12/2/2014. Accounting Update. Agenda. Abbreviations. John R. Null Audit & Assurance Shareholder

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1 Accounting Update John R. Null Audit & Assurance Shareholder Agenda Financial Reporting Initiatives IFRS/SEC/PCAOB FASB Private Company Council Accounting Standards Updates Revenue Recognition Current Projects / On the Horizon 2 Abbreviations FASB: Financial Accounting Standards Board PCC: Private Company Council SEC: Securities and Exchange Commission PCAOB: Public Company Accounting Oversight Board IFRS: International Financial Reporting Standards ASU: Accounting Standards Updates ASC: Accounting Standards Codification 3 1

2 What is Driving Changes to Financial Reporting Standards? Satisfy needs of users / Relevance varies greatly (Investors, Owners, Lenders, Regulators) Globalization Convergence with IFRS Cost vs. benefit - Private Company Council, FASB Simplification Initiative Disclosure Framework Project Fair value vs. historical cost 4 International Financial Reporting Standards No decision from SEC on a future convergence plan Various obstacles to adoption Existing projects wrapping up Newly issued standards include many in areas that are not addressed under IFRS FASB will continue to work on global accounting issues with the IASB through its membership in the Accounting Standards Advisory Forum (ASAF), a newly established advisory body comprising twelve standard setters from across the globe Limited success of FASB/IASB collaboration (business combinations, fair value, revenue recognition) 5 SEC Dodd-Frank Act JOBS Act Technological Resilience Transparency Compliance Enforcement 6 2

3 PCAOB Broker-Dealers Supplemental Information Related Parties Auditor s Reporting Model Trends in the Profession Inspection Reports 7 FASB Simplification Initiative To reduce sources of unnecessary complexity in current standards To identify aspects of GAAP that might be streamlined for all companies both public and private as well as for not-for-profit organizations To consider whether improvements can be made to simplify GAAP while maintaining or improving the relevance of reported financial information 8 Types of Complexity To Be Addressed Complicated, dense standard obscures its meaning Accounting treatment is clear, but applying it is lengthy, convoluted & expensive 9 3

4 Disclosure Framework Project Objective: Improve the effectiveness of disclosures in notes to financial statements by clearly communicating the information most important to users of those statements. Are financial statements a vehicle for communications with investors? Or are they more of a compliance exercise? 10 Field Study Results More guidance around discretion facilitates more qualitative considerations The word materiality has a strong quantitative connotation in practice Preparers thought notes were generally more effective after applying their assigned discretion criterion Obstacles in the financial reporting system discourage the application of discretion 11 Entity s Decision Process Next Steps Develop ways the Board can promote the appropriate use of discretion. This will include exploring section-specific disclosure modifications Examine in the context of the Proposed Statement of Financial Accounting Concepts, Notes to Financial Statements. Findings may become a basis for other Codification modifications Pensions Fair Value Measurement Income Taxes Inventory 12 4

5 Private Company Council 2006 FASB created the Private Company Financial Reporting Committee (PCFRC) 2008 Financial Accounting Foundation (FAF) created the Standard- Setting Process Oversight Committee Early 2009 FAF undertook a nationwide listening tour December AICPA, FAF and National Association of State Boards of Accountancy (NASBA) established the blue ribbon panel January 2011 Blue Ribbon panel recommended creation of a new, separate and authoritative standard-setting board October 2011 FAF issues a plan to establish a private company standards council May 23, 2012 PCC was established 13 What are the PCC s responsibilities? The PCC has two principal responsibilities: 1. To determine whether exceptions or modifications to existing non-governmental U.S. GAAP are required to address the needs of users of private company financial statements. 2. Serve as the primary advisory body to the FASB on the appropriate treatment for private companies for items under active consideration on the FASB s technical agenda. ThePCCandtheFASBwillmutuallyagreeoncriteria for determining whether and when exceptions or modifications to U.S. GAAP are warranted for private companies. 14 Private Company Council Current Projects: PCC Issue No , Definition of a Public Business Entity (phase 2) will be considering whether amendments to the existing codification is necessary to conform to phase 1 definition entered into the Master Glossary PCC Issue No A, "Accounting for Identifiable Intangible Assets in a Business Combination Completed Projects: PCC Issue No , "Applying Variable Interest Entity Guidance to Common Control Leasing Arrangements ASU PCC Issue No B, "Accounting for Goodwill" ASU PCC Issue No A, "Accounting for Certain Receive-Variable, Pay- Fixed Interest Rate Swaps Simplified Hedge Accounting Approach ASU

6 PCC Meeting September 16, 2014 PCC voted to finalize alternatives in accounting for identifiable intangible assets. The PCC s changes will be presented to the FASB for endorsement at an upcoming meeting. Discussed potential ways to improve accounting for stock-based compensation for private companies. The FASB will consider adding a project to its agenda to address accounting for stock-based compensation for public and private companies. PCC also shared its views on the FASB Lease project. The next meeting will be held on December 11, PCC Issue No A, Accounting for Identifiable Intangible Assets in a Business Combination The PCC reached a final consensus to allow private companies to elect the following alternative: Do not recognize the following intangible assets in a business combination: 1. Non-competition agreements (NCAs) 2. Customer-related intangible assets (CRIs) that are not capable of being sold or licensed independently from the other assets of a business. Would require adoption of ASU No CRIs often would not meet the criterion for recognition. CRIs that may meet the criterion for recognition include mortgage servicing rights, commodity supply contracts, and core deposits. Awaiting approval by FASB Expected to be effective for annual periods beginning after Dec. 15, 2015, with early adoption permitted. 17 Accounting Standards Update-Newly Effective Standards ASU Comprehensive Income (Topic 220) Reporting of Amounts Reclassified Out of Accumulated Other Comprehensive Income Effective for years beginning after December 15, 2012 (public) and beginning after December 15, 2013 (nonpublic). Early adoption permitted. 18 6

7 Newly Effective Standards (continued) ASU Foreign Currency Matters (Topic 830) Parent s Accounting for the Cumulative Translation Adjustment upon Derecognition of Certain Subsidiaries or Groups of Assets within a Foreign Entity or of an Investment in a Foreign Entity ASU Not-for-Profit Entities (Topic 958) Services Received from Personnel of an Affiliate Effective prospectively for years beginning after June 15, Early adoption permitted 19 Newly Effective Standards (continued) ASU Presentation of Financial Statements (Topic 205) Liquidation Basis of Accounting Effective for years beginning after December 15, Early adoption permitted ASU Financial Services Investment Companies (Topic 946) Amendments to the Scope, Measurement, and Disclosure Requirements Effective for years beginning after December 15, Early adoption prohibited ASU Income Taxes (Topic 740) Presentation of an Unrecognized Tax Benefit When a Net Operating Loss Carryforward, a Similar Tax Loss, or a Tax Credit Carryforward Exist Effective for years beginning after December 15, 2013 (public) and beginning after December 15, 2014 (nonpublic). Early adoption permitted 20 Newly Effective Standards (continued) ASU Definition of a Public Business Entity One definition of public business entity No impact to existing requirements Excludes all NFPs from the definition No more bright line for determining reporting alternatives (i.e. the issuance of publicly traded debt) Effective immediately, application of accounting standards for NFPs will be addressed on a standard-by-standard basis

8 Recently Issued Standards ASU Intangibles Goodwill and Other (Topic 350) Accounting for Goodwill (a consensus of the Private Company Council) Accounting alternative for private companies (excludes SEC, NFP, EBPs) If elected, goodwill amortized over 10 years, or less if another useful life is appropriate Applies prospectively to existing and new goodwill A company now has the OPTION of assessing goodwill for impairment at either an entity-wide or reporting unit level. It would need to make an accounting policy election at the time of adoption as to which level it will assess goodwill for impairment. No additional disclosures required and the tabular rollforward of goodwill is eliminated Effective for years beginning after December 15, Early adoption is permitted 22 Recently Issued Standards (continued) ASU Derivatives and Hedging (Topic 815) Accounting for Certain Receive-Variable, Pay-Fixed Interest Rate Swaps Simplified Hedge Accounting Approach (a consensus of the Private Company Council) If elected, should be applied retrospectively using either a modified or a full retrospective approach, in annual periods beginning after December 15, Early application is permitted. 23 Recently Issued Standards (continued) ASU Consolidations: Applying VIE Guidance to Common Control Leasing Arrangements (a consensus of the Private Company Council) Permits a Private Company Lessee to elect an alternative to NOT apply VIE guidance to a lessor IF: the private company lessee and the lessor entity are under common control, the private company lessee has a lease arrangement with the lessor entity, substantially all of the activities between the private company lessee and the lessor entity are related to leasing activities (including supporting leasing activities) between those two entities, AND if the private company lessee explicitly guarantees or provides collateral for any obligation of the lessor entity related to the asset leased by the private company, then the principal amount of the obligation at inception of such guarantee or collateral arrangement does not exceed the value of the asset leased by the private company from the lessor entity. The accounting alternative should be applied retrospectively to all periods presented. The alternative will be effective for annual periods beginning after December 15, Early application is permitted. 24 8

9 Recently Issued Standards (continued) ASU Presentation of Financial Statements (Topic 205) and Property, Plant, and Equipment (Topic 360): Reporting Discontinued Operations and Disclosures of Disposals of Components of an Entity This update changes the requirements for reporting discontinued operations. A discontinued operation may include a component of an entity or a group of components of an entity, or a business or nonprofit activity. A disposal of a component of an entity or a group of components of an entity is required to be reported in discontinued operations if the disposal represents a strategic shift that has (or will have) a major effect on an entity s operations and financial results when any of the following occurs: The component of an entity or group of components of an entity meets the criteria in paragraph E to be classified as held for sale. The component of an entity or group of components of an entity is disposed of by sale. The component of an entity or group of components of an entity is disposed of other than by sale (for example, by abandonment or in a distribution to owners in a spinoff). Effective for annual financial statements with years that begin on or after December 15, Early adoption is permitted. 25 Recently Issued Standards (continued) ASU Development Stage Entities (Topic 915) To improve financial reporting by reducing the cost and complexity. The amendments affect entities that are development stage entities under U.S. GAAP. In addition, it may affect the consolidation decisions for companies. Update removes the definition of a development stage entity from the Master Glossary of the Accounting Standards Codification, thereby removing the financial reporting distinction between development stage entities and other entities. Amendments eliminate the requirements for development stage entities to: Present inception-to-date information in the statements of income, cash flows, and s/h equity Label the financial statements as those of a development stage entity, Disclose a description of the development stage activities in which the entity is engaged, and Disclose in the first year in which the entity is no longer a development stage entity that in prior years it had been in the development stage. Effective for annual financial statements with years that begin on or after December 15, Early adoption is permitted. 26 Recently Issued Standards (continued) ASU Compensation Stock Compensation (Topic 718): Accounting for Share-Based Payments When the Terms of an Award Provide That a Performance Target Could Be Achieved after the Requisite Service Period (a consensus of the FASB Emerging Issues Task Force) Requires that a performance target that affects vesting and that could be achieved after the requisite service period be treated as a performance condition. The performance target should not be reflected in estimating the grant-date fair value of the award. Compensation cost should be recognized in the period in which it becomes probable that the performance target will be achieved and should represent the compensation cost attributable to the period(s) for which the requisite service has already been rendered. If the performance target becomes probable of being achieved before the end of the requisite service period, the remaining unrecognized compensation cost should be recognized prospectively over the remaining requisite service period. The total amount of compensation cost recognized during and after the requisite service period should reflect the number of awards that are expected to vest and should be adjusted to reflect those awards that ultimatelyvest. The requisite service period ends when the employee can cease rendering service and still be eligible to vest in the award if the performance target is achieved. Effective for annual periods beginning after December 15, Earlier adoption is permitted. 27 9

10 Recently Issued Standards (continued) ASU Presentation of Financial Statements Going Concern (Subtopic ): Disclosure of Uncertainties about an Entity s Ability to Continue as a Going Concern Currently going concerns are evaluated through the end of the next fiscal year, and are not explicitly management s responsibility in US GAAP. This update requires management to assess the entity s ability to continue as a going concern for one year after the date the financial statements are issued, or made available for issue. When a going concern issue is identified, management should consider whether its plans to mitigate those conditions or events will alleviate the substantial doubt. If the substantial doubt is alleviated by management s plan, the following should be disclosed: 1. Principal conditions or events that raised the going concern issue. 2. Management s evaluation of the significance of those conditions. 3. Management s plan s that alleviated the going concern issue. If substantial doubt is NOT eliminated, the substantial doubt must be disclosed. Effective for the annual period ending after December 15, Early adoption is permitted. 28 Recently Issued Standards (continued) ASU Derivatives and Hedging (Topic 815): Determining Whether the Host Contract in a Hybrid Financial Instrument Issued in the Form of a Share Is More Akin to Debt or to Equity (a consensus of the FASB Emerging Issues Task Force) Affects all entities that are issuers of, or investors in, hybrid financial instruments that are issued in the form a of share. Provides clarifying guidance Effective for periods beginning after December 15, Early adoption is permitted. 29 ASU No : Revenue from Contracts with Customers Purpose of the new standard The who, when and how of the new standard Main provisions of the new standard Disclosure requirements Examples & Illustrations 30 10

11 Purpose Creation of a common revenue standard for US GAAP and IFRS Topic 606 Revenue from Contracts with Customers IFRS 15 Revenue from Contracts with Customers U.S. GAAP included broad revenue recognition concepts coupled with specific industry guidance which led to different accounting for economically similar transactions IFRS included limited, principles based, guidance which could be difficult to apply to complex transactions 31 Who is Affected Any entity that either enters into contracts with customers to transfer goods or services or enters into contracts for the transfer of nonfinancial assets (with exceptions) The guidance supersedes the existing revenue recognition requirements (Topic 605) as well as most industry-specific guidance The guidance also supersedes some cost guidance for constructiontype and production-type contracts 32 Effective Dates Public entities For annual reporting periods beginning after December 15, 2016, including interim periods within that reporting period Early adoption is not permitted Nonpublic entities For annual reporting periods beginning after December 15, 2017 and interim periods within annual periods beginning after December 15, Early adoption is permitted but cannot be earlier than periods beginning after December 15,

12 Implementation Guidance Method #1 - Retrospectively to each prior period presented Entity may elect any of the following practical expedients: #1 - For completed contracts, an entity need not restate contracts that begin and end within the same annual reporting period #2 - For completed contract that have variable consideration, an entity may use the transaction price at the date the contract was completed rather than estimating variable consideration amounts in the comparative periods #3 - For all reporting periods presented before the date of initial application, an entity need not disclose the amount of the transaction price allocated to remaining performance obligations and an explanation of when the entity expects to recognize that amount as revenue 34 Implementation Guidance (Cont.) Method #2 Retrospectively with the cumulative effect of initially applying the standard recognized at the date of initial application. If this transition method is elected, an entity needs to provide the additional disclosures in reporting periods that include the date of initial application of: The amount by which each financial statement line item is affected in the current reporting period by application of the new standard An explanation of the reasons for significant changes 35 Main Provisions Step 1 Step 2 Step 3 Step 4 Step 5 Identify the contract(s) with a customer Identify the performance obligations in the contract Determine the transaction price Allocate the transaction price to the performance obligations in the contract Recognize revenue when (or as) the entity satisfies a performance obligation 36 12

13 Step 1: Contracts Contract - an agreement between two or more parties that creates enforceable rights and obligations. A contract must meet the following criteria: 1. Approval and commitment of the parties 2. Identification of the rights of the parties 3. Identification of the payment terms 4. Contains commercial substance 5. Probable collectability of the considerations entitled under the contract 37 Step 1: Contracts (Cont.) Combining Contracts An entity should combine contracts and account for them as one contract if they were entered into at or near the same time with the same customer and one or more of the following are met: 1. Contacts achieve a single commercial objective and are negotiated as a package 2. The price or performance of one contact influences the amount of consideration to be paid in the other contract 3. The goods or services in the separate contacts represent a single performance obligation 38 Step 1: Contracts (Cont.) Contract Modifications Approved contract modifications are accounted for as a separate contract if both of the following conditions are met: 1. Adds one or more distinct performance obligations to the contract 2. Price increases by an amount that reflects the standalone selling price of the additional distinct performance obligation(s) If both of the above conditions are not met, entity must select one of the two following options: 1. New goods or services are distinct - treated as a termination of the existing contract and creation of a new contract 2. Newgoodsorservicesarenotdistinct-treatedasifitwerepartofthe existing contract 39 13

14 Step 1: Contracts (Cont.) To prepare for step 1, entities should consider the following now: Review the terms of current contracts to determine if they are impacted under the new standard Consider how job functions and internal controls might be impacted Evaluate processes for contract modifications 40 Step 2: Performance Obligations Performance obligation - a promise in a contract with a customer to transfer a good or service to the customer. If an entity promises in a contract to transfer more than one good or service to the customer, the entity should account for each promised good or service as a performance obligation only if it is (1) distinct or (2) a series of distinct goods or services that are substantially the same and have the same pattern of transfer. A good or service is distinct if both of the following criteria are met: 1. Capable of being distinct The customer can benefit from the good or service either on its own or together with other resources that are readily available to the customer. 2. Distinct within the context of the contract The promise to transfer the good or service is separately identifiable from other promises in the contract. 41 Step 2: Performance Obligations (Cont.) To prepare for step 2, entities should consider the following now: Identify contracts with multiple goods or services Review contracts to determine what might constitute separate performance obligations under the new standard Consider how internal controls and processes might be impacted 42 14

15 Step 3: Transaction Price Transaction price - amount of consideration to which an entity expects to be entitled in exchange for transferring promised goods or services to a customer, excluding amounts collected on behalf of third parties. In determining the transaction price, the following should be considered: 1. Variable consideration 2. Constraining estimates of variable consideration 3. The existence of a significant financing component 4. Noncash consideration 5. Consideration payable to the customer 43 Step 3: Transaction Price (Cont.) To prepare for step 3, entities should consider the following now: Identify contracts with variable consideration and if constraints apply Consider whether contracts contain significant financing components and if the practical expedient applies Consider how internal controls and processes might be impacted 44 Step 4: Allocation of Price This step only applies to contracts that have more than one performance obligation Requires allocation of the transaction price to each performance obligation in an amount that depicts the amount of consideration to which the entity expects to be entitled in exchange for satisfying each performance obligation. Standalone selling price at contract inception If standalone selling price is not available, an entity must estimate it. Suitable methods for estimating the standalone selling price of a good or service include, but are not limited to, the following: 1. Adjusted market assessment approach 2. Expected cost plus a margin approach 3. Residual approach 45 15

16 Step 4: Allocation of Price (Cont.) Treatment of Discounts An entity should allocate a discount entirely to one or more, but not all, performance obligations in the contract if all of the following criteria are met: 1. The entity regularly sells each distinct good or service in the contract on a standalone basis. 2. The entity also regularly sells on a standalone basis a bundle of some of those distinct goods or services at a discount to the standalone selling prices of the goods or services in each bundle. 3. The discount attributable to each bundle of goods or services described in (2) is substantially the same as the discount in the contract, and an analysis of the goods or services in each bundle provides observable evidence of the performance obligation to which the entire discount in the contract belongs. If all of the above criteria are not met, the entity should allocate a discount proportionately to all performance obligations in the contract. 46 Step 4: Allocation of Price (Cont.) Subsequent Accounting After contract inception, the transaction price can change for various reasons, including the resolution of uncertain events or other changes in circumstances that change the amount of consideration to which an entity expects to be entitled in exchange for the promised goods or services. Except for contract modifications (previously discussed), an entity should allocate to the performance obligations in the contract any subsequent changes in the transaction price on the same basis as at contract inception. Amounts allocated to a satisfied performance obligation should be recognized as revenue, or as a reduction of revenue, in the period in which the transaction price changes. 47 Step 4: Allocation of Price (Cont.) To prepare for step 4, entities should consider the following now: Determine if observable stand-alone selling prices for their goods or services exist If not, determine how an estimated stand-alone selling price will be determined Consider how internal controls and processes might be impacted 48 16

17 Step 5: Revenue Recognition An entity should recognize revenue when (or as) it satisfies a performance obligation by transferring a promised good or service to a customer. A good or service is transferred when (or as) the customer obtains control of that good or service. Performance obligation can be satisfied over time or at a point in time Satisfied over time if one of following criteria are met: 1. The customer simultaneously receives and consumes the benefits provided by the entity s performance as the entity performs. 2. The entity s performance creates or enhances an asset (for example, work in process) that the customer controls as the asset is created or enhanced. 3. The entity s performance 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. 49 Step 5: Revenue Recognition (Cont.) If none of the criteria are met from the previous slide, the performance obligation is satisfied at a point in time. The following indicators are used to determine the point in time in which the performance obligation is satisfied (and the customer gains control of the promised asset): 1. The entity has a present right to payment for the asset. 2. The customer has legal title to the asset. 3. The entity has transferred physical possession of the asset. 4. The customer has the significant risks and rewards of ownership of the asset. 5. The customer has accepted the asset. * The above list of indicators serve as a guide and are not meant to be all-inclusive or limited othoseindicators. 50 Step 5: Revenue Recognition (Cont.) Over Time Accounting For each performance obligation that an entity satisfies over time, an entity shall recognize revenue over time by consistently applying a method of measuring the progress toward complete satisfaction of that performance obligation. Appropriate methods of measuring progress include output methods and input methods. As circumstances change over time, an entity should update its measure of progress to depict the entity s performance completed to date. Output method (i.e., units produced) Input method (i.e., cost incurred or labor hours) 51 17

18 Step 5: Revenue Recognition (Cont.) Other unique considerations include the following: Licensing of intellectual property Warranties Principal vs. agent considerations Repurchase agreements Bill and hold arrangements Consignment arrangements Customer acceptance 52 Step 5: Revenue Recognition (Cont.) To prepare for step 5, entities should consider the following now: Review contracts to determine if revenue will be recognized at a point in time or over time If recognized over time, determine what method might be used and how that data can be obtained and tracked Consider how internal controls and processes might be impacted 53 Other Provisions Incremental costs of obtaining a contract An entity should recognize as an asset the incremental costs of obtaining a contract that the entity expects to recover. As a practical expedient, an entity may expense these costs when incurred if the amortization period is one year or less. Costs to fulfill a contract To account for the costs of fulfilling a contract with a customer, an entity should apply the requirements of other standards if applicable. Otherwise, an entity should recognize an asset from the costs to fulfill a contract if those costs meet all of the following criteria: 1. Relate directly to a contract (or a specific anticipated contract) 2. Generate or enhance resources of the entity that will be used in satisfying performance obligations in the future 3. Are expected to be recovered. 4. Entities should determine where there are differences in current practices vs. cost guidance in the new standard 54 18

19 Disclosure Requirements The disclosure requirements in the new standard enable the financial statement user to understand the nature, amount, timing and uncertainty of revenue and cash flows from contracts with customers (quantitative and qualitative disclosures). The three main categories of disclosures include: 1. Contracts with customers 2. Significant judgments and changes in judgments 3. Assets recognized from the costs to obtain or fulfill a contract. 55 Disclosure Requirements (Cont.) To prepare for the new disclosure requirements, entities should consider the following now: Identify gaps between what information is available now and what will be required under the new standards Consider how internal controls and processes might be impacted 56 Guidance on Identifying Performance Obligations A good or service is distinct if both of the following criteria are met: 1. Capable of being distinct 2. Distinct within the context of the contract 57 19

20 Example 1 Will sell and install equipment Installation could be performed by others How many performance obligations are there? 58 Solution 1 The equipment is distinct The installation services are distinct Separate performance obligations for the equipment and for the installation. 59 Guidance on Variable Consideration Estimate the amount expected to be received Update at each reporting date for subsequent changes in circumstances To estimate, utilize either of the following: Expected value method Most likely method 60 20

21 Example 2 Provide cost management consulting services over 6 months. Client pays $20,000 at the beginning of each month At the end of the contract Consultant will give the client refund of $10,000; or is entitled additional $10,000, depending on client's cost savings. Consultant has extensive experience with similar types of contracts Believes 80% chance to receive the additional $10,000 What would be the consultant's initial determination of the transaction price be using the Expected Value Method and the Most Likely Value Method? 61 Solution 2 The Expected Value Method Expected Possible Consideration Amounts Probabilities Consideration $130,000 ($20,000 X 6 + $10,000) 80% $104,000 $110,000 ($20,000 X 6 $10,000) 20% $22,000 Transaction price at contract inception $126, Solution 2 Most Likely Value Method: Transaction price at contract inception $130,

22 Guidance on Significant Financing Adjust the amount of consideration for the effects of the time value of money Objective is for an entity to recognize revenue at the cash selling price of the goods or services Use the discount rate that would be reflected in a separate financing transaction Effects of financing presented separately from revenue in P&L 64 Example 3 $10,000 payment due two years after the product is transferred to the customer Discount rate = 6%. What is the transaction price for this performance obligation? 65 Solution 3 When the entity transfers the product to the customer, it recognizes revenue of $8,900 [$10,000/(1.06 X 1.06)]

23 Guidance on Allocation of Transaction Price Allocate to all separate performance obligations based on the standalone selling price Adjusted market assessment approach Expected cost plus a margin approach Residual approach Discounts may be allocated entirely to one or more than one obligation Variable consideration that is promised in a contract may be attributable to the entire contract or to a specific part of the contract 67 Example 4 Sale of product for $100 Customer gets a 40% discount voucher for any future purchases in next 30 days, up to $100. Offering 10% discount on all sales during the next 30 days as part of a seasonal promotion 80% likelihood of discount voucher redemption Customers on average, purchase $50 of additional products What are the performance obligations, the transaction price, and how should the transaction price be allocated to each performance obligation? 68 Solution 4 The discount voucher is a separate performance obligation The transaction price is $100, the standalone-selling price 30 percent reflects the incremental value of the discount to the customer Standalone selling price of the discount voucher is $12 ($50 x 30 % discount x 80 % likelihood of exercising the option Since the standalone-selling price of the product is $100, the entity allocates $12 to the discount voucher and $88 to the product 69 23

24 Guidance on Revenue Recognition Performance obligation can be satisfied over time or at a point in time Satisfied over time if one of following criteria are met: 1. The customer simultaneously receives and consumes the benefits provided by the entity s performance as the entity performs. 2. The entity s performance creates or enhances an asset (for example, work in process) that the customer controls as the asset is created or enhanced. 3. The entity s performance 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. 70 Example 5 Highly customized equipment; customer involved with design Fixed price = $240,000 Nonrefundable progress payments are made on a quarterly basis for work completed during the quarter Equipment is manufactured at the entity's facility Legal title passes to the customer upon delivery If the contract is terminated before manufacturing complete customer retains the part-completed equipment and must pay for any work completed to date Is this a continuous performance obligation? 71 Solution 5 Customer controls the equipment as it is manufactured The customer has an unconditional obligation to pay throughout the contract The customer specifies the design of the equipment and has involvement in the manufacturing process The customer also has the ability to take possession of the equipment during manufacturing and engage another entity to complete the manufacturing. Although the customer does not obtain legal title of the equipment until delivery of the complete or part-complete equipment, the entity's retention of title is a protective right, and not an indicator that the entity has retained control Revenue should be recognized over time 72 24

25 Example 6 Manufacturer sells equipment, fixed price = $240,000 The customer is obliged to make quarterly payments of $60,000 Manufactured at the entity's facility Standard design Legal title passes upon delivery Is this a continuous performance obligation? 73 Solution 6 The terms of the contract and all the related facts and circumstances indicate that the customer does not obtain control of the equipment until it is delivered Revenue would be recognized upon delivery of the equipment 74 Guidance on Contract Modifications A contract modification results in the creation of a separate and new contract when both of the following occur: Scope of the contract increases because of the addition to the contract includes distinct goods and services The price of the contract increases by an amount that reflects the standalone selling price If the contract modification is not accounted for as a separate contract, treatment varies based on if the remaining goods or services are considered distinct 75 25

26 Example 7 Three-year service contract $100,000 payable annually in advance; standalone selling price = $100,000 At the beginning of the third year the entity agrees to reduce the price for the third year of services to $80,000. In addition, customer agrees to pay additional $220,000 for 3 year extension. Standalone selling price of the services at the beginning of the third year is $80,000 per year. How should the contract modification be reflected? 76 Solution 7 The services for the last four years are clearly distinct since they are sold at that price by the entity The entity should account for the contract modification separately from the original contract 77 Example 8 Three-year services contract $100,000 payable annually in advance; standalone selling price = $100,000 At the beginning of the third year the entity agrees to reduce the price for the third year of services to $80,000. At the beginning of the third year, the customer agrees to pay additional $180,000 for 3 year extension How should the entity reflect the contract modification? 78 26

27 Solution 8 The services provided during the first two years are priced at their standalone-selling price of $100,000 per year. However, the services provided during the subsequent four years are priced at a $40,000 discount and, therefore, their price is dependent on the price of the services in the original contract. The entity should account for the contract modification together with the original contract. At the date of modification, the entity recognizes the cumulative effect of the contract modification as a reduction to revenue in the amount of $40,000 The entity recognizes revenue of $100,000 per year for the first two years' $40,000 in the third year, and $80,000 per year in the fourth, fifth, and sixth years. 79 Guidance on Right of Return Not accounted for as a separate performance obligation Instead, an entity should recognize all of the following: Revenue for goods not expected to be returned A refund liability An asset (and cost of sales) for the right to recover products 80 Example products sold for $100 each. Customary business practice allows return of unused product within 30 days and receive a full refund Cost of each product is $60 Probability of returns: 25% that 1 product will be returned; 50% that 3 products will be returned; 25% that 5 products will be returned How would the seller recognize this transaction? 81 27

28 Solution 9 Estimate of 3 products will be returned ([1 x 25%] + [3 x 50%] + [5 x 25%]) The entity would recognize: a. Revenue of $9,700 ($100 x 97 products expected not to be returned); b. A refund liability for $300 ($100 x 3 products expected to be returned); c. An asset of $180 ($60 x 3 products) for its right to recover products from customers on settling the refund liability. The amount recognized in cost of sales for 97 products is $5,820 ($60 x 97). 82 Example 10 Product sold to a customer FOB shipping point using 3 rd party carrier The entity's past business practice: provide customer a FREE replacement product, if product is damaged or lost while in transit How should the promise to provide a replacement product be accounted for? 83 Solution 10 Implicitly created an enforceable obligation Entity has not satisfied all performance obligations at point of shipment Would not recognize all of the revenue at that point. Some revenue would be recognized as it covers the risk of loss during transit

29 Guidance on Nonrefundable Fees Assess whether the fee relates to the transfer of a promised good or service If the upfront fee is an advance payment for future goods or services then they would be recognized as revenue when those future goods or services are provided 85 Example 11 Health club contract = 1 year of access to clubs. Charges nonrefundable-joining fee for registering Customer can renew contract annually; no additional joining fee. How would the health club recognize revenue related to the membership fee? 86 Solution 11 The entity's activity of registering the customer does not transfer any service to the customer and, hence, is not a performance obligation. The nonrefundable joining fee is recognized as revenue during the period that the entity expects to provide services to the customer and includes any reasonably estimable renewal periods

30 Guidance on Principal vs. Agent An entity is a principal if the entity controls a promised good or service before the entity transfers the good or service to a customer recognizes revenue in the gross amount An entity is an agent if the entity s performance obligation is to arrange for the provision of goods or services by another party Recognizes revenue in the net amount 88 Example 12 An entity negotiates with airlines to buy tickets at discount Entity agrees to buy a specific number of tickets and must pay for those tickets regardless of whether can resell them. Entity responsibilities Sells tickets/collects consideration from customers when tickets are purchased; (no credit risk) Assists the customers in resolving complaints for airline issues. Airline responsibilities Fulfilling obligations with the ticket, Remedies to customer for issues with service. Is the entity acting as a principal or as an agent? 89 Solution 12 In determining whether the entity controls the right to fly before it transfers to the customer, the entity considers the following: 1. The entity is primarily responsible for providing the right to fly, but not for providing the flight itself. 2. The entity has the inventory risk for the tickets as they are purchased before they are sold to the customers. 3. The entity has the right to determine the price of the tickets. 4. Because it has the right to set the price, the entity does not earn a commission, but revenue based upon the amount for which the ticket is sold less the cost to the entity. The entity is a principal not an agent

31 Guidance on Bill-and-Hold A customer is deemed to have control if all of the following criteria have been met: a. The reason must be substantive. b. The product must be identified separately as belonging to the customer. c. The product must be currently ready for transfer. d. The vendor cannot have the ability to use the product or to direct it to another customer. 91 Example 13 Sale of a machine and spare parts, takes 2 years to make Machine & parts are distinct = 2 (PO) s satisfied at a point in time. On December 31, 20XX: Customer pays for both Physical possession of only machine. Customer inspects and accepts spare parts Customer requests spare parts be stored at entity's warehouse due to close proximity to customer's factory. Customer has legal title to the spare parts, and the parts can be identified as belonging to the customer. Spare parts in separate section of warehouse, parts ready for immediate shipment at customer's request. How should Vendor recognize revenue? 92 Solution 13 Vendor determines that the custodial service is a performance obligation because it is a service provided to the customer and it is distinct. Thus, there are three performance obligations in this contract. The transaction is allocated to the machine, to the spare parts, and to the custodial services. Revenue allocated to the machine is recognized on December 31, 20XX. Control of spare parts transfers to the customer also at December 31, 20XX, when control transferred to customer because they have inspected and accepted them. The custodial service performance is satisfied over time as the services are provided

32 Current Projects / On the Horizon Fair Value Measurement: Disclosures for Investments in Certain Entities that Calculate Net Asset Value per Share (or Its Equivalent) Earnings Per Share : Effects on Historical Earnings per Unit of Master Limited Partnership Dropdown Transactions Compensation Retirement Benefits : Practical Expedient for the Measurement Date of an Employer s Defined Benefit Obligation and Plan Assets Interest Imputation of Interest: Simplifying the Presentation of Debt Issuance Cost Intangibles Goodwill and Other Internal-Use Software: Customer s Accounting for Fees Paid in a Cloud Computing Arrangement Income Statement Extraordinary and Unusual Items: Simplifying Income Statement Presentation by Eliminating the Concept of Extraordinary Items Inventory: Simplifying the Measurement of Inventory Business Combinations: Pushdown Accounting (ASU ) Financial Instruments Credit Losses Accounting for Financial Instruments and Revisions to the Accounting for Derivative Instruments and Hedging Activities Financial Instruments and Derivatives and Hedging Insurance Contracts Targeted improvements to the accounting for long-duration contracts Consolidation: Principal versus Agent Analysis Leases Not for Profit Financial Reporting Model 94 Lessee Model Approaches Current U.S. GAAP (IFRS) IASB FASB Capital (Finance) Leases Type A TypeA Operating Leases Type A Type B All leases are financing. Not all leases are the same. Classification is based on IAS 17 (similar to FAS 13). 95 Lessee Accounting Overview Balance Sheet Income Statement Cash Flow Statement Type A Right of use asset Lease liability Amortization expense Interest expense Cash paid for principal and interest payments Type B Right of use asset Lease liability Single lease expense on a straight line basis Cash paid for lease payments 96 32

33 Lessor Accounting Overview Balance Sheet Income Statement Cash Flow Statement Type A Net investment in the lease Interest income and any profit on the lease Cash received for lease payments Type B Continue to recognize underlying asset Lease income, typically on a straight line basis Cash received for lease payments 97 Preparing for the (Eventual) Leases Standard Inventory all leases Donated space (no or nominal rent) excluded Assess capitalization threshold Monitor the continued developments in the project at fasb.org, newsletters, etc. Depending on final decisions: Understand any potential impact on debt financial covenants (debt/equity ratios) and any other key financial metrics by which the organization is measured. Understand any potential impact on cost recovery agreements (primarily, equipment leases). The FASB is very aware of these issues for NFPs, as well as Government contractors, etc. 98 Thank You! Up Next: 2014 Tax Update John R. Null Audit & Assurance Shareholder jnull@schneiderdowns.com 33