II. Non-regulated contract services within the water industry A. Overview B. 5 step approach C. Other considerations III. Regulated utilities within the water industry IV. Implementation and footnotes disclosure V. Conclusions and closing remarks 18

19 N O N - R E G U L A T E D C O N T R A C T S E R V I C E S W I T H I N T H E W A T E R I N D U S T R Y A. Overview Different types of non-regulated Contract Services - Procurement contract - Construction contract - Operation and Maintenance (O&M) contract - Concession contract Scope of the presentation - O&M contract: Local government (e.g. municipal, county) engages a non-regulated operations company to operate and maintain its drinking water or waste water treatment systems Term from a few years up to several decades Main obligations - Operation and maintenance of the facility - Standards and regulations in effect for health safety, the environment and quality 19

20 N O N - R E G U L A T E D C O N T R A C T S E R V I C E S W I T H I N T H E W A T E R I N D U S T R Y A. Overview (continued) Main features - Remuneration and fee structure Fixed fee Performance based fee Liquidated damages - Maintenance and asset management Risk of asset condition Routine replacement of small, low value parts of equipment Additional service agreement 20

21 N O N - R E G U L A T E D C O N T R A C T S E R V I C E S W I T H I N T H E W A T E R I N D U S T R Y B. 5 step approach Step 1 : Identify the contract(s) with a customer - O&M Contract: fixed fees over 10 years, capex are the municipal s responsibility Step 2 : Identify the performance obligations (POs) in the contract - Definition: A PO is a promise to transfer a distinct good or service, or a series of distinct goods or services that are substantially the same and have the same pattern of transfer, to a customer. - Operate and maintain the plant 24 hours a day 7 days a week - Other POs such as a toll-free customer service hotlines The O&M of a water treatment plant for which delivery of the same service is required over time would generally be treated as a single performance obligation satisfied continuously throughout the contract. 21

22 N O N - R E G U L A T E D C O N T R A C T S E R V I C E S W I T H I N T H E W A T E R I N D U S T R Y B. 5 step approach (continued) Step 3: Determine the transaction price (TP) - Fixed fees + Variable consideration (if any) Step 4: Allocate the TP to the POs in the contract Step 5: Recognise revenue when (or as) the entity satisfies a PO - The utility company satisfies its performance obligations and recognizes revenue over time. The utility company should recognize revenue over time by consistently applying a method of measuring the progress toward completing the performance obligation. The permissible methods are the output or input method. 22

23 N O N - R E G U L A T E D C O N T R A C T S E R V I C E S W I T H I N T H E W A T E R I N D U S T R Y C. Other considerations Variable consideration performance bonus - Included in the service contracts - When determining the TP (step 4), utility entities should estimate the amount of consideration using the more predictive of: Expected value method Most likely amount method - Sum of probability-weighted amounts for various possible outcomes The most likely amount in a range of possible outcomes An entity needs to consider which method it expects to better predict the amount of consideration to which it will be entitled and apply that method consistently for similar types of contracts. The company s position needs to be documented. - Requirement to reassess the estimate of the TP at each reporting period 23

24 N O N - R E G U L A T E D C O N T R A C T S E R V I C E S W I T H I N T H E W A T E R I N D U S T R Y C. Other considerations (continued) Criteria for capitalization of contract costs (mandatory) Costs of obtaining a contract Costs to fulfil a contract Incremental costs Costs which the entity expects to recover Practical expedient: expense as incurred if amortisation period is one year or less Costs directly related to a contract or to an anticipated contract and Costs which generate or enhance resources of the entity that will be used in satisfying (or continuing to satisfy) POs in the future and Costs expected to be recovered. The amortisation period can extend beyond a single contract if the capitalised costs relate to multiple or anticipated contracts 24

25 N O N - R E G U L A T E D C O N T R A C T S E R V I C E S W I T H I N T H E W A T E R I N D U S T R Y C. Other considerations (continued) Significant financing component - No specific consideration under the current U.S. GAAP (except time value of money principle) - Definition and requirement under the new standard - Recognize a portion of the consideration as interest income / expense - More complex contracts requiring judgment 25

26 A G E N D A I. Overview of the new revenue recognition standard II. Non-regulated contract services within the water industry III. Regulated utilities within the water industry A. Overview B. Current practice for recognizing revenue C. Potential considerations under new recognition policy D. Status update on the AICPA Power and Utilities Revenue Recognition Task force IV. Implementation and footnotes disclosure V. Conclusions and closing remarks 26

27 R E G U L A T E D U T I L I T I E S W I T H I N T H E W A T E R I N D U S T R Y A. Overview Regulated utilities currently follows the authoritative guidance set forth under ASC 980. The new revenue guidance will essentially supersede almost all current US GAAP revenue recognition guidance and a critical issue for the Water Industry is determining how the standard applies to rate-regulated activities. The scope of this new guidance as not yet been confirmed to determine if the standard applies to revenues based on regulated tariffs. 27

28 R E G U L A T E D U T I L I T I E S W I T H I N T H E W A T E R I N D U S T R Y A. Overview (continued) Guidance for alternative revenue programs (ASC ) from regulatory commissions are broken out by: Type A - adjust billings for the effects of weather abnormalities or broad external factors or to compensate the utility for demand-side management initiatives (for example, no-growth plans and similar conservation efforts). Type B - provide for additional billings (incentive awards) if the utility achieves certain objectives, such as reducing costs, reaching specified milestones, or demonstratively improving customer service. The AICPA task force has indicated that alternative revenue programs generally fall outside of the scope of revenue from contracts with customers. 28

29 R E G U L A T E D U T I L I T I E S W I T H I N T H E W A T E R I N D U S T R Y B. Current practice for recognizing revenue Aqua America, Inc. and Subsidiaries Our utility revenues recognized in an accounting period include amounts billed to customers on a cycle basis and unbilled amounts based on estimated usage from the last billing to the end of the accounting period. American Water Works Company, Inc. Revenues of the regulated utility subsidiaries are recognized as water and wastewater services are provided, and include amounts billed to customers on a cycle basis and unbilled amounts based on estimated usage from the date of the meter reading associated with the latest customer bill to the end of the accounting period. Middlesex Water Company Retail customer invoices for regulated utility service are typically comprised of two components; a fixed service charge and a volumetric or consumption charge. Revenues from retail customers, except Tidewater fixed service charges, include amounts billed in arrears on a cycle basis and unbilled amounts estimated from the last meter reading date to the end of the accounting period. Practically, revenue recognition is driven by customer consumption. 29

30 R E G U L A T E D U T I L I T I E S W I T H I N T H E W A T E R I N D U S T R Y C. Potential considerations under new recognition policy Permitted that there is no guidance related to tariff based sales, what possible impacts could there be? What are the performance obligations: One obligation to deliver water to customers, or Multiple PO s:» Processing of water» Operation and maintenance of system» Health, safety, environmental, and quality» Customer service? What would be the satisfaction of these PO s and would it lead to different results? Modification (surcharges, etc.) Financing component (Contributions in Aid of Construction CIAC, etc.) 30

31 R E G U L A T E D U T I L I T I E S W I T H I N T H E W A T E R I N D U S T R Y D. Status update on the AICPA Power and Utilities Revenue Recognition Task force IDENTIFIED REVENUE RECOGNITION IMPLEMENTATION ISSUES Below is a list of potential revenue recognition implementation issues identified by the Power and Utilities Revenue Recognition Task Force. The list will be updated as the task force continues it discussions. Full revenue recognition implementation issues will be posted below for informal comments after review by the AICPA Financial Reporting Executive Committee (FinREC). Issue # Description of Implementation Issue 1 Scope clarification regarding tariff sales to regulated customers This implementation issue discusses whether revenues from sales under a regulated utility s tariff (other than revenues from alternative programs specifically excluded from the scope of Topic 606) are within the scope of Topic 606 Status Submitted to FinREC - January Accounting for contracts with price and/or volume variability 3 Strip vs. step price arrangements This implementation issue will addresses strip (constant fixed price per unit delivered) and step (increasing fixed price per unit delivered) pricing conventions applied to the same seller performance (delivery of a fixed quantity of commodity units consecutively over a multi-year term). Submitted to AICPA RRWG 31

32 R E G U L A T E D U T I L I T I E S W I T H I N T H E W A T E R I N D U S T R Y D. Status update on the AICPA Power and Utilities Revenue Recognition Task force (continued) Issue # Description of Implementation Issue Status 4 Application of Series guidance to storable commodities This implementation issue will discuss considerations for applying the series guidance described in ASC and to sales involving commodities other than electricity. Submitted to AICPA RRWG 5 Accounting for contract modifications This implementation issue discusses blend-and-extend modifications (whether they include a financing element), as well as treatment of partial terminations. Question submitted to FASB TRG 6 Partial terminations 7 Accounting for bundled arrangements 8 Revenue timing for RECs 9 Contributions in Aid of Construction 10 Accounting for sales of non-financial assets 32

33 A G E N D A I. Overview of the new revenue recognition standard II. Non-regulated contract services within the water industry III. Regulated utilities within the water industry IV. Implementation and footnotes disclosure A. Transition plan B. Modified retrospective / full retrospective application C. Impacts on footnotes disclosure D. Implementation challenges V. Conclusions and closing remarks 33

34 I M P L E M E N T A T I O N A N D F O O T N O T E S D I S C L O S U R E A. Transition plan Entities in the Water industry, as a result of the new revenue guidance, may have to change their internal processes and information systems so appropriate data can be obtained to appropriately apply the new standard, along with financial statement disclosures. Entities should perform initial assessments on how they will be affected as soon as possible so they can determine how to prepare to implement the new standard. Stay current on updates/ discussions held by the FASB, SEC, AICPA task force, etc. Also refer to AICPA s- Implementation Timeline Guidance / _LIPlan.pdf 34

35 I M P L E M E N T A T I O N A N D F O O T N O T E S D I S C L O S U R E B. Modified retrospective / full retrospective application Nonpublic companies December 2019 calendar year end - Full Retrospective 2019: New standard 2018: New standard 2017: Cumulative effect at January 1, Modified Restrospective 2019: New standard but need to disclose old GAAP 2018: Cumulative effect at January 1,

36 I M P L E M E N T A T I O N A N D F O O T N O T E S D I S C L O S U R E C. Impacts on footnotes disclosure Significantly more disclosures required by the new standard ASU s Objective: users of financial statements to understand the nature, amount, timing, and uncertainty of revenue and cash flows arising from contracts with customers. Additional quantitative and qualitative information including: Disaggregation of revenue Costs to Obtain of Fulfill a Contract Performance Obligations Contract Balances Significant Judgments 36

37 I M P L E M E N T A T I O N A N D F O O T N O T E S D I S C L O S U R E D. Implementation challenges Increased in judgment Retrospective Application Systems, processes and control 37

38 A G E N D A I. Overview of the new revenue recognition standard II. Non-regulated contract services within the water industry III. Regulated utilities within the water industry IV. Implementation and footnotes disclosure V. Conclusions and closing remarks 38

39 Q U E S T I O N S? 39

40 C O N T A C T S Julie Petit Senior Manager (P) (E) Julie.Petit@weisermazars.com Brian Jones Senior Manager (P) (E) Brian.Jones@weisermazars.com