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