BDO Annual Nonprofit Accounting and Auditing Update

Transcription

1 BDO Annual Nonprofit Accounting and Auditing Update July 25, 2017 BDO USA, LLP, a Delaware limited liability partnership, is BDO KNOWLEDGE Webinar Series the U.S. member of BDO International Limited, a UK BDO Annual Nonprofit Accounting and Auditing Update company limited by guarantee, and forms part of the Page 1 international BDO network of independent member firms.

2 Presenters Lee Klumpp, CPA, CGMA National Assurance, Partner, Nonprofit & Government Practice (703) Dick Larkin, CPA National Technical Director, Nonprofit (703) Divya Gadre, CPA Assurance Senior Manager Nonprofit Services (703) Page 2

3 NFP Accounting Trifecta Page 3

4 The NFP TRIFECTA NFP Presentation, ASU Effective Date: For fiscal years beginning after 12/15/2017 Early Adoption: Permitted Revenue Recognition from Contracts with a Customer, ASU Effective Date: Nonpublic entities, Fiscal years beginning after December 15,2018. (Conduit Debt Obligors will be one year earlier) Early Adoption: Permitted but not before years ends December 31, 2017 Leases, ASU Effective Date: Nonpublic entities, Fiscal years beginning after December 15, 2019 (Conduit Debt Obligors will be one year earlier) Early Adoption: Permitted Page 4

5 Financial Statements of Not-for-Profit Entities ASU Page 5

6 Net Assets Cash Flows Liquidity Expenses Operating Measure Page 6

7 NFP Financial Statements Project Key Objectives (recommended by FASB s NFP Advisory Committee (NAC)) Update, not overhaul, the current model Improve net asset classification scheme Improve information in financial statements and notes about: Financial performance Cash flows Liquidity Better enable NFPs to tell their financial story Page 7

8 Usefulness to Users Donations/ Contributions are a NFPs biggest source of resources Donors and Creditors need to be assured that the resources are being used appropriately. Updates that will allow this to happen: Eliminating the time restriction by donors Increase disclosures regarding net assets Requiring expenses to be comparable Allowing either method for the cash flow statement. Page 8

9 Net Assets Page 9

10 Net Assets Current GAAP Unrestricted Temp. Restricted Perm. Restricted Proposed GAAP + Disclosures Without Donor Restrictions Amount, purpose, and type of board designations * With Donor Restrictions Nature and amount of donor restrictions * New disclosure requirement Page 10

11 Example Effect on Statement of Financial Position Not-for-Profit Entity A Statements of Financial Position June 30, 20X1 and 20X0 (in thousands) 20X1 20X0 Assets: Cash and cash equivalents $ 4,575 $ 4,960 Accounts and interest receivable 2,130 1,670 Inventories and prepaid expenses 610 1,000 Contributions receivable 3,025 2,700 Short-term investments 1,400 1,000 Assets restricted to investment in land, buildings, and equipment 5,210 4,560 Land, buildings, and equipment 61,700 63,590 Long-term investments 218, ,500 Total assets $ 296,720 $ 282,980 Liabilities and net assets: Accounts payable $ 2,570 $ 1,050 Refundable advance 650 Grants payable 875 1,300 Notes payable 1,140 Annuity trust obligations 1,685 1,700 Long-term debt 5,500 6,500 Total liabilities 10,630 12,340 Net assets: Without donor restrictions (Note DD) 92,600 84,570 With donor restrictions (Note B) 193, ,070 Total net assets 286, ,640 Total liabilities and net assets $ 296,720 $ 282,980 Note: Shaded lines are required to be presented. Source: ASU 958 Page 11

12 Impact of Changes to Net Assets CHANGES FOR CONSIDERATION AND DISCUSSION NOTES: Change Unrestricted to Without Donor Restrictions Combine TRNA and PRNA into one line and change description to With Donor Restrictions May want to consider disaggregated presentation on the face to show board designations, reserves and other set asides Possible changes to note references Page 12

13 Example of Effect on Statement of Activities - Columnar Format EXAMPLE OF EFFECT ON STATEMENT OF ACTIVITIES - COLUMNAR FORMAT Note: Shaded lines are required to be presented. Source: ASU Page 13

14 Impact on the Statement of Activities CHANGES FOR CONSIDERATION AND DISCUSSION NOTES: Combine TRNA and PRNA column Considerations regarding operating measure Page 14

15 Disclosures Related to Net Assets Amounts and purposes of governing board designations, appropriations, and similar actions that result in self-imposed limits on the use of resources without donor-imposed restrictions as of the end of the period. Composition of net assets with donor restrictions at the end of the period and how the restrictions affect the use of resources. Additional information related to underwater endowment funds. Page 15

16 Disclosures Related to Net Assets (Cont d) Information about the nature and amounts of different types of donorimposed restrictions should be reported either on the face of the statements or in the notes. Separate line items that distinguish between the different types of restrictions may be used such as: Assets, such as land or works of art, donated with stipulations that they be used for a specified purpose, be preserved, and not be sold. Assets donated with stipulations that they be invested to provide a permanent source of income. Support of particular operating activities. Investment for a specified term. Use in a specified future period. Acquisition of long-lived assets. Page 16

17 Net Asset Disclosure Example With donor restrictions Perpetual in nature $ 200,000 Purpose restricted 1,840,000 Time-restricted only, for periods after 20X1 150,000 $ 2,190,000 Without donor restrictions Designated by the Board for [purpose] $ 1,000,000 Undesignated 24,000,000 25,000,000 Net assets $ 27,190,000 Excerpt from ASC Source: ASU 958 Page 17

18 Underwater Endowments Revised net asset classification To be reflected in net assets with donor restrictions rather than in net assets without donor restrictions Enhanced disclosures In addition to aggregate amounts by which funds are underwater (current GAAP), also disclose aggregate of original gift amounts (or level required by donor or law) for such funds, fair value, and any governing board policy or decision to reduce or not spend from such funds. Page 18

19 Endowment disclosures A nonprofit is required to report the following for endowments: Net asset classification (i.e., With or without donor restrictions) Net asset composition (i.e., Board-designated endowment or with donor restrictions) Changes in net asset composition Spending policies Related investment policies No substantial changes here other than in naming convention of net asset classifications and underwater endowments as described on previous page. Page 19

20 Impact on Endowment Disclosures CHANGES FOR CONSIDERATION AND DISCUSSION NOTES: Disclosures contained in footnote(s) will need to be modified to conform with the two classes of net assets. Footnote will need to be modified to indicate the components of net assets with donor restrictions, without donor restrictions and those that are internally designated (e.g., Board Designated) and indicate the restriction on the use of the assets. Funds with deficiencies should be reclassified to net assets with donor restrictions. Page 20

21 Expiration of Capital Restrictions Gifts of cash restricted for acquisition or construction of PP&E NFPs would be required to use the placed-in-service approach (no more implied time restrictions) Page 21

22 Liquidity Page 22

23 Liquidity and Availability NFPs are required to provide the following information that will be useful for a reader to determine how the organization manages its liquid assets to meet cash needs for general expenditures within one year of the Statement of Financial Position (SOFP) date: Qualitative information on how an NFP manages its liquid available resources and its liquidity risk (in the notes) Quantitative information that communicates the availability of an NFP s current financial assets at the balance sheet date to meet cash needs for general expenditures (on the face and/or in the notes) Availability of financial assets may be affected by the nature of the asset, external limits imposed by donors, laws or contracts with others, or internal limits imposed by governing board decisions. Page 23

24 Quantitative and Qualitative Liquidity and Availability of Resources Disclosure Example Source: ASU Page 24

25 Quantitative Disclosure of Financial Asset Availability Financial assets, at year end* $ 234,410 Less those unavailable for general expenditures within one year, due to: Contractual or donor-imposed restrictions: Restricted by donor with time or purpose restrictions (11,940) Subject to apropriation and satisfaction of donor restrictions** (174,700) Investments held in annuity trust (4,500) Board designations: Quasi-endowment fund, primarily for long-term investing** (36,600) Amounts set aside for liquidity reserve (1,300) Financial assets available to meet cash needs for general expenditures within one year $ 5,370 * Total assets, less nonfinancial assets (e.g., PP&E, inventory, prepaids) ** Excludes amounts that have been appropriated for next 12 months that do not have purpose restrictions Source: ASU Page 25

26 Impact Due to Liquidity and Availability Footnote CHANGES FOR CONSIDERATION AND DISCUSSION NOTES: NFPs will need to determine the most desirable format to comply with the quantitative component of this disclosure. Ideally the reader would be able to tie the financial assets on the face of the statement of financial position to the footnote prior to amounts being deducted due to restrictions or unavailability. NFPs will need to determine the qualitative disclosures to comply with the disclosure requirements. Page 26

27 Operating Measure Page 27

28 Operating Measure: Improved Disclosures For those NFPs that utilize an operating measure and show governing board designations, appropriations, and similar actions (internal transfers) in the measure These NFPs must report these types of internal transfers appropriately disaggregated and described by type (either on the face of the financial statements or in the notes) Page 28

29 Example of Operating Measure Presentation Page 29 Source: ASU

30 Expenses Page 30

31 Inconsistencies of Expense Reporting Donors, creditors and other users may not be seeing the full picture when a NFP all information regarding its expenses for a period. With the issuance of this update, all NFPs will be required to report all expenses per period by Nature and Function. The effects include: Having the users be able to see the full picture of the NFP The users will be able to see if the NFP is using its resources appropriately Page 31

32 Expense Reporting Report expenses, either on the face of financial statements or in the notes, by: Function * Natural classification Analysis (disaggregate function by nature) * currently required in GAAP NFPs are now required to provide qualitative disclosures about methods used to allocate costs among program activities and supporting services ASU also provides enhanced guidance on allocations from management and general (M&G) expenses Key concept: direct conduct or direct supervision Page 32

33 Expense Reporting Additional Information If expenses are reported in other line items within the statement of activities (e.g., salaries are included in costs of goods sold) they should be included in the functional reporting schedule by their natural classification. External and direct internal investment expenses that are netted against investment return should not be included in the functional expense analysis. Page 33

34 Example Disclosure for Expense Allocation Disclosure NOTE X. METHODS USED FOR ALLOCATION OF EXPENSES FROM MANAGEMENT AND GENERAL ACTIVITIES The financial statements report certain categories of expenses that are attributable to one or more program or supporting functions of the Organization. Those expenses include depreciation and amortization, the Source: ASU 958 president s office, communications department, and information technology department. Depreciation is allocated based on square footage, the president s office is allocated based on estimates of time and effort, certain costs of the communications department are allocated based on estimates of time and effort, and the information technology department is allocated based on estimates of time and costs of specific technology utilized. Page 34

35 Impact on Changes to Presentation and Disclosure of Expenses CHANGES FOR CONSIDERATION AND DISCUSSION NOTES: Will need to present by function and nature in one location determine whether you want to include on face of statement of activities, as a separate statement of functional expenses or in the footnotes. (Note: This analysis of expenses cannot be presented as supplemental information.) Will need to add disclosures about the methods used to allocate costs. Would recommend this be done in the significant accounting policies note. Page 35

36 INVESTMENT RETURN Page 36

37 Reporting of Investment Returns Net presentation of investment expenses against investment return on the face of the statement of activities - Netting limited to external and direct internal expenses Disclosure of investment expenses no longer required, no longer require disclosure of investment income components Page 37

38 Investment Return Direct internal investment expenses involve the direct conduct or direct supervision of the strategic and tactical activities involved in generating investment return including: Salaries, benefits, travel, and other costs associated with the officer and staff responsible for the development and execution of investment strategy. Allocable costs associated with internal investment management and supervising, selecting, and monitoring of external investment management firms. Direct internal investment expenses do not include items that are not associated with generating investment return. For example, the costs associated with unitization and other such aspects of endowment management would not be allocated. Page 38

39 Impact Related to Changes in Reporting Investment Return CHANGES FOR CONSIDERATION AND DISCUSSION NOTES: NFPs already reports investment return net of fees, however, they need to consider whether there are any direct internal investment costs that are not currently being reflected in the cost to manage the funds. Page 39

40 Cash Flow Statement Page 40

41 Cash Flow Statement Continue to Allow free choice between the Direct Method and the Indirect Method - However the Indirect reconciliation will no longer be required for Direct Method Page 41

42 Impediment of Cash Flow Statement The extra work need to complete the indirect method reconciliation when the direct method is used By removing the reconciliation requirement, the NFP Cuts costs Doesn t show some information twice It simplifies the Cash flow statement NFP still has freedom to select either method Page 42

43 Impact of Changes to Statement of Cash Flows CHANGES FOR CONSIDERATION AND DISCUSSION NOTES: Currently, NFPS utilize both the direct and indirect method, management will need to determine if they would like to change the presentation. - Pros many consider the direct method to be easier for users to understand, direct method may be easier to adopt since no longer required to show reconciliation from change in net assets - Cons direct method not widely used, considered more difficult to prepare by many Page 43

44 Implementation and Effective Date Page 44

45 Effective Date, Early Adoption, and Transition Effective Date: For fiscal years beginning after 12/15/2017 (e.g., FY for Higher Eds) Interim financials the following year Early Adoption: Permitted, but must apply the regular transition provisions. Transition: For year of adoption: apply all provisions. For comparative years presented: apply all provisions, except can choose not to present: Analysis of expenses by nature and function, and/or Disclosures around liquidity and availability of resources Page 45

46 Important Notes NFPs are already permitted to incorporate many of the changes in the ASU The only changes that cannot be done without formally adopting the ASU are: (1) Presenting one class of restricted net assets (consolidating temporarily and permanently restricted) (2) Underwater endowment accounting (3) Eliminated disclosures of investment return components and netted expenses (4) Eliminated requirement to provide indirect reconciliation if using direct method for operating cash flows Page 46

47 Recently Issued Standards Revenue Recognition Accounting for Grants and Contracts Leases Consolidation Pension Page 47

48 Revenue Recognition from Contracts with a Customer Page 48

49 Accounting for grants and Contracts Page 49

50 Grants and Contracts (Currently in Deliberations) Unique NFP guidance on contributions, but long-standing diversity in practice in classifying grants and contracts, particularly from governmental entities Terminology and Transition - Contributions encompasses both grants and donations - A change in classification in connection with enhanced/clarified guidance would not be the correction of an accounting error Page 50

51 Grants and Contracts (Currently in Deliberations) U.S. GAAP focuses on: - Issue 1: Exchange vs. Non-exchange (contribution) - Issue 2: Conditions vs. Restrictions ASU , Topic 606 (Revenue from Contracts with Customers) - Heightened this issue; raised question as to whether grants and contracts are in scope of that guidance - Removed limited exchange guidance and focuses on whether or not the transaction is reciprocal Page 51

52 Revenue Recognition: Overview of New ASU Page 52

53 Revenue from Contracts with Customers Introduction and Transition ASC 606 Revenue from Contracts with Customers issued in May 2014 A single, principle-based revenue standard for U.S. GAAP and IFRS that replaces almost all existing U.S. GAAP and IFRS guidance The new revenue standard aims to improve accounting for contracts with customers by: - Providing a more robust framework for addressing revenue issues as they arise - Increasing comparability across industries and capital markets - Requiring better disclosure The new revenue standard states in that exchange transaction shall be accounted for in accordance with Topic ASC 606 Revenue from Contracts with Customers Page 53

54 Revenue Recognition (Topic 606) Objective: To develop a single, principle-based revenue standard for US GAAP and IFRS The revenue standard aims to improve accounting for contracts with customers by: Providing a robust framework for addressing revenue issues as they arise Increasing comparability across industries and capital markets Requiring better disclosure Substantially converged with IFRS on major provisions Page 54

55 Scope All contracts with customers, except Lease contracts Insurance contracts Financial instruments Guarantees Non-monetary exchanges in the same line of business to facilitate sales to customers Contracts not with customers are excluded: Contributions Collaborative arrangements Page 55

56 Final U.S. GAAP Model Recognition Core Principle: Recognize revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services Steps to apply the core principle: 1. Identify the contract(s) with the customer 2. Identify the performance obligations 3. Determine the transaction price 4. Allocate the transaction price 5. Recognize revenue when (or as) a performance obligation is satisfied Page 56

57 Revenue from Contracts with Customers Nonprofit & Higher Education Specific Revenue Subject to this ASU i. Membership ii. Subscription iii. Products and Services iv. Royalty Agreements v. Sponsorship vi. Conferences and Seminars vii.tuition viii.advertising ix. Licensing x. Federal and State Grants and Contracts Page 57

58 Final U.S. GAAP Model Disclosure Disaggregation of revenue Information about contract balances Remaining performance obligations Interim requirements Qualitative and quantitative* disaggregation of revenue into categories that depict how revenue and Opening cash and flows closing are affected balances by * economic Amount of factors revenue recognized from contract liabilities * Explanation of significant changes in contract Transaction balances price * allocated to remaining performance obligations * Quantitative or qualitative explanation of when amounts will be recognized as revenue * Quantitative disclosures * Page * for public entities only

59 Transition, Effective Date and Early Application PY2 (2016) PY1 (2017) CY (2018) CY Footnotes Retrospective (with optional practical expedients) Cumulativ e catch-up Rev rec under new standard Cumulative effect at date of application Effective dates: Rev rec under legacy standard - Public entities: annual reporting periods after 12/15/2017 (including interim period) - Nonpublic entities: one year later (annual reporting periods after 12/15/2018) annual period in first year, interim periods thereafter - Early application option no earlier than original public company effective date (annual reporting periods after 12/15/2016) Page Cumulative catch-up Existing* and new contracts under new standard *contracts for which all (or substantially all) of the revenue has not been recognized under legacy revenue guidance Existing and new contracts disclosed under legacy standard for CY (2018)

60 LEASES Page 60

61 Leases (Topic 842) A lease contract conveys the right to use an asset (the underlying asset) for a period of time in exchange for consideration Page 61

62 Lessee Model All leases (more than 12 months) are recognized on the lessee s balance sheet Current U.S. GAAP (IFRS) IASB FASB Capital (Finance) Leases Type A Type A Operating Leases Type A Type B All leases are accounted for the same. Classification is based on existing U.S. GAAP/IFRS Page 62

63 Lessee Accounting Overview Balance Sheet Income Statement Cash Flow Statement Financin g Right-of-use asset Lease liability Amortization expense Interest expense Cash paid for principal and interest payments Operatin g Right-of-use asset Lease liability Single lease expense on a straight-line basis Cash paid for lease payments Page 63

64 Lessor Accounting Overview Balance Sheet Income Statement Cash Flow Statement Sales-Type / Direct Financing Net investment in the lease Interest income and any profit on the lease Cash received for lease payments Operating Continue to recognize underlying asset Lease income, typically on a straight-line basis Cash received for lease payments Page 64

65 Leases Effective Date Public Companies* Fiscal years beginning after December 15, 2018, including interim periods within those fiscal years (CY 2019; FY ) All Other Organizations Fiscal years beginning after December 15, 2019 and interim periods beginning after December 15, 2020 (CY 2020; FY ) Early Application Permitted for all organizations * Public Companies refers to the following: (1) public business entities, (2) a not-for-profit entity that has issued, or is a conduit bond obligor for, securities that are traded, listed, or quoted on an exchange or an-over-the-counter market, and (3) an employee benefit plan that files or furnishes statements with or to the SEC (Same Here as Revenue Recognition Standard) Page 65

66 Consolidation Page 66 66

67 Consolidation (Topic 810) ASU & Specific Considerations for Not-for-Profits Current Guidance in Topic 810 Amendment Separate accounting model for limited partnerships and similar legal entities (810-20). Includes a presumption that a general partner (GP) controls and thus consolidates the limited partnership. Substantive kick-out or participating rights must exist to overcome the presumption. Eliminates the separate accounting model. Eliminates the presumption of control by a GP. Adds for limited partnerships and similar legal entities that: They may qualify as Voting Entities if partners have substantive kickout or participating rights over GP An LP with a controlling financial interest consolidates Effective for CY 2017 (FY ); Project recently added to provide clarity for NFPs Page 67

68 Pensions Page 68

69 NET PERIODIC PENSION COST AND NET PERIODIC POSTRETIREMENT BENEFIT COST Background Net benefit cost contains several components with different nature No GAAP guidance on presentation Reduced predictive value and usefulness of information to users Board added project Presentation of net benefit cost in the income statement (retrospectively application) Service cost in the same line item or items as other current employee compensation costs Remaining components in a separate line item or items outside operating items, if applicable Capitalization of only service cost in assets (prospective application) Effective for Public Companies for annual periods beginning after December 31, 2107 (Private companies and Nonprofits annual periods beginning after December 31, 2018) Page 69

70 Other Active Projects Disclosure Framework Simplification Initiative EITF Cash Flows 70 Page 70

71 Disclosure Framework Phase I: Board s Decision Process Exposure Draft Re-deliberations Purpose of the notes General limitations Relevance Costs Certain forward-looking information Information that could be appropriate for inclusion in notes Considerations for interim reporting Phase II: Entity s Decision Process Guidance on applying materiality Applied individually and in the aggregate Legal concept Quantitative and qualitative Omission of immaterial disclosure is not an accounting error Comment period for exposure draft ended December 8th Page 71

72 Simplification Initiative Debt Classification - exposure draft being issued Q Debt Issuance Costs - final ASU available (ASU ) Equity Method of Accounting - Elimination of retroactive method (ASU ) Emerging Issues Task Force 14-B, Fair Value Hierarchy Levels for Certain Investments (ASU ) No longer require investments for which fair value is measured at net asset value (or its equivalent) using the practical expedient to be categorized in the fair value hierarchy Page 72

73 Cash Flow Classification Issues (EITF Issue 15-F) (ASU issued in August 2016) 1. Debt prepayment or extinguishment costs 2. Settlement of zero-coupon bonds 3. Contingent consideration payments made after a business combination 4. Restricted cash* (now Issue 16-A; to be issued) 5. Proceeds from the settlement of insurance claims 6. Proceeds from the settlement of life settlement contracts 7. Distributions received from equity method investees 8. Beneficial interests in securitization transactions 9. Application of the predominance principle 41 * Sub-issues: amounts moved between unrestricted and restricted cash accounts; amounts deposited and paid directly from restricted cash accounts Page 73

74 Questions? 74

75 Appendix Revenue From Contracts with a Customer Page 75

76 Revenue from Contracts with Customers Step #1 identify the contract STEP ONE Points to note Contracts can be written, oral, or implied by the entity s business practices Contracts with customers must meet ALL the following criteria: (i) The parties to the contract must approve it and be committed to perform their respective obligations. (iii) The payment terms for goods and services to be transferred can be identified. (ii) Each party s rights regarding goods and services to be transferred can be identified. (iv) The contract must have commercial substance. (v) It is probable that the entity will collect the consideration to which it is entitled. Note: Reassessment required in certain circumstances. Page 76

77 Revenue from Contracts with Customers Step #1 identify the contract STEP ONE Combining contracts One or more contracts that are entered into at (or near) the same time with the same customer (or related party) are accounted for as a single contract if any of the following applies: Package with a single commercial objective The contracts are negotiated as a package with a singe commercial objective. Interdependent consideration The consideration receivable under each of the contracts is interdependent on each other. Single performance obligation The goods or services to be provided under the contracts in total represents a single performance condition. Contrast to existing U.S. GAAP: Current guidance exists specifically for combining contracts in multiple-element arrangements (including software arrangements) and constructiontype/production-type contracts. The proposed guidance would apply to all revenue arrangements. Page 77

78 Revenue from Contracts with Customers Step #1 identify the contract STEP ONE Contract modifications Contract modifications are changes in the scope and/or price of the contract: i.e. create new or amend existing enforceable rights and obligations. A contract modification must be approved, in writing, orally, or otherwise as implied by the entities business practices Depending on the circumstances may be accounted for as follows: A separate contract Termination replace the old contract with the new contract Continuation treat modification as part of the original contact Page 78

79 Revenue from Contracts with Customers Step #2 identify separate performance obligations STEP TWO Definition of performance obligation A performance obligation is a promise to provide goods or services (or a bundle of goods or services) that are either: i. Distinct ii. Homogenous, and both: Each distinct good or service is a performance obligation satisfied over time (refer to Step #5), and The same method would be used to measure the entity s progress towards complete satisfaction of the performance obligation to transfer each distinct good or service to the customer (refer to Step #5). Page 79

80 Revenue from Contracts with Customers Step #2 identify separate performance obligations STEP TWO Examples of performance obligation Goods produced for sale (e.g. a manufacturer)or purchased for resale (e.g. a retailer) Providing a service of arranging for another party to transfer goods or services to the customer (e.g. acting as an agent of another party) Standing ready to provide goods or services Constructing, manufacturing, or developing an asset on behalf of a customer (e.g. building an asset for the specifications of a customer) Granting licenses or rights to use intangible assets Granting options to purchase additional goods or services (when those options provide the customer with a material right) Granting rights to goods or services to be provided in the future that the customer can resell or provide to its customer Performing a contractually agreed-upon task (or tasks) for a customer. Page 80

81 Revenue from Contracts with Customers Step #2 identify separate performance obligations STEP TWO Definition of a distinct good or service Can the customer benefit from the good or service, either on its own, or with other readily available resources? ( readily available resources are those that the customer possess or is able to obtain from the entity or another third party) Is the promise to transfer a good or service separate from the other promised goods or services in the contract? Indictors may include: The entity does not provide a significant service of integrating the goods and services Yes A good or service does not significantly modify or customize the other goods and services A good or service is not highly dependent or interrelated with the other goods and services No No The good or service is not distinct (these are then grouped into bundles of goods and services that are themselves distinct ) Yes The good or service is distinct Page 81

82 Revenue from Contracts with Customers Step #2 identify separate performance obligations STEP TWO EXAMPLE Significant Customization of Software Nonprofit A and Customer B enter a contract in which A will provide the following to B: - License to customer relationship management software - Consulting services to significantly customize the software to B s information technology environment - Technical support - Unspecified upgrades Total consideration to be paid by B = $600K Question: How many performance obligations? Page 82

83 Revenue from Contracts with Customers Step #2 identify separate performance obligations STEP TWO EXAMPLE Significant Customization of Software (continued) Answer: Three performance obligations 1) The software product license and consulting service are not distinct within the context of the contract because the consulting service does significantly customize the software product. In other words, significant integration exists. Nonprofit A would account for the license and consulting services together as one performance obligation. Nonprofit A would recognize revenue for that performance obligation over time by selecting an appropriate measure of progress toward complete satisfaction of the performance obligation (assuming the ASC 606 criteria are met for satisfaction of a performance obligation over time). 2) Technical Support 3) Unspecified upgrades Page 83

84 Revenue from Contracts with Customers Step #3 Determine the transaction price STEP THREE Definition Transaction price The transaction price is the 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 e.g. sales taxes etc. The consideration promised in a contract with a customer can vary in terms of nature and timing, and this affects the determination of the transaction price. Specific consideration is given to: i. Variable consideration (including constraints on estimates of variable consideration) ii. The existence of a significant financing component in the contract iii.non-cash consideration iv. Consideration payable to a customer. Page 84

85 Revenue from Contracts with Customers Step #3 Determine the transaction price STEP THREE (i) Variable consideration Variable consideration can arise due to: Discounts, rebates, refunds, and credits Price concessions, incentives, and performance bonuses Penalties Consideration that is contingent on the occurrence or non-occurrence of a future event. When a contract contains variable consideration, the transaction price is estimated. (i) Expected value method i.e. the sum of the probably weighted amounts for a range of possible outcomes. (Appropriate where there are a larger number of contracts with similar characteristics) (ii) Most likely amount i.e. the single most likely amount out of a possible range of outcomes. (Appropriate where there are only two possible outcomes) Contrast to existing U.S. GAAP: Currently ASC S99 (SAB 104) requires the seller's price to the buyer be fixed or determinable as one criteria for revenue recognition. The proposed guidance would shift this concept to a measurement principle, rather than a recognition principle. Page 85

86 Revenue from Contracts with Customers Step #3 Determine the transaction price STEP THREE (i) Variable consideration (cont d) Special Rule for Sales or usage based royalties For licenses of intellectual property based on sales or usage based royalties, consideration can only be recognized as revenue as and when the use or sales occur Reassessment The estimate of variable consideration, as it affects the transaction price, is reassessed (and updated where necessary) at each reporting date. Page 86

87 Revenue from Contracts with Customers Step #3 Determine the transaction price STEP THREE (i) Variable consideration (cont d) Constraining the estimate of variable consideration ASC 606 limits (i.e. constrains ) the estimate of variable consideration only to the extent that it is probable that a significant reversal in the amount of cumulative revenue recognized will not occur. Assessment of this constraint requires judgment, in considering both: The probability of a change in variable consideration The magnitude of that change in variable consideration. Factors that may indicate a significant revenue reversal may occur include: Extent of factors that are outside the control of the entity (i.e. market volatility) Uncertainty in the estimate is not expected to be resolved in the short-term The entity s practice and/or experience with similar contracts The is a larger number and broad range of possible consideration amounts. Page 87

88 Revenue from Contracts with Customers Step #3 Determine the transaction price STEP THREE EXAMPLE Variable consideration Nonprofit XYZ will receive a certain milestone payment upon the completion of specific research performed per a fixed fee grant with the U.S. Department of Health and Human Services (HHS). To date, Nonprofit XYZ has received a positive recommendation feedback from the program office at HHS and submitted interim research reports on time. Based on its experiences, experience of another federal agency with a similar type of research, and the feedback to-date from HHS, Nonprofit XYZ has determined it is 90% likely to be entitled to the entire milestone payment, and 10% likely to be entitled to no milestone payment. Question: Which method should be used to determine the transaction price? Page 88

89 Revenue from Contracts with Customers Step #3 Determine the transaction price STEP THREE EXAMPLE Variable consideration Answer: The most likely amount method should be used given there are only two possible outcomes. Page 89

90 Revenue from Contracts with Customers Step #3 Determine the transaction price STEP THREE (ii) Significant financing component (iii) Non-cash consideration (iv) Consideration payable to a customer Page 90

91 STEP FOUR Revenue from Contracts with Customers Step #4 Allocate the transaction price to Performance Obligations An entity allocates/splits the transaction price (determined in Step #3) between its performance obligations (identified in Step #2). The allocation is based on the relative standalone selling prices of each identified performance obligation, being: The price at which an entity would sell a promised good or service separately to a customer (i) Determining the standalone selling price of a performance obligation Question: Is there an observable price of a good or service for sales in similar circumstances and to similar customers? Yes: Use that price No: Estimate, maximizing the use of observable inputs and considering all available information (i.e. market conditions, entity specific, customers) Page 91

92 Revenue from Contracts with Customers Step #4 Allocate the transaction price to Per Obligations STEP FOUR Methods of determining the standalone selling price ((i) Adjusted market approach Estimate the price customers in the market would be willing to pay May also consider reference to competitors prices for similar goods and services. ((ii) Expected cost plus a margin approach Forecast the expected costs and then add an appropriate margin. ((iii) Residual approach Total transaction price less the observable standalone selling prices of other performance obligations However, must meet either of the below criteria: i. The selling price varies significantly (the same good or service is sold at the same time to other customers for a very broad range of prices) ii. The selling price is uncertain (selling price has not yet been established and the good or service has not previously been sold on a standalone basis). Can only be used after the allocation of any discounts (refer next slide). Contrast to existing U.S. GAAP: Currently, use of the residual method allocates the entire discount to the delivered item. In contrast, a residual approach under the new standard is used to estimate the standalone selling price, not to actually allocate consideration to a performance obligation. Page 92

93 Revenue from Contracts with Customers Step #4 Allocate the transaction price to Per Obligations STEP FOUR Discounts determining allocation Discounts exist where the sum of the standalone selling prices exceed the promised consideration. Allocation of the discount is made to either: i. Specific performance obligation(s) ii. Proportionately between all performance obligations. Specific allocation (i) occurs only if there is observable evidence that both: There are regular sales, on a standalone basis, of the (bundle) of goods or services The sales of the (bundle) of goods or services are regularly priced at a discount. Page 93

94 Revenue from Contracts with Customers Step #4 Allocate the transaction price to Per Obligations STEP FOUR Example Allocation methodology and discounts An Nonprofit sells Products A, B, and C to a member for $100 Each sale is a separate performance obligation Product A has a stand-alone observable price of $50 The estimated stand-alone selling prices of Products B and C are $25 and $75 The total stand-alone selling prices is $150 (i.e. $50 discount) The Nonprofit notes that there is no evidence that the discount relates entirely to either, or a group of, the products being sold Question: How is the discount allocated to each of the products? Page 94

95 Revenue from Contracts with Customers Step #4 Allocate the transaction price to Per Obligations STEP FOUR Example Allocation methodology and discounts Answer: The discount is allocated proportionately to all of the products: Product A = ($100 x ($50 / $150)) $33 Product B = ($100 x ($25 / $150)) $17 Product C = ($100 x ($75 / $150)) $50 Total $100 Page 95

96 Revenue from Contracts with Customers Step #4 Allocate the transaction price to Per Obligations STEP FOUR Variable consideration determining allocation The allocation of variable consideration (including changes in the estimate of variable consideration) will vary and may be allocated to either: i. The entire contract ii. One or more (but not all) performance obligations (e.g. bonuses) iii.one or more (but not all) goods or services within a single performance obligation (e.g. CPI adjustments for year 2 in a two year maintenance contract). Variable consideration is allocated to (ii) or (iii) above if both: It relates specifically to the satisfaction of the performance obligation of transfer of the goods or services Allocation is consistent with the overall allocation principle. Page 96

97 Revenue from Contracts with Customers Step #5 Recognize revenue STEP FIVE Revenue is recognized as/when an nonprofit satisfies each performance obligation. Satisfaction occurs as/when the nonprofit transfers control of the goods or services to the customer. Control is the ability to direct the use of and obtain substantially all of the remaining benefits from an asset (or prevent others from doing so). Common examples where a customer would usually obtain control include: Using the asset to produce goods or provide services (including public services) Using the asset to enhance the value of other assets Using the asset to settle liabilities or reduce expenses Selling or exchanging the asset Pledging the asset to secure a debt liability Holding the asset. Page 97

98 Revenue from Contracts with Customers Step #5 Recognize revenue STEP FIVE Revenue is recognized either: (i) Over time Subject to various criteria under ASC 606 (refer to subsequent slides) (ii) At a point in time If the criteria for recognition over time under ASC 606 are not met. The two approaches are mutually exclusive. Key points will be discussed on the following slides. Page 98

99 Revenue from Contracts with Customers Step #5 Recognize revenue STEP FIVE Recognize revenue over time OVER TIME Criteria (i) - The customer simultaneously receives and consumes all of the benefits provided by the entity s as the entity performs A customer simultaneously receives and consumes all of the benefits provided as the entity performs, where: Another entity would not need to re-perform the work already completed to date to fulfill the remaining performance obligation, and The entity s work does not create an asset (i.e. WIP inventory). In practice, it is likely that only (some) service contracts would satisfy this criteria (i.e. not goods contracts). Page 99

100 Revenue from Contracts with Customers Step #5 Recognize revenue STEP FIVE Recognize revenue over time Criteria (ii) - The asset that is created or enhanced is controlled by the customer An entity needs to consider the indicators of whether control has been transferred as noted on the previous slide, i.e. whether: i. Is there a present right to payment for the asset? ii. Who has legal title to the asset? iii. Has physical possession of the asset been transferred? iv. Have the significant risks and rewards of ownership been transferred? v. Has there been acceptance of the asset by the customer? Note: This approach is similar to the rationale of the percentage of completion method under ASC for construction contracts (i.e. that there is a continuous sale and that the customer controls the work in progress). Page 100 OVER TIME

101 Revenue from Contracts with Customers Step #5 Recognize revenue STEP FIVE Recognize revenue over time Criteria (iii) - The entity s performance does not create an asset with an alternative use to the entity An entity has an alternative use for the asset if it can readily redirect the use of the asset, both: Contractually, and Practically. If the asset can be readily interchanged with other assets produced by the entity, then there is no substantive contractual restriction preventing the redirection of the specific asset being produced (i.e. generic widgets ). If there is either no substantial cost on rework, or no substantial loss on sale of the asset to another customer for the asset in its current state, then there is no practical restriction preventing the redirection of the specific asset being produced. OVER TIME Page 101

102 Revenue from Contracts with Customers Step #5 Recognize revenue STEP FIVE Recognize revenue over time OVER TIME Criteria (iii cont d) - There is an enforceable right to payment for performance completed to date Enforceability Consider whether, in similar circumstances, legislation or legal precedent confers rights to payment: Exist, even though they are not included in the contractual agreement Do not exist, even though they are included in the contractual agreement. Also consider the entities business practices in choosing whether to persue rights to payments. Payment for performance completed The amount: Need not be fixed, however, must at least compensate the entity for performance to date Must approximate goods or services transferred to date (not merely compensation for loss of profit) Page 102

103 Revenue from Contracts with Customers Step #5 Recognize revenue STEP FIVE Question: For revenue recognized over time, how is progress towards completion of the performance obligation determined? OVER TIME The method used as the basis of revenue recognition over time must reflect the pattern of how the goods or services are transferred to the customer. These methods are broadly categorized as being either: i. Output methods (i.e. results, milestones, units produced/delivered etc.) ii.input methods (i.e. resources consumed, labor/machine hours, costs incurred etc.) Note: Must exclude from these methods any measure relating to goods or services that has not been transferred to the customer. Note: Only one method per performance obligation can be used, and application must be consistent for similar performance obligations. Note: Subsequent changes in the method used are a change in estimate. Page 103

104 Revenue from Contracts with Customers Step #5 Recognize revenue STEP FIVE Recognize revenue at a point in time if criteria for recognition over time are not met: Indicators to be considered when determining whether control has been transferred to the customer include: (i) Is there a present right to payment for the asset? (ii) Who has legal title to the asset? (iii) Has physical possession of the asset been transferred? (iv) Have the significant risks and rewards of ownership been transferred? (v) Has there been acceptance of the asset by the customer? Page 104

105 Revenue from Contracts with Customers Step #5 Recognize revenue STEP FIVE EXAMPLE Recognize Revenue OVER TIME Nonprofit A (Trade Association) publishes a journal on current topics related its industry that are relevant to its members and others. The journal is included as part of a members membership dues but also is available on a subscription basis for non-members. Questions: Does the performance obligation related to the subscription get satisfied over time? Is the recognition for members different from that nonmembers? Page 105

106 Revenue from Contracts with Customers Step #5 Recognize revenue STEP FIVE EXAMPLE (continued) OVER TIME Answers: The subscription performance obligation is satisfied over time. The annual membership dues would need to be allocated between membership and subscription. Page 106

107 Revenue from Contracts with Customers Other key areas (i) Contract costs Treatment is dependent on whether the costs are Not in the scope of another standard In the scope of another standard Recognize an asset for incremental costs of obtaining a contract Practical expedient if amortization period is one year or less expense as incurred Recognize an asset for costs to fulfil a contract if all of the following criteria are met: Costs are directly related to the contract Costs will generate/enhance entity s resources that will be used in satisfying performance obligations in the future Costs are expected to be recovered. Recognize in accordance with the applicable standards, e.g. ASC Inventory ASC 360 PP&E ASC 350 Intangibles. Otherwise recognize as an expense Page 107

108 Revenue from Contracts with Customers Other key areas (i) Contract costs (contd.) Subsequent to recognition, the contract asset is Amortized based on a systematic basis consistent with the pattern of transfer of the goods or services. Assessed for impairment Carrying amount of contract asset Remaining expected consideration Remaining costs to be incurred Page 108

109 Revenue from Contracts with Customers Other key areas (ix) Licensing This is the right to use, but not own, intellectual property of the entity. (a) Assess if the license is distinct from other goods or services in the contract (b) If the license is distinct from other goods or services in the contract, assess whether the license is recognized over time or at a point in time Revenue is recognized over time, where an entity remains involved in the intellectual property (IP), if: i. There is a contractual requirement or reasonable expectation (based on business practice, policy, statements, shared economic interests) that the IP will be updated by the entity, and the customer has rights of access to those updates ii. There is no transfer of a good or service to the customer as a result of the entity s activities (i.e. there is no performance obligation) iii.the customer is exposed to positive and negative effects of the entity s activities as and when they occur. If the criteria are not met, the rights to the IP are therefore static, and revenue is recognized at a point in time when control is transferred to the customer. Page 109