INTRODUCING THE NEW REVENUE RECOGNITION STANDARD ASU 2014-09 November 19, 2014 Dave Dacey Frank Boutillette Today s Objective Understand differences between new standard and current GAAP Walk away with best practice implementation practices Understand timing considerations for new standard implementation 1
Effective Dates Public entities Years and interim periods beginning >= 12/15/2016 (e.g. calendar 2017) Non-public entities Three election alternatives: 1. The public entity effective date years beginning >= 12/15/2016, (e.g. calendar 2017) 2. Years beginning >= 12/15/2016 (e.g. calendar 2017) and interim periods during years beginning >= 12/15/17 (e.g. calendar 2018) 3. Years beginning >= 12/15/2017 (e.g. calendar 2018) and interim periods during years beginning >= 12/15/17 (e.g. calendar 2018) Initial Adoption Considerations Full retrospective application cumulative effect to opening retained earnings (or equivalent) of the earliest period presented in the financial statements (three practical expedients) Modified retrospective application retrospective application at the date of initial application Disclose quantitative effect of each financial statement line item in current period of application Disclose reasons for significant changes 2
Conditions for Revenue Recognition Existing GAAP Arrangement supported by evidence Buyer s price fixed and determinable Collection is reasonably assured Delivery has occurred or services have been rendered New Standard When performance obligation is satisfied by transferring promised goods or services to a customer (e.g. customer obtains control ) Recorded in an amount that reflects consideration to which the entity expects to be entitled To recognize revenue entities should follow the 5-step process Framework for Recognizing Revenue Existing GAAP - ABCD A. Arrangement supported by evidence B. Buyer s price fixed and determinable C. Collection is reasonably assured D. Delivery has occurred or services have been rendered New Standard 5 Steps 1. Identify contract(s) with a customer 2. Identify performance obligations in the contract 3. Determine the transaction price 4. Allocate the transaction price to the contract s performance obligations 5. Recognize revenue when or as entity satisfies a performance obligation 3
Step 1 Identifying Contract(s) With Customers Contract creates enforceable rights and obligations and meets all of the following: Approval and commitment or its parties Identified rights of the parties Identified payment terms Has commercial substance Collectability of consideration is probable Enforceability is a matter of law Contracts can be written, oral or implied When Does a Contract Not Yet Exist? When there is a uniform enforceable right to terminate a wholly unperformed contract, without compensating the other party Unperformed contracts meet both of the following criteria: No promised goods or services yet transferred and No entitlement to yet receive consideration 4
Conditions for Combining Multiple Contracts With Same Customer Any of the following triggers combining contracts: Contracts negotiated as a package Consideration paid for one contract depends on price or performance of another contract Goods or services in the contracts represent a single performance obligation Contract Modifications AKA Change Order Variation or Amendment Change in scope or price or both Modification exists when there is an approval that creates enforceable right and obligation that either: Creates a new contract or Changes an existing contract Modifications can be written, oral or implied Changes in scope, where price change hasn t been finalized requires an estimate 5
Conditions for Accounting for Contract Modification as a Separate Contract Must meet both: The addition of promised goods or services are distinct from original contract Incremental contract price reflects entity s standalone selling price of additional promised goods or services If both conditions not met, modification isn t accounted for as a separate contract Accounting for Contract Modifications That Are Not Separate Contracts If remaining goods or services are distinct from goods or services transferred prior to date of modification: Termination of existing contract and creation of a new contract Consideration is the sum of (1) unrecognized consideration that was promised under prior contract plus (2) consideration promised under contract modification 6
Accounting for Contract Modifications That Are Not Separate Contracts If remaining goods or services are NOT distinct from goods or services transferred prior to date of modification: Contract (with modification) represents a single performance obligation Adjust revenue at the date of modification on a cumulative catch-up basis Comparison of Contract Modification Guidance Current GAAP Guidance was industry specific (e.g. construction contracts) New Standard Principles based Focused on type of modification: Is it a separate contract? Are remaining goods or services distinct or not distinct 7
Comparison of Collectability and Contracts Current GAAP One of four conditions for revenue recognition Transaction price equal to what the entity expects to receive New GAAP Refers to customer s credit risk Probability of collection is consideration as to whether a valid contract exists Transaction price not adjusted for customer credit risk Impairments of receivables is presented as an expense Step 2 Identifying Performance Obligations Old GAAP Units of account referred to as deliverables or elements New GAAP Units of account referred to as performance obligations Defined as a promise to transfer a distinct or series of distinct goods or services to a customer FASB feels that new GAAP may provide for more performance obligations than old GAAP 8
Two Conditions for Distinct Goods and Services Under New Standard Capable of being distinct either on its own or in conjunction with other goods or services Distinct within the context of the contract The good or service is not an input of another good or service Does not significantly modify or customize another good Not highly dependent or inter-related with other goods or services Performance Obligations May Include But Not Be Limited To Sale of goods produced Providing a service of arranging Resale of goods purchased of another party to transfer goods or services to a customer (e.g. Resale of rights to goods or acting as an agent) services Granting rights to future goods or Performing contractually services that a customer can agreed upon task(s) resell or provide to its customer Providing service of Constructing, manufacturing or standing ready to provide developing an asset for a goods or services customer Granting licenses Granting options (a material right) to a customer to purchase additional goods or services 9
Step 3 Determining the Transaction Price Transaction price defined Amount of consideration for which the entity expects to be entitled in exchange for transferred goods and services Consider the following in determining the transaction price: Variable consideration and constraining estimates Significant financing components Noncash considerations Consideration payable to the customer Considering Variable Consideration Causes of variable consideration Discounts, rebates, refunds, credits Price concessions, incentives, performance bonuses, penalties, or other similar items Contingent entitlement such as right of return How variable consideration is identified: Explicitly stated in the contract Customary business practice Published policy or specific statements of price concessions Other facts may be indicators of intent to offer a price concession 10
Constraining Estimates of Variable Consideration The principle Variable consideration can be constrained in the recognition of revenue. Constraints pertain to uncertain estimates in determining variable consideration adjustments Revenue should only be recognized to the extent that it is probable that the amount of cumulative revenue will not reverse Factors in Assessing Probability and Amount of a Constraining Estimate Factors outside of the entity s control (e.g. 3 rd party judgments and actions, weather conditions, market volatility, etc.) Uncertainty of the amount of consideration not expected to be resolved for a long period of time Entity s experience (or supporting evidence) has limited predictive value) Entity s history of price concessions or changing payment terms in similar circumstances The contract has a broad range of possible consideration amounts 11
Evaluating Variable Consideration Current Standards Inconsistent between industries Recognize revenue when variability is resolved New Standards One accounting model Only recognize revenue when it is probable that variable consideration will not reverse Consideration can now be estimated, so revenue recognition may be accelerated How much revenue would you recognize? Current Standards 1. Assume that all other steps for revenue recognition have been met. 2. Distributor sells 10 pairs of women s shoes to a retailer for $100. Existing Business New Business Retailer has historically returned 8% of products that they couldn t resell to distributor annually. Industry returns average 9% How much revenue should be recorded? 1. $92 (8% expected returns) 2. $91 (9% expected returns ) 3. Record no revenue Too early to establish the distributor s track record for average returns Industry returns average 9% How much revenue should be recorded? 1. $91 (9% expected returns) 2. Record no revenue 12
How much revenue would you recognize? New Standard 1. Assume that all other steps for revenue recognition have been met. 2. Distributor sells 10 pairs of women s shoes to a retailer for $100. Existing Business New Business Retailer has historically returned 8% of products that they couldn t resell to distributor annually. Industry returns average 9% How much revenue should be recorded? 1. $92 (8% expected returns) 2. $91 (9% expected returns ) 3. Record no revenue Too early to establish the distributor s track record for average returns Industry returns average 9% How much revenue should be recorded? 1. $91 (9% expected returns) 2. Record no revenue A Few More Principles Regarding Variable Consideration Adjust estimate at the end of each reporting period (Type 1 subsequent event) Exception for sales-based or usage-based royalty income. Only recognize revenue after both of the following: Subsequent sale or usage occurs and Performance obligation related to the royalty has been satisfied (or to the extent it is partially satisfied) 13
Variable Consideration and Financing Components (When Financing is Involved) Adjust promised amount of consideration for the effects of the time value of money Factors to consider include: Amount of promised consideration and cash selling price of the goods Combined effect of both: The length of time to transfer and customer s payment and Prevailing market interest rate Factors Precluding a Significant Finance Component Advanced customer payment of goods or services and customer discretion on when to take delivery of such goods or services Substantial variable consideration based on the occurrence or non-occurence of future events, outside the control of the parties Differences between promised consideration and cash selling price not related to financing 14
A Few Final Words on Financing Use a discount rate that would be used in a financing transaction between the entity and its customer at the contract s inception Present interest income effects separately from revenue No requirement to adjust for effects of financing component if contract is one year or less Non-Cash Consideration Measure at fair value of non-cash consideration of if not reasonably determinable then by reference to stand-alone selling price of consideration being transferred If consideration varies, apply principles of constraining estimates Assess when control is obtained of non-cash consideration 15
Consideration Payable to a Customer Consideration payable could be cash, credits or other items (e.g. voucher or coupon) Reduction of transactions price = reduction of revenue at the later of: Either when the revenue is recognized for the related goods or services or When the entity promises to pay the customer Variable reductions follow principles of constraints Consideration for distinct goods or services = charge to appropriate account for the particular good or service Step 4 Allocate Transaction Price to Performance Obligations If more than one obligation = Allocate to each obligation for what the entity expects to be entitled Allocating based on relative standalone selling price estimated based on methods including but not limited to: Adjusted market assessment approach Expected cost plus margin approach Residual approach if either: Highly variable selling prices from past transactions or No established price yet on a standalone basis 16
Determining Standalone Selling Price Current GAAP Based on following heirarchy: 1 st VSOE 2 nd Third Party Evidence 3 rd Best Estimate Industry specific guidance such as software and films (e.g. for software VSOE or defer) New GAAP Eliminates VSOE requirement for software transactions Standalone selling price must be determined for each performance obligation Standalone selling price can be calculated or estimated in various ways Allocating Discounts Generally proportionate to all performance obligations Specific to one (or more) but not all obligations if all of the following: Regularly sells distinct goods or services (or bundled goods or services) on a standalone basis Regularly sells bundle(s) at a discount Observable evidence that discount belongs to specific bundle(s) 17
Other Allocation Considerations Allocate variable consideration to single performance obligations (if related to those obligations) or in a manner based on standalone selling price Changes to transaction price in same manner as allocations done at contract s inception Follow contract modification rules where applicable Step 5 Recognizing Revenue When (or as) the Entity Satisfies Performance Obligations Recognize revenue when (or as) entity transfers promised good or service and customer obtains control Control of asset = Customer s ability to direct the use of the asset and obtains benefits of the asset 18
Control Of Good Or Service Transferred If One Of The Following Occurred: Customer receives and consumes benefits of entity s performance Entity s performance creates or enhances an asset that customer controls Entity s performance doesn t create an asset with alternative use to the entity and entity has an enforceable right to payment for performance completed to date Comparison with Existing Guidance Current GAAP Percentage of completion is normally applied for long-term contracts Milestone and progress payment agreement to pay assuming performance New GAAP New guidance requires analysis of contract to determine whether performance obligation is satisfied over time or at a point in time Milestone or progress payment based on right to receive payment if contract were terminated 19
Indicators that Performance Obligations Are Satisfied at a Point in Time Include, but not Limited To Customer obligated to pay and entity has present right to receive payment Customer has legal title to the asset Physical possession of asset has been transferred Customer has significant risks and rewards of ownership Customer has accepted the asset Qualitative and Quantitative Disclosures About the Following Contracts with customers, including: Revenue and impairments Disaggregation of revenue (public companies only) Information about contract balances and remaining performance obligations (public companies only) Assets recognized from cost to obtain or fulfill contracts Significant judgments and changes in judgments regarding timing of performance obligations Contract balances information including activity during period Disclosure of description regarding performance obligations 20
Disclosures The revenue recognition standard states that the objective of the disclosure requirements Enable users of financial statements to understand the nature, amount, timing, and uncertainty of revenue and cash flows arising from contracts with customers, and assets recognized from the costs to obtain or fulfill a contract with a customer. Qualitative and quantitative information is required Contracts with customers-including revenue and impairments recognized, disaggregation of revenue, and information about contract balances and performance obligations (including the transaction price allocated to the remaining performance obligations) Significant judgments and changes in judgments-determining the timing of satisfaction of performance obligations (over time or at a point in time), and determining the transaction price and amounts allocated to performance obligations Assets recognized from the costs to obtain or fulfill a contract 21
Disaggregation of Revenue An entity shall disaggregate revenue recognized from contracts with customers into categories that depict how the nature, amount, timing, and uncertainty of revenue and cash flows are affected by economic factors. An entity shall apply the guidance in paragraphs 606-10-55-89 through 55-91 when selecting the categories to use to disaggregate revenue Examples of Categories Type of good or service (major product lines) Geographical region (country or region) Market or type of customer (government and nongovernment customers) Type of contract (fixed-price and time-and-materials contracts) Contract duration (short-term and long-term contracts) Timing of transfer of goods or services (revenue from goods or services transferred to customers at a point in time and revenue from goods or services transferred over time) Sales channels (goods sold directly to consumers and goods sold through intermediaries). 22
Non Public Entity Relief An entity, may elect not to apply the quantitative disaggregation disclosure guidance however, the entity shall disclose, at a minimum, revenue disaggregated according to the timing of transfer of goods or services (revenue from goods or services transferred to customers at a point in time and revenue from goods or services transferred to customers over time) and qualitative information about how economic factors (such as type of customer, geographical location of customers, and type of contract) affect the nature, amount, timing, and uncertainty of revenue and cash flows. Contract Balances Entity should disclose all of the following: Opening and closing balances of receivables, contract assets, and contract liabilities, 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 (for example, changes in transaction price) 23
Contract Balances An entity shall explain how the timing of satisfaction of its performance obligations (see paragraph 606-10-50-12(a)) relates to the typical timing of payment (see paragraph 606-10-50-12(b)) and the effect that those factors have on the contract asset and the contract liability balances. The explanation provided may use qualitative information. Contract Balances Provide an explanation of the significant changes in the contract asset and liability balances during the reporting period. The explanation shall include qualitative and quantitative information. Examples include any of the following: Changes due to business combinations 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 (including any changes in the assessment of whether an estimate of variable consideration is constrained), or a contract modification Impairment of a contract asset A change in the time frame for a right to consideration to become unconditional (that is, for a contract asset to be reclassified to a receivable) A change in the time frame for a performance obligation to be satisfied (that is, for the recognition of revenue arising from a contract liability). 24
Non-Public Entity Relief An entity, may elect not to provide any or all of the disclosures in paragraphs 606-10-50-8 through 50-10. However, the entity shall provide the disclosure in paragraph 606-10-50-8(a), which requires the disclosure of the opening and closing balances of receivables, contract assets, and contract liabilities from contracts with customers, if not otherwise separately presented or disclosed Disclosures on Performance Obligations Description should include all of the following: When the entity typically satisfies its performance obligations (for example, 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 The significant payment terms (for example, 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 that the entity has promised to transfer, highlighting any performance obligations to arrange for another party to transfer goods or services (acting as an agent) Obligations for returns, refunds, and other similar obligations Types of warranties and related obligations 25
Transaction Price Allocated to the Remaining Performance Obligations An entity shall disclose the following information about its remaining performance obligations: The aggregate amount of the transaction price allocated to the performance obligations that are unsatisfied (or partially unsatisfied) as of the end of the reporting period An explanation of when the entity expects to recognize as revenue which the entity shall disclose in either of the following ways: On a quantitative basis using the time bands that would be most appropriate for the duration of the remaining performance obligations By using qualitative information Transaction Price Allocated to the Remaining Performance Obligations As a practical expedient, an entity need not disclose the information regarding the remaining performance obligation if either of the following conditions is met: The performance obligation is part of a contract that has an original expected duration of one year or less. The entity recognizes revenue from the satisfaction of the performance obligation in accordance with paragraph 606-10-55-18. An entity shall explain qualitatively whether it is applying the practical expedient and whether any consideration from contracts with customers is not included in the transaction price and, therefore, not included in the information disclosed For example, an estimate of the transaction price would not include any estimated amounts of variable consideration that are constrained 26
Non-Public Entity Relief May elect not to provide the disclosures for Remaining Performance Obligations Warrantees and Licensing Warrantees: If distinct service, consider warrantee to be a performance obligation If not a distinct service, account for as a guarantee Licensing Account as a separate performance obligation if it is distinct, otherwise account with other promised goods or services 27
Have a Great Day! Dave Dacey, ddacey@withum.com Frank Boutillette, fboutillette@withum.com 28