The New Era of Revenue Recognition. Chris Harper, CPA, MBA, Senior Manager

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1 The New Era of Revenue Recognition Chris Harper, CPA, MBA, Senior Manager

2 Measuring Temperature What is your level of familiarity with revenue recognition standards that were issued in 2014? I practically drafted the standards singlehandedly I have attended some CPE sessions I perused a few articles regarding the new standards I read the subject lines of several e mails before deleting the messages

3 ASU Issued by the FASB in May 2014 FASB Accounting Standards Codification amended to include Topic 606, Revenue from Contracts with Customers

4 Convergence A collaborative effort between the FASB and IASB with specified objectives IASB issued IFRS 15, Revenue from Contracts with Customers

5 Core Principle Entity should recognize revenue to Depict the transfer of promised goods or services to customers In an amount that reflects consideration to which the entity expects to be entitled in exchange for those goods and services

6 Core Principle Entity should apply the following steps Identify the contract(s) with a customer Identify the performance obligations in the contract Determine the transaction price Allocate the transaction price to the performance obligations in the contract Recognize revenue when (or as) the entity satisfies a performance obligation

7 Major Difference

8 Identify the Contract Customer A party that has contracted with the entity to obtain goods or services that are an output of the entity s ordinary activities in exchange for consideration. ASC Contract An agreement between two or more parties that creates enforceable rights and obligations. ASC Step 1

9 Identify the Contract A contract is an agreement between two or more parties that creates enforceable rights and obligations Revenue recognition requirements apply to each contract that meets the following criteria Approval and commitment Identification of rights Payment terms Collection is probable Step 1

10 Identify the Contract Form of contract Written Oral Implied by customary business practices Includes written or verbal side agreements Must have commercial substance Step 1

11 Identify the Contract Contract entered at or near the same time with the same customer will be considered a single contract if any of the following apply Package with a single commercial objective Interdependent consideration Single performance obligation Step 1

12 Identify Performance Obligations Performance obligation A promise Contained in a contract with a customer To transfer a good or service to the customer Step 2

13 Identify Performance Obligations Multiple goods or services Each promised good or service is a performance obligation only if it is Distinct or A series of distinct goods or services that are substantially the same and have the same pattern of transfer (homogeneous) A good or service that is not distinct should be combined with other promised goods or services until the bundle is distinct. Step 2

14 Identify Performance Obligations Per ASC a good or service is distinct it is both Capable of being distinct The customer can benefit from the good or service either on its own or together with other resources that are readily available to the customer Distinct within the context of the contract The entity s promise to transfer the good or service to the customer is separately identifiable from other promises in the contract Step 2

15 Identify Performance Obligations Can the customer utilize the good or service on its own or with other readily available resources? Yes Is the promise to transfer a good or service separate from other goods or services in the contract? No No Yes The good or service is NOT distinct The good or service IS distinct Step 2

16 Determine the Transaction Price Transaction price Amount of consideration to which an entity expects to be entitled in exchange for transferring promised goods or services to a customer Excludes amounts collected on behalf of third parties Step 3

17 Determine the Transaction Price Variable consideration options Estimate expected value of the most likely amount Sum of probability weighted amounts from a range of possible amounts The single most likely amount from a range of possible amounts Selected option should best predict amount of consideration to which the entity will be entitled Step 3

18 Determine the Transaction Price Constraining estimates of variable consideration Only include if it is probable that a significant reversal will not occur Step 3

19 Allocate to Performance Obligations Multiple performance obligations Allocate price to each performance obligation Amount of consideration the entity expects to be entitled for satisfying each performance obligation Determine the standalone selling price at contract inception Allocate based upon relative standalone selling prices Must estimate if the standalone price is not observable Step 4

20 Allocate to Performance Obligations Standalone selling price Price the entity charges for a good or service When sold separately to similar customers under similar circumstances May consider competitors prices for similar goods or services? Estimated selling price Expected cost plus appropriate margin Assessment of market prices for similar goods and services adjusted for entity specific costs and margins Residual approach (in very limited situations) Step 4

21 Recognize Revenue Recognize revenue when (or as) a performance obligation is satisfied Customer obtains control of the good or service This is a marked departure from extant GAAP s concept of transferring risks and rewards to the customer Performance obligations are considered satisfied when (or as) transfer of control occurs Step 5

22 Recognize Revenue Determine if an entity satisfies the performance obligation over time For each performance obligation If the performance obligation is not satisfied over time, then it is satisfied at a point in time Step 5

23 Recognize Revenue Performance obligation is satisfied over time if one of the following criteria is met The customer simultaneously receives and consumes the benefits provided by the entity s performance as the entity performs it The entity s performance creates or enhances an asset (for example, WIP) that the customer controls as the asset is created or enhanced The entity s performance does not create an asset with an alternative use to the entity, and the entity has an enforceable right to payment for performance completed to date Step 5

24 Recognize Revenue Recognizing revenue over time Consistent application of a method used to measure progress toward complete satisfaction of a performance obligation Output methods Input methods Measure should be updated as circumstances change over time Subsequent changes in method are a change in estimate Step 5

25 Recognize Revenue Indicators of transfer of control at a point in time (examples, but not all inclusive) Entity has a present right to payment for the asset Customer has legal title to the asset Entity has transferred physical possession of the asset Customer has the significant risks and rewards of ownership Customer has accepted the asset Step 5

26 Warranties Assurance warranties Assures that a product will function according to specifications Customer cannot purchase separately NOT a separate performance obligation Governed by other provisions of U.S. GAAP (ASC 460) Service warranties Provides an additional service to the customer May be purchased separately Is a separate performance obligation Governed by ASC 606

27 Disclosures Qualitative Quantitative Future cash flows Amount Timing Uncertainty EXTRA! EXTRA! $$$

28 Disclosures Entity s contracts with customers Disaggregation of revenue Information about an entity s contract assets and liabilities Information regarding performance obligations Performance obligations remaining at the end of a reporting period Significant judgments Determining timing of performance obligation satisfaction Determining transaction price and allocations to performance obligations Assets recognize from costs to fulfill a contract Utilization of practical expedients

29 Effective Dates Public companies First interim period within annual reporting periods beginning after December 15, 2017 Other entities Annual reporting periods beginning after December 15, 2018 Interim periods within annual periods beginning after December 15, 2019 Early adoption is permitted for non public entities, but no earlier than periods beginning after December 15, 2016

30 Application Retrospective application to each reporting period presented (full restatement of comparative figures) Modified retrospective application with one or more practical expedients Cumulative effect of change at adoption date (disclose effect of applying new standard)

31 Implementation Checklist Identify and summarize contracts Develop cross functional teams Discuss with external auditor or accountant Initiate proactive communication with stakeholders Evaluate potential impact on Legal agreements Debt covenants Compensation structure Key financial metrics Assess processes, controls and data processing systems

32 Questions? Chris Harper, CPA, MBA