Webinar Slides: Is Your Company Ready for the New Revenue Recognition Standards?

Is Your Company Ready for the New
Revenue Recognition Standards?
Presented by:
James Comito
June 12, 2014
June 25, 2014

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The information in this Executive Education Series
course is a brief summary and may not include all
the details relevant to your situation.
Please contact your service provider to further
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Disclaimer

Today’s Presenter
James Comito, CPA
Shareholder
858.795.2029 | jcomito@cbiz.com
A member of MHM’s Professional Standards Group,
James has expertise in all aspects of revenue
recognition, business combinations, impairment of
goodwill and other intangible assets, accounting for
stock-based compensation, accounting for equity and
debt instruments and other accounting issues.
Additionally, he has significant experience with a variety
of other regulatory and corporate governance issues
pertaining to publicly traded companies, including all
aspects of internal control. In addition, James frequently
speaks on accounting and auditing matters at various
events for MHM.

Today’s Agenda
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1
2
3
Background
Current Practice
Changes Under the New Guidance
4 Next Steps

FASB’S NEW REVENUE
RECOGNITION STANDARD
BACKGROUND

The FASB and the IASB initiated a joint project to clarify the principles for
recognizing revenue and to develop a common revenue standard for U.S.
GAAP and IFRS that would:
1. Remove inconsistencies and weaknesses in existing revenue
recognition standards and practices. U.S. GAAP has multitude of
Industry and transaction specific standards. IFRS has two standards
on Revenue Recognition IAS 11 and IAS 18.
2. Provide a more robust framework for addressing revenue recognition
issues. Weaknesses exist in both set of standards.
3. Improve comparability of revenue recognition practices across
entities, industries, jurisdictions and capital markets.
4. Simplify the preparation of financial statements by reducing the
number of requirements to which entities must refer.
Reasons for the New Guidance

The new guidance utilizes a contract-based approach that places the focus
on the assets and liabilities that are created when an entity enters into and
performs under a contract.
While some of the concepts in the new guidance are similar to existing
guidance, other may change existing practice leading to changes in the
amount and timing of revenue recognized.
Reasons for the New Guidance - continued

REVENUE RECOGNITION
CURRENT PRACTICE

 The current revenue recognition model followed under U.S. Generally
Accepted Accounting Principles is focused on the “earning process”
(CON-5).
 Generally, it is appropriate to recognize revenue upon the culmination
of the earnings process.
 This means the seller must determine when the earnings process is completed
(when the seller has substantially completed what it agreed to do). This
determination is not always readily apparent for a variety of reasons.
 The determination of “earned” focuses on measurement and
recognition thresholds (e.g., the four basic revenue recognition criteria)
 Industry guidance also plays a significant role in revenue recognition.
Revenue Recognition Basics

Revenue is generally realized, or realizable, and earned
when all of the following criteria are met:
 Persuasive evidence of arrangement
 Price is fixed or determinable
 Delivery has occurred or service has been rendered
 Collectability is reasonably assured
Basic Revenue Recognition Criteria

CHANGES TO REVENUE
RECOGNITION UNDER THE NEW
GUIDANCE

FASB Accounting Standard Update No. 2014-09
Revenue from Contracts with Customers (Topic 606)
 Originally issued: June 24, 2010
 Re-exposed during 2011
 A second re-exposure completed during 2012
 Final standard issued May 2014
Revenue Recognition – The Future has Arrived

Core principle:
The core principle of the guidance is that an entity should recognize
revenue to depict the transfer of promised goods, or services, to
customers in an amount that reflects the consideration to which the
entity expects to be entitled, in exchange for those goods or services.
Five steps to apply the core principle:
1. Identify the contract(s) with a customer.
2. Identify the performance obligations in the contract.
3. Determine the transaction price.
4. Allocate the transaction price to the performance obligations in the
contract.
5. Recognize revenue when (or as) the entity satisfied a performance
obligation.
Core Principle and Five-Step Process

 Basic Observations
 On the surface the five step process does not seem overly complex
and arguably, it appears to include much of what is currently done to
determine revenue recognition.
 However, each of the five steps will require significant judgments by
management and auditor in applying the underlying principles
included in the new guidance.
 The transfer of “control” to the customer becomes the driving issue
in evaluating the appropriateness of revenue recognition under the
new guidance.
 Currently, the evaluation of “risk and reward” often drives the
determination of revenue recognition. While it remains an
important consideration, it is no longer determinant under the new
guidance.
Core Principle and Five-Step Process

1. Identify the Contract with the Customer
 A contract is an agreement between two or more
parties that creates enforceable rights and
obligations.
 An entity shall account for a contract with a
customer that is within the scope of the guidance
only when all of the following criteria are met:
 The parties to the contract have approved the contract
(written, oral, or in accordance with other customary
business practices) and are committed to perform their
respective obligations.
 The entity can identify each parties rights regarding the
goods or services to be transferred.
Five-Step Process

 A contract is an agreement between two or more
parties that creates enforceable rights and
obligations.
 The entity can identify the payment terms for the goods
or services to be transferred.
 The contract has commercial substance (that is, the risk,
timing, or amount of the entity’s future cash flows is
expected to change as result of the contract)
 It is probable that the entity will collect the consideration
to which it will be entitled in exchange for the goods or
services that will transferred to the customer.
Five-Step Process

 A customer is a party that has contracted with an entity to
obtain goods and/or services that are the output of the
entity’s ordinary activities.
 The revenue recognition guidance is applied to each
contract with a customer.
 Multiple contracts between the customer and the entity are
evaluated for combination.
Five-Step Process

 Contract Combination
 An entity shall combine two or more contracts entered into at or
near the same time with the same customer (or related parties of the
customer), and account for the contracts as a single contract if one
or more of the following criteria are met:
 The contracts are negotiated as a package with a single
commercial objective.
 The amount of consideration to be paid in one contract depends
on the price or performance of the other contract.
 The goods or services promised in the contracts (or some goods
or services promised in each of the contracts) are a single
performance obligation.
Five-Step Process

 Contract Modifications
 A contract modification exists when the parties to a contract approve
a modification that either creates new or changes existing
enforceable rights and obligations of the parties to the contract.
there are two paths to consider when evaluating the accounting
related to the modification.
 An entity shall account for a contract modification as a separate
contract if both of the following conditions are present:
 The scope of the contract increases because it results in the addition of
promised goods or services that are distinct.
 The price of the contract increases by an amount of consideration that reflects
the entity’s standalone selling prices of the additional promised goods and
services and any appropriate adjustment to that price to reflect the
circumstances of the particular contract.
Five-Step Process

 If a contract modification is not accounted for as a separate contract,
an entity shall account for the promised goods or services not yet
transferred at the date of contract modification in whichever of the
following ways is applicable:
 An entity shall account for the contract modification as if it were a
termination of the existing contract and the creation of a new
contract, if the remaining goods or services are distinct from the
goods or services transferred on or before the date of the contract
modification.
 An entity shall account for the contract modification as if it were
part of the existing contract if the remaining goods or services are
not distinct, and, therefore, form part of a single performance
obligation that is partially satisfied at the date of the contract
modification.
Five-Step Process

 If the remaining goods or services are a combination of
the items above, then the entity shall account for the
effects of the modification on unsatisfied (including
partially unsatisfied) performance obligations in modified
contract in a manner that is consistent with the
objectives of the relevant paragraph.
Five-Step Process

2. Identifying Performance Obligations
 A performance obligation is a promise in a contract with a
customer to transfer to the customer:
 A good or service (or bundle of goods or services) that is distinct.
 A series of distinct goods or services that are substantially the
same and that have the same pattern of transfer to the customer.
 Generally explicit but may also include promises that are implied by
an entity’s customary business practices, published policies or
specific statements, if at the time of entering into the contract those
promises create a valid expectation of the customer that the entity
will transfer a good or service to the customer.
Five-Step Process

2. Identify the Separate Performance Obligations
 A promised good or service is considered distinct if both of
the following conditions are met:
 The customer can benefit from the good or service either on
its own or together with other resources that are readily
available to the customer (that is, the good or service is
capable of being distinct).
 The entity’s promise to transfer the good or service to the
customer is separately identifiable from other promises in the
contract (that is, the good or service is distinct within the
context of the contract)
Five-Step Process

 A customer can benefit from a good or service, if the good
or service could be used, consumed, sold for an amount
greater than scrap value, or otherwise held in a way that
generates economic benefit.
 Various factors may provide evidence that the customer can
benefit from the good or service either on its own or in
conjunction with other readily available resources. For example,
the fact that an entity regularly sells a good or service separately
would indicate that a customer can benefit from the good or
service on its own or with other readily available resources.
Five-Step Process

 Determining whether the good or service is “distinct within the context
of the contract” is a critical aspect of identifying the performance
obligations. Factors that indicate that an entity’s promise to transfer a
good or service to a customer is separately identifiable include but are
not limited to:
 The entity does not provide a significant service of integrating the
goods or services into the bundle of goods or services that the
customer has contracted for.
 The good or service does not significantly modify or customize
another good or service promised in the contract.
 The good or service is not highly dependent on, or highly
interrelated with, other goods or services promised in the contract.
Five-Step Process

 If a promised good or service is not distinct, an entity
shall combine that good or service with other promised
goods or services until it identifies a bundle of goods or
services that is distinct.
 In some cases, that would result in the entity accounting for
all the goods or services promised in a contract as a single
performance obligation.
Five-Step Process

3. Determining the Transaction Price
 The transaction price is the amount of consideration that
an entity expects to be entitled to in exchange for
transferring promised goods or services to a customer.
Issues that impact the determination of the transaction
price include the following:
 Variable consideration
 Constraining estimates of variable consideration
 The existence of a significant financing component in the
contract
 Non cash consideration
 Consideration payable to a customer.
Five-Step Process

 Variable Consideration
 Often, part of the contractual consideration related to a good or
service is variable in nature or contingent on future events.
(not an all inclusive list):
 Discounts
 Rebates
 Refunds
 Credits
 Incentives
 Performance bonuses
 Royalty
Five-Step Process

 An entity shall estimate an amount of variable consideration by
using either of the following methods, depending on which method
the entity expects to better predict the amount of consideration to
which it will be entitled:
 The expected value – the expected value is the sum of probability
weighted amounts in a range of possible consideration amounts. An
expected value may be an appropriate estimate of the amount of variable
consideration if an entity has a large number of contracts with similar
characteristics.
 The most likely amount – the most likely amount is the single most likely
amount in a range of possible consideration amounts (that is, the single
most likely outcome of the contract). The most likely amount may be an
appropriate estimate of an amount of variable consideration if the
contract has only two possible outcomes.
Five-Step Process

 An entity shall include in the transaction price some or all of an
amount of variable consideration 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.
Five-Step Process

 Factors that could increase the likelihood or the magnitude of a
revenue reversal include, but are not limited to any of the following:
 The amount of consideration is highly susceptible to factors outside
the entity’s influence.
 The uncertainty about the amount of consideration is not expected
to be resolved for a long period of time.
 The entity’s experience (or other evidence) with similar types of
contracts is limited, or that experience (or other evidence) has
limited predictive value.
 The entity has a practice of either offering a broad range of price
concessions or changing payment terms and conditions of similar
contracts in similar circumstances.
 The contract has a large number and broad range of possible
consideration amounts.
Five-Step Process

 Reassessment of Variable Consideration
 At the end of each reporting period, an entity shall update the
estimated transaction price (including updating its assessment of
whether an estimated variable consideration is constrained) to
represent faithfully the circumstances present at the end of the
reporting period and the changes in circumstances during the
reporting period.
Five-Step Process

 The Existence of a Significant Financing Component in the Contract
 In determining the transaction price, a contract must be adjusted for the
effects of the “time value of money” when the contract contains a
financing component.
 A practical expedient is provided that allows an entity to ignore the time
value of money when the time between the transfer of the
goods/services and payment is less than one year. This is allowable
even when the contract itself exceeds one year.
 The following factors should be considered when determining whether a
significant financing component is present in the contract.
 The length of time between when the transfer of goods or services to the customer
occurs and when payment is made.
 Whether the amount of consideration in the contract would substantially differ if the
customer paid cash when the transfer of the goods or services occur.
 The interest rate in the contract and the prevailing interest rate in the relevant market.
Five-Step Process

4. Allocating the Transaction Price
 The objective when allocating the transaction price is for an
entity to allocate the transaction price to each performance
obligation (or distinct good or service) in an amount that
depicts the amount of consideration which the entity expects
to be entitled in exchange for transferring the promised goods
or services to the customer.
 To meet the allocation objective, an entity shall allocate the
transaction price to each performance obligation in the
contract on a relative stand-alone selling price basis.
 Relative selling price is best evidenced by the observable price of a
good or service when sold separately in similar circumstances and
to similar customers.
 If a stand-alone selling price is not directly observable, an entity
shall estimate the standalone selling price.
Five-Step Process

4. Allocate the Transaction Price
 When estimating the relative stand-alone selling price,
management should maximize the use of observable
inputs. The following are some possible estimation
methods (not all inclusive):
 Adjusted market assessment approach
 Expected cost plus a margin approach
 Residual approach (in certain circumstances).
Five-Step Process

5. Recognize Revenue When a Performance Obligation is
Satisfied.
 An entity shall recognize revenue when (or as) the entity satisfies a
performance obligation by transferring a promised good or service
(that is, an asset) to a customer. An asset is transferred when (or
as) the customer obtains control of that asset.
 Control of an asset refers to the customer’s ability to direct the use of
and obtain substantially all of the remaining benefits from the asset.
Indicators that a customer has obtained control are as follows:
 The entity has a right to payment for the asset.
 The entity transferred legal title to the asset.
 The entity transferred physical possession of the asset.
 The customer has the significant risk and reward of ownership.
 The customer has accepted the asset.
Five-Step Process

Satisfied.
 Performance Obligations Satisfied Over Time
 An entity transfers control of a good or service over time and,
therefore, satisfies a performance obligation and recognizes
revenue over time if one of the following criteria are met:
 The customer simultaneously receives and consumes the
benefits provided by the entity’s performance as the entity
performs.
 The entity’s performance creates or enhances an asset (WIP) that
the customer controls as the asset is created or enhanced.
 The entity’s performance does not create an asset with an
alternative use to the entity and the entity has a right to payment
for performance completed to date.
Five-Step Process

Satisfied.
 Performance Obligations Satisfied at a Point in Time
 If a performance obligation is not satisfied over time, an entity
satisfies the performance obligation at a point in time. The specific
point in time is dependent on when the customer obtains control of
the promised asset and the entity satisfies the performance
obligation.
Five-Step Process

 Licenses
 The new revenue recognition guidance will provide criteria
to distinguish between two types of licenses of intellectual
property.
 A license that provides “access” to IP is considered a
performance obligation satisfied over time.
 A license that provides a “right to use” an entity’s IP is a
performance obligation that is satisfied at a point in time.
 The guidance focuses on whether the licensed IP is
considered dynamic or static. A license to dynamic IP is
one where the IP might change over time based on actions
of the licensor.
 A static license grants access to IP that will not change
after the license transfers to the licensor.
Other Issues

 Disclosures
 The objective of the disclosure requirements (Topic 606) is for
an entity to disclose sufficient information to enable users of
financial statements to understand the nature, amount,
timing, and uncertainty of revenue and cash flows arising
from contracts with customers.
 The disclosure requirements found in the new revenue recognition
guidance are significantly in excess of what is currently required
under U.S. GAAP.
Disclosures

 Disclosures
 An entity shall disclose qualitative and quantitative
information about all of the following:
 Its contracts with customers
 The significant judgments, and changes in the judgments made in
applying the guidance in Topic 606 to those contracts
 Any assets recognized from the costs to obtain or fulfill a contract
with a customer.
Disclosures

 Disclosures
 Contracts with customers
 Disaggregation of Revenue
 Contract balances
 Performance obligations
 Transaction price allocated to the remaining performance
obligations
 Significant judgments in the application of the guidance in
Topic 606
 Determining the transaction price and the amounts allocated
to performance obligations
 Practical expedients
Disclosures

PREPARING FOR THE CHANGE
NEXT STEPS

 Effective Date of Adoption (Public Entity)
 For a public entity, the amendments in Topic 606 are
effective for annual reporting periods beginning after
December 15, 2016, including interim periods within that
reporting period. Early application is not permitted.
Next Steps

 Effective Date of Adoption (Nonpublic entities)
 For all other entities (nonpublic entities) the amendments
in Topic 606 are effective for annual reporting periods
beginning after December 15, 2017, and interim periods
within annual periods beginning after December 15, 2018.
 A non public entity may elect to apply the guidance in Topic 606
earlier, however, only as of the following:
 An annual reporting period beginning after December 15, 2016,
including interim periods within that reporting period (public company
effective date)
 An annual reporting period beginning after December 15, 2016 and
interim periods with annual periods beginning after December 15,
2017
 An annual reporting period beginning after December 15, 2017,
including interim periods within that reporting period.
Next Steps

 It is hard to imagine a more significant event to financial
reporting than the significant overhaul of historical revenue
recognition guidance. History tells us that many entities will
misjudge the amount of time, effort and expertise that is
required when extensive changes are made to significant
accounting guidance.
 The adoption of fair value and consolidation accounting
guidance is a relatively recent example for us to consider.
Next Steps

 The impact from the adoption of the new revenue
recognition standard will likely be complex and far-
reaching and involve many different functions within an
organization.
 Information systems may require adjustment.
 Standard “sales” contracts and other sales agreements
should be evaluated in light of the changes.
 Sales incentives/commissions should be considered.
 Internal control processes may need updating.
 Executive compensation arrangements
 Debt covenants
 Tax Implications
Next Steps

 Changing Business Models?
 Existing sales strategies and legal documents used in the
selling process may require change or no longer be
required under the new guidance.
 Over the years many selling strategies have developed to
deal with the “bright-line” accounting rules. Upon adoption
of the new revenue recognition guidance there is a unique
opportunity to rethink the way business is done.
Next Steps

 Those entities that are currently subject to significant
industry guidance are likely to experience the most
significant impact.
 Telecommunication
 Software
 Construction/Aerospace and Defense
 Real Estate
 Entertainment and Media
 Multiple Deliverable Contracts
Next Steps

 Transition
 The FASB has allowed two methods for transition:
 Retrospectively to each prior reporting period
presented.
 Practical expedients provided
 Retrospectively with the cumulative effect of initially
applying the guidance recognized at the date of initial
adoption. Certain disclosures are required:
 The amount by which each financial statement line
item is affected in the current reporting period by the
application of Topic 606 as compared to the
guidance that was in effect before the change.
 An explanation of the reasons for significant
changes.
Next Steps

 Transition and Implementation
 Challenges for entities with contracts that span multiple
years.
 What do investors expect?
 What are your peers likely to do?
Next Steps

 The implementation of the new revenue recognition
standard should be a team effort across many different
corporate functions.
 The level of effort and amount of time necessary will be
contingent on a number of variables including the size,
complexity and previous reliance on industry related
revenue recognition guidance.
 Start early. With the long “on-ramp” that FASB has
allowed for, it is easy for entities to get lulled into a false
sense of security. Large public companies with three
year P&L presentations face the most time pressure.
Next Steps

 Consider the use of an implementation team approach.
 Existing pricing committees might be a good way to
govern the implementation process.
 Talk with your auditor and/or professional advisors.
 Watch for further education opportunities from the FASB
Revenue Recognition Implementation Group.
Next Steps

Questions?
‹#›

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If You Enjoyed This Webinar…
 Join us for these related EES courses:
 8/14 & 8/26: Revenue Recognition for the Construction
Industry
 10/14 & 11/13: Revenue Recognition for the Technology
Industry
 Read these related publications:
 MHM Messenger 2014-18: Final Revenue Recognition
Standard Issued
 Additional thought leadership will be published soon now
that the new standard has been issued.

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