CFMA KnowledgeNOW Webinar Q&A It s Here: The New Revenue Recognition Standard

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1 CFMA KnowledgeNOW Webinar Q&A It s Here: The New Revenue Recognition Standard Presented by Michael Sobolewski, CPA & Timothy Wilson, CPA, CCIFP June 24, 2014 Below are the questions posed to Mike Sobolewski, of PriceWaterhouseCoopers, and Tim Wilson, of BKD, during the June 2014 Revenue Recognition Webinar followed by the presenters responses. 1. Does the existence of a "directed to proceed clause" imply "approval" of a change order? Change orders are discussed in the contract modifications area of the standard ( thru 13). If the "directed to proceed clause" is determined to have been a contract modification that created a new or changed an existing enforceable right and obligation under the initial contract, then the parties would have passed the threshold under the new standard for Step 1 Identifying the Contract. 2. Regarding Change Order approval as to scope must this be dually executed approval in writing? Change orders are discussed in the contract modifications area of the standard ( thru 13). Under the standard, a contract modification could be approved in writing, by oral agreement, or implied by customary business practices. Therefore, it is not mandatory that the change order approved as to scope be dually executed in writing. 3. Does treatment of time and material contracts change? Time and material contracts will need to be evaluated under the new standard, but it is not expected that the revenue recognition under the new standard will be materially different. 4. How is "approved as to scope" defined for unapproved change orders? Written? Oral? In the contract modifications section of the new standard ( ), there is some specific discussion regarding the situation where a contract modification may exist even though both parties to the contract have a dispute about the scope or price (or both). The key is to determine whether the contract modification has created or modified any rights and obligations that are enforceable, and the entity shall consider all relevant facts and circumstances including the terms of the contract and other evidence. This can be written or oral. 5. If you build multiple buildings for a client will each constitute a separate performance obligation or just one obligation under one contract with the client? Identifying separate performance obligations within a single contract will be a significant area of judgment under the new standard. In the standard ( ), an entity must assess at contract inception the goods or services promised in a contract with a customer and shall identify as a performance obligation each promise to transfer to the customer either (1) a good or service that is distinct or (2) a series of distinct goods or services that are substantially the same pattern of transfer 2014 CFMA. All Rights Reserved. 1

2 to the customer (see ). Simply constructing multiple buildings under one contract may not create separate performance obligations. In the standard ( ), a good or service that is promised to a customer is distinct if both the following criteria are met: (a) The customer can benefit from the good or service on its own or together with other resources and (b) The entity's promise to transfer the good or service to the customer is separately identifiable from other promises in the contract. Also in the standard ( ) there are factors that indicate whether an entity's promise to transfer a good or service is separately identifiable, including factors such as integration of the services and the relationship between inputs and outputs. 6. What if you were building 2 separate buildings at the same site? 7. Can you provide an example of when you would have more than one performance obligation? 8. Could you provide an example of a contract fact pattern that would result in more than one performance obligation? 9. On Step 2 You can almost use that same argument for all jobs that the "obligations" are interrelated. Is this much ado about nothing? 10. Does the same approach (expected value approach vs. most likely amount approach) have to be used on all projects within the reporting entity? Yes, you would have to evaluate all variable consideration under one of these methods for all projects. 11. Are there any rules associated with aggregating separate contracts? In the standard, paragraph discusses the combination of contracts. An entity shall combine two or more contracts entered into at or near the same time with the same customer if one or more of the following are present (1) the contracts are negotiated as a package with a single commercial objective or (2) the amount of consideration to be paid in one contract depends on the price or performance of the other contract or (3) the goods or services promised in the contracts are a single performance obligation. 12. What terms in the contract would have made the field a separate component from the school (different completion dates/milestones, separate LDs, etc.)? See No. 2 above in the example, the entity would need to evaluate the components under to determine whether the field and school were distinct CFMA. All Rights Reserved. 2

3 13. If a highway/heavy contractor has a project with roadway and multiple bridges would this be multiple performance obligations? See No. 2 above if the goods or services (in this case the roadway and bridges) would need to be evaluated whether under the terms of the contract they are distinct. Many times, the roadway and bridges would be highly interrelated, creating one performance obligation. 14. Performance Obligation How would you handle pre construction services that happen prior to the construction and usually has their own fees but are billed together with the construction billings. See #2 above in the example, the entity would need to evaluate the components under to determine whether the preconstruction services were distinct from other obligations in the contract. 15. Do we recognize claims using SOP 81 1 guidance under new policy? SOP 81 1 is completely superseded by the new standard. Claims will need to be evaluated as a change in the transaction price, discussed at paragraphs thru What does "probable" mean? More than 50% likelihood? Probable under the new standard is defined as "The future event or events are likely to occur". Many different interpretations of this exist, but in general, "probable" means around 70 80% likely. 17. How would subcontract cost with no markup in the contract be considered for revenue recognition? This question is assuming the subcontract qualifies as a separate performance obligation. The entity will need to allocate the transaction price to each performance obligation under the contract using a standalone selling price methodology (or reasonable estimate). 18. Can you further discuss losses not required to be accrued on contracts less than one year in duration? This is new, right? In the proposed standard, FASB was considering an onerous contract test, which included the exemption for contracts less than one year in duration. In the final standard, this was dropped under the belief that the existing guidance was sufficient. Bottom line no change in accrual of loss contracts because of the new revenue recognition standard. 19. RE: Uninstalled materials you will no longer be able to recognize margin on job specific (designed and manufactured to spec) uninstalled materials? The Boards observed that if a customer obtains control of the goods before they are installed by an entity, then it would be inappropriate for the entity to continue to recognize the goods as inventory. Instead, the entity should recognize revenue for the transferred goods in accordance with the core principle of Topic 606. The Boards also observed that if the entity applies a cost to cost method of measuring progress (that is, costs incurred compared with total expected costs), the entity might (in the absence of clear guidance) include the cost of the goods in the cost to cost calculation and, therefore, recognize a contract wide profit margin for the transfer of the goods. The Boards noted 2014 CFMA. All Rights Reserved. 3

4 that recognizing a contract wide profit margin before the goods are installed could overstate the measure of the entity s performance and, therefore, revenue would be overstated. Alternatively, requiring an entity to estimate a profit margin that is different from the contract wide profit margin could be complex and could effectively create a performance obligation for goods that are not distinct (thus bypassing the guidance for identifying performance obligations). Therefore, the Boards decided that, in specified circumstances, an entity should recognize revenue for the transfer of the goods but only in an amount equal to the cost of those goods. In those circumstances, an entity also should exclude the costs of the goods from the cost to cost calculation to be consistent with the costto cost methodology. (BC171) 20. How will uninstalled materials be identified? Goods that meet the conditions in paragraph (b) would be considered "Uninstalled" for purposes of applying the guidance in that section of Topic 606. That is, the Boards noted that the adjustment to the cost to cost measure of progress for uninstalled materials is generally intended to apply to a subset of goods in a construction type contract that is, only to those goods that have a significant cost relative to the contract and only if the entity is essentially providing a simple procurement service to the customer. (BC172) 21. So, I understand uninstalled materials are stripped from cost at cost, but am I understanding correctly that when uninstalled materials are stripped from the contract amount for revenue recognition the standard will accept them being stripped at cost as well and not cost plus a markup? The amount of revenue to be "stripped from cost to cost" will equal the cost of the uninstalled materials. 22. How will uninstalled materials be identified? See previous response 23. If you have markup on stored materials will you be able to recognize that profit? See previous response. In a cost to cost model, if these materials do not meet the conditions noted in paragraph (b) or BC , then you would recognize revenue and costs associated with these materials when control transfers and measure the recognition of such revenues and costs within the cost to cost model. 24. Ditto the question on markup on stored materials... will we be able to recognize that profit? See previous response. 25. Regarding disaggregation: By customer, for example who defines customer types? Assuming that such disclosures are required (e.g., a public business entity, etc.), a preparer would consider the guidance in paragraphs through in considering the level of disaggregation CFMA. All Rights Reserved. 4

5 26. What kind of reconciliation of contract balances and costs? See previous response 27. What kind of reconciliation of contract balances and costs will be done? An entity will be required to disclose the following (unless such disclosure is otherwise not required for certain entities (e.g., nonpublic) as defined in paragraph ): a. The opening and closing balances of receivables, contract assets, and contract liabilities from contracts with customers, if not otherwise separately presented or disclosed. b. Revenue recognized in the reporting period that was included in the contract liability balance at the beginning of the period. c. Revenue recognized in the reporting period from performance obligations satisfied (or partially satisfied) in previous periods (for example, changes in transaction price). d. Qualitative and quantitative disclosures about significant changes in the contract asset and contract liability balance during the reporting period. e. Explanation of how the timing of satisfaction of its performance obligations relate to the timing of payment. ( > )" 28. On BS if name changed to contract asset/liability from billing/costs in excess, what would be the name change on the income statement? Preparers will still have the opportunity to use the terms "Billing in excess of costs /Costs in excess of billings " There is not expected to be a "name change" on the income statement. 29. Where can I find a list of required new disclosures for non public companies? Topic 606, Paragraphs through Is SOP 81 1 completely repealed by this standard? Including provisions on claims and contingencies? Yes, All of Topic (F/K/A SOP 81 1), and IAS 11 under IFRS will be replaced by the new revenue standard. 31. In a Joint venture, if one partner is a public entity and the other is not, what effective date will the JV use for the new standard? The entity would be defined as the Joint Venture and the effective date provisions would be applied based on whether the Joint Venture is a Public Entity or not CFMA. All Rights Reserved. 5

6 32. We are a roofing company. Can we recognize revenue over time? You will need to determine, based on the principles in Topic 606, if the performance obligation is satisfied over time or at a point in time. If you conclude, based on the facts of the contract, that the performance obligation is satisfied over time, then you in turn would be required to recognize revenue over time. 33. What do you think the implications will be on the comparability of financial statements and metrics historically vs. going forward? Will existing benchmarks, etc. be comparable when evaluating companies? The true impact on comparability remains to be seen. There is a general expectation that certain changes will result from the new revenue standard that may impact comparability, key metrics, and other financial and operational areas within the organization. 34. Do homebuilders stick with the point of time or completed contract method? You will need to determine, based on the principles in Topic 606, if the performance obligation is satisfied over time or at a point in time. If you conclude, based on the facts of the contract, that the performance obligation is satisfied over time, then you in turn would be required to recognize revenue over time. 35. Do the one year or less amortization exceptions (cost to obtain a contract and accruals for loss contracts) apply to public companies? Since we report on 10 Q each quarter this may be an issue for SEC? Yes, provided the principles are met. 36. Is "Lease" accounting and the impact on revenue recognition a separate topic? Lease contracts within the scope of ASC Topic 840, Leases, are not within the scope of the revenue standard. 37. Do you have a sense as to how much this will impact a company's financials (e.g. increase/decrease/stay the same on the revenue amounts)? The impact that Topic 606 will have on a company's financial statements will vary company tocompany; and indeed contract by contract. It is therefore critical that an early assessment is performed to determine the impact that Topic 606 will have on entity wide functions, including financial reporting, key metrics, tax, controls, processes, etc CFMA. All Rights Reserved. 6