Annual Accounting and Auditing Update 11 December 2015.

Annual Accounting and Auditing Update

11 December 2015

11 December 2015 Annual Accounting and Auditing Update

Disclaimer

► The views expressed by panelists are not necessarily those of Ernst & Young LLP.

► These slides are for educational purposes only and are not intended, and should not be relied upon, as accounting advice.


Agenda

► ASC 606 – New Revenue Recognition Standard

► FASB Developments - Leases

► Restatement Themes


Introduction to today’s speakers

Drew Nagus Matt SchulerEY - Financial Accounting Advisory Services Raytheon


Where are we now?

► The new standard was issued on 28 May 2014, and a number of questions have arisen in transition.

► The Financial Accounting Standards Board (FASB)/International Accounting Standards Board (IASB) Joint Transition Resource Group for Revenue Recognition (TRG) and American Institute of Certified Public Accountants (AICPA) industry task forces are actively discussing issues submitted to them.

► Some of the issues discussed by the TRG have resulted in FASB and IASB activity:► May 2015 – FASB issued an Exposure Draft (ED) on licenses and performance

obligations► August 2015 – FASB issued an ED covering principal versus agent assessments ► September 2015 – FASB issued an ED covering certain transition issues, noncash

consideration, sales taxes, and collectibility► The IASB issued a single ED covering its proposed amendments

► The complexity of implementing the new standard should not be underestimated.

► Many companies are appropriately accelerating implementation efforts.


Effective date deferral

► The FASB issued Accounting Standards Update (ASU) 2015-14 on 13 August 2015, which finalized the one-year deferral for the new revenue standard:► It will be effective in 2018 for calendar-year public companies.► Early adoption will be allowed – using original effective dates

(annual periods beginning after 15 December 2016).

► The IASB has approved a one-year deferral for IFRS 15:► Companies will be required to adopt it in 2018.► Early adoption will continue to be allowed.


Journey to implement the new standardYou have a choice in transition methods

2015 and prior 2016 2017 2018(year of adoption)

2019 and beyond

Full retrospective

Modified retrospective

SAB 74 disclosures(including transition method and impact)

Legacy GAAPReporting 10-K, 10-Q

Footnotes

Legacy GAAP Legacy GAAP

Bef

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Cumulative catch-up adjustment at January 1, 2016

Reporting 10-K, 10-Q

Footnotes

New GAAP New GAAP

Aft

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ASC 250

ExpandedExpanded

Joint Transition Resource Group and industry groupsPresented in 2018 financial statements

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Expanded

Reporting 10-K, 10-Q

Footnotes

Legacy GAAP Legacy GAAP

Aft

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Cumulative catch-up adjustment at January 1, 2018

Legacy GAAPExpanded

Presented in 2018 financial statements


Revenue recognitionSummary of the model

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.

Step 1: Identify the contract(s) with a customer

Step 2: Identify the performance obligations in the contract

Step 3: Determine the transaction price

Step 4: Allocate the transaction price to the performance obligations

Step 5: Recognize revenue when (or as) each performance obligation is satisfied


Allocation

Estimating standalone selling prices

Exceptions for allocating variable consideration and discounts

Recognition timing

Transfer of control: point in time or over time

Measuring progress over time

Consignment arrangements

Customer acceptance

Repurchase provisions

Performance obligations

Identifying promised goods and services

Determining performance obligations (i.e., distinct goods and services)

Options granting a material right

Transaction price

May not equal “contractual” price

Variable consideration, incl. bonuses, returns, concessions, discounts

Significant financing component

Noncash consideration

Payments to customers

Subsequent changes in

transaction price

Constraint on variable consideration

Contracts

Strict criteria to be a contract

Principal versus agent

Contract modifications

Identify explicit and implicit contract terms

Assessing collectibility

Identifying the customer

Combining contracts

Established business practices

Service-type and assurance-type warranties

Licenses

What makes this complex?


Revenue recognition Step 1: Identify the contract(s) with a customer

► Contract defined as an agreement between two or more parties that creates enforceable rights and obligations► Can be written, oral or implied► Does not exist if both parties have not performed and can cancel

without penalty► Arrangement must meet these criteria to be within scope

of standard:► Parties have approved the contract and are committed to perform► Each party’s rights and payment terms can be identified► Contract has commercial substance► Collection is probable

► Contracts entered into at the same time with the same customer should be combined if certain criteria are met


Revenue recognitionStep 2: Identify the performance obligations

► A performance obligation is a promise (explicit or implicit) to transfer to a customer either: ► A distinct good or service ► A series of distinct goods or services that are substantially the

same and have the same pattern of transfer

► Performance obligations are identified at contract inception and determined based on contractual terms, customary business practice

► Proposed new guidance will allow entity to disregard promises that are deemed to be immaterial to a contract

► Proposed new guidance on shipping and handling


Revenue recognitionStep 2: Identify the performance obligations (cont.)

► A good or service is distinct if the following criteria are met:► It is capable of being distinct► It is distinct within the context of the contract

► Principal vs. agent considerations ► Incidental obligations or marketing incentives may be

performance obligations (e.g., “free” maintenance provided by auto manufacturers)

► Does not include activities to satisfy an obligation (e.g., setup activities) unless a good or service is transferred


Revenue recognitionStep 3: Determine the transaction price

► Transaction price is defined as the amount of consideration to which an entity expects to be entitled in exchange for transferring promised goods or services to a customer

► Transaction price includes the effects of the following:► Variable consideration (including application of the constraint)► Significant financing component► Consideration paid or payable to a customer

► TRG discussions regarding interaction of variable consideration and “later of” guidance

► Noncash consideration


Revenue recognitionStep 3: Determine the transaction price (cont.)

► Variable consideration is estimated using an “expected value” or a “most likely amount” approach

► An entity is required to evaluate whether to “constrain” amounts of variable consideration included in the transaction price► Amounts are included in the transaction price only if it is “probable”

a significant revenue reversal will not occur when uncertainties are resolved


Revenue recognitionStep 4: Allocate the transaction price

► Transaction price is generally allocated to each separate performance obligation on a relative standalone selling price basis► Model provides two possible exceptions relating to the allocation of

variable consideration and discounts, if certain criteria are met

► When a standalone selling price is not observable, an entity is required to estimate it► Maximize the use of observable inputs ► Apply estimation methods consistently in similar circumstances► Standard describes three estimation methods, but others are permitted

(and a combination of estimation methods is allowed)

► Standalone selling prices used to perform the initial allocation should not be updated after contract inception


Revenue recognitionStep 5: Recognize revenue

► Revenue recognized upon satisfaction of a performance obligation by transferring control of a good or service to a customer

► Control transfers over time if one of three criteria is met, otherwise control transfers at a point in time► Customer simultaneously receives and consumes the benefits as the entity

performs► Entity’s performance creates or enhances an asset that the customer controls as

the asset is created or enhanced► Entity’s performance doesn’t create an asset with an alternative use to the entity,

and the entity has an enforceable right to payment for performance to date

► The following indicators should be considered when determining the point in time that control transfers:► The entity has a present right to payment for the asset► The customer has legal title to the asset► The customer has physical possession of the asset► The customer has the risk and rewards of ownership of the asset► The entity has evidence of the customer’s acceptance of the asset


Other aspects of the modelIncremental costs of obtaining a contract

► Incremental costs of obtaining a contract would be capitalized if they are expected to be recovered► Incremental costs are costs that would not have been incurred if the

contract had not been obtained► Practical expedient to allow immediate expense recognition, if the asset’s

amortization period is one year or less► Assets are amortized over the period in which the related goods or

services are transferred and subject to impairment► If costs are determined to relate to more than one contract (e.g., expected

contract renewals), amortization should consider both current and anticipated contracts

► Current US GAAP allows an option to either immediately expense or capitalize costs of obtaining a contract

What’s changing?


Other aspects of the modelCosts to fulfill a contract

► Other applicable literature is considered first► Costs of fulfilling a contract that cannot be capitalized under another

standard would be capitalized if they meet all of the following criteria:► Relate directly to a contract► Generate or enhance resources that will be used to satisfy performance

obligations in the future► Are expected to be recovered

► Costs of fulfilling a contract that are capitalized would be amortized consistent with the pattern of transfer of the related good or service and would be subject to impairment

► “Abnormal costs” not considered in the price of the contract would be expensed as incurred


Revenue recognitionDisclosure

Excerpt from Accounting Standards Codification Example 41 — Disaggregation of Revenue — Quantitative Disclosure

Segments Consumer Products Transportation Energy Total

Primary Geographical Markets

North America $ 990 $ 2,250 $ 5,250 $ 8,490

Europe 300 750 1,000 2,050 Asia 700 260 – 960 $ 1,990 $ 3,260 $ 6,250 $ 11,500

Major Goods/Service Lines

Office Supplies $ 600 – – 600

Appliances 990 – – 990 Clothing 400 – – 400 Motorcycles – 500 – 500

Automobiles – 2,760 – 2,760 Solar panels – – 1,000 1,000 Power plant – – 5,250 5,250

$ 1,990 $ 3,260 $ 6,250 $ 11,500 Timing of Revenue Recognition

Goods transferred at a point in time $ 1,990 $ 3,260 $ 1,000 $ 6,250 Services transferred over time – – 5,250 5,250 $ 1,990 $ 3,260 $ 6,250 $ 11,500


Revenue recognitionDisclosure (cont.)

Excerpt from Accounting Standards Codification Example 42 — Disclosure of the Transaction Price Allocated to the Remaining Performance Obligations

20X8 20X9 Total

Revenue expected to be recognized on this contract as of December 31, 20X7 $1,575(a) $788(b) $2,363

(a) Transaction price = $3,150 ($100 x 24 months + $750 variable consideration) recognized evenly over 24 months at $1,575 per year

(b) $1,575 2 = $788 (that is, for 6 months of the year)

• On June 30, 20X7, an entity enters into two-year noncancellable

contract. • The customer pays fixed consideration of $100 per month and a one-

time variable consideration payment ranging from $0 - $1,000 (that is, a performance bonus).

• The entity estimates that it will be entitled to $750 of the variable consideration.


What are we learning?Key observations and lessons learned from diagnostics

► Understanding the standard’s complexity is necessary for adequate planning► Leveraging a top down strategic scoping approach may reduce the number of

detailed contract reviews required► The process of identifying revenue streams should include consideration of

multiple different categories to disaggregate a company’s business► Surveying can be challenging and time consuming, but may save time in the

long run► Working closely with local management, operations and legal when reviewing

contracts is essential for a comprehensive understanding of the revenue streams

► Templates for gap analysis and contract reviews should include information beyond the technical accounting details

► Extrapolating the impacts of changes in revenue recognition patterns of one or more individual contracts across a larger revenue stream population can be time consuming and may require significant estimates and data inputs


Program overviewBusiness processes and system enablement – critical path

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Governance objective and plan

Revenue streamidentification and

scoping Awareness, education and change management

Full retrospective -- interim processing environment, including cumulative adjustment and “look-back” transaction processing

Other considerations – I/C prices, transfer pricing and indirect taxes

Assess and implement changes to customer contracting process, legal terms or business practices, finance planning and analysis, and investor relations

Individual contract selection and review

Preliminary accounting policy decision

Training and implement new policyExpanded contract review to support

changes and lack thereof

Diagnostic Solution development Implementation

Program governance structure, ongoing management, budget and resource management, dependency analysis, risk management

Communication structure, approach, routine work sessions with stakeholders

Follow TRG, FASB and IASB activities, AICPA and peer group implementation developments

Accounting and disclosuregap analysis

Finalizenew policy

Identify new or different temporary differences Document, train and execute new tax policies and procedures

Transition contract and data approach, consideration and capture until future state environment is live

Maintain legacy processing environmentfor modified retrospective disclosures

Sustain

Develop systems and business processes

requirements

Design systems andprocesses enhancementsUnderstand and assess current

transaction processing by revenue streamDesign and implement I/C changes

Implement systems andprocesses enhancements

Test and remediate I/C changes

Go live in future state environment

Sustain I/C environment

File method changes and adjust transfer pricingIdentify tax method changes and finalize new policy

Modified retrospective -- interim processing environment, including cumulative adjustment

Timely discussion of key implementation considerations with external audit team

Analyze accounting differences and potential financial impacts

Evaluate enhanced disclosure requirements and data to support

Transition method evaluation Transition method selection

2015 2016 2018 2019 and beyond2017

* Dates assume early adoption not elected


Critical pathSample full vs. modified retrospective timelines

Modified retrospective sample timeline

Dataconversion

and cumulative catch-up

(5 months)

Testing(6 months)

Implementation(6 months)

Design**(3 months)

2015 2016 2017

J F M A M J J A S O N D J F M A M J J A S O N D J F M A M J J A S O N D

System enablement evaluation (1 month)

Accounting Diagnostic(3 months) Start year-

end close

2018*

Dual reporting for

footnote disclosure

Typical system blackout dates

*Timelines assume a January 2018 effective date

Phase timeline**Includes solution approach for revenue forecasting

Go-live

Data conversion cumulative catch-up

and reprocessing transaction activity

from January 2016 to April 2017 (5 months)

Testing(6 months)

Implementation(6 months)

Design**(3 months)

System enablement evaluation (1 month)

Accounting Diagnostic (3 months)

Parallel accounting and audit

(6 months)

Turn off oldGAAP

Dual reporting for

2016 and 2017

Full retrospective sample timeline

2015 2016 2017

J F M A M J J A S O N D J F M A M J J A S O N D J F M A M J J A S O N D

2018*

Start year-end close

Record cumulative effect adjustment

Record cumulative effect adjustment

Go-live


FASB developments - Leases


LeasesOverview

► The FASB and the IASB have substantially completed redeliberations on the new leases standards► Key remaining item – effective date

► Key changes to today’s US GAAP guidance include: ► Lessees would recognize assets and liabilities for most leases► New presentation and disclosure requirements for lessees► Real estate-specific guidance would be eliminated► Leases would be classified using a principle similar to IAS 17, Leases► Only costs that would not have been incurred if a lease had not been

executed would qualify as initial direct costs

Q4 2015 Final standard

2014–Q2 2015Redeliberations on second ED

2011–2013Redeliberations and second ED

Q3 2010Exposure draft (ED)

Final standards are not likely to be effective before 1 January 2018


LeasesDefinition of a lease

► A contract is a lease if it both:► Depends on the use of an identified asset (explicitly or implicitly)

► No identified asset if the supplier has a substantive substitution right► Conveys the right to control the use of an identified asset – that is, the

customer has the right to (both): ► Direct the use of the identified asset► Obtain substantially all of the potential economic benefits from directing the use

► Non-lease components of a contract would be accounted for separately under other applicable GAAP ► Subject to practical expedient for lessees


LeasesLease classification

► Lessees and lessors would classify leases using a classification principle similar to IAS 17, Leases ► Similar to US GAAP but without bright lines ► Today’s real estate-specific guidance would be eliminated ► Today’s additional lessor classification criteria would be changed

► Lessees would classify most leases as either: ► Type A – similar to today’s capital leases ► Type B – similar to today’s operating leases► Optional exemption for short-term leases

► Lessors would classify all leases as either: ► Type A – similar to today’s sales-type or direct financing leases ► Type B – similar to today’s operating leases


LeasesLessee accounting

Type A lease Type B leaseInitial recognition and measurement

Initially measure the right-of-use (ROU) asset and lease liability at present value of lease payments. Initial measurement of the ROU asset also includes the lessee’s initial direct costs and prepayments made to the lessor less lease incentives received from the lessor.

Subsequent measurement –

lease liability

Accrete the lease liability based on the interest method using discount rate determined at lease commencement* and reduce the lease liability by the payments made

Measure the lease liability at the present value of remaining lease payments using discount rate determined at lease commencement

Subsequent measurement –

ROU asset

Amortize the ROU asset, generally on a straight-line basis over shorter of lease term or useful life of ROU asset

Measure ROU asset at amount of lease liability and adjust for cumulative prepaid or accrued rents (i.e., non-straight-line rent payments), any lease incentives received and lessee initial direct costs

Income statement effect

► Generally “front-loaded” expense► Separate interest and amortization

► Generally straight-line expense► Single line of lease or rent expense

.

* As long as a reassessment and a change in the discount rate has not been triggered.


LeasesLessor accounting

► Many aspects of today’s lessor accounting would remain the same► Type A leases – similar to today’s sales-type or direct financing leases

► Selling profit (if any) would be deferred if lease does not transfer control of underlying asset to lessee (and collection of lease payments is probable)

► Lessors can recognize profit for Type A leases that meet all of the following: ► Selling profit is included (fair value is greater than carrying value)► Control of the underlying asset is transferred to the lessee ► Collectibility of lease payments is probable

► If collectibilty is not probable: defer income recognition (similar to ASC 606)

► Type B leases – similar to today’s operating leases


Restatement themes


Learning objectives

► Determine whether the accounting topics that most commonly gave rise to restatements in recent years could require action on your part


Restatement themes

► Accounting for income taxes, revenue recognition and statement of cash flows continue to be leading causes of annual restatements

► Correct identified errors as soon as practicable to avoid restatement due to an accumulation of individually immaterial errors

Top three topics – 2014 % Top three topics – 2013 %

Income taxes 17 Income taxes 15

Revenue recognition 13 Revenue recognition 10

Statement of cash flows 6 Statement of cash flows 10


Restatement themesGeneral observations

► Restatements in 2014 not concentrated by issue ► General observations

► Identify and account for key contractual terms► Focus on changes in business and effects on estimates on a timely basis ► Track tax basis of assets and liabilities beyond rollforward of basis

differences ► Consider implications on internal controls

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Annual Accounting and Auditing Update 11 December 2015.

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