Revenue from Contracts with Customers: The Final Standard

Transcription

1 Revenue from Contracts with Customers: The Final Standard 1

2 TABLE OF CONTENTS Overview and effective date Key provisions of the standard Transition Planning How Experis Finance can help REVENUE CONTRACTS WITH CUSTOMERS: THE FINAL STANDARD

3 OVERVIEW AND EFFECTIVE DATE On May 28, 2014, the Financial Accounting Standards Board (FASB) issued the long-awaited Accounting Standards Update (ASU), Revenue from Contracts with Customers (the Standard) which was then amended on July 9, 2015 to defer the effective date by one year. The Standard replaces virtually all U.S. GAAP guidance that currently exists on revenue recognition with a single model to be applied to all contracts with customers. On July 9, 2015 the FASB decided to defer the effective date of Accounting Standards Update (ASU) (the new revenue recognition standard) by one year for both public and private companies. The amended ASU will require public entities to apply the new revenue recognition guidance for annual reporting periods beginning after December 15, 2017 (in other words, January 1, 2018 for calendar-year entities) and interim reporting periods within annual reporting periods beginning after December 15, The amended ASU will require nonpublic entities to apply the new revenue recognition standard for annual reporting periods beginning after December 15, 2018 (in other words, January 1, 2019 for calendar-year entities) and interim reporting periods within annual reporting periods beginning after December 15, 2019 (meaning that nonpublic entities will not be required to apply the new revenue recognition standard in interim periods within the year of adoption). Both public and nonpublic entities will be permitted to apply the new revenue recognition standard as of the original effective date for public entities (annual periods beginning after December 15, 2016). KEY PROVISIONS OF THE STANDARD Scope The guidance provided by the Standard applies to all contracts with customers, except for: Lease contracts. Insurance contracts. Certain contractual rights or obligations within the scope of other standards, including financial instruments. Certain guarantees within the scope of other standards, other than product warranties. Nonmonetary exchanges between entities in the same line of business to facilitate sales to customers. The Core Principle The core revenue recognition principle is that an entity should 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.the following five steps should be taken to achieve the core principle: 1. Identify the contracts with a customer. 3

4 2. Identify performance obligations in the contract. 3. Determine the transaction price. 4. Allocate the transaction price to performance obligations in the contract. 5. Recognize revenue when (or as) the entity satisfies a performance obligation. Step 1 Identify the Contracts with the Customer The Standard requires the existence of a contract before revenue recognition. A contract is defined as an agreement between parties that creates enforceable rights and obligations and has commercial substance. A customer is a party that has contracted with an entity to obtain goods or services that are an output of the entity s ordinary activities. A contract does not exist for purposes of revenue recognition if both parties can terminate a wholly unperformed contract without compensating the other party. In general, the criteria for a contract in the Standard are similar to the evaluation required under current A contract is defined as an agreement between parties that creates enforceable rights and obligations. Contract Combination U.S. GAAP to determine whether there is persuasive evidence of an arrangement. The Standard points out that, consistent with current U.S. GAAP, contracts do not need to be written. Rather, an entity s practices and processes for establishing contracts would be considered in assessing whether the criteria are met. The Standard requires legally separate contracts entered into at or near the same time with the same customer (or related parties) to be combined for accounting purposes if one or more of the following conditions exist: The contracts are negotiated as a package with a single commercial objective. The amount of consideration to be paid in one contract depends on the price or performance of the other contract. All or some of the goods or services promised are a single performance obligation. In general, this guidance is consistent with legacy guidance. As a practical expedient, the Standard allows the application of the guidance to a portfolio of contracts (or performance obligations) with similar characteristics if it is reasonably expected that the result of doing so would not be materially different from applying the guidance to the individual contracts (or performance obligations). Contract Modifications A contract modification will be accounted for as a separate contract if the modification results in the addition to the contract of both: (a) distinct promised goods or services, i.e., a separate performance obligation; and (b) the right to receive consideration that reflects the entity s standalone selling price of the promised goods 4 REVENUE CONTRACTS WITH CUSTOMERS: THE FINAL STANDARD

5 or services. Otherwise, a modification is accounted for as an adjustment to the original contract, either prospectively or through a cumulative catch-up adjustment, as further discussed below. The effect of a contract modification will be determined when the modification is approved. An entity will account for a modification, including a contract modification that only affects the transaction price, (1) prospectively if the goods or services in the modification are distinct from those transferred before the modification, or (2) as a cumulative catch-up adjustment if the goods or services in the modification are not distinct and are part of a single performance obligation that is only partially satisfied when the contract is modified. Step 2 Identify performance obligations in the contract The Standard describes a performance obligation as a promise to transfer a good or service to a customer. In most cases, it will be fairly easy to determine whether a provision or clause in a contract represents a performance obligation. An entity will account for a promised good or service (or a bundle of goods or services) as a separate performance obligation only if both of the following criteria are met: The promised good or service is capable of being distinct because 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. The promised good or service is distinct in the context of the contract because the good or service is not highly dependent on, or highly interrelated with, other promised goods or services in the contract. The Board provided additional clarifications regarding the identification of performance obligations within contract such as, an entity is not required to identify goods or services promised to the customer that are immaterial in the context of the contract with a customer. Also, shipping and handling activities that occur before the customer obtains control of the related good are fulfillment activities. Entities are permitted, as an accounting policy election, to account for the shipping and handling activities that occur after the customer has obtained control of a good as fulfillment activities. Step 3 Determine the transaction price The transaction price is defined as the amount of consideration that the seller expects to be entitled to in exchange for the promised goods or services. This does not include the amounts collected on behalf of third parties or the effects of the customer s credit risk. An entity should consider the effects of all of the following when determining the transaction price: Variable Consideration For many contracts, measuring the consideration to be received is simple because the contract states a fixed price. However, contracts may have prices that vary, for example, based on the vendor s performance, the customer s use of the goods or services, future changes in price or value of the goods or services, or other factors including but not limited to rebates, incentives, performance bonuses and royalties. 5

6 The objective of this constraint is that an entity should recognize revenue as performance obligations are satisfied only up to an amount that is not subject to significant reversals in the future. This constraint also applies to contracts with a fixed price if it is uncertain whether the entity will be entitled to all of the consideration even after the performance obligation is satisfied. Companies can estimate the cumulative amount of revenue to be recognized by using either of the following methods, depending on which method the entity expects to better predict the amount of consideration to which it will be entitled: Expected value representing the sum of probability weighted amounts in a range of possible consideration amounts. Most likely amount is the single most likely amount in a range of possible consideration amounts. Time Value of Money The Standard requires that the transaction price be adjusted to reflect the time value of money if the contract has a financing component that is significant to the contract. As a practical expedient, such an adjustment is not necessary if the entity expects that the period between payment by a customer and the transfer of the promised goods or services is one year or less. Noncash Consideration The Standard does not change legacy guidance regarding nonmonetary transactions. These transactions The Standard requires that the transaction price be adjusted to reflect the time value of money if the contract has a financing component that is significant to the contract. Consideration Payable to the Customer will continue to be recognized at fair value (as long as they have commercial substance). In the event that the fair value of any noncash consideration cannot be reasonably estimated, it is measured indirectly based on its stand-alone selling prices of the goods or services in the arrangement. Consideration paid (or expected to be paid) to a customer (or to a customer s customer) will reduce the transaction price. An entity will recognize the reduction of revenue when the latter of the following occurs: The entity recognizes revenue for the transfer of the promised goods or services to the customer, or The entity pays or promises to pay the consideration (even if the payment is conditional on a future event). That promise might be implied by the entity s customary business practice. Step 4 Allocate the transaction price to performance obligations in the contract Under the guidance in the Standard, consideration is allocated to each performance obligation based on the relative standalone selling prices of the goods or services at the inception of the contract. When such standalone prices are not known, they should be estimated. Suitable estimation methods include, but are not limited to: (a) the adjusted market assessment approach; (b) the expected cost plus a margin approach; and (c) the residual approach. Revenue is reallocated based on changes after contract inception in the stand-alone selling prices of the distinct goods or services. 6 REVENUE CONTRACTS WITH CUSTOMERS: THE FINAL STANDARD

7 Changes in the transaction price After the inception of a contract, the transaction price could change for various reasons, including the resolution of or a change in the estimate of the outcome of a contingency. When this occurs, changes in the transaction price should be allocated to the separate performance obligations on the same basis that was used at contract inception. Amounts allocated to satisfied performance obligations would be recognized in revenue, increasing or decreasing revenue at the time the transaction price changes. Step 5 Recognize revenue when (or as) the entity satisfies a performance obligation This requirement is comparable to the delivery requirement under legacy U.S. GAAP. The Standard requires that revenue be recognized when (or as) an entity satisfies a performance obligation that is identified in the contract. Satisfaction of a performance obligation is deemed to occur when the customer obtains control of the promised good or service (i.e., the asset), as evidenced by the customer s ability to direct the use of and obtain substantially all of the remaining benefits of the asset. Indicators that the customer has obtained control of goods or services include: The entity has a right to payment for the asset. The entity transferred legal title to the asset. The entity transferred physical possession of the asset. The customer has the significant risk and rewards of ownership. The customer has accepted the asset. In many instances, a performance obligation is satisfied at a single point in time (e.g., when a purchased product is physically delivered to the customer). Therefore, revenue is recognized at that point in time. In other instances, delivery occurs continuously over a period of time (e.g., a provider of transaction processing services transfers control of the results of the services to its customer as it performs those services). Therefore, revenue is recognized over time. Specific topics Licensing and Rights to Use A license establishes a customer s rights to the intellectual property (IP) and may include, but is not limited to, software, motion pictures, music, franchises, patents, trademarks, and copyrights. When a contract with a customer includes a promise to grant a license in addition to other promised goods or services, companies need to identify each of the performance obligations in the contract. If the promise to grant a license is distinct from other promised goods or services in the contract and, therefore, the promise to grant the license is a separate performance obligation, companies need to determine whether the license transfers to a customer either at a point in time or over time. If providing a right to use IP which transfers at a point in time, revenue is recognized when that right transfers to the customer. Licenses that provide access to IP are performance obligations that are satisfied over time and, therefore, revenue is recognized over time. 7

8 The Board clarified that an entity s promise to transfer a license to functional IP (that is, IP that has significant standalone functionality) that is a separate performance obligation is satisfied at the point in time the license is granted unless both of the following criteria are met: 1. The functionality of the IP to which the customer has rights is expected to substantively change during the license period as a result of activities of the entity that do not transfer a promised good or service to the customer. 2. The customer is contractually or practically required to use the updated IP resulting from criterion (1). The Board also clarified that an entity s promise to transfer a license to symbolic IP (that is, all IP that does not have significant standalone functionality) is satisfied over time because the entity s promise to the customer includes continuing to support or maintain the intellectual property to which the customer has rights. The Standard also includes a narrow exception to the constraint on variable consideration for sales-based or usage-based royalties on licenses of IP. Royalties from licenses of IP are not included in the transaction price until they are no longer variable (that is, when the customer s subsequent sales or usage occur). The Board clarified the scope and applicability of the implementation guidance on sales-based or usage-based roylaties promised in exchange for a license of IP as follows: 1. An entity should not split a single royalty into a portion subject to the sales-based and usage-based royalties recognition exception and a portion that is not subject to the exception (and, therefore, would be subject to the general guidance on variable consideration, including the constraint on variable consideration). 2. The sales-based and usage-based royalties exception should apply whenever the predominant item to which the royalty relates is a license of IP. If the promise to grant a license is not distinct from other promised goods or services in the contract, companies should account for the promise to grant a license and those other promised goods or services together as a single performance obligation. Contract Costs Under legacy guidance, direct costs of providing services were usually capitalized if they are incurred before revenue can be recognized when the vendor performs its obligation at a single point in time. These costs were expensed as incurred if revenue is recognized over a period of time. However, because legacy guidance provides limited guidance on such related costs, there is diversity in practice. The Standard provides guidance on accounting for the costs of revenues (i.e., contract costs), and thus resolves much of the historical uncertainty and diversity. First, the Standard recognizes that costs incurred in fulfilling a customer contract involve the creation of an asset as defined in other parts of U.S. GAAP (e.g., inventory; property, plant, and equipment; or software). Second, incremental costs of obtaining a contract result in the creation of an asset. 8 REVENUE CONTRACTS WITH CUSTOMERS: THE FINAL STANDARD

9 The Standard requires that costs incurred in fulfilling a contract should be capitalized as an asset if they meet all of the following criteria: Relate directly to a contract; Generate or enhance resources of the entity that will be used in satisfying performance obligations in the future; and Are expected to be recovered. The Standard requires incremental costs of obtaining a contract with a customer to be capitalized if the entity expects to recover those costs. An entity may, however, elect to recognize incremental costs of obtaining a customer contract as an expense if the amortization period is one year or less. The incremental costs of obtaining a contract are those costs that would not have been incurred if the contract had not been obtained (e.g., sales commissions). Collectability Under the guidance of the Standard, collectability is no longer a recognition threshold. As a result, revenue might be recognized earlier by entities that currently defer recognition of revenue due to collectability issues. If accounts receivable become impaired subsequent to the initial transaction, entities should expense them at the time of impairment. Repurchase Agreements Repurchase agreements generally come in three forms: 1. An entity s unconditional obligation to repurchase the asset (a forward), 2. An entity s unconditional right to repurchase the asset (a call option), and 3. An entity s unconditional obligation to repurchase the asset at the customer s request (a put option). An unconditional obligation or unconditional right to repurchase the asset (a forward or a call option), does not allow the customer to obtain control of the asset because the option to repurchase is within the entity s control, even though the customer may have physical possession of the asset. Entities should account for these transactions as either a lease, if the entity can repurchase the asset for an amount that is less than the original selling price of the asset, or a financing arrangement, if the entity can repurchase the asset for an amount that is equal to or more than the original selling price of the asset. If an entity has an unconditional obligation to repurchase the asset at the customer s request (a put option) at a price that is lower than the original selling price of the asset, the entity should consider at contract inception whether a customer has a significant economic incentive to exercise that right. The customer s exercising of that right results in the customer effectively paying the entity consideration An unconditional obligation or unconditional right to repurchase the asset does not allow the customer to obtain control of the asset because the option to repurchase is within the entity s control for the right to use a specified asset for a period of time. Hence, if the customer has a significant economic incentive to exercise that right, the entity should account for the agreement as a lease. 9

10 Consignment Arrangements Generally, inventory on consignment is typically controlled by the entity until a sale occurs, the products are returned, or they are transferred to another dealer. Since the dealer does not obtain control of the product, the entity would not recognize revenue upon delivery of the products to the dealer. This guidance is similar to legacy guidance. Bill-and-Hold Arrangements A bill-and-hold arrangement is a contract under which an entity bills a customer for a product but the entity retains physical possession of the product until it is transferred to the customer at a point in time in the future. For a customer to have obtained control of a product in a bill-and-hold arrangement, all of the following criteria should be met: 1. The reason for the bill-and-hold arrangement must be substantive. 2. The product must be identified separately as belonging to the customer. 3. The product currently must be ready for physical transfer to the customer. 4. The entity cannot have the ability to use the product or to direct it to another customer. Customer options for additional goods or services Entities may offer customer options to acquire additional goods or services for free or at a discount. Such options come in many forms, including sales incentives, customer award credits or points, contract renewal options, or other discounts on future goods or services. If the option provides a material right to the customer that it would not receive without entering into that contract, that option represents a separate performance obligation to which entities are required to allocate a portion of the transaction price. If the stand-alone selling price for a customer s option to acquire additional goods or services is not directly observable, an entity should estimate it. Principle versus Agent If an entity obtains control of the goods or services of another party before it transfers those goods or services to the customer, the entity is acting as a principal and should recognize revenue in the gross amount to which it is entitled. If the entity is satisfying a performance obligation to obtain a contract for the other party, the entity is acting as an agent and should recognize revenue on a net basis. On August 31, 2015, the FASB issued a proposed ASU that would amend the Standard to address issues raised regarding how an entity should assess whether it is the principal or the agent that include three or more parties. In particular, stakeholders have questioned (1) how to determine the unit of account (i.e., whether it should be at contract level or the performance obligation level), (2) whether the related indicators in the new Standard are intended to assist in a single evaluation of control or represent an additional evaluation, and (3) how certain indicators are related to the Standards general control principle. 10 REVENUE CONTRACTS WITH CUSTOMERS: THE FINAL STANDARD

11 Warranties Some warranties provide a customer with assurance that the related product complies with agreed-upon specifications. Other warranties provide the customer with a service in addition to the assurance that the product complies with agreed-upon specifications. If a warranty provides a customer with a service in addition to the assurance that the product complies with agreed-upon specifications, the warranty should be considered a separate performance obligation and an entity should allocate the transaction price to the product and the warranty service. Factors to consider when assessing whether a warranty provides a customer with a service in addition to the assurance that the product complies with agreed-upon specifications, include: A. Whether the warranty is required by law. B. The length of the warranty coverage period. C. The nature of the tasks that the entity promises to perform. This guidance is similar to legacy guidance. Sale with right of return Entities will account for the transfer of products with a right of return (and for some services that are provided subject to a refund), by recognizing all of the following: A. Revenue for the transferred products in the amount of consideration to which the entity is reasonably assured to be entitled (considering the products expected to be returned), B. A refund liability, and C. An asset (and corresponding adjustment to cost of sales) for its right to recover products from customers on settling the refund liability. These amounts should be assessed each period and adjusted as appropriate to reflect refund liabilities outstanding. Customers unexercised rights (Breakage) A customer s nonrefundable prepayment to an entity gives the customer a right to receive a good or service in the future and obliges the entity to stand ready to transfer a good or service. Initially, the entity should record a contract liability in the amount of the prepayment. The entity should subsequently recognize revenue as the performance obligation is satisfied. The contract liability amount should be evaluated at each period. If the entity determines the customer will not exercise either a portion or all of its rights, the liability should be adjusted at that time and recognized as revenue. 11

12 Non-refundable upfront fees When an entity charges a customer a nonrefundable upfront fee at or near contract inception, it should be assessed whether the fee relates to the transfer of a promised good or service that should be accounted for as a separate performance obligation. If not, the upfront fee represents an advance payment for future goods or services that should be recognized as revenue when those future goods or services are provided. Customer acceptance In legacy guidance, customer acceptance clauses that allowed the customer to cancel a contract or require an entity to take remedial action if a good or service does not meet agreed-upon specifications resulted in the deferral of revenue until the entity receives the customer s acceptance. The Standard provides that, although it is an indicator of control, customer acceptance may be a formality that would not affect an entity s determination of when the customer has obtained control of the good or service. For example, if an entity can objectively determine that control of a good or service has been transferred to the customer in accordance with the agreed-upon specifications in the contract, revenue may be able to be recognized before customer acceptance is received. Disclosures The disclosure requirements of the Standard are extensive. Companies will be required to disclose sufficient information to enable users of financial statements to understand the nature, amount, timing, and uncertainty of revenue and cash flows arising from contracts with customers. To achieve that objective, companies are advised to disclose qualitative and quantitative information about all of the following: a. Its contracts with customers b. The significant judgments, and changes in the judgments, made in applying the guidance in this topic to those contracts c. Any assets recognized from the costs to obtain or fulfill a contract with a customer. Although these requirements appear straightforward, the time and resources required to compile and prepare this disclosure information may be significant. TRANSITION Entities can apply the Standard retrospectively and use certain practical expedients such as not restating contracts that begin and end in the same period and using hindsight in accounting for variable consideration in completed contracts. Entities can also choose to use the following method to simplify transition: Apply the Standard to all existing contracts as of the effective date and to contracts entered into subsequently. Recognize the cumulative effect of applying the new standard to existing contracts in the opening balance of retained earnings on the effective date. 12 REVENUE CONTRACTS WITH CUSTOMERS: THE FINAL STANDARD

13 In the year the Standard is initially adopted, provide the following additional disclosures, beginning with the first interim period: The amount by which each financial statement line item is affected in the current year as a result of the entity applying the Standard, and An explanation of the significant changes between the reported results under the Standard and legacy guidance. PLANNING The new revenue recognition accounting standard will have a significant and wide-spread effect on most organizations, impacting some industries more than others. Industries such as retail, aerospace, technology, transportation, and manufacturing will face significant effort to implement the new standard. Companies should start now to assess the impact of the Standard to their organization. For example, it may be determined that revenue will be recognized earlier than under previous guidance, which will impact budgeting and forecasting processes. An initial impact assessment will provide companies the opportunity to evaluate the need for additional resources to prepare revenue recognition related disclosures and the changes that may be required across the organization. Key implementation considerations include: 1. Create a centralized contracts database A contract can be written, oral or implied by an entity s customary business practice. Furthermore, companies will need to apply the Standard to each contract or combination of contracts with a customer. Depending on their contract origination and monitoring procedures, some companies may need extra time to identify all contracts. 2. Evaluate each contract and identify each performance obligation Identifying separate performance obligations is critical as they represent the units of account to which the transaction price is allocated, and satisfaction of those separate performance obligations determines the timing of revenue recognition. It is important to remember that explicit and implicit promises in a contract to provide goods or services, including offers to provide goods or services that the customer can resell or provide to its customer (an end customer ), are performance obligations even if they are satisfied by another party. Contracts with customers to provide a series of promised goods or services delivered consecutively will need to be assessed to determine whether the contract is a single performance obligation or contains multiple separate performance obligations. 3. Define and support revenue recognition assumptions The devil is in the detail. Greater understanding and monitoring of contract terms will be required to ensure items such as renewals, extensions and variable lease payments are appropriately recorded and disclosed. In some cases, companies will also need to develop the ability to support their experience with performance obligations identified in order to substantiate transaction prices allocated. Industries such as retail, aerospace, technology, transportation, and manufacturing will face significant effort to implement the new standard. 13

14 4. Assess impacts to existing IT infrastructure Understand what systems are used to manage contracts with customers and determine if additional features and capabilities will be required to maintain and monitor various contract terms under the Standard. 5. Consider income tax related impacts Changes to revenue recognition for US GAAP are not being accompanied by changes to tax rules for revenue recognition. As such, companies should evaluate changes to tax provisions for timing differences. Additionally, possible changes include modifications to sales and use tax calculations, state income tax apportionment methods and adjustments to foreign statutory reporting to US GAAP for tax compliance. 6. Consider changes to internal controls and audit plans New revenue recognition rules will likely result in new processes and procedures for recording revenue and changes in internal controls that govern the revenue process. These new controls will need to be documented and tested by management as part of their Sarbanes-Oxley compliance. Additionally, the initial implementation of the new revenue standard will be a significant event for many organizations and will be subject to auditor testing from both a substantive audit and controls audit perspective. 7. Evaluate impacts to other areas of the business Changes in how a company recognizes revenue can mean changes in timing of sales-based compensation, achievement of earnings targets, income tax impacts, changes to budgets and financial objectives and many other areas. Additionally, executives and board members will need to be educated on the impacts of the new rules. 14 REVENUE CONTRACTS WITH CUSTOMERS: THE FINAL STANDARD

15 HOW EXPERIS FINANCE CAN HELP Experis Finance, a ManpowerGroup product solutions and financial advisory organization, is uniquely positioned to assist companies in efficiently and effectively implementing the key requirements set forth in the Standard. Within Experis Finance, our Technical Accounting and Financial Reporting Center of Expertise provides many public and private companies with accounting and financial reporting consulting services, including SEC consulting and support. We work with all sizes of global and domestic private, public and not-for-profit organizations assisting them in analyzing complex accounting transactions and business operations. Our experienced team of advisors and professionals provides our clients with cost effective, practical and actionable solutions for a wide range of accounting, tax, compliance and business performance issues. Contact us today to arrange a meeting to discuss your specific situation with an Experis Finance professional. We are here to assist you and help you achieve your goals. Experis Finance Technical Accounting and Financial Reporting Center of Expertise Jay Smith, National Practice Director jay.smith@experis.com

16 Experis Finance 100 Manpower Place Milwaukee, WI USA MANPOWERGROUP. ALL RIGHTS RESERVED.