The New RevenueRecognition Rules

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John R. Troyer, CPAMichael B. Klein, CPA, MBA

Ciuni & Panichi, Inc.

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Revenue Recognition– ASU 2014-09 (Topic 606), Revenue from Contracts

with Customers– ASU 2015-14 deferred the effective date by one year:

• Public Companies (Entities): Fiscal years beginning after 12/15/17 (i.e., Q1 2018) – RIGHT NOW

– Some NFP’s may be “public entities”

• Private Companies and all Others: Fiscal years beginning after 12/15/18 (i.e., 2019 year ends and Q1 2020)

• Note different interim period.

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Revenue Recognition– Objectives for the new standard:

• A convergence standard (approved by FASB and IASB)

• A comprehensive framework for revenue recognition to replace 200 pieces of guidance in current US GAAP

• Uniform financial statements and disclosures • Comparability across the world and across

industries

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Revenue RecognitionSituations where this does not apply:1. Lease contracts2. Insurance contracts3. Financial instruments4. Guarantees5. Nonmonetary exchanges between entities in

the same line of business to facilitate sales to customers or potential customers.

6. Contributions

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Revenue RecognitionCurrent rules. Recognize revenue when:

1.Persuasive evidence of an arrangement exists2.Delivery has occurred or services rendered3.Seller’s price to buyer is fixed and

determinable4.Collectability is reasonably assured

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Revenue Recognition– Core principle: “An entity should recognize

revenue to depict the transfer of 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.”

Revenue Recognition

Principal vs. Agent• An entity is a principal if it controls the goods or

services before they are transferred to the customer• If principal, recognize the revenue at gross

amount• If agent, recognize revenue at net amount

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Revenue RecognitionNew Rules: 5 step process for revenue recognition:

1. Identify the contract with a customer2. Identify the separate performance obligations in

the contract3.Determine the transaction price4.Allocate the transaction price to the separate

performance obligations in the contract5.Recognize revenue when (or as) the entity

satisfies a performance obligation

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Revenue Recognition1. Identify the contract with a customer

• To meet the definition of a contract, 5 criteria must be met:– Both parties have approved the contract and are

committed to performing their obligations. Can be written or oral.

– Each party’s rights regarding the goods or services to be transferred can be identified.

– Payment terms must be identifiable.– Contract has commercial substance – the risk, timing,

or amount of future cash flows are expected to change as a result of the contract.

– Collection must be probable (i.e., likely to occur).

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Revenue Recognition• Observations:

– A contract modification is a separate contract if both of the following conditions are present: (1) Scope changes due to additional promised goods and services and (2) Price of Contract increases by the “stand alone price” of those services.

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Revenue Recognition2. Identify the separate performance obligations

in the contract• A promise to transfer to the customer goods or

services that are distinct.• A good or service is distinct if both:

– The customer can benefit from the good or service either on its own or together with other resources.

And– The entity’s promise to transfer the good or service to

the customer is separately identifiable from other promises in the contract.

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Revenue Recognition• Observations:

– Factors that suggest two or more promises are not distinct within a contract.• Seller provides a significant service of integrating

various goods or services promised in a contract.• Good or service significantly modifies/customizes

another goods or services promised in a contract.• Good or service is highly dependent on, or highly

interrelated with, other goods or services promised in a contract.

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Revenue Recognition• Observations:

– New windows would not be “distinct” in the construction of a new home. (i.e., not a performance obligation therefore do not recognize revenue separately.)• While the windows are capable of being distinct.• Homebuilder decides its construction services are not distinct

within the context of the contract.– Homebuilder provides a significant service of integrating

the construction into a single output (new home).

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Revenue Recognition

3. Determine the transaction price• The amount of consideration to which an entity

expects to be entitled in exchange for transferring promised goods and services.

• Transaction price may include fixed amounts, variable amounts, or both.

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Revenue Recognition3. Determine the transaction price

• Only recognize revenue where entity has rights (i.e., exclude customer options).

• If you have rights, adjust for variable consideration (expected discounts, refunds, rebates.) Use either expected value method (probability-weighted) or “most likely amount” method (if only two potential outcomes). Change in estimates may occur in future periods.

– When using a probability-weighted approach.• For example: 80% probability of realizing $130 and 20%

probability of realizing $110 would equal recognized revenue of $126 ((80%*130)+(20%*$110)).

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Revenue Recognition3. Determine the transaction price

• Variable Consideration subject to the concept of “Constraint.”

• Old rule: revenue had to be fixed and determinable• Now you can estimate and recognize future variable

consideration based on “what you expect to receive.”• Subject to a constraint rule, which stipulates that

estimated revenue must be adjusted downward to exclude any amount for which it is “probable” that a significant reversal will occur in the future.

• May lead to earlier revenue recognition, especially in technology industries.

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Revenue RecognitionObservations:

– Adjust for time value of money or financing (if payment terms greater than 1 year). Financing revenue is presented separately from contract revenues.

– Include noncash consideration at fair value.– Refund liability may need to be recorded when

company is expected to refund some or all of the consideration to the customer.

– Change in estimates may occur in future periods.

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Revenue Recognition4. Allocate the transaction price to the separate

performance obligations in the contract• If there are deemed to be separate performance

obligations, use “stand-a-lone selling price” at contract inception of the goods or services underlying each performance obligation.

• If the stand-a-lone selling price is not observable, the entity must estimate it.

• Allocate changes in variable consideration. • Subjective depending on terms of contract.

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Revenue RecognitionObservations• Sellers and service providers frequently sell customers a

combination of goods and services for a single bundled price that represents an overall discount to the combined price of the individual items. Examples of bundled sales for a single discounted transaction price include the following:– Goods and shipping; or– Interrelated pieces of equipment; or– Equipment plus installation.

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Revenue RecognitionObservations

– allocate the discount proportionately to all items in the combined group of goods and services, unless the circumstances indicate that the discount relates only to a subset (one or more but not all) of the performance obligations in the contract.

– Generally, the seller or service provider allocates the variable consideration to the specific performance obligations to which the consideration relates. This may be done proportionately if it relates to each performance obligation.

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Revenue RecognitionObservations• If an observable market price is unavailable, the entity must estimate

the standalone selling price. The seller may use various approaches, such as the following:

• Adjusted market assessment approach: The entity estimates the market price based on observable inputs;

• Expected cost plus margin approach: The entity estimates the standalone selling price by computing the cost of providing the goods or services to the customer and adding its anticipated profit margin;

• Residual approach: The entity estimates the standalone selling price as the total transaction price for a bundle of goods and services less the amount allocated to other performance obligations using other approaches.

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Revenue Recognition5. Recognize revenue when (or as) the entity

satisfies a performance obligation• At the time promised goods or services are

transferred to a customer. • May be as of a point of time or satisfied over

time.• Key concept: When does the customer gain

control?

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Revenue Recognition• Observations:

– Revenue recognized at a point of time, indicators that control has been transferred:• Entity has a present right to payment for the asset• Customer has legal title to the asset• Customer has physical possession of the asset• Customer has the significant risks and rewards of ownership• Customer has accepted the asset

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Revenue Recognition• Observations:

– Revenue must be recognized over a period of timewhen:• The customer simultaneously receives and consumes the

benefits OR• The entity’s performance creates or enhances an asset (e.g.,

work in progress) that the customer controls OR• The entity’s performance does not create an asset with an

alternative use to the entity and the entity has an enforceable right to payment for performance completed to date.

• Conclusion: Construction company likely has to recognize revenue over a period of time.

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Revenue Recognition• Observations:

– Revenue recognized over a period of time• Input Method: Recognize revenue on the basis of the entity’s

efforts to the satisfaction of a performance obligation (e.g., resources consumed, labor hours expended, costs incurred, time elapsed, machine hours used) relative to the total expected inputs. Straight Line may be appropriate if inputs are incurred evenly over time.

• Construction Company (cost-to-cost method) often appropriate.

• Output Method: Recognize revenue based on surveys, appraisals, milestones, time elapsed, and units produced or delivered.

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Revenue Recognition• Observations:

– Contract assets and liabilities may be required: • In some instances, for example, an entity may receive

funds from a customer that represent consideration for a performance obligation that the entity has not yet fulfilled. If so, the entity must recognize a contract liability (sometimes referred to as “deferred revenue”).

• Conversely, an entity may earn funds through the satisfaction of a performance obligation for which payment is not yet due. If so, the entity does not record a receivable; it records a contract asset.

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Revenue RecognitionNew Rules: 5 step process for revenue recognition:

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 in the contract.5.Recognize revenue when (or as) the entity

satisfies a performance obligation.

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Revenue RecognitionIncreased disclosure (non public companies):1. Timing of transfer of goods and services (e.g., point in time

or period of time recognition)2. Opening and closing balances of a/r, contract assets, and

contract liabilities3. What constitutes a performance obligation and how is it

typically satisfied (e.g., upon shipment, services rendered, etc.)

4. Significant variable consideration5. Significant financing components6. Obligations for returns, refunds, warranties

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Revenue RecognitionWhat should you do now?– Understand your current revenue streams

• Review your contracts.• Point of sale or over a period of time?• Any variable revenue (customer options, returns,

incentives)?• Do you finance customers over long-term contracts?

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Revenue RecognitionWhat should you do now?– Walk through the five step process with your

business revenues.– Will recognizing revenue change and will it impact:

• Compensation arrangements• Income taxes• Debt covenants• Your information systems

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Any questions, please contact:

Michael B. Klein, CPA,MBA mklein@cp-advisors.com

John R. Troyer, CPA jtroyer@cp-advisors.com