Published on May 28, 2014
Is Your Company Ready for the New Revenue Recognition Standards? Presented by: James Comito May 27, 2014
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3#CBIZMHMwebinar#CBIZMHMwebinar ‹#› This webinar is eligible for CPE credit. To receive credit, you will need to answer periodic polling questions throughout the webinar. External participants will receive their CPE certificate via email immediately following the webinar. CPE Credit
4#CBIZMHMwebinar#CBIZMHMwebinar 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 discuss the impact on your business. Disclaimer
5#CBIZMHMwebinar#CBIZMHMwebinar Today’s Presenter James Comito, CPA Shareholder 858.795.2029 | email@example.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.
6#CBIZMHMwebinar#CBIZMHMwebinar Today’s Agenda ‹#› 1 2 3 Background Current Practice Changes Under the New Guidance 4 Next Steps
FASB’S NEW REVENUE RECOGNITION STANDARD BACKGROUND
8#CBIZMHMwebinar#CBIZMHMwebinar 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
9#CBIZMHMwebinar#CBIZMHMwebinar 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
11#CBIZMHMwebinar#CBIZMHMwebinar 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
12#CBIZMHMwebinar#CBIZMHMwebinar 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
14#CBIZMHMwebinar#CBIZMHMwebinar FASB EXPOSURE DRAFT Revenue Recognition (Topic 605) Revenue from Contracts with Customers Originally issued: June 24, 2010 Re-exposed during 2011 A second re-exposure completed during 2012 Final redeliberations now complete Final standard issued? Revenue Recognition – A Look Ahead
15#CBIZMHMwebinar#CBIZMHMwebinar Core principle: The core principle would require an entity to recognize revenue to depict the transfer of goods, or services, to customers in an amount that reflects the consideration that it receives, or expects to receive, in exchange for those goods or services. Five steps to apply the core principle: 1. Identify the contract(s) with the customer. 2. Identify the separate performance obligations 3. Determine the transaction price 4. Allocate the transaction price 5. Recognize revenue when a performance obligation is satisfied Core Principles
16#CBIZMHMwebinar#CBIZMHMwebinar On the surface the five step process does not seem overly complex and arguably, it includes much of what is currently done to determine revenue recognition. However, each of the five steps will require significant management judgments 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 Principles
17#CBIZMHMwebinar#CBIZMHMwebinar 1. Identify the Contract with the Customer In developing a single customer focused contract based model, it makes sense to evaluate what is considered a contract and customer under the new guidance. A contract is an agreement between two of more parties that creates enforceable rights and obligations and has commercial substance. Written Oral Implied by entity’s ordinary and customary business practices. Five-Step Process
18#CBIZMHMwebinar#CBIZMHMwebinar 1. Identify the Contract with the Customer 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
19#CBIZMHMwebinar#CBIZMHMwebinar 1. Identify the Contract with the Customer Contract Combination If more than one contract exists between an entity and customer (including related parties), they will be combined and treated as a single contract for accounting purposes only if they are entered into at or near the same time and 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 related to one contract depends on the amount to be paid or performance on the other contract(s). The goods or services promised in the separate contracts are considered a single performance obligation. Five-Step Process
20#CBIZMHMwebinar#CBIZMHMwebinar 1. Identify the Contract with the Customer Contract Modifications Upon the modification of a contract, there are two paths to consider when evaluating the accounting related to the modification. A modification is treated as a separate contract if it results in the addition of a separate performance obligation and the price reflects the stand-alone selling price of that performance obligation. For other modifications (those that do not result in the addition of a performance obligation), the modification is treated as an adjustment to the original contract. Prospectively Cumulative catch-up. Five-Step Process
21#CBIZMHMwebinar#CBIZMHMwebinar 2. Identify the Separate Performance Obligations A performance obligation is a promise in a contract with a customer to transfer goods and/or services to the customer. Explicit Implicit Implied by the entity’s customary business practices Five-Step Process
22#CBIZMHMwebinar#CBIZMHMwebinar 2. Identify the Separate Performance Obligations A promised good or service (including bundled goods/services) is accounted for as a separate performance obligation only when both the following conditions are met: The promised good or service is capable of being considered distinct because the customer can receive benefit from the good or service either on its own or together with other resources that are readily available to the customer. The promised good or service is considered distinct because the good or service is not highly dependent on, or highly interrelated with, other promised goods or services in the contract. Five-Step Process
23#CBIZMHMwebinar#CBIZMHMwebinar 2. Identify the Separate Performance Obligations Determining whether the good or service is “distinct within the context of the contract” is a critical aspect of identifying the performance obligations. Indicators a “distinct” good or service are: 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 customer is able to purchase or not purchase the good or service without significantly affecting the other promised goods or services in the contract. The good or service does not significantly modify or customize another good or service promised in the contract. Five-Step Process
24#CBIZMHMwebinar#CBIZMHMwebinar 2. Identify the Separate Performance Obligations The good or service is not part of a series of consecutively delivered goods or services promised in a contract that meet the following conditions: The promises to transfer those goods or services to the customers are performance obligations that are satisfied over time. The entity uses the same method for measuring progress to depict the transfer of those goods or services to the customer. Five-Step Process
25#CBIZMHMwebinar#CBIZMHMwebinar 2. Identify the Separate Performance Obligations Goods and services are combined with other goods and services in the contract (if they are not individually separable) until a separate performance obligation is identified. Five-Step Process
26#CBIZMHMwebinar#CBIZMHMwebinar 3. Determine the Transaction Price It many cases the determination of the transaction price will be relatively straightforward. However, certain contracts will require significant judgment as the new guidance introduces some significant changes from past practices. The transaction price is the amount of consideration that an entity expects to be entitled to in exchange for transferring the promised goods or services. Five-Step Process
27#CBIZMHMwebinar#CBIZMHMwebinar 3. Determine the Transaction Price 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
28#CBIZMHMwebinar#CBIZMHMwebinar 3. Determine the Transaction Price Variable Consideration The basic objective of the new guidance is to limit revenue recognition to an amount that is not subject to significant reversal in the future. FASB introduced a constraint to related to the recognition of variable consideration. It must be considered “probable” that a significant revenue reversal will not occur. Five-Step Process
29#CBIZMHMwebinar#CBIZMHMwebinar 3. Determine the Transaction Price The new guidance provides indicators that might suggest the variable consideration is subject to a significant reversal: The amount of consideration is highly susceptible to factors outside the influence of the entity. Resolution of the uncertainty about the amount of consideration is not expected for a long period of time. The entity has limited experience with similar types of contracts. The entity has a practice of either offering a broad range of price concessions or changing payment terms and conditions in similar circumstances for similar contracts. The contract has a large number and broad range of possible consideration amounts. Five-Step Process
30#CBIZMHMwebinar#CBIZMHMwebinar 3. Determine the Transaction Price Time value of money 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
31#CBIZMHMwebinar#CBIZMHMwebinar 4. Allocate the Transaction Price Subsequent to the determination of the performance obligations and determination of the transaction price, the transaction price is then allocated to the separate performance obligations in the contract. The transaction price is allocated to the separate performance obligations based on the relative stand-alone selling price of the specific goods or services promised under the terms of the contract. Relative selling price is best evidenced by the observable price of a good or service when sold separately. Management may need to estimate the selling price if relative stand- alone selling price is not available. Five-Step Process
32#CBIZMHMwebinar#CBIZMHMwebinar 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): Expected cost plus reasonable profit margin. Consideration of market prices for similar goods or services. Residual approach (in certain circumstances). Five-Step Process
33#CBIZMHMwebinar#CBIZMHMwebinar 5. Recognize Revenue When a Performance Obligation is Satisfied. Revenue recognition occurs when a good or service is transferred to the customer and the customer obtains control of that good or service. 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
34#CBIZMHMwebinar#CBIZMHMwebinar 5. Recognize Revenue When a Performance Obligation is Satisfied. Performance obligations satisfied over time or at a point In time. An entity recognizes revenue over time if any of the following criteria are met: The customer receives and consumes the benefit of 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 alternative use to the entity and the customer does not have control over the asset created, however, the entity has a right to payment for performance completed to date. Five-Step Process
35#CBIZMHMwebinar#CBIZMHMwebinar 5. Recognize Revenue When a Performance Obligation is Satisfied. Measuring progress towards satisfying a performance. For performance obligations satisfied over time, the objective is to recognize revenue in a manner that depicts the transfer of control to the customer. Methods for measuring progress include: Output methods that recognize revenue based on units produced or delivered, contract milestones, or surveys of work performed. Input methods that recognize revenue based on cost incurred, labor hours, time lapsed or machine hours used. Five-Step Process
36#CBIZMHMwebinar#CBIZMHMwebinar 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
37#CBIZMHMwebinar#CBIZMHMwebinar Collectibility During its final deliberations, the FASB decided to introduce a collectibility threshold to the revenue recognition model in order to determine whether a contract is both valid and a genuine transaction. An entity must determine whether it is “probable” at the inception of the contract that it will collect the transaction price (including variable consideration) to which it is entitled under the terms of the contract. The assessment is based on the customers ability and intent to pay. An entity considers credit risk but not other uncertainties. The transaction price in the aforementioned determination also includes consideration of whether a pricing concession is anticipated. Other Issues
38#CBIZMHMwebinar#CBIZMHMwebinar Collectibility If at inception, collectibility is not considered “probable”, the contract is not within the scope of the revenue recognition model. Revenue would not be recognized until performance is complete and either: All consideration is received and nonrefundable, or The contract is cancelled and amounts received are nonrefundable. Other Issues
39#CBIZMHMwebinar#CBIZMHMwebinar Disclosures The revenue standard includes several disclosure requirements which the FASB believes will better enable the users of financial statements to understand the amount, timing and judgments related to revenue recognition and corresponding cash flows. The disclosure requirements found in the new revenue recognition guidance are significantly in excess of what is currently required under U.S. GAAP. Disclosures
40#CBIZMHMwebinar#CBIZMHMwebinar Disaggregation of revenue Requires disaggregated revenue information in categories that depict how the nature, amount and timing and uncertainty of revenue and cash flows are affected by economic factors. Reconcile disaggregated revenue to revenue for reportable segments. Reconciliation of contract balances Disclose opening and closing balances of contract assets and liabilities and provide a qualitative description of significant changes such balances. Disclose the amount of revenue recognized in the current period related to performance obligations satisfied in a prior period (for example, variable consideration). Disclosures
41#CBIZMHMwebinar#CBIZMHMwebinar Remaining performance obligations Disclose the amount allocated to any remaining performance obligations not subject to significant revenue reversal. Provide a narrative description of potential additional revenue in constrained arrangements. Cost to obtain or fulfill contracts Disclose the closing balance of capitalized costs to obtain and fulfil a contract and the amount of amortization in the period. Disclose the method used to determine amortization for each reporting period. Other qualitative disclosures Disclose significant judgments and changes in judgments that affect the amount and timing of revenue from contracts with customers. Disclose how management determines the minimum amount of revenue not subject to the variable consideration constraint. Describe the practical expedients, including those for transition, used in the entity’s revenue accounting policies. Disclosures
42#CBIZMHMwebinar#CBIZMHMwebinar Interim disclosures Maintain current interim disclosure requirements under existing standards. Disclose disaggregation of revenue, contract balances, and remaining performance obligation disclosures. Disclosures
PREPARING FOR THE CHANGE NEXT STEPS
44#CBIZMHMwebinar#CBIZMHMwebinar Effective Date of Adoption The final standard will be effective for the first interim period within annual reporting periods beginning on or after December 15, 2016 (U.S. GAAP). Non-public entities (as defined under U.S. GAAP) receive a one-year deferral. Next Steps
45#CBIZMHMwebinar#CBIZMHMwebinar 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
46#CBIZMHMwebinar#CBIZMHMwebinar 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
47#CBIZMHMwebinar#CBIZMHMwebinar 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
48#CBIZMHMwebinar#CBIZMHMwebinar Those entities that are currently subject to significant industry guidance are likely to experience the most significant impact. Telecommunication Software Construction Real Estate Multiple Deliverable Contracts Next Steps
49#CBIZMHMwebinar#CBIZMHMwebinar Transition and Implementation The FASB has allowed for a flexible approach to transition. Full retrospective adoption (as if the new guidance had always been in place). Time consuming and expensive. An entity can instead opt to present current year revenue (in the year of adoption) under the new guidance and disclose within the notes to the financial statements all financial statement line items as if they had continued to be accounted for under the entity’s historical revenue recognition policies. Next Steps
50#CBIZMHMwebinar#CBIZMHMwebinar 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
51#CBIZMHMwebinar#CBIZMHMwebinar Transition and Implementation 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
52#CBIZMHMwebinar#CBIZMHMwebinar Transition and Implementation 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
53#CBIZMHMwebinar#CBIZMHMwebinar Questions? ‹#›
54#CBIZMHMwebinar#CBIZMHMwebinar ‹#› 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 7-11: Revenue Recognition to be Re- exposed Additional thought leadership will be published soon now that the new standard has been issued.
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