SPECIAL REPORT: Comprehensive Coverage of the New U.S. GAAP Revenue Recognition Requirements

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1 Checkpoint Contents Accounting, Audit & Corporate Finance Library Editorial Materials Accounting and Financial Statements (US GAAP) Accounting and Auditing Update (June 2014): SPECIAL REPORT: Comprehensive Coverage of the New U.S. GAAP Revenue Recognition Requirements SPECIAL REPORT: Comprehensive Coverage of the New U.S. GAAP Revenue Recognition Requirements Prepared by Allan B. Afterman, CPA, Ph.D. SUBJECT: SPECIAL REPORT: Comprehensive Coverage of the New U.S. GAAP Revenue Recognition Requirements SYNOPSIS ASU No and its international counterpart, IFRS 15, provide sweeping new, globally applicable converged guidance concerning recognition and measurement of revenue. In addition, significant additional disclosures are required about the nature, amount, timing, and uncertainty of revenue and cash flows arising from contracts with customers. The new rules, which, under U.S. GAAP, become effective for public entities in calendar year 2017 and for other entities in calendar year 2018, will replace virtually all existing revenue guidance, including most industry-specific guidance. INTRODUCTION The Financial Accounting Standards Board (FASB) has issued Accounting Standards Update (ASU) No , Revenue from Contracts with Customers (Topic 606), which amends the FASB Accounting

2 Standards Codification (ASC or the "Codification") by adding new FASB ASC Topic 606, Revenue from Contracts with Customers, and superseding the revenue recognition requirements in FASB ASC 605, Revenue Recognition, and in most industry-specific topics. In addition, the amendments supersede certain cost guidance in FASB ASC Subtopic , Revenue Recognition-Construction-Type and Production-Type Contracts. At the same time that the FASB issued ASU No , the International Accounting Standards Board (IASB) issued IFRS No. 15, Revenue from Contracts with Customers. Together, the new requirements represent the culmination of more than a decade-long effort by the FASB and the IASB to issue a converged revenue standard. This Special Report provides comprehensive coverage of the new rules, including computational examples that illustrate compliance with various provisions of the recognition and measurement requirements. Principles-Based Guidance The new rules establish a core principle requiring the recognition of revenue to depict the transfer of promised goods or services to customers in an amount reflecting the consideration to which the entity expects to be entitled in exchange for such goods or services. Specifically, to apply the core principle, an entity must (1) identify the contract, (2) identify the performance obligations in the contract, (3) determine the transaction price, (4) allocate the transaction price to the performance obligations, and (5) recognize revenue as each performance obligation is satisfied. In addition, pursuant to new FASB ASC , Other Assets and Deferred Costs-Contracts with Customers, (1) incremental costs of obtaining a contract expected to be recovered should be recognized as an asset, or charged to operations immediately if the amortization period is one year or less, and (2) costs of fulfilling a contract should be accounted for pursuant to other applicable United States generally accepted accounting principles (U.S. GAAP), or recognized as an asset if such costs are expected to be recovered and generate or enhance resources that will be used in satisfying performance obligations. Quantitative and qualitative disclosures required under the new rules concern the nature, amount, timing, and uncertainty of revenue and cash flows arising from contracts with customers. Because the new guidance is principles-based and creates a general revenue-recognition framework, it (1) can be applied to all contracts with customers regardless of industry-specific or transaction-specific fact patterns, (2) should remain relevant as markets and transactions evolve, and (3) is a considerably less complex approach than the guidance that it replaces. International Applicability

3 As the new FASB and IASB standards are virtually identical, they have resulted in a global approach for recognizing revenue that can be consistently applied by all entities reporting under U.S. GAAP or International Financial Reporting Standards (IFRS) to various types of transactions, across most industries, and in the world's largest capital markets. Note that, while the two new standards are substantially the same in all significant respects, there are minor differences between them, including the following: Under each standard, there is an explicit collectibility threshold that a contract must meet before revenue can be recognized (i.e., an entity must conclude that it is probable that it will collect the consideration to which it will be entitled in exchange for the goods or services that will be transferred to the customer). However, under U.S. GAAP and IFRS, the term "probable" has different meanings. Specifically, under U.S. GAAP, probable means "likely to occur," which is interpreted to mean a threshold of somewhat greater than 50%, whereas under IFRS, probable is defined as "more likely than not to occur," which is interpreted to mean anything more than 50%. IFRS 15 requires the reversal of an impairment loss on an asset recognized for costs to obtain or fulfill a contract, which is in accordance with the guidance in IAS 36, Impairment of Assets, whereas, consistent with other applicable U.S. GAAP, an impairment loss on such an asset may not be subsequently reversed. The amendments made by ASU No are effective, generally, (1) for public companies for years beginning after December 15, 2016, and (2) for non-public entities, for years beginning after December 15, Public companies are not allowed to apply the new guidance earlier than the effective date, while non-public companies may apply the new guidance early, but no earlier than the effective date for public companies. IFRS 15 is effective for years beginning on or after January 1, 2017, with early adoption permitted. ASU No provides certain disclosure, transition, and effective date relief for non-public companies, whereas, under IFRS 15, no such relief applies, because full IFRS does not distinguish between public and non-public entities. Rather, the IFRS for Small and Medium-Sized Entities is available for entities not having public accountability. Main Differences From Current U.S. GAAP The main differences from current U.S. GAAP include the following: Under current standards, there are numerous requirements concerning revenue recognition and

4 measurement, particularly along industry lines and in respect of variable consideration received. Under the new guidance, a consistent core principle will be applied, regardless of the industry involved, and a single model to account for variable consideration, which includes rebates, discounts, bonuses, or a right of return, will be required. Under current U.S. GAAP, many goods or services promised in a contract with a customer are deemed not to be distinct revenue-generating transactions, when in fact those promises might represent separate obligations of the selling entity to the customer. Pursuant to the new guidance, selling entities will have to identify each of the goods or services promised to determine whether those goods or services represent a performance obligation, and recognize revenue when, or as, each performance obligation is satisfied. Under current U.S. GAAP, in a multiple-element arrangement, the amount of consideration allocated to a delivered element is limited to the amount that is not contingent on delivering future goods or services. Under the new guidance, a selling entity will allocate the transaction price to each performance obligation in the contract on the basis of the relative standalone selling price of the underlying goods or services. Under current standards, disclosure concerning revenue recognition and measurement is limited, whereas, under the new guidance, considerably more information will be disclosed. NEW GUIDANCE Following is a discussion of the principal elements of the new revenue recognition, measurement, and disclosure guidance, which has been codified in new FASB ASC 606. Scope The guidance applies to all contracts with customers, except for the following: Lease contracts. Insurance contracts. Financial instruments and other contractual rights or obligations relating to (1) receivables, (2) investments in debt and equity securities, (3) investments in equity method investees and joint ventures, (4) liabilities and debt, (5) derivatives and hedging, (6) financial instruments, and (7) transfers and servicing of financial assets.

5 Guarantees, other than product or service warranties. Non-monetary exchanges between entities in the same line of business to facilitate sales to customers or potential customers. The new guidance applies to a contract only if the counterparty to the contract is a customer. A customer is a party that has contracted with the selling entity to obtain goods or services that are an output of the selling entity's ordinary activities, in exchange for consideration. A counterparty to a contract is not considered to be a customer if, for example, the counterparty has contracted with the selling entity to participate in an activity or process in which both parties to the contract share in the risks and benefits that result from the activity or process (e.g., developing an asset in a collaboration arrangement), rather than to obtain the output of the entity's ordinary activities. A contract is deemed not to exist if each party to the contract has the unilateral enforceable right to terminate a wholly unperformed contract without compensating the other party(ies). A contract is wholly unperformed if (1) the selling entity has not yet transferred any promised goods or services to the customer, and (2) the selling entity has not yet received, and is not yet entitled to receive, any consideration in exchange for promised goods or services. Note that, while the guidance addresses accounting for individual contracts with customers, as a practical expedient, the guidance may be applied to a portfolio of contracts or performance obligations having similar characteristics if it is reasonably expected that the effects on the financial statements of accounting for the contracts or performance obligations as a portfolio would not differ materially from accounting separately for individual contracts or performance obligations within that portfolio. Recognition and Measurement-Application of the Core Principle Revenue recognized should depict the transfer of promised goods and services to customers in an amount reflecting the consideration to which the selling entity expects to be entitled in exchange for goods and services (i.e., the transaction price). Operationally, this requires the selling entity to perform the following recognition and measurement steps: Identify the contract with a customer (i.e., an agreement between two or more parties that creates enforceable rights and obligations). Identify the separate performance obligations within a contract (i.e., the promise to transfer to a customer either (1) a distinct good or service or a distinct bundle of goods or services, or (2) a series of distinct goods or services that are substantially the same and have the same pattern of transfer). Determine the transaction price (i.e., the amount of consideration to which the selling entity expects to

6 be entitled in exchange for transferring promised goods or services to a customer, excluding amounts collected on behalf of third parties). Allocate the transaction price to the separate performance obligations, typically on the basis of the relative standalone selling prices of each distinct good or service (i.e., the price at which an entity would sell a promised good or service separately to a customer, or, if standalone prices do not exist, estimates thereof). Recognize revenue when, or as, each performance obligation (i.e., as each promise specified in the contract to transfer goods or services) is satisfied, either over a period of time or at a point in time. Identifying the Contract A contract with a customer is to be accounted for only as such when all of the following conditions have been met: (1) the parties have approved the contract and are committed to satisfying their respective obligations; (2) the selling entity is able to identify each party's enforceable rights concerning the goods or services to be transferred; (3) the selling entity can identify the terms and manner of payment; (4) the contract has commercial substance (i.e., the risk, timing, or amount of future cash flows is expected to change as a result of the contract); and (5) the selling entity determines that, based on an analysis of the customer's ability and intention to pay, it is probable that the selling entity will collect the consideration to which it will be entitled, which may be less than the price stated in the contract if the consideration is variable (i.e., because the selling entity may be offering the customer a price concession). If a contract with a customer meets the foregoing criteria, such criteria should not subsequently be reassessed, unless there is an indication of a significant change in facts and circumstances (e.g., the customer's ability to pay the consideration deteriorates significantly, causing the selling entity to reevaluate whether it is probable that it will collect the consideration to which it will be entitled in exchange for the remaining goods or services to be transferred to the customer). If a contract does not meet the foregoing criteria, the selling entity should continue to assess the contract to determine whether the criteria are subsequently met. Moreover, if a contract does not meet the foregoing criteria, and the selling entity receives consideration from the customer, the consideration received should be recognized as revenue only when either (1) the selling entity has no remaining obligations to transfer goods or services to the customer, and all, or substantially all, of the consideration promised by the customer has been received by the selling entity and is nonrefundable, or (2) the contract has been terminated, and the consideration received from the customer is nonrefundable. Otherwise, consideration received should be recognized as a liability,

7 representing the selling entity's obligation either to transfer goods or services in the future, or refund the consideration received. Two or more contracts entered into at or near the time of sale with the same customer, or its related parties, should be combined and accounted for as a single contract if any one of the following criteria is met: The contracts are negotiated as a package with a single commercial objective. The amount of consideration to be paid in one of the contracts is dependent on the price or performance of the other contract(s). All or some of the goods or services promised represent a single performance obligation. A contract modification represents a change in the scope and/or price of a contract that is approved by the parties to the contract, and should be accounted for as a separate contract if (1) the modification results in an increase in the contract's scope because of the addition of distinct promised goods or services, and (2) the price of the contract increases by an amount of consideration that reflects the selling entity's standalone selling prices of the additional promised goods or services and any appropriate adjustments to that price to take account of the contract's specific circumstances (e.g., by allowing a customer a discount because selling costs relating to the sale of the goods to a new customer would not be incurred). A contract modification that does not constitute a separate contract should be accounted for, depending on the nature of the remaining goods or services, as follows: If the remaining goods or services are "distinct" from the goods or services transferred on or before the date of the contract modification, the modification should be accounted for as if it were a termination of the existing contract and the creation of a new contract. The amount of consideration to be allocated to the remaining performance obligations, or to the remaining distinct goods or services in a single performance obligation, is the sum of (1) the consideration promised by the customer, including amounts already received from the customer, that was included in the estimate of the transaction price and that had not been recognized as revenue, and (2) the consideration promised as part of the contract modification. If the remaining goods or services are not distinct and, thus, form part of a single performance obligation that is partially satisfied at the date of the contract modification, the contract modification should be accounted for as if it were a part of the existing contract. The effect that the contract modification has on the transaction price and on the entity's measure of progress toward complete satisfaction of the performance obligation is recognized as an adjustment to revenue, either as an

8 increase in or a reduction of revenue, at the date of the contract modification (i.e., the adjustment to revenue is made on a cumulative catch-up basis). Thus, in effect, the contract modification is accounted for as if it were part of the original contract. If the remaining goods or services are a combination of distinct and non-distinct goods and services, the effects of the modification on the unsatisfied - including partially unsatisfied - performance obligations in the modified contract should be accounted for in a manner consistent with the foregoing approaches, as applicable. Goods or services are considered distinct if (1) the customer can benefit from the good or service (i.e., it could be used, consumed, sold for an amount that is greater than scrap value, or otherwise held in a way that generates economic benefits) either on its own or together with other resources that are readily available (i.e. the goods or services are sold separately either by the selling entity or another entity, or the customer has already obtained them through other transactions or events), and (2) the selling entity's promise to transfer the good or service is separately identifiable from other promises in the contract (i.e., the good or service is distinct within the context of the contract). Generally, a series of distinct goods or services has the same pattern of transfer if they are transferred to a customer over the same period of time and an acceptable method of measuring progress depicts the pattern of transfer. Identifying Separate Performance Obligations At inception of a contract, the selling entity must identify, as a separate performance obligation, each promise to transfer to the customer either (1) a distinct good or service or bundle of goods or services, or (2) a series of distinct goods or services that are substantially the same and have the same pattern of transfer to the customer. Depending on the contract, itself, promised goods or services may include: The sale of goods produced (e.g., inventory of a manufacturer). The resale of goods purchased by an entity (e.g., merchandise of a retailer). The resale of rights to goods or services purchased by an entity (e.g., a ticket resold by an entity acting as a principal). Performing a contractually agreed-upon task for a customer. Providing a service of standing ready to provide goods or services (e.g., unspecified updates to software that are provided on a when-and-if-available basis) or of making goods or services available for a customer to use as and when the customer decides). Providing a service of arranging for another party to transfer goods or services to a customer (e.g.,

9 acting as an agent of another party). Granting rights to goods or services to be provided in the future that a customer can resell or provide to its own customer (e.g., an entity selling a product to a retailer promises to transfer an additional good or service to an individual who purchases the product from the retailer). Constructing, manufacturing, or developing an asset on behalf of a customer. Granting licenses. Granting options to purchase additional goods or services when those options provide a customer with a material right. In addition to promises specified within a contract to transfer goods or services to a customer, performance obligations include promises implied by a selling entity's customary business practices, published policies, or statements if such promises create a valid expectation that the selling entity will transfer goods or services. Performance obligations do not include activities that the selling entity must undertake to fulfill a contract, unless such activities transfer a good or service to a customer (e.g., various administrative tasks that need to be performed to set up a contract do not transfer a service to the customer as the tasks are performed and, thus, are not deemed to be a performance obligation). Determining the Transaction Price The nature, timing, and amount of consideration promised by a customer affect the seller's estimate of the transaction price. When determining the transaction price, the selling entity should take into account the effects of all of the following: Variable consideration, including constraining estimates thereof. The effects of a significant financing component. Non-cash consideration. Consideration payable by the selling entity to the customer. The amount of consideration may vary (i.e., it is not fixed) because of discounts, rebates, refunds, credits, price concessions, incentives, performance bonuses, penalties, or other similar items. Promised consideration may also vary if the selling entity's entitlement to the consideration is contingent upon the occurrence or nonoccurrence of a future event (e.g., a product is sold with a right of return). The variability of consideration may be explicitly stated in the terms of the contract or under either of the following circumstances: (1) the customer has a valid expectation arising from a selling entity's customary business

10 practices, published policies, or specific statements that the selling entity will accept an amount of consideration that is less than the price stated in the contract (i.e., the seller will offer a price concession); or (2) other facts and circumstances indicate that the selling entity's intention when entering into the contract is to offer a price concession to the customer. The following estimation method that best predicts the expected amount of consideration should be used, and must be applied consistently throughout the duration of the contract: Expected value, which is the sum of the probability-weighted amounts within a range of possible outcomes. The most likely amount, which is the single most likely amount in a range of possible outcomes. In estimating the amount of variable consideration, all information (i.e., historical, current, and forecast) that is reasonably available should be taken into account, and a reasonable number of possible amounts should be identified. The information used to estimate the amount of variable consideration typically would be similar to that which the selling entity's management would use in a bid-and-proposal process in establishing prices for promised goods or services. If some or all of the consideration received is expected to be refunded to the customer, a refund liability must be established, and, if applicable, adjusted, together with a corresponding change in the contract price, based on changing circumstances at each reporting date. Estimated variable consideration should be included in the transaction price only to the extent that it is probable that a significant reversal in the amount of cumulative revenue recognized will not occur when the uncertainty associated with the variable consideration is subsequently resolved, which is referred to as the constrained estimate. In assessing the amount to be included, the following factors, which could increase the likelihood or the magnitude of a revenue reversal, should be taken into account: The amount of consideration is highly susceptible to factors outside the entity's influence, including volatility in a particular market, the judgment or actions of third parties, weather conditions, and a high risk of obsolescence of the promised good or service. Uncertainty about the amount of consideration is not expected to be resolved for an extended period. The selling entity's experience or other evidence with similar types of contracts is limited, or such experience or other evidence has limited predictive value. The selling entity has a practice of either offering a broad range of price concessions or changing the payment terms and conditions of similar contracts in similar circumstances.

11 The contract has a large number and broad range of possible consideration amounts. At the end of each reporting period, the estimated transaction price, including the assessment of whether an estimate of variable consideration is constrained, should be updated to represent the circumstances that exist at the end of the reporting period and the changes in circumstances during the reporting period. A significant financing component is deemed to exist within a contract if the timing of payments agreed to by the parties, either explicitly or implicitly, provides the customer or the selling entity with a significant benefit of financing the transfer of goods or services to the customer. In determining whether a significant financing component is present, the selling entity should take into account (1) any difference between the amount of promised consideration and the cash selling price of the goods or services, and (2) the combined effect of the expected length of time between the point at which the selling entity transfers the promised goods or services to the customer and the time that the customer makes payment to the selling entity, plus the prevailing interest rates in the relevant market. Nevertheless, a contract would not be deemed to contain a significant financing component under any of the following circumstances: The customer paid for the goods or services in advance, and the timing of the transfer of those goods or services is at the discretion of the customer. A substantial amount of the consideration promised by the customer is variable, and the amount or timing of such consideration varies on the basis of the occurrence or nonoccurrence of a future event that is not substantially within the control of the customer or the selling entity (e.g., the consideration is a sales-based royalty). The difference between the promised consideration and the cash selling price of the goods or services arises for reasons not relating to financing either for the customer or the selling entity, and the difference between such amounts is proportional to the reason for the difference (e.g., the payment terms provide the selling entity or the customer with protection from the other party's failure to complete some or all of its obligations under the contract). When a significant financing component exists, the promised amount of consideration should be adjusted for the time value of money by discounting the amount, at inception of the contract, at an interest rate that would be used in a separate financing transaction with the same customer, taking into account the customer's creditworthiness (i.e., so that revenue is recognized in an amount that reflects the cash selling price of the goods or services). Note that the (1) discount rate would not be adjusted for subsequent changes in the customer's credit standing or in market interest rates; and (2) as a practical expedient, discounting is not required if, at the contract's inception, the selling entity expects that the period between

12 the customer's payment and the transfer of the promised goods or services will be less than one year. Non-cash consideration, received or promised, should be measured at its fair value, unless fair value cannot be reasonably estimated, in which case the non-cash consideration should be measured indirectly by reference to the standalone selling price of the goods or services transferred, without subsequent adjustment to the amount of revenue for changes in the fair value of the non-cash consideration already received. The fair value of non-cash consideration may vary because of its form (e.g., a change in the price of a share to which an entity is entitled to receive from a customer). If the fair value of non-cash consideration varies for reasons other than only its form (e.g., because of the selling entity's performance), the variable consideration to be included in the transaction price would be subject to constraint on the amount (i.e., it should be included only to the extent that it is probable that a significant reversal in the amount of cumulative revenue recognized will not occur when the uncertainty is subsequently resolved). Consideration payable to the customer refers to the amount of consideration paid, or expected to be paid, to the customer in the form or cash or credit that can be applied against amounts owed by the customer. If consideration payable to a customer represents payment for the acquisition of distinct goods or services from that customer, the selling entity should account for the purchase of the goods or services in the same way that it otherwise accounts for other purchases from suppliers. If the amount of consideration payable to the customer exceeds the fair value of the distinct goods or services that the selling entity receives from the customer, such an excess should be accounted for as a reduction of the transaction price. If the selling entity cannot reasonably estimate the fair value of the goods or services received from the customer, it should account for all of the consideration payable to the customer as a reduction of the transaction price. If consideration paid to the customer is deemed to be a reduction of the transaction price, it should be recognized as a reduction of revenue upon the latter of when (1) the entity transfers the promised goods or services to the customer, or (2) the entity pays or promises to pay the consideration, even if such payment is conditional on a future event. Allocating the Transaction Price to Performance Obligations The next step in applying the core principle is to allocate the transaction price to the separate performance obligations on a relative standalone selling price basis of the goods or services. The best evidence of a standalone selling price is the observable price of goods or services sold separately by the entity in similar circumstances and to similar customers. A contractually stated price or a list price for goods or services may be, but should not be presumed to be, the standalone selling price of that good or service. If a standalone

13 selling price is not directly observable, it must be estimated. Any of the following estimation approaches may be used: The adjusted-market-assessment approach, which involves (1) evaluating the market in which the entity sells the goods or services and then estimating the price that customers in such market would be willing to pay for the specific goods or services, or (2) referencing prices from competitors for similar goods or services and then making an adjustment to such prices to reflect the selling entity's costs and margins. The expected-cost-plus-margin approach, which involves forecasting expected costs of satisfying a performance obligation and then adding to such costs the margin that the selling entity requires for the specific goods or services. The residual approach, which might be applied if the standalone selling price of the goods or services is highly variable because a representative standalone selling price is not discernible from past transactions or other observable evidence (i.e., the same goods or services are sold to different customers for a broad range of amounts), or the standalone selling price is uncertain (i.e., when the price has yet to be established for goods and services that have not been previously sold). Under this approach, the standalone selling price is estimated by reference to the total transaction price less the sum of observable standalone selling prices of other goods and services in the contract. A combination of approaches may be used to estimate the standalone selling prices of goods or services if two or more of the goods or services have highly variable or uncertain standalone selling prices. Thus, for example, (1) a residual approach could be used to estimate the aggregate standalone selling price of goods or services having highly variable or uncertain standalone selling prices, and (2) another approach could be used to estimate the standalone selling prices of the other individual goods or services relative to that estimated aggregate standalone selling price determined by the residual approach. If the sum of standalone selling prices of promised goods or services exceeds the transaction price (i.e., because of a discount to the customer for purchasing a bundle of goods or services), the discount should be allocated to all separate performance obligations on the basis of relative standalone selling prices. If all of the following circumstances are met, however, the entire discount should be allocated to one or more, but not all, performance obligations: The selling entity regularly sells each distinct good or service, or each bundle of distinct goods or services, in the contract on a standalone basis.

14 The selling entity also regularly sells, on a standalone basis, a bundle or bundles of some of those distinct goods or services at a discount to the standalone selling prices of the goods or services in each bundle. The discount attributable to each bundle of goods or services is substantially the same as the discount in the contract, and an analysis of the goods or services in each bundle provides observable evidence of the performance obligation(s) to which the entire discount in the contract belongs. If the entire discount is allocated to one or more, but not all, performance obligations, the discount should be allocated before applying the residual approach to estimate the standalone selling price of goods or services. A variable amount of consideration, and subsequent changes to that amount, should be allocated entirely to a performance obligation or to a distinct good or service that forms part of a single performance obligation if (1) the terms of a variable payment relate specifically to the selling entity's efforts to satisfy the performance obligation or transfer the distinct good or service, or to a specific outcome from satisfying the performance obligation or transferring the distinct good or service, and (2) after considering all performance obligations and payment terms in the contract, entirely allocating the variable amount would best depict the amount of consideration to which the entity expects to be entitled in exchange for satisfying each separate performance obligation. Subsequent changes in the transaction price should be allocated to all performance obligations on the same basis on which the allocation was made at contract inception (i.e., the transaction price should not be reallocated to reflect changes in standalone selling prices after contract inception). Amounts so allocated to already satisfied performance obligations should be recognized as revenue, or, if applicable, as a reduction of revenue, in the period in which the transaction price changes. A change in the transaction price should be allocated entirely to one or more, but not all, performance obligations or distinct goods or services in a series that forms part of a single performance obligation, only if (1) the terms of the change relate specifically to the selling entity's efforts to satisfy the performance obligation or transfer the distinct good or service, or to a specific outcome from satisfying the performance obligation or transferring the distinct good or service, and (2) after considering all performance obligations and payment terms in the contract, entirely allocating the change would best depict the amount of consideration to which the entity expects to be entitled in exchange for satisfying each separate performance obligation. A change in the transaction price resulting from a contract modification should be accounted for in the same manner as the related contract modification (i.e., either as a separate contract or not as a separate contract, as applicable (see earlier discussion)). Satisfying Performance Obligations-Recognizing Revenue

15 Revenue should be recognized when, or as, an identified performance obligation is satisfied (i.e., promised goods or services are transferred to a customer) and when the customer obtains control of such goods or services (i.e., the asset). Control is considered to be obtained when the customer has the ability to direct the use of, and receive benefit from, the goods or services, including the ability to prevent other entities from directing the use of, and receiving benefits from, the goods or services. At contract inception, the selling entity must determine whether performance obligations are satisfied over a period of time or at a point in time. Goods or services are transferred over time (i.e., rather than as of a point in time) if any one of the following conditions is met: The customer simultaneously receives and consumes the benefits of performance as the selling entity performs (e.g., a routine cleaning service in which the receipt and simultaneous consumption of the benefits of the selling entity's performance can be readily identified). The selling entity's performance creates or enhances an asset (e.g., work-in-process in a construction-type contract) controlled by the customer as such asset is created or enhanced. The asset created or enhanced does not have an alternative use to the selling entity (i.e., the selling entity is unable, either contractually or practically, to direct the asset to another customer), and the selling entity has a right to payment for performance completed to date. If the promised goods or services underlying a separate performance obligation are transferred to a customer over a period of time, the following method that best measures the entity's progress in satisfying the obligation (i.e., that depicts the entity's performance in transferring control of goods or services to the customer) should be consistently applied to similar performance obligations and in similar circumstances: An output method that recognizes revenue on the basis of direct measurements of the value to the customer of the goods or services transferred to date, which would include (1) units produced, (2) contract milestones, and (3) appraisals of results achieved. Note that, as a practical expedient, if the selling entity has a right to consideration from a customer in an amount that corresponds directly with the value to the customer of the selling entity's performance completed to date (e.g., a service contract in which a selling entity bills a fixed amount for each hour of service provided), the selling entity may recognize revenue in the amount to which it has the right to invoice the customer. An input method that recognizes revenue on the basis of efforts expended to date (e.g., the costs of resources consumed, labor hours worked, or machine hours used) relative to total efforts intended to be expended.

16 A method based on the passage of time (e.g., the straight-line method) if efforts or inputs are expended evenly over the performance period. When the outcome of a performance obligation is not subject to reasonable measurement (e.g., in the early stages of a contract), but all costs incurred in satisfying the performance obligation are expected to be recovered, revenue should be recognized only to the extent of costs incurred until such time that the outcome can be reasonably measured. A performance obligation not satisfied over a period of time is one that is satisfied at a point in time. In determining the point in time at which the customer obtains control, and, thus, when revenue should be recognized), the following indicators should be considered: The selling entity has a present right to payment for the asset. Note that such a right need not be an unconditional one. Rather, the relevant criterion is whether the selling entity would have an enforceable right to demand or retain payment for performance completed to date if the contract were to be terminated before completion for reasons other than the selling entity's failure to perform as promised. The customer has legal title to the asset (i.e., the goods or services). The customer holds physical possession of the goods. The customer holds the significant risks and rewards of ownership. The customer has accepted the asset. In evaluating whether the customer has accepted the asset, consideration should be given to the specific provisions of the contract's customer acceptance clause, which may allow a customer to cancel a contract or require the selling entity to take remedial action if goods or services do not meet agreed-upon specifications. If the selling entity can objectively determine that control of goods or services has been transferred to the customer in accordance with the agreed-upon specifications in the contract, customer acceptance is but a formality that would not affect the selling entity's determination of when the customer has obtained control of the goods or services. Thus, for example, if the customer acceptance clause in the contract is based on meeting specified size and weight characteristics, a selling entity would be able to determine whether such criteria have been met before receiving confirmation of the customer's acceptance. The selling entity's experience with contracts for similar goods or services may provide evidence that goods or services provided to the customer are in accordance with the agreed-upon specifications in the contract. If revenue is recognized before formal customer acceptance, the selling entity must still consider whether there are any remaining performance obligations (e.g., installation), and evaluate whether to account for them separately.

17 If, however, the selling entity cannot objectively determine that the goods or services are in accordance with the agreed-upon specifications in the contract, the selling entity would not be able to conclude that the customer has obtained control until the customer's acceptance has been received. If the selling entity delivers products to a customer for trial or evaluation purposes and the customer is not committed to pay any consideration until the trial period lapses, control of the product is deemed not to have been transferred to the customer until either (1) the customer accepts the product, or (2) the trial period lapses. SPECIFIC RECOGNITION AND MEASUREMENT SITUATIONS Sales With a Right of Return A sale with the right of return results in variable consideration, which must be estimated using either the expected value or the most likely amount method. See the earlier discussion concerning variable consideration. In accounting for transfers of products with a right of return, which exclude exchanges by customers of one product for another of the same type, quality, condition, and price, all of the following should be recognized: Revenue for the transferred products in the amount of consideration to which the selling entity expects to be entitled (i.e., revenue would not be recognized for the products expected to be returned). A refund liability representing amounts received or receivable to which an entity does not expect to be entitled. An asset, and corresponding adjustment to cost of sales, for the right to recover products from customers on settling the refund liability, which should be measured by reference to the former carrying amount of the product (e.g., inventory) less any expected costs to recover those products, including potential decreases in the value to the selling entity of returned products. Note that the selling entity's promise to stand ready to accept a returned product during the return period is not considered to be a performance obligation in addition to the obligation to provide a refund. Subsequently, at the end of each reporting period, the selling entity should update its assessment of amounts to which it expects to be entitled and make a corresponding change to the transaction price and, thus, the amount of revenue recognized. Additionally, at the end of each reporting period, (1) the measurement of the refund liability should be updated for changes in expectations about the amount of

18 refunds, with corresponding adjustments as revenue or reductions of revenue, and (2) the measurement of the asset arising from changes in expectations about products to be returned should be updated. Warranties If a customer has the option to purchase a warranty separately (e.g., because it is priced or negotiated separately), the warranty is considered a distinct service (i.e., because the selling entity promises to provide the service to the customer in addition to the product that has the functionality described in the contract). In such circumstances, the warranty should be accounted for as a separate performance obligation, and a portion of the transaction price should be allocated thereto. If a customer does not have the option to purchase a warranty separately, the warranty should be accounted for as a guarantee in accordance with FASB ASC , Guarantees-Overall, unless the promised warranty, or a part of the promised warranty, provides the customer with a service in addition to the assurance that the product complies with agreed-upon specifications (i.e., an accrual is required if, based on available information, it is probable that customers will make claims under warranties relating to goods or services that have been sold). If a warranty, or a part of a warranty, provides a customer with a service in addition to the assurance that the product complies with agreed-upon specifications, the promised service qualifies as a separate performance obligation. Thus, the transaction price should be allocated to the product and to the service. If both an assurance-type warranty and a service-type warranty are promised, but they cannot reasonably be accounted for separately, both of the warranties, taken together, should be accounted for as a single performance obligation. Principal vs. Agent Considerations When another party is involved in providing goods or services to a customer, the reporting entity should determine whether the nature of its promise is a performance obligation to provide the specified goods or services itself (i.e., the reporting entity is a principal and, thus, also the selling entity), or to arrange for the other party to provide the goods or services (i.e. the reporting entity is an agent). A reporting entity is a principal if it controls a promised good or service before it is transferred to a customer. Note, though, that an entity is not necessarily acting as a principal if it obtains legal title of a product only momentarily before legal title is transferred to a customer. When a principal satisfies a performance obligation, even if a subcontractor satisfies some or all of such obligation on behalf of the principal, revenue should be recognized by the principal (i.e., the selling entity) in the gross amount of consideration to which it expects to be entitled in exchange for those goods or services transferred. On the other hand, when the reporting

19 entity is an agent (i.e., its performance obligation is to arrange for another party to provide goods or services to a customer), revenue should be recognized only in the amount of the fee or commission to which it expects to be entitled. Following are indicators that the reporting entity is acting as an agent: Another party is primarily responsible for fulfilling the terms of the contract. The reporting entity does not bear inventory risk before or after the goods have been ordered by the customer, during shipping, or upon the customer's return of the goods. The reporting entity does not have discretion in establishing prices for the other party's goods or services, and, thus, the benefit that the reporting entity can receive from such goods or services is limited. The reporting entity's consideration is in the form of a fee or commission. The reporting entity is not exposed to credit risk for the amount receivable from a customer in exchange for the other party's goods or services. If another entity assumes the selling entity's performance obligation and contractual rights such that the reporting entity is no longer obliged to satisfy the performance obligation to transfer the promised goods or services to the customer (i.e., the reporting entity is no longer acting as the principal), the reporting entity should not recognize revenue for the performance obligation. However, the reporting entity should evaluate whether it is acting as agent (i.e., because its performance obligation was to obtain a contract for the other party). Customer Options to Acquire Additional Goods or Services If, within a contract, the selling entity grants to a customer the option to acquire additional goods or services, that option gives rise to a performance obligation, to which some portion of the transaction price should be allocated based on standalone selling prices, only if the option provides a "material right" to the customer that it would not receive without having entered into that contract (e.g., a discount that is incremental to the range of discounts typically given for such goods or services to that class of customer in that geographical area or market). If the standalone selling price for a customer's option to acquire additional goods or services is not directly observable, it must be estimated. Such estimate should reflect the discount that the customer would obtain when exercising the option, adjusted for (1) any discount that the customer could receive without exercising the option, and (2) the likelihood that the option will be exercised. If a customer has the option to acquire additional goods or services at a price that would reflect their standalone selling prices, the option does not provide the customer with a material right, even if the option can be exercised

20 only by entering into a previous contract. If a customer has a material right to acquire future goods or services, and those goods or services are similar to the original goods or services in the contract and are provided in accordance with the terms of the original contract (e.g., options for contract renewals), as a practical alternative to estimating the standalone selling price of the option, the transaction price may be allocated to the optional goods or services by reference to the goods or services expected to be provided and the corresponding expected consideration. Unexercised Customer Rights Upon receipt of a prepayment from a customer, the selling entity should recognize a contract liability in the amount of the prepayment for its performance obligation to transfer, or to stand ready to transfer, goods or services in the future. That contract liability should be derecognized, with a corresponding recognition of revenue, when the selling entity transfers the goods or services (i.e., the performance obligation has been satisfied). A nonrefundable prepayment gives the customer a right to receive goods or services in the future, and obliges the selling entity to stand ready to transfer the goods or services. In some cases, however, the rights will not be exercised. Unexercised rights are often referred to as "breakage." If a selling entity expects to be entitled to breakage in a contract liability, the expected amount should be recognized as revenue in proportion to the pattern of rights that are exercised by the customer. If a selling entity does not expect to be entitled to a breakage amount, the selling entity should recognize the expected breakage amount as revenue when the likelihood of the customer exercising its remaining rights becomes remote. Nonrefundable Upfront Fees To identify performance obligations in contracts requiring an upfront fee, an assessment should be made regarding whether the fee relates to the transfer of a promised good or service. In many cases, even though a nonrefundable upfront fee relates to an activity that the selling entity is required to undertake at or near contract inception to fulfill the contract, that activity does not result in the transfer of goods or services to the customer. Rather, the upfront fee is an advance payment for future goods or services and, thus, would be recognized as revenue only when those future goods or services are provided. Note that the revenue recognition period in such a situation would extend beyond the initial contractual period if the selling entity grants the customer the option to renew the contract and that option provides the customer with a material right. See the earlier discussion concerning customer options to acquire additional goods or services. If, however, the nonrefundable upfront fee relates to goods or services, an evaluation should be made regarding whether to account for the goods or services as a separate performance obligation in the

21 contract. If the nonrefundable upfront fee is, in part, compensation for costs incurred in setting up a contract or other administrative tasks, and the setup activities do not satisfy a performance obligation, those activities and related costs should be disregarded when measuring progress of a performance obligation satisfied over time. Licensing A license granted to a customer establishes the customer's rights to the entity's intellectual property. In addition, an entity may also promise to transfer other goods or services to the customer. Those promises may be explicitly stated in the contract or implied by the entity's customary business practices, published policies, or specific statements. When a contract with a customer includes a promise to grant a license in addition to other promised goods or services, each of the performance obligations in the contract must be identified. If the promise to grant a license is not distinct from other promised goods or services, the promise to grant a license and the other promised goods or services should be accounted for together as a single performance obligation. Examples of licenses that are not distinct from other goods or services promised include (1) a license that forms a component of a tangible good and that is integral to the functionality of the good, and (2) a license that the customer can benefit from only in conjunction with a related service (e.g., an online service provided by the entity that enables, by granting a license, the customer to access content). If the promise to grant the license is distinct from the other promised goods or services (i.e., the promise to grant the license is a separate performance obligation), a determination must be made regarding whether the license is transferred to the customer at a point in time or over a period of time. In making this determination, consideration should be given to whether the nature of the entity's promise in granting the license to a customer is to provide the customer with (1) a right to access the intellectual property as it exists throughout the license period, or (2) a right to use the intellectual property as it exists at the point in time at which the license is granted. An entity's promise in granting a license is considered a promise to provide a right to access the entity's intellectual property, and, thus, the performance obligation is satisfied over time, if all of the following criteria are met: The contract requires, or the customer reasonably expects, that the entity will undertake activities that significantly affect the intellectual property to which the customer has rights. The rights granted by the license directly expose the customer to any positive or negative effects of the entity's activities.

22 Such activities do not result in the transfer of a good or a service to the customer as those activities occur. If all of the foregoing criteria are not met, the nature of an entity's promise is to provide a right to use the entity's intellectual property as that intellectual property exists, in terms of form and functionality, at the point in time at which the license is granted. Accordingly, the licensing entity should account for the promise to provide a right to use the entity's intellectual property as a performance obligation satisfied at a point in time. Note, however, that revenue may not be recognized for a license that provides a right to use intellectual property before the beginning of the period during which the customer is able to use and benefit from the license. Thus, for example, if a software license period begins before the licensing entity provides, or otherwise makes available, to the customer a code that enables the customer to use the software immediately, the licensing entity could not recognize revenue before that code has been provided, or otherwise made available, to the customer. Revenue for a sales-based or usage-based royalty promised in exchange for a license of intellectual property should be recognized when, or as, the latter of (1) the subsequent sale or usage occurs, or (2) the performance obligation to which some or all of the sales-based or usage-based royalty was allocated has been satisfied or partially satisfied. Repurchase Agreements A repurchase agreement in the context of a contract with a customer is one in which the selling entity promises or has the option, either in the same contract or in another contract, to repurchase the asset that was sold, which may be the original asset sold to the customer, an asset that is substantially the same as the original asset, or another asset of which the asset that was originally sold is a component. If the selling entity has an obligation or a right to repurchase the asset (i.e., a forward or a call option), the customer does not obtain control of the asset because the customer is limited in its ability to direct the use of, and obtain substantially all of the remaining benefits from, the asset, even though the customer may have physical possession of it. Accordingly, the selling entity should account for the contract either as: A lease, if the selling entity can or must repurchase the asset for an amount that is less than the original selling price of the asset. If, however, the contract is part of a sale-leaseback transaction, it should be accounted for as a financing arrangement (i.e., not as a sale-leaseback). A financing arrangement, if the selling entity can or must repurchase the asset for an amount that is equal to or more than the original selling price of the asset.

23 In comparing the repurchase price with the selling price, the time value of money should be considered. If the repurchase agreement is a financing arrangement, the selling entity should continue to recognize the asset and also recognize a financial liability for any consideration received from the customer. The difference between the amount of consideration received from the customer and the amount of consideration to be paid to the customer as interest, and, if applicable, as processing or holding costs (e.g., insurance), should be recognized as a financial liability. If the option lapses unexercised, the liability should be derecognized, with a corresponding recognition of revenue. If the selling entity has an obligation to repurchase the asset at the customer's request (i.e., a put option) at a price that is lower than the original selling price of the asset, the selling entity should consider at inception of the contract whether the customer has a significant economic incentive to exercise the right. In making that determination, consideration should be given to the relationship of the repurchase price to the expected market value of the asset at the date of the repurchase and the amount of time until the right expires, taking into account the time value of money. If the repurchase price is expected to exceed the market value of the asset significantly, it may indicate that the customer does, indeed, have a significant economic incentive to exercise the put option, which, if exercised, would result in the customer effectively paying the selling entity consideration for the right to use a specified asset for a period of time. Accounting for the contract would be as follows: If the customer has a significant economic incentive to exercise the right, the selling entity should account for the agreement as a lease. If, however, the contract is part of a sale-leaseback transaction, the selling entity should account for the contract as a financing arrangement, rather than as a sale-leaseback. If the customer does not have a significant economic incentive to exercise its right at a price that is lower than the original selling price of the asset, the selling entity should account for the agreement as if it were the sale of a product with a right of return. If the repurchase price of the asset is equal to or greater than the original selling price, and is more than the expected market value of the asset, the contract should be accounted for as a financing arrangement. If the repurchase price of the asset is equal to or greater than the original selling price and is less than or equal to the expected market value of the asset, and the customer does not have a significant economic incentive to exercise its right, then the entity should account for the agreement as if it were the sale of a product with a right of return.

24 If the put option lapses unexercised, the liability should be derecognized, with a corresponding recognition of revenue. Consignment Arrangements Revenue should not be recognized upon delivery of a product to another party (e.g., a dealer) if the delivered product is held on consignment. Indicators that an arrangement is a consignment include the following: The product is controlled by the reporting entity until a specified event occurs (e.g., the sale of the product to a customer of the dealer), or until a specified period expires. The reporting entity is able to require the return of the product or transfer the product to a third party (e.g., another dealer). The dealer does not have an unconditional obligation to pay for the product, even though the dealer might be required to pay a deposit. Bill-and-Hold Arrangements Under a bill-and-hold arrangement, the selling entity bills a customer for a product, but the selling entity retains physical possession of the product until it is transferred to the customer at a point in time in the future. Under such an arrangement, the selling entity should determine when it has satisfied its performance obligation to transfer a product by evaluating when the customer obtains control of that product. For some contracts, control is transferred either when the product is delivered to the customer's site or when the product is shipped, depending on the terms of the contract, including delivery and shipping terms. For some contracts, however, the customer may obtain control of a product even though that product remains in the selling entity's physical possession. In such a situation, the customer has the ability to direct the use of, and obtain substantially all of the remaining benefits from, the product, even though it has decided not to exercise its right to take physical possession of that product. Consequently, the selling entity does not control the product. Rather, it is merely providing custodial services to the customer for the customer's asset. In a bill-and-hold arrangement, in addition to the relevant general indicators of the transfer of control, all of the following criteria must be met:

25 The reason for the bill-and-hold arrangement must be substantive (e.g., the customer has requested the arrangement). The product must be identified separately as belonging to the customer. The product currently must be ready for physical transfer to the customer. The selling entity cannot have the ability to use the product or to direct it to another customer. If the foregoing criteria are met, and, thus, revenue is recognized by the selling entity, the selling entity should also consider whether it has remaining performance obligations (e.g., for custodial services) to which a portion of the transaction price should be allocated. PRESENTATION AND DISCLOSURE Contract assets and contract liabilities should be presented separately in the balance sheet. A contract asset, which excludes amounts presented as receivables, arises when the selling entity transfers goods or services to a customer before the customer pays consideration or before payment is due. A contract liability represents the selling entity's obligation to transfer goods or services to a customer for which the selling entity has received consideration, or the amount is due, from the customer. A receivable, which should be presented separately from contract assets, is an entity's right to unconditional consideration (i.e., only the passage of time is required before payment of the consideration is due). Upon initial recognition of a receivable from a contract with a customer, any difference between the measurement of the receivable and the corresponding amount of revenue recognized should be presented as an expense (e.g., as an impairment loss). The following information should be disclosed for each reporting period for which a statement of comprehensive income is presented, and as of each reporting period for which a balance sheet is presented. Revenue The amount of revenue recognized from contracts with customers, separately from other sources of revenue. The amount of revenue disaggregated into categories that (1) depict how the nature, amount, timing, and uncertainty of revenue and cash flows are affected by economic factors, and (2) enable users to understand the relationship between the disaggregated revenue and amounts of revenue disclosed for each reportable segment.

26 Note that, in selecting categories, consideration should be given to the type of revenue information (1) presented in earnings releases and other documents, (2) regularly reviewed by the entity's chief operating decision maker in evaluating segment performance, and (3) used by investors to assess the entity's overall performance. Categories might include the following: - The type of goods or services (e.g., major product lines). - The type of sales channel (e.g., goods sold directly to consumers and goods sold to intermediaries). - The geographical region (e.g., by country). - The type of customer or market (e.g., goods sold to governments and goods sold to not-for-profit entities). - The type of contract (e.g., fixed-price, cost-plus, or time- and- materials). - Contract duration (short-term and long-term). - The timing of the transfer of goods or services (e.g., goods transferred at a point in time or goods transferred over a period of time). Note that such disaggregation is required only of public business entities, not-for-profit entities that have issued, or are conduit bond obligors for, securities that are traded, listed, or quoted on an exchange or an over-the-counter market, or employee benefit plans that file or furnish financial statements with or to the SEC. Entities not required to provide such disclosures must still disclose, at a minimum, revenue disaggregated according to the timing of transfer of goods or services and qualitative information about how economic factors affect the nature, amount, timing, and uncertainty of revenue and cash flows. The amount of any impairment loss on receivables or contract assets arising from contracts with customers, separately from other impairment losses. Contract Balances The opening and closing balances of receivables, contract assets, and contract liabilities from contracts with customers, if not otherwise separately presented or disclosed. Revenue recognized in the reporting period that was included in the contract liability balance at the beginning of the period. Revenue recognized in the reporting period from performance obligations satisfied, or partially satisfied, in previous periods (e.g., changes in transaction price).

27 An explanation of how the timing of satisfaction of performance obligations relates to the typical timing of payment. An explanation of the significant changes in the contract asset and the contract liability balances during the reporting period, which should include both qualitative and quantitative information. Examples of such changes include (1) changes due to business combinations, (2) cumulative catch-up adjustments to revenue that affect the corresponding contract asset or contract liability, including adjustments arising from a change in the measure of progress, a change in an estimate of the transaction price, or a contract modification, (3) impairment of a contract asset, (4) a change in the time frame for a right to consideration to become unconditional (i.e., for a contract asset to be reclassified to a receivable), and (5) a change in the time frame for a performance obligation to be satisfied (i.e., for the recognition of revenue arising from a contract liability). Note that, in respect to contract balances, entities that are not public business entities, not-for-profit entities that have issued, or are conduit bond obligors for, securities that are traded, listed, or quoted on an exchange or an over-the-counter market, or employee benefit plans that file or furnish financial statements with or to the SEC are required only to disclose opening and closing balances of receivables, contract assets, and contract liabilities from contracts with customers, if not otherwise separately presented or disclosed. Performance Obligations A description of each of the following: The point at which performance obligations are typically satisfied (e.g., upon shipment, upon delivery, as services are rendered, or upon completion of service), including when performance obligations are satisfied in a bill-and-hold arrangement. Significant payment terms (e.g., when payment typically is due, whether the contract has a significant financing component, whether the consideration amount is variable, and whether the estimate of variable consideration is typically constrained). The nature of the goods or services promised to be transferred, highlighting any performance obligations to arrange for another party to transfer goods or services (i.e., the entity is acting as an agent). Obligations for returns, refunds, and other similar obligations. Types of warranties and related obligations. Transaction Price Allocated to Remaining, Unsatisfied Performance Obligations

28 The aggregate amount of the transaction price allocated to unsatisfied, or partially unsatisfied, performance obligations as of the end of the reporting period. An explanation, which may include quantitative information, such as the presentation of time bands, of when revenue related to such unsatisfied or partially unsatisfied performance obligations is expected to be recognized. Note that the foregoing information (1) as a practical expedient, need not be disclosed if the performance obligation is part of a contract that has an original expected duration of one year or less, or the entity has a right to consideration from a customer in an amount that corresponds directly with the value to the customer of the entity's performance completed to date, and (2) is not required of entities that are not public business entities, not-for-profit entities that have issued, or are conduit bond obligors for, securities that are traded, listed, or quoted on an exchange or an over-the-counter market, or employee benefit plans that file or furnish financial statements with or to the SEC. Significant Judgments Judgments and changes in such judgments that significantly affect the determination of the amount and timing of revenue from contracts with customers. Specifically: In respect to the timing of the satisfaction of performance obligations over time, the methods used to recognize revenue (e.g., an output method or input method and how those methods are applied), an explanation of why such methods provide a faithful depiction of the transfer of goods or services, and, regarding the satisfaction of performance obligations at a point in time, the judgments made in evaluating when a customer obtains control of goods or services. Information concerning the methods, inputs, and assumptions used for (1) determining the transaction price, including estimating variable consideration, adjusting the consideration for the effects of the time value of money, and measuring noncash consideration, (2) assessing whether an estimate of variable consideration is constrained, (3) allocating the transaction price, including estimating standalone selling prices of promised goods or services and allocating discounts and variable consideration to a specific part of the contract, and (4) measuring obligations for returns, refunds, and similar items. Note that entities other than public business entities, not-for-profit entities that have issued, or are conduit bond obligors for, securities that are traded, listed, or quoted on an exchange or an over-the-counter market, or employee benefit plans that file or furnish financial statements with or to the SEC are not required to disclose the following:

29 In respect of performance obligations satisfied over time, an explanation of why the methods used to recognize revenue provide a faithful depiction of the transfer of goods or services to a customer. In respect of performance obligations satisfied at a point in time, the significant judgments made in evaluating when a customer obtains control of promised goods or services. The methods, inputs, and assumptions used to determine the transaction price and to allocate the transaction price. However, disclosure must still be made of the methods, inputs, and assumptions used to assess whether an estimate of variable consideration is constrained. Practical Expedient Note that, if applicable, entities other than public business entities, not-for-profit entities that have issued, or are conduit bond obligors for, securities that are traded, listed, or quoted on an exchange or an over-the-counter market, or employee benefit plans that file or furnish financial statements with or to the SEC are not required to disclose the fact that an election has been made to apply the practical expedient concerning the existence in a contract of a significant financing component (i.e., discounting is not required if, at the contract's inception, the selling entity expects that the period between the customer's payment and the transfer of the promised goods or services will be less than one year). ACCOUNTING FOR CERTAIN CONTRACT COSTS ASU No also amended the Codification by adding FASB ASC , which provides guidance covering (1) incremental costs of obtaining a contract with a customer, and (2) costs incurred in fulfilling a contract with a customer. Incremental Costs of Obtaining a Contract The incremental costs of obtaining a contract are costs that would not have been incurred if the contract had not been obtained (e.g., sales commissions). Such costs should be capitalized if they are expected to be recovered. Note, though, that, as a practical expedient, incremental costs of obtaining a contract could be charged directly to operations when incurred (i.e., not capitalized), if the amortization period of the asset is one year or less. Costs to obtain a contract that would have been incurred regardless of whether the contract was obtained should be recognized as an expense when incurred, unless such costs are explicitly chargeable to the customer regardless of whether the contract is obtained.

30 Costs to Fulfill a Contract Costs incurred in fulfilling a contract should be capitalized only if such costs (1) relate directly to a contract, or an anticipated contract, that can be specifically identified (e.g., costs relating to services to be provided under renewal of an existing contract or costs of designing an asset to be transferred under a specific contract that has not yet been approved), (2) generate or enhance resources of the entity that will be used in satisfying, or in continuing to satisfy, performance obligations in the future, and (3) are expected to be recovered. Note, however, that costs incurred in fulfilling a contract with a customer that are covered by other applicable U.S. GAAP (e.g., inventory, internal-use software, property, plant, and equipment, and costs of software to be sold, leased, or otherwise marketed) should be accounted for in accordance with such U.S. GAAP. Costs directly relating to a contract, or a specific anticipated contract, include: Direct labor (e.g., salaries and wages of employees who provide services directly to the customer). Direct materials (e.g., supplies used in providing services to the customer). Allocated costs (e.g., costs of contract management, supervision, insurance, and depreciation of equipment or tools used in fulfilling the contract). Costs explicitly chargeable to the customer under the terms of the contract. Other costs incurred solely because the entity entered into the contract (e.g., payments to subcontractors). All other costs of fulfilling a contract, including the following, should be recognized as expenses when incurred: General and administrative, unless they are explicitly chargeable to the customer under the terms of the contract. Costs relating to already satisfied performance obligations (i.e., costs that are attributable to past performance). Costs of wasted materials, labor, or other resources used to fulfill the contract and that are not reflected in the price of the contract. Costs that are indistinguishable in terms of whether they relate to satisfied or unsatisfied, including partially satisfied, performance obligations.

31 An asset representing capitalized costs to fulfill a contract or the incremental costs of obtaining a contract should be amortized on a systematic basis consistent with the pattern of transfer of the goods or services to the customer to which they relate. If necessary, accumulated amortization should be updated to reflect any significant change in the selling entity's expected timing of transfer to the customer. An impairment loss must be recognized equal to (1) the amount by which the asset's carrying amount is greater than the remaining amount of consideration to which the entity expects to be entitled, based on the same principles used to determine the related contract's transaction price and adjusted to take account of the customer's credit risk, without giving effect to constraining estimates of variable consideration, (2) less costs relating directly to providing the goods or services. Before recognizing an impairment loss for an asset relating either to capitalized incremental costs of obtaining a contract or costs of fulfilling a contract, an impairment loss should first be recorded covering other assets relating to the contract that have been recognized in accordance with other U.S. GAAP (e.g., inventory, costs of software to be sold, leased, or otherwise marketed, property and equipment, and goodwill and other intangibles). A previously recognized impairment loss may not be subsequently reversed. The following information is required to be disclosed concerning contract costs: The judgments made in determining the amount of the costs incurred to obtain or fulfill a contract with a customer. The method used to determine the amortization for each reporting period. The closing balances of assets recognized from costs incurred to obtain or fulfill a contract with a customer by main category of asset (e.g., costs to obtain contracts with customers, pre-contract costs, and setup costs). The amount of amortization, if any, during the reporting period. If applicable, the amount of any impairment loss recognized during the reporting period. If applicable, a statement that an election has been made to apply the practical expedient that incremental costs of obtaining a contract have been charged directly to operations as incurred (i.e., not capitalized) when the amortization period of the asset is one year or less. Note that the foregoing disclosures are not required of entities that are not public business entities, not-for-profit entities that have issued, or are conduit bond obligors for, securities that are traded, listed, or quoted on an exchange or an over-the-counter market, or employee benefit plans that file or furnish financial statements with or to the SEC.

32 EFFECTIVE DATE AND TRANSITION The new guidance regarding revenue recognition, including the new guidance concerning contract costs, is effective as follows: For public business entities, for not-for-profit entities that have issued, or are conduit bond obligors for, securities that are traded, listed, or quoted on an exchange or an over-the-counter market, and for employee benefit plans that file or furnish financial statements with or to the SEC, for annual reporting periods beginning after December 15, 2016, including interim reporting periods within that reporting period. Earlier application is not permitted. For all other entities, for annual reporting periods beginning after December 15, 2017, and interim reporting periods within annual reporting periods beginning after December 15, However, such entities may elect to apply the new guidance earlier, but only as of: (1) an annual reporting period beginning after December 15, 2016, including interim reporting periods within that reporting period (i.e., the effective date for public entities), (2) an annual reporting period beginning after December 15, 2016, and interim reporting periods within annual reporting periods beginning after December 15, 2017, or (3) an annual reporting period beginning after December 15, 2017, including interim reporting periods within that reporting period. Initial adoption may be accounted for either retrospectively to each prior reporting period presented, or retrospectively with the cumulative effect of initial application recognized at the date the new guidance is initially applied. If retrospective application is applied to each reporting period presented, any or all of the following practical expedients, which must be applied consistently to all contracts within all reporting periods presented, may be elected: For completed contracts, restatement is not required of contracts that begin and end within the same annual reporting period. For completed contracts having variable consideration, the transaction price at the date the contract was completed may be used (i.e., rather than estimating variable consideration amounts in the comparative reporting periods). For all reporting periods presented before the date of initial application, disclosure is not required (1) of the amount of the transaction price allocated to the remaining performance obligations, and (2) when such amount is expected to be recognized as revenue.

33 If applicable, disclosure is required of the practical expedients used and, to the extent feasible, a qualitative assessment of the estimated effect of applying each of the expedients. If initial adoption is applied retrospectively with the cumulative effect of initial application recognized at the date the new guidance is applied, the cumulative effect should be recorded as an adjustment to the opening balance of retained earnings of the annual reporting period that includes the date of initial application. Under this transition method, the new guidance should be applied retrospectively only to contracts that are not completed contracts at the date of initial application (e.g., January 1, 2017, for entities with a calendar year-end). If this transition method is elected, the following information is required to be disclosed for reporting periods that include the date of initial application: The amount by which each financial statement line item is affected in the current reporting period by the application of the new guidance, as compared with the guidance that was in effect before the change. An explanation of the reasons for significant changes identified. Note that, for purposes of initial application, a completed contract is one for which the reporting entity has transferred all of the goods or services identified in accordance with applicable guidance that was in effect prior to the date of initial application of the new guidance. APPLICATION GUIDANCE The following examples illustrate compliance with various provisions of the guidance amended by ASU No Example 1 - Full Amount of Consideration Not Deemed Collectible FACTS: Assume the Client Company, Inc. agrees to sell manufacturing equipment to Brittany Corp. at a selling price of $125,000. Also assume that under the terms of the contract, Brittany pays Client Company a nonrefundable deposit of $25,000 (i.e., 20% of the selling price) and enters into a long-term financing arrangement under which Client Company will finance the remaining 80% of the promised consideration. The financing arrangement provides that, if, at any time, Brittany defaults, Client Company can repossess the equipment but cannot seek further compensation, even if the value of the equipment does not cover the remaining amount owed by Brittany Corp (i.e., the financing arrangement is on a non-recourse basis). Further assume that Brittany takes control of the equipment at inception of the sales contract. Finally, assume that, based on Client Company's assessment of Brittany's credit standing and the non-recourse

34 basis of the financing agreement, Client Company determines that it will not collect the full amount of the selling price. SOLUTION: Because all of the criteria have not been met to account for the contract (i.e., it is not probable that Client Company will collect the full amount of consideration to which it is entitled), the nonrefundable deposit will, at inception of the contract, be accounted for as a deposit liability, as will future receipts of principal and interest, and revenue will not be recognized until such time that (1) Client Company has no remaining obligations to transfer goods or services to the customer, and all, or substantially all, of the consideration promised by Brittany has been received, or (2) the contract has been terminated, and the consideration received from the customer is nonrefundable. Note that Client Company will continue to assess the contract to determine whether the criteria for accounting for the contract have been subsequently met. Example 2 - Consideration to Be Received is Less Than the Stated Contract Price FACTS: Assume that Client Company, Inc. sells 5,000 units of a product to Brittany Corp, a new customer, at a price of $20 each (i.e., a total of $100,000). Also assume that Client Company's analysis of Brittany's ability and intention to pay reveals that it is possible that Client Company will collect less than the full sale price of $100,000 from Brittany. Further assume, though, that Client Company believes that establishing a relationship at this time with Brittany will help Client Company to gain other customers in the near future and, thus, expects to provide a price concession and accept only $70,000. SOLUTION: Because Client Company will accept $70,000 from Brittany, the transaction price is deemed to be that amount, rather than $100,000 (i.e., the consideration is variable), because facts and circumstances indicate that Client Company's intention when entering into the contract was to offer a price concession to Brittany. Accordingly, when Client Company evaluates the contract's terms, it concludes that all of the conditions necessary to account for the contract have been met, including the condition that it is probable that it will collect the consideration (i.e. $70,000) to which it will be entitled. Thus, Client Company will recognize revenue in the amount of $70,000 at inception of the contract. Example 3 - Modification of a Contract for Additional Goods That Reflect the Standalone Selling Price FACTS: Assume that Client Company, Inc. promises to sell 120 individual products to Brittany Corp. over a

35 three-month period at a price of $100 per product (i.e., an aggregate price of $12,000). Also assume that control of each product is transferred at a point in time. Further assume that, after half of the products were delivered and control was transferred, the contract was modified to require delivery of an additional 40 products, which were distinct from the original 120 products, at a price of $90 per product, which is equal to the standalone selling price of the products at the date of the contract modification. SOLUTION: Since (1) the modification results in an increase in the contract's scope because of the addition of distinct promised goods or services, and (2) the price of the contract increases by an amount of consideration that reflects the selling entity's standalone selling prices of the additional promised goods, the modification should be accounted for as a separate contract (i.e., it does not affect the accounting for the original contract). Thus, Client Company will recognize revenue on the original contract of $100 per product as the products are transferred over the three-month period, and $90 per product on the new separate contract as the additional products are delivered and control is transferred. Example 4 - Variable Consideration Not Included in the Transaction Price FACTS: Assume that Client Company, Inc. enters into a contract to construct a building for Brittany Corp. Under the terms of the contract, the fixed price is $2 million and a bonus of $400,000 if Client Company completes construction within 24 months. Also assume that Client Company accounts for the contract as a single performance obligation satisfied over time. Further assume that, at the contract's inception, Client Company expects to incur total costs of $1,400,000. In addition, assume that, at inception, Client Company excludes the $400,000 bonus (i.e., the variable consideration) from the transaction price because it determines that it is not probable that a significant reversal in the amount of cumulative revenue recognized will not occur when the uncertainty associated with the variable consideration is subsequently resolved. Finally, assume that, at the end of the first year of the contract, based on an acceptable input measure (i.e., costs incurred to date of $840,000/estimated total costs of $1,400,000), Client Company determines that it has satisfied 60% of the performance obligation. SOLUTION: At the end of the first year, Client Company will recognize revenue in the amount of $1,200,000 ($2 million x 60%) and costs actually incurred of $840,000. Note that Client Company will continue to assess the estimated transaction price, including the assessment of whether the variable consideration bonus element remains constrained. Example 5 - Contract Modification Resulting in a Cumulative Catch-up

36 Revenue Adjustment FACTS: Assume the same facts as in Example 4, except that, during the first quarter of the second year of the contract, Client Company and Brittany agree to modify the specifications of the warehouse, such that the fixed amount of consideration will increase by $300,000, and costs to be incurred are expected to increase by $240,000. In addition, the time allotted for Client Company to earn the $400,000 bonus has been extended to 30 months from the original contract date. Further assume that, at the date of contract modification, Client Company concludes that it is probable that including the bonus in the transaction price will not result in a significant reversal in the amount of cumulative revenue recognized. Finally, assume that Client Company determines that the remaining goods and services to be provided under the modified contract are not distinct from those previously provided. SOLUTION: Because the remaining goods or services are not distinct from those previously transferred and, thus, form part of a single performance obligation that is partially satisfied at the date of the contract modification, the contract modification should be accounted for as if it were a part of the existing contract. The effect that the contract modification has on the transaction price and on the measure of progress toward satisfaction of the performance obligation is recognized as a cumulative catch-up adjustment to revenue at the date of the contract modification. Accordingly, as of the contract modification date, the modified transaction price is $2,700,000, comprising the original $2 million plus the additional fixed consideration of $300,000, plus inclusion of the performance bonus of $400,000. Using costs incurred, Client Company now estimates that it is 51.22% complete toward satisfying the single performance obligation, computed as actual costs incurred of $840,000 divided by estimated total costs of $1,640,000 (i.e., $1,400,000 plus an additional $240,000 under the contract modification). Based on that progress toward completion, the total amount of revenue that should be recognized at the date of the contract modification is $1,382,940, which is computed as 51.22% of the total potential consideration of $2,700,000. Accordingly, the cumulative revenue catch-up adjustment (i.e., additional revenue) would be $182,940, computed as the amount of total revenue to be recognized, $1,382,940, minus the amount recognized prior to the contract modification, from Example 4, of $1,200,000. Example 6 - Sales With the Right of Return FACTS: Assume that Client Company, Inc. enters into a contract to sell 1,000 items of merchandise to Brittany Corp. for $100,000, with each item having a selling price of $100 and a cost of $70 to Client Company. Also assume that, under the terms of the sale, Brittany can return the goods at any time within

37 the first 30 days to receive a full refund. Further assume that Client Company estimates that 40 of the 1,000 products will be returned (i.e., 960 of them will not be returned) and that variable consideration in the amount of $96,000 (i.e., 960 x $100) may be included in the transaction price. Finally, assume that Client Company determines that the returned products can be resold at a profit. SOLUTION: When the products are delivered to Brittany, Client Company will recognize the following: Revenue for the transferred products in the amount of consideration to which the selling entity expects to be entitled (i.e., excluding the products expected to be returned). A refund liability representing amounts received or receivable to which an entity does not expect to be entitled (i.e., that offset the amount received or receivable expected to be returned). An asset, and a corresponding adjustment to cost of sales, for the right to recover products from customers on settling the refund liability. Thus, at the time of the sale, Client Company will make the following journal entries: Accounts receivable (1,000 products x $100) 100,000 Sales (960 products x $100) 96,000 Refund liability 4,000 Cost of sales (960 products x $70) 67,200 Right to recover products (40 products x $70) 2,800 Inventory (1,000 products x $70) 70,000 Example 7 - Volume Discount Incentive-Variable Consideration FACTS: Assume that Client Company, Inc. enters into a contract with Brittany Corp. to sell Brittany a specific product at a price of $100 per unit. Also assume that, under the terms of the contract, if Brittany

38 purchases more than 1,000 units of the product in a calendar year, the unit price will be retroactively decreased to $90. Further assume that, (1) for the first quarter of the year, Brittany purchased 75 units, and Client Company estimates that Brittany will not acquire more than 1,000 units during the year, and (2) for the second quarter, Brittany purchased an additional 500 units, and Client Company now estimates that Brittany's total purchases for the year will exceed 1,000 units, and also concludes that it is not probable that a significant reversal in the amount of cumulative revenue recognized will not occur when the uncertainty associated with the variable consideration is subsequently resolved. SOLUTION: Because, for the first quarter, Client Company estimates that the 1,000-unit threshold will not be met, and, thus, the transaction price will be $100 per unit sold, the amount of revenue recognized in that quarter will be $7,500 (i.e., 75 units sold x $100 per unit). For the second quarter, however, because Client Company determines that the volume incentive will be met by Brittany, and that a significant reversal in cumulative revenue is not probable, the variable consideration must be included in the new transaction price. Hence, for the second quarter, Client Company will recognize revenue in the amount of $44,250, computed as $45,000 (i.e., 500 units sold times the new transaction price of $90 per unit) less $750 (i.e., 75 units sold in the first quarter times the retroactive reduction of $10 per unit price). Example 8 - Significant Financing Component in the Contract-Interest Rate Does Not Reflect Market Rate FACTS: Assume that Client Company, Inc. enters into a contract to sell equipment to Brittany Corp. in exchange for a note in the amount of $800,000 that bears interest at 8%. Also assume that the note is to be repaid in full at the end of three years, but interest is to be paid annually. Further assume that the 8% rate is considerably lower than the 14% rate that would be used in a separate financing transaction between Client Company and Brittany (i.e., based on Brittany's credit characteristics). SOLUTION: At inception of the contract, Client Company will determine the transaction price by adjusting the promised amount of consideration to reflect Brittan's credit standing (i.e., at a 14% interest rate). The present value of the note - computations not shown - is $688,560, which is equal to the cash selling price. Thus, Client Company will make the following journal entry at inception of the contract: Note receivable 800,000 Discount ($800,000 - $688,560) 111,440

39 Sales 688,560 Subsequently, as $64,000 of interest is received at the 8% rate stated in the contract, the discount will be amortized and interest income recognized by applying the interest method. Thus, at the end of year 1, the journal entry to be recorded will be: Cash ($800,000 x 8%) 64,000 Discount ($96,398 - $64,000) 32,398 Interest income ($688,560 x 14%) 96,398 Example 9 - Transaction Price Comprises Non-Cash Consideration FACTS: Assume that Client Company, Inc. enters into a contract with Brittany Corp. to provide weekly cleaning services of Brittany's premises for three months in exchange for 100 shares of Brittany's stock, payable each month as the services are provided. Also assume that Client Company concludes that the entire year's services represent a single performance obligation. Finally, assume that the market price of one of Brittany's shares is $2.00 at the end of the first month, $2.40 at the end of the second month, and $2.10 at the end of the third month. SOLUTION: The amount of revenue to be recognized will be $200 for the first month (i.e., $2.00 x 100 shares), $240 for the second month (i.e., $2.40 x 100 shares), and $210 for the third month (i.e., $2.10 x 100 shares). Note that, even though the market price of Brittany's shares fluctuated each month, Client Company would not subsequently adjust revenue already recognized for such changes. Example 10 - Consideration Payable to the Customer FACTS: Assume that Client Company, Inc. enters into a one-year contract to sell goods to Brittany Corp., which makes a commitment to purchase at least $10 million of goods during the year. Also assume that the

40 contract requires Client Company to make a $1 million nonrefundable payment to Brittany at the contract's inception to cover Brittany's costs to change shelving in order to display Client Company's goods. Further assume that Client Company determines that the $1 million payment does not represent payment for distinct goods or services from Brittany and, thus, should be accounted for as a reduction of the transaction price. Finally, assume that, in the first month of the contract, Brittany purchased goods at an aggregate selling price of $500,000 (i.e., the amount that was invoiced to Brittany). SOLUTION: For the first month, the amount of revenue recognized by Client Company would be $450,000, which is computed as the $500,000 invoice amount less a 10% reduction in the transaction price attributable to the consideration paid to Brittany (i.e., $1 million/$10 million). Note that, even though the payment to Brittany was paid upon inception of the contract, it is required to be recognized as a reduction of revenue upon the latter of when (1) the selling entity transfers the goods to the customer, or (2) the selling entity pays, or promises to pay, the consideration. Example 11 - Allocating the Transaction Price to Performance Obligations FACTS: Assume that Client Company, Inc. enters into a contract to sell three different products to Brittany Corp. for an aggregate price of $1,000. Also assume that Client Company regularly sells Product 1 separately at a standalone price of $500, but that the standalone selling prices of Products B and C are not directly observable, and Client Company estimates them to be $250 and $750, respectively. Thus, in the aggregate, the standalone selling prices total $1,500 (i.e., $500 + $250 + $750), which results in a $500 discount to Brittany (i.e., $1,500 minus the contract price of $1,000) for purchasing the three-product bundle. Further assume that Client Company determines that, without evidence to the contrary, the discount should be allocated to all of the products on the basis of relative standalone selling prices. SOLUTION: Because the $500 discount is being allocated to all of the products proportionately on the basis of their standalone selling prices, even though, for two of the products, such selling prices had to be estimated, the total transaction price of $1,000 comprises allocated transaction prices, as follows: Product Standalone Selling Price Proportion Allocated Discount Allocated Transaction Price A $500 1/3 $167 $ 333 B 250 1/

41 C 750 1/ $1,000 Example 12 - Allocating Variable Consideration in a Sales-Based Royalty License FACTS: Assume that Client Company, Inc. enters into a contract with Brittany Corp. for two intellectual property licenses, License #1 and License #2, which Client Company has determined to represent as two separate performance obligations that are each satisfied at a point in time. Also assume that the standalone selling price of License #1 is $8,000 and that of License #2 is $10,000. Further assume that, under the terms of the contract, the price for License #1 is a fixed amount of $8,000, whereas, for License #2, the consideration is 3% of Brittany's future sales of products that use License #2. Also assume that Client Company estimates the sales-based royalty for License #2 (i.e., the variable consideration) to be $10,000. SOLUTION: In allocating the transaction price, Client Company must determine how the variable consideration (i.e., the sales-based royalty) will be allocated. Client Company concludes that the sales-based royalty should be allocated entirely to License #2 because (1) the terms of a variable payment relate specifically to a specific outcome from satisfying the performance obligation to transfer License #2 (i.e., Brittany's subsequent sales of products that use License #2), and (2) after considering all performance obligations and payment terms in the contract, entirely allocating the variable amount would best depict the amount of consideration to which Client Company expects to be entitled in exchange for satisfying the performance obligations (i.e., because the $8,000 price for License #1 approximates its standalone selling price, and the estimated sales-based royalty amount of $10,000 approximates the standalone selling price of License #2). Accordingly, when License #1 is transferred, $8,000 of revenue will be recognized. However, in respect of License #2, revenue will not be recognized upon satisfaction of the performance obligation. Rather, it will be recognized as Brittany's future sales of products that use License #2 take place. Example 13 - Customer Option to Acquire Additional Goods FACTS: Assume that Client Company, Inc. enters into a contract to sell a product to Brittany Corp. for $1,000. Under the terms of the contract, Client Company gives Brittany a 40% discount voucher for any future purchases up to $1,000 within the ensuing 30 days. Also assume that Client Company will be offering

42 a 10% discount, which Brittany cannot combine with the 40% discount, on all sales during the next 30 days as a part of its annual sales event. Thus, because all customers will receive a 10% discount, Brittany is provided with a material right (i.e., one it would not receive without having entered into the contract) only to the extent of the additional 30% discount. Accordingly, that material right (i.e., the incremental discount) gives rise to a performance obligation. Further assume that Client Company estimates (1) an 80% likelihood that Brittany will exercise the option, and (2) that, on average, $500 of future purchases will be made by Brittany during the next 30 days. SOLUTION: Because the standalone selling price of the discount voucher is not directly observable, it must be estimated. Based on the facts, the estimated amount will be $120, computed as an average of $500 that will be purchased times the incremental 30% discount times an 80% likelihood that the voucher will be exercised (i.e., ($500 x 30%) x 80%). The contract price of $1,000 is, thus, allocated to the product and to the discount voucher (i.e., the separate performance obligations) in proportion to standalone selling prices as follows: Standalone Selling Allocated Transaction Item Price Proportion Price Product $1, % $ Voucher % $1, Revenue in the amount of $ will be recognized when the product is delivered to Brittany, and revenue relating to the discount voucher will be recognized as Brittany uses it, or when it expires unused. Example 14 - Customer Loyalty Program FACTS: Assume that Client Company, Inc. sponsors a customer loyalty program under which a customer is rewarded 1 point for every $10 of purchases, and each loyalty point is redeemable for a $1 discount on future purchases of any of Client Company's products. Also assume that, during 20x1, customers purchased products at an aggregate price of $100,000, which represents the aggregate standalone selling price of such products, and, thus, earned 10,000 points. Also assume that Client Company expects that 95% of the points awarded will be redeemed (i.e., 9,500 points) and that, based on the likelihood of

43 redemption, it estimates the standalone selling price of $.95 per point, or a total of $9,500, computed as 10,000 points earned times $.95. Finally, assume that, during 20x1, 4,500 points were redeemed. SOLUTION: Because customers would not receive reward points without entering a contract, Client Company concludes that the promise to provide the points is a separate performance obligation to which a portion of the transaction price must be allocated. The transaction price of $100,000 is allocated to the product and to the points (i.e., the separate performance obligations), in proportion to their standalone selling prices, as follows: Standalone Selling Allocated Transaction Item Price Proportion Price Product $100, % $ 91,324 Points 9, % 8,676 $100,000 At the end of 20x1, Client Company would recognize revenue of $4,110 relating to the loyalty points (i.e., (4,500/9,500) x $8,676), and would establish a contract liability for the unredeemed points of $4,566 (i.e., $8,676 - $4,110). Example 15 - Repurchase Agreement-Call Option FACTS: Assume that Client Company, Inc. enters into a contract to sell an asset to Brittany Corp. on January 1, 20x2, at a price of $100,000. Also assume that the contract includes a call option giving Client Company the right to repurchase the asset for $105,000 at any time on or before December 31, 20x2. SOLUTION: Because the exercise price of the call option is more than the selling price of $100,000, the transaction is not accounted for as a sale. Rather, it is accounted for as a financing transaction under which a corresponding financial liability would be recognized in the amount of the cash received (i.e., $100,000). If the option is exercised, Client Company will record the difference between the exercise price of $105,000 and the cash received of $100,000 as interest expense. If the option lapses unexercised, the liability will be derecognized, and revenue will be recognized. Example 16 - Incremental Costs of Obtaining a Contract

44 FACTS: Assume that Client Company, Inc. incurred the following costs to obtain a contract to provide services to Brittany Corp., a new client: legal fees relating to contract preparation totaling $16,000; travel costs to make presentations and deliver the proposal totaling $27,000; and commissions to sales associates totaling $12,000. Also assume that the costs of travel would have been incurred even if the contract had not been obtained, but legal fees and sales commissions would not have been incurred had the contract not been obtained. Finally, assume that amounts expended for legal fees and sales commissions are expected to be recovered through fees for services to Brittany. SOLUTION: Client Company would establish an asset in the amount of $28,000, comprising $16,000 for legal fees and $12,000 for sales commissions, because such costs would not have been incurred if the contract had not been obtained. Travel costs of $27,000 would be charged to operations because they would have been incurred regardless of whether the contract had been obtained. Example 17 - Costs to Fulfill a Contract FACTS: Assume that Client Company, Inc. incurs a total of $200,000 of setup costs to fulfill a contract, of which $80,000 are expected to generate or enhance resources that will be used in satisfying performance obligations in the future. Client Company expects to recover such costs from contracts with the customer. Of the remaining costs of $120,000, $40,000 is for general and administrative expenses, and $80,000 is related to performance obligations that have previously been satisfied. SOLUTION: Client Company will capitalize only the $80,000 of costs expected to generate or enhance resources that will be used in satisfying performance obligations in the future. The other costs relating to general and administrative expenses and to already satisfied performance obligations will be charged to operations as incurred. Example 18 - Establishing a Contract Liability and a Receivable FACTS: Assume that, on January 1, 20x2, Client Company, Inc. enters into a contract to transfer a product to Brittany Corp. on April 1, 20x2. Also assume that the contract requires Brittany to pay to Client Company consideration of $10,000 on February 1, 20x2 (i.e., in advance of the transfer). Further assume that Brittany pays the consideration on March 1, 20x2, and Client Company transfers the product on April 1, 20x2. SOLUTION: On February 1, 20x2, Client Company will make the following journal entry to recognize the receivable and establish a contract liability:

45 Due from Brittany 10,000 Contract liability 10,000 The contract liability represents Client Company's obligation to transfer goods or services to Brittany for which the consideration from Brittany is due. The receivable represents Client Company's unconditional right to the consideration. On March 1, 20x2, when Brittany makes payment, Client Company will make the following entry: Cash 10,000 Due from Brittany 10,000 Finally, on April 1, 20x2, when the product is transferred, Client Company will recognize revenue and eliminate the contract liability by making the following journal entry: Contract liability 10,000 Sales 10,000 Example 19 - Granting of Franchise Rights FACTS: Assume that Client Company, Inc., the franchisor, enters into a contract with Brittany Corp. to grant Brittany a franchise license providing Brittany with the right to use Client Company's trade name and sell Client Company's products for the ensuing 15 years. Also assume that, under the terms of the franchise license, Client Company will provide Brittany with the equipment necessary to operate the franchise. Further assume that the consideration to be received will be a fixed amount of $250,000 for the equipment, which approximates its standalone selling price, and a sales-based royalty equal to 6% of Brittany's monthly sales. In addition, assume that Client Company determines that the equipment and the franchise license are separate performance obligations.

46 SOLUTION: Client Company determines that the variable consideration (i.e., the sales-based royalty) should be allocated entirely to the performance obligation to transfer the franchise license, and the fixed amount of $250,000 should be allocated to the performance obligation to provide the equipment. Based on its analysis, Client Company also determines that the nature of the promise to grant the franchise license is to provide access to its intellectual property in its current form throughout the 15-year franchise period (i.e., the performance obligation is satisfied over a period of time). Finally, because the variable consideration is a sales-based royalty, Client Company will recognize revenue when the sales are made by Brittany Thomson Reuters/Tax & Accounting. All Rights Reserved.