Latest issues in revenue recognition - presented by McGladrey at December 2011 EEI Conference on Advanced SEC/FASB Reporting and Compliance Conference

1
©2011 McGladrey & Pullen, LLP. All Rights Reserved.
Brian Marshall, Partner, McGladrey & Pullen, LLP
December 2011
Latest issues in revenue recognition

2 ©2011 McGladrey & Pullen, LLP. All Rights Reserved.
McGladrey overview
 5th largest accounting firm in the U.S.
 Provide assurance, tax and consulting services
 7,000 professionals in more than 80 offices
nationwide
 $1.3 billion in total revenue and more than
50,000 clients
 US member of RSM International (RSMI) – 6th
largest global network of accounting and
consulting firms with $3.9 billion in total revenue
- 700 offices in 83 countries with more than 32,500
professionals

Agenda
 Revised revenue recognition Exposure Draft
 Updated multiple deliverable arrangements
guidance

Revised revenue recognition
Exposure Draft - “Revenue from
Contracts with Customers”

Overview
 Preliminary Views document issued in
December 2008
 Exposure Draft issued in June 2010
 Revised Exposure Draft issued in November
2011
 Final standard expected in late 2012

Overview
 Scope
- Applicable to all industries & entities
- Specific contracts with customers outside of scope:
• Financial instruments
• Guarantees (other than warranties)
• Insurance
• Leases
• Certain nonmonetary exchanges
- Contracts with performance obligations in multiple
standards

Overview
 Core principle
- 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

Overview
 Approach to comply with this core principle
1. Identify the contract with a customer
2. Identify the separate performance obligations in the
contract
3. Determine the transaction price
4. Allocate the transaction price to the separate
performance obligations
5. Recognize revenue when (or as) each separate
performance obligation is satisfied

1. Identify the contract with a customer
 Contract is an enforceable agreement between
parties
 Can be written, oral or implied
 Contract combination
- Required for contracts entered into at or near the
same time if certain other criteria are met
 Contract modifications
- Treat separately if separate performance obligation
is added with consideration consistent with
standalone selling price
- Otherwise combine with original contract

2. Identify separate performance obligations
 Promise in a contract to transfer a good or service
 Account for separately if distinct based on meeting
either of the following criteria:
- Good or service is regularly sold separately by the entity; or
- Customer can benefit from good or service on its own or
together with other readily available resources
 However, bundle of promised goods or services is
accounted for as one performance obligation if:
- Highly interrelated and require significant integration service;
and
- Significantly modified or customized to fulfill contract

 Amount of consideration to which an entity
expects to be entitled to from a customer
 Variable consideration
- Estimate based on probability-weighted or most-
likely amount
 Time value of money
- Only affects transaction price if significant financing
component
- Can ignore if time between payment and transfer of
goods or services is one year or less

 Noncash consideration
- Measure at fair value or by reference to standalone
selling price of related goods or services
 Consideration payable to a customer
- Reduction of transaction price unless in exchange
for distinct good or service
 Collectibility
- Not considered in transaction price
- Record allowance adjacent to revenue

4. Allocate the transaction price
 Generally based on relative standalone selling
price of performance obligations
 Standalone selling price
- Observable price when sold separately (best)
- Otherwise estimate:
• Cost plus margin
• Adjusted market assessment
• Residual technique allowed if highly variable or uncertain
• Others?
 Subsequent changes allocated on a relative
standalone selling price basis unless certain
criteria are met

5. Recognize revenue
 Recognize revenue as performance obligations are
satisfied based on transfer of control
 Determine if satisfied (and revenue recognized)
over time, based on whether entity’s performance:
- Creates or enhances an asset the customer controls; or
- Does not create an asset with an alternative use and one
of following criteria is met:
• Customer receives a benefit as entity performs tasks
• Another entity would not need to reperform tasks performed to
date
• Vendor has right to payment for performance to date
 Select method of progress toward completion
(output or input)

5. Recognize revenue
 If prior criteria not met then satisfied at a point in time
 Recognize revenue when customer obtains control
based on following indicators:
- Entity has right to payment
- Entity has transferred physical possession
- Customer has legal title and risks and rewards of ownership
- Customer has accepted goods or services
 Recognize amount allocated to performance obligation
except for certain variable consideration, which is limited
to reasonably assured amount based on:
- Experience with similar performance obligations
- Whether that experience is predictive of outcome

Onerous performance obligations
 Only applicable to performance obligations satisfied
over period > 1 year
 Recognize liability if allocated transaction price is
less than lower of:
- Direct costs to satisfy performance obligation; or
- Amount to be paid to exit the performance obligation
 Direct costs include:
- Direct labor & materials
- Allocated costs directly related to contract
- Costs explicitly chargeable to the customer
- Other costs incurred only because contract entered into

Contract costs
 Capitalize direct costs of fulfilling a contract or
anticipated contract if those costs:
- Generate or enhance a resource that will be used to
satisfy performance obligations in the future (e.g.,
setup costs); and
- Are expected to be recovered
 Capitalize incremental costs to obtain contract if
expected to be recovered
 Practical expedient to expense costs as
incurred if amortization period would have been
less than one year

Return rights
 Defer revenue and record refund liability for
goods expected to be returned
 Adjust refund liability (and revenue) for changes
in return expectations
 Record asset (rather than cost of sales) for right
to recover products at former carrying amount
less costs of recovery

Warranties
 Customer option to purchase separately
- Separate performance obligation (warranty service)
 No customer option to purchase separately and
warranty does not provide an additional service
- Recognize revenue and accrue expected costs
- Consider following in determination of whether
additional service is being provided:
• Whether warranty is required by law
• Length of warranty period
• Nature of tasks to be performed

Optional goods or services
 Considered a performance obligation if provides
a material right customer otherwise would not
receive
 Estimate standalone selling price of option
using:
- Directly observable option price,
- Option discount adjusted for likelihood of exercise
and discount available without the option

Other issues
 Customers’ unexercised rights (“Breakage”)
- Relatively consistent with current US GAAP
 Licensing and rights to use
- Same guidance as for other goods or services
- Revenue recognized at point in time if separate
performance obligation
 Repurchase agreements
- Entity obligation (forward) or right (call option) to
repurchase asset
- Customer right to require entity to repurchase (put
option)

Treatment similar to current US GAAP
 Nonrefundable upfront fees
 Principal vs. agent considerations
 Consignment arrangements
 Bill-and-hold arrangements
 Customer acceptance

Balance sheet presentation
 Asset/liability based on comparison of entity’s
performance to customer’s performance
 Entity > customer = asset
 Entity < customer = liability
 Receivables are classified separately from other
asset
- Unconditional right to receive consideration

Disclosures / transition / effective date
 Disclosure objective:
- Quantitative and qualitative information regarding
nature, amount, timing and uncertainty of revenue
and related cash flows
 Retrospective transition with certain practical
expedients
 Effective date no earlier than 2015 for public
entities and 2016 for nonpublic entities.
 Comments due by March 13

Updated multiple deliverable
arrangements guidance
(ASU 2009-13 & 14)

ASU 2009-13 (EITF 08-1), “Revenue
Arrangements with Multiple Deliverables”
 Response to criticisms of EITF 00-21 (ASC 605-
25)
- Often unable to separate into multiple units of
accounting (lack of fair value of the undelivered
items)
- Accounting often did not match economics
 Allows more flexibility in determining values of
separate elements
 Effective for arrangements entered into or
materially modified in fiscal years beginning on
or after 6/15/2010

ASU 2009-13 - Separation guidance
 Delivered item is a separate unit of accounting if
the following criteria are met:
- The delivered item has value to the customer on a
standalone basis
• Does vendor sell the item separately?
• Can customer resell item on a standalone basis?
- There is objective and reliable evidence of the fair
value of the undelivered item(s)
- If the arrangement includes a general right of return,
delivery or performance of the undelivered item(s) is
probable and within control of vendor

ASU 2009-13 - Allocation guidance
 Allocate consideration using relative selling price
method
- Eliminates requirement for objective and reliable
evidence of FV of undelivered items
- Eliminates use of residual method; probably results in
earlier recognition
 Hierarchy of evidence to use for allocation
- Vendor specific objective evidence (VSOE) of selling
price
- Third-party evidence (TPE) of selling price
- Best estimate of standalone selling price
• No practicality exception provided

ASU 2009-13 - Estimating standalone
selling price
 No specific methodology prescribed
 Gather all reasonably available data points
 Adjust based on:
- Market conditions
- Entity-specific factors
 Consider all information that is reasonably
available without undue cost or effort to
determine estimated selling price

ASU 2009-13 - Disclosures
 Ongoing disclosures
- Quantitative and qualitative information about significant
judgments used in applying ASU 2009-13 and changes in
those judgments or in the application that may
significantly affect the allocation of revenue
- Inputs, methods, and significant assumptions used in
evaluating arrangements and the significant deliverables
in those arrangements
 Transition disclosures (if adopt prospectively)
- Qualitative description of how the ASU was adopted
- Supplement with quantitative disclosures if material

ASU 2009-14 (EITF 09-3), “Certain Revenue
Arrangements that Include Software Elements”
 EITF consensus in ASU 2009-13 (EITF 08-1)
led to this Issue
 Effective date mirrors ASU 2009-13
 Should scope of ASC 985-605 (SOP 97-2)
and/or criteria be eased?
- ASC 985-605 seen as very conservative
• No VSOE = no separation; defer until established or
delivered
- Does scope capture more arrangements than
intended?
• Are underlying economics being distorted as a result?

ASU 2009-14 - Overview
 EITF agreed to amend scope of ASC 985-605
- Tangible products containing software components and non-
software components that function together to deliver the
product's essential functionality should be considered non-
software deliverables
 The following are excluded from ASC 985-605 scope:
- Non-software components of software-reliant tangible products
- Software components bundled with tangible products if the
software components and non-software components function
together to deliver the product’s essential functionality
- Undelivered elements that relate to software that is essential to
the above described tangible product’s functionality

ASU 2009-14 - Determining “Function Together to
Deliver the Product’s Essential Functionality”
 Rebuttable presumption that software elements are
essential to the functionality of the tangible product if
sales of the tangible product without the software
elements are infrequent
 The evaluation to determine whether or not the tangible
product and software are functioning together is done at
the product level, not the model level
 The separate standalone sale of the software does not
cause a presumption that the software is not essential to
the functionality of the tangible product

ASU 2009-14 - Determining “Function Together to
Deliver the Product’s Essential Functionality”
 Software elements do not need to be embedded on a
device to be considered essential to the device’s
functionality
 The non-software elements of the tangible product must
substantively contribute to the tangible product’s
essential functionality
Entities will need to evaluate existing product
lines to determine which software stays within
the scope of ASC 985-605 and which does not

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Latest issues in revenue recognition - presented by McGladrey at December 2011 EEI Conference on Advanced SEC/FASB Reporting and Compliance Conference

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