Published on October 15, 2014
1. How the New Revenue Recognition Standard will Impact the Technology Industry Presented by: James Comito and Mark Winiarski Oct. 14 & Nov. 13, 2014
2. #CBIZMHMwebinar 2 To view this webinar in full screen mode, click on view options in the upper right hand corner. Click the Support tab for technical assistance. If you have a question during the presentation, please use the Q&A feature at the bottom of your screen. Before We Get Started…
3. #CBIZMHMwebinar 3 This webinar is eligible for CPE credit. To receive credit, you will need to answer periodic participation markers throughout the webinar. External participants will receive their CPE certificate via email immediately following the webinar. CPE Credit
4. #CBIZMHMwebinar 4 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 5 Today’s Presenters James Comito, CPA Shareholder, MHM 858.795.2029 | firstname.lastname@example.org 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. Mark Winiarski, CPA Senior Manager, CBIZ MHM 913.234.1656 | email@example.com Mark is located in our Kansas City office in an audit and advisory function. In addition to serving his clients which are primarily in the manufacturing, retail and distribution industries, Mark supports MHM’s Professional Standards Group by consulting with clients and engagement teams across the country on accounting and auditing issues in areas including revenue recognition, consolidations and business combinations.
6. #CBIZMHMwebinar 6 Today’s Agenda 1 2 Background Revenue Recognition Current Practice 3 Changes to Revenue Recognition Under New Guidance 4 Next Steps
7. FASB’S NEW REVENUE RECOGNITION STANDARD BACKGROUND
8. #CBIZMHMwebinar 8 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. Generally Accepted Accounting Principles (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 9 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
10. REVENUE RECOGNITION CURRENT PRACTICE
11. #CBIZMHMwebinar 11 The current revenue recognition model followed under U.S. GAAP 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 originally published as SOP 97-2 plays a significant role in revenue recognition for software transactions Percentage of completion for certain software transactions Software as a Service (SAAS) (EITF 00-3) Multiple element guidance for non-software transactions (ASU 2009-13). Revenue Recognition Basics
12. #CBIZMHMwebinar 12 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
13. CHANGES TO REVENUE RECOGNITION UNDER THE NEW GUIDANCE
14. #CBIZMHMwebinar 14 FASB Accounting Standard Update No. 2014-09 Revenue from Contracts with Customers (Topic 606) Standard applies to all transactions which relate to and include: Contract Customer Terminology has changed – first step is to gain understanding of the new language of revenue recognition Revenue Recognition – The Future has Arrived
15. #CBIZMHMwebinar 15 Industry guidance from SOP 97-2 will no longer be relevant. Decisions relative to revenue and, to some degree, costs will be guided by the principles of ASU 2014-09. The FASB expects industry practice guidance to be developed but it will not be under the authority of the FASB. AICPA has formed multiple industry groups to address and modify current audit and accounting guides – these will not be GAAP unless designated by FASB. Taking your Crutch Away
16. #CBIZMHMwebinar 16 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. Core Principle
17. #CBIZMHMwebinar 17 Five steps to apply the core principle: Five-Step Process 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.
18. #CBIZMHMwebinar 18 Many technology companies provide integrated solutions for their customers that result in the transfer of multiple products and services. 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. This is the standard that permits multiple performance obligations to be bundled and reported on a total contract basis. 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. Identifying Performance Obligations
19. #CBIZMHMwebinar 19 A promised good or service is considered distinct if both of these 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). Distinct
20. #CBIZMHMwebinar 20 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. Distinct
21. #CBIZMHMwebinar 21 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. Distinct
22. #CBIZMHMwebinar 22 Example – Base Case (Distinct) Vendor licenses software to a customer, agrees to perform installation for the customer and provides unspecified software updates and online and phone technical support (PCS). The vendor sells the license, installation and technical support separately. The installation service is routinely performed by other entities and does not significantly modify the software. The software remains functional without the update and technical support. Distinct
23. #CBIZMHMwebinar 23 The following criteria are evaluated: 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 vendor observes that software is delivered before the other goods and services and remains functional without the updates and technical support. 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). The entity observes that the installation service does not significantly modify or customize the software, as such, the software and installation services are separate outputs promised by the entity instead of inputs used to produce a combined output. Distinct
24. #CBIZMHMwebinar 24 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, this would result in the entity accounting for all the goods or services promised in a contract as a single performance obligation. Example – Assume that only the vendor is able to provide customization of the software and integration services. When software is significantly customized by the vendor in compliance with the terms of the contract, the license and services are not considered distinct, because the customer is unable to benefit from the software on its own (or together with readily available resources). Also, the promise to deliver the software license is not separately identifiable from the services to provide implementation services. Distinct
25. #CBIZMHMwebinar 25 The new revenue recognition guidance replaces all industry specific guidance including specific guidance related to software and software related transactions. The impact of this will be significant. Elimination of Software-Specific Guidance
26. #CBIZMHMwebinar 26 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: 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 Determining the Transaction Price
27. #CBIZMHMwebinar 27 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 — early completion, savings sharing, etc. Royalty Unit pricing Economic price adjustments Latent defects Variable Consideration
28. #CBIZMHMwebinar 28 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: Expected value –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. Most likely amount –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. Variable Consideration
29. #CBIZMHMwebinar 29 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. Constraint on Transaction Price
30. #CBIZMHMwebinar 30 Factors that could increase the likelihood or the magnitude of a revenue reversal include, but are not limited to: 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. Constraint on Transaction Price
31. #CBIZMHMwebinar 31 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 Significant Financing Component
32. #CBIZMHMwebinar 32 The new revenue recognition standard does not require a deferral for those software arrangements with extended payment terms (i.e., rebuttable presumption). Accordingly, revenue recognition for deliverables with extended payment terms may recognize revenue sooner than past practice. However, management will need to consider whether extended payment terms represent a significant financing component under the new guidance. Significant Financing Component – Extended Payment Terms
33. #CBIZMHMwebinar 33 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. Reassessment
34. #CBIZMHMwebinar 34 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 stand-alone selling price. Allocate the Transaction Price
35. #CBIZMHMwebinar 35 Vendor Specific Objective Evidence (VSOE) of fair value, will no longer be required for undelivered items in order to separate and allocate the transaction price among the identified performance obligations. VSOE has always been viewed as a high threshold and the elimination of VSOE from U.S. GAAP may accelerate revenue recognition for transactions that in the past had to defer revenue recognition based on a lack of VSOE. Management will need estimate the standalone value of PCS when VSOE was not previously available. Allocate the Transaction Price
36. #CBIZMHMwebinar 36 Post Contract Customer Support (PCS) Under existing U.S. GAAP, PCS is typically a “deliverable.” Current practice is to allocate value to the PCS contract in total (assuming VSOE is present). Under the new guidance, management will need to consider whether each promise within a PCS agreement is a separate performance obligation (e.g., online support, telephone support and “if and when” available software upgrades and enhancements). Additionally, specified upgrades, including those that are included in an entity’s product “roadmap,” are separate performance obligations. Allocate the Transaction Price
37. #CBIZMHMwebinar 37 4. Allocate the Transaction Price When estimating the relative stand-alone selling price, management should maximize the use of observable inputs. Possible estimation methods (not all inclusive): Adjusted market assessment approach Expected cost plus a margin approach Residual approach (in certain circumstances) Allocate the Transaction Price
38. #CBIZMHMwebinar 38 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. Recognize Revenue as Performance Obligation is Satisfied
39. #CBIZMHMwebinar 39 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 these 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. Performance Obligation Satisfied Over Time
40. #CBIZMHMwebinar 40 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. Performance Obligation Satisfied at a Point in Time
41. #CBIZMHMwebinar 41 An entity should recognize as an asset the incremental costs of obtaining a contract that the entity expects to recover. Incremental costs are those costs that the entity would not have incurred if the contract had not been obtained. Practical expedient – expense costs if amortization period is one year or less Costs to Obtain a Contract
42. #CBIZMHMwebinar 42 Follow existing guidance under other standards, if applicable. Otherwise, recognize as an asset if those costs meet all of the following criteria: Relate directly to a contract (or a specific anticipated contract) Generate or enhance resources of the entity that will be used in satisfying performance obligations in the future Are expected to be recovered Examples Pre-construction costs Mobilization Costs to Fulfill a Contract
43. #CBIZMHMwebinar 43 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
44. #CBIZMHMwebinar 44 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
45. #CBIZMHMwebinar 45 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
46. PREPARING FOR THE CHANGE: NEXT STEPS
47. #CBIZMHMwebinar 47 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
48. #CBIZMHMwebinar 48 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 nonpublic 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
49. #CBIZMHMwebinar 49 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 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
50. #CBIZMHMwebinar 50 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
51. #CBIZMHMwebinar 51 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
52. #CBIZMHMwebinar 52 Transition and Implementation What do bankers expect? What do investors expect? What are your peers likely to do? Next Steps
53. #CBIZMHMwebinar 53 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
54. #CBIZMHMwebinar 54 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
55. #CBIZMHMwebinar 55 Questions?
56. #CBIZMHMwebinar 56 Join us for these courses: 11/13: Repeat broadcast Previously recorded: Is Your Company Ready for the New Revenue Recognition Standards? Read these related publications: MHM’s Revenue Recognition Serial Final Revenue Recognition Standard Issued James Comito Discusses New Revenue Recognition Standard with Accounting Today If You Enjoyed This Webinar…
57. #CBIZMHMwebinar 57 Connect with Us linkedin.com/company/ mayer-hoffman-mccann-p.c. @mhm_pc youtube.com/ mayerhoffmanmccann slideshare.net/mhmpc linkedin.com/company/ cbiz-mhm-llc @cbizmhm youtube.com/user/ BizTipsVideos slideshare.net/CBIZInc MHM CBIZ
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