NARUC: REVENUE RECOGNITION

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Transcript of NARUC: REVENUE RECOGNITION

Microsoft PowerPoint - 2017-09-11 Revenue Recognition - NARUC- FINALMazars USA LLP is an independent member firm of Mazars Group.
NARUC: REVENUE RECOGNITION JULIE PETIT – AUDIT SENIOR MANAGER
BRIAN JONES – AUDIT SENIOR MANAGER
MONDAY, SEPTEMBER 11TH, 2017 Mazars USA LLP is an independent member firm of Mazars Group.
Mazars USA LLP is an independent member firm of Mazars Group.
AGENDA
• Overview
• Other aspects
OVERVIEW – GENERAL INFORMATION
The new standards were issued in May 2014 and replace nearly all existing US GAAP and IFRS guidance on revenue recognition. Several amendments were issued in 2016 that clarified the new guidance.
The Financial Accounting Standards Board (FASB) and International Accounting Standards Board (IASB) Joint Transition Resource Group for Revenue Recognition (TRG) and the American Institute of Certified Public Accountants’ (AICPA) industry task forces are actively discussing issues.
Both Boards amended their standards resulting in some additional differences • For a summary of all differences between ASC 606 and IFRS 15
Page 5
OVERVIEW – SCOPE AND EXCEPTIONS
Contracts with customers Sale of some nonfinancial assets that are not an output of the entity’s
ordinary activities (e.g., property, plant and equipment; real estate; intangible assets)
Everything covered by other standards Leasing contracts Insurance and other contracts Financial instruments contracts Certain nonmonetary exchanges Certain put options on sale and repurchase agreements Guarantees
What is in scope or affected
What is not in scope
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Adoption of ASC 606 Requires evaluation of the policies,
processes, systems and controls by which revenue is recognized and disclosed
Utilizes more principles than prescriptive guidance and may require more estimates and greater judgment
Eliminates industry-specific guidance Potential changes:
Change in the number of performance obligations (identify, track, allocate revenue)
Timing of revenue patterns Disconnect between billing
and revenue recognition, in some cases
Products (SAB Topic 13)
Construction-type and production-type contracts
(ASC 605-35, e.g., completed
Software (ASC 985-605)
Multiple-element arrangements (ASC 605-25)
OVERVIEW – OBJECTIVE OF THE STANDARD - TRANSFER OF CONTROL
To clarify the principles for recognizing revenue and to develop a common revenue standard for US GAAP and IFRS that would:
– Remove inconsistencies and weaknesses in existing revenue requirements – Provide a more robust framework for addressing revenue issues – Improve comparability of revenue recognition practices across entities, industries, jurisdictions and
capital markets – Provide more useful information to users of financial statements through improved disclosure
requirements – Simplify the preparation of financial statements by reducing the number of requirements to which
an entity must refer
One global ERP
Differences in the number of performance obligations
Multiple, disparate IT systems
Less complex More complex
OVERVIEW – EFFECTIVE DATES
Under IFRS – Effective for annual periods beginning on or after January 1, 2018. Early 
adoption is permitted.
Under US GAAP – U.S. Public Companies: Effective for annual reporting periods beginning after 
December 15, 2017 (December 2018 calendar year end)
– U.S. Nonpublic Companies: Effective for annual reporting periods beginning after  December 15, 2018 (December 2019 calendar year end)
– Early application is permitted, but not before the original effective date (i.e.  annual periods beginning after December 15, 2016)
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New GAAPLegacy GAAP Legacy GAAP
Legacy GAAP
20182016 2017
(1) This slide does not reflect early adoption
KEY CONSIDERATIONS UNDER THE NEW MODEL
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KEY CONSIDERATIONS UNDER THE NEW MODEL SUMMARY OF THE NEW REVENUE RECOGNITION 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:
Step 2:
Step 3:
Step 4:
Step 5:
Identify the performance obligations in the contract
Determine the transaction price
Allocate the transaction price to the performance obligations
Recognize revenue when (or as) the entity satisfies a performance obligation
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KEY CONSIDERATIONS UNDER THE NEW MODEL WHAT MAKES THIS COMPLEX?
Allocation
Exceptions for allocating variable consideration and discounts
Recognition timing
Measuring progress over time
Determining performance obligations (i.e., distinct goods and services)
Options granting a material right
Transaction price
Variable consideration, including bonuses, returns, concessions, discounts
Significant financing component
Constraint on variable consideration
Principal versus agent
Assessing collectibility
Page 15
STEP 1: IDENTIFY THE CONTRACT WITH THE CUSTOMER DEFINITION OF A CONTRACT A contract is defined as an agreement between two or more parties that creates
enforceable rights and obligations. – Can be written, oral or implied, but must meet specific criteria – Does not exist if both parties can cancel a wholly unperformed contract
without penalty A contract exists only if all of the following criteria are met:
– Parties have approved the contract and are committed to perform – Each party’s rights regarding the goods and services are identifiable – The payment terms for the goods and services are identifiable – Contract has commercial substance – It is probable that the entity will collect substantially all of the consideration it’s entitled
to in exchange for the transfer of goods/services to the customer These criteria are assessed at the inception of the arrangement.
– If the criteria are met at inception, reassessment only occurs if there is a significant change in facts and circumstances
– If the criteria are not met at inception, continue to assess
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STEP 1: IDENTIFY THE CONTRACT WITH THE CUSTOMER WHAT HAPPENS WHEN THE 5 CRITERIA ARE NOT MET? (1/2)
Does the contract meet the criteria listed in ASC 606/IFRS 15 at inception?
Continue to assess the contract to determine whether the criteria are
subsequently met
Yes
No
The contract is accounted for in accordance with ASC 606/IFRS 15 i.e. revenue may be recognised
No reassessment of those criteria unless there is an indication of a significant change in facts and
circumstances (e.g. a change in customer’s credit risk)
See next slide for the accounting consequence in case cash is
received
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STEP 1: IDENTIFY THE CONTRACT WITH THE CUSTOMER WHAT HAPPENS WHEN THE 5 CRITERIA ARE NOT MET? (2/2)
Did the entity received consideration from the customer (and the criteria for identifying a contract are not met)?
Yes
Does the entity have no remaining obligations to transfer goods or services to the customer and all, or substantially all, of the
consideration promised by the customer has been received by the entity and is non-refundable?
Yes
No Nothing to do
Has the contract been terminated and the consideration received from the customer is non-refundable?
Yes
No
Recognize the consideration received as a liability until one of the above events occurs or until the criteria in ASC 606/IFRS
15 are subsequently met
Page 18
STEP 1: IDENTIFY THE CONTRACT WITH THE CUSTOMER COMBINING CONTRACTS Two or more contracts entered into at or near the same time with the same customer
(or related parties) are combined if any of the following conditions are met: – Contracts are negotiated as a package with a single commercial objective – Consideration in one contract depends on the price or performance of the other
contract – Some or all of the goods and services promised in the contracts are a single
performance obligation
Multiple contracts may be combined into a portfolio of contracts with similar characteristics if the entity reasonably expects the effects on the financial statements would not materially differ
Criteria are generally consistent with underlying principles in current guidance on combining contracts
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STEP 1: IDENTIFY THE CONTRACT WITH THE CUSTOMER CONTRACT MODIFICATIONS A contract modification is any approved change in the scope or price (or both) of a contract
that creates new, or changes existing enforceable rights and obligations of the parties to the contract. Modifications are accounted for differently, depending on the attributes of the remaining goods and/or services
Yes
The new goods and services should be treated as a separate contract.
Is the contract modification for additional goods and services that are distinct and
at their standalone selling price?
Prospective: Allocate the remaining transaction price to the remaining goods and services
(transaction price for performance obligations already satisfied is not adjusted)
Are the remaining goods and services distinct from those already provided?
Blend of two
Retrospective: Update the transaction price and measure of progress for the single performance obligation (recognize change as a cumulative
catch-up to revenue)
Page 21
STEP 2: IDENTIFY PERFORMANCE OBLIGATIONS
A performance obligation is a promise (explicit or implicit) to transfer to a customer: – A distinct good or service or – 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 practices
Incidental obligations or marketing incentives may be performance obligations (e.g., “free” maintenance provided by automotive manufacturers, loyalty points provided by a hotel)
Does not include activities that an entity must undertake to fulfill a contract (e.g., setup activities) unless a good or service is transferred
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STEP 2: IDENTIFY PERFORMANCE OBLIGATIONS
Evaluate whether multiple promised goods or services work together to deliver a combined
output(s) Assess whether the good or service is
integrated with, highly interdependent on, highly interrelated with, or significantly
modifying or customizing other promised goods or services in the contract
Step 1 – Focus on whether the good or service is
capable of being distinct
on its own
Customer can use good or service with other readily available resources
Or
Step 2 – Focus on whether the good or service is distinct in the context
of the contract
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STEP 2: IDENTIFY PERFORMANCE OBLIGATIONS IDENTIFY PERFORMANCE OBLIGATIONS – EXAMPLE
Entity enters into a contract to manufacture and install customized equipment and provide maintenance services for a five-year period Installation services include the integration of multiple pieces of
equipment at the customer’s facility in order for the equipment to operate as a single unit Equipment cannot operate without installation Entity sells equipment and installation services together and does not
sell installation separately Other vendors can provide the installation services The maintenance services are sold separately
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STEP 2: IDENTIFY PERFORMANCE OBLIGATIONS IDENTIFY PERFORMANCE OBLIGATIONS – EXAMPLE
Step 2 – Distinct within the context of the contractStep 1 – Capable of being distinct
Maintenance Services have a distinct function, because they are sold separately. Move to Step 2.
Services are not highly interrelated. No integration, modification or customization required. Services are distinct.
Installation
Equipment
Good cannot be used without installation, but customer can obtain installation from another source. Good is distinct. Move to Step 2.
Equipment and installation are highly interrelated. Significant customization is required during installation. Good isn’t distinct on its own, because it must be combined with installation.
Installation can be provided by multiple vendors, so service is distinct. Move to Step 2.
See discussion above. Equipment and installation are not distinct from one another.
In this example, there would be two performance obligations: (1) the equipment and installation, because they are not individually distinct; (2) maintenance services, because they are distinct services in the contract.
Page 25
STEP 2: IDENTIFY PERFORMANCE OBLIGATIONS SERIES OVERVIEW
If a good or service is part of a series of distinct goods or services that are substantially the same and have the same pattern of transfer, the series must be treated as one performance obligation if:
– Each distinct good or service in the series would be satisfied over time – The same method of progress is used to measure the transfer of each distinct good or
service in the series to the customer The FASB has confirmed that the series guidance is not an optional practical
expedient rather than a requirement
Distinct & substantially
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STEP 3: DETERMINE THE TRANSACTION PRICE
Transaction price is the amount of consideration to which an entity expects to be entitled to in exchange for transferring promised goods or services to a customer, excluding amounts collected on behalf of third parties.
Transaction price may vary because of variable consideration (e.g., bonuses, discounts, rebates, refunds, credits, price concessions, incentives, market-based fees).
Identifying variable consideration is an important step in the new model because the constraint has to be considered for each type of variable consideration.
An entity shall estimate the amount of consideration using the technique that will best predict the amount to which the entity will be entitled.
Expected value
Sum of the probability-weighted amounts in a range of possible outcomes
Most predictive when the transaction has a large number of possible outcomes
Can be based on a limited number of discrete outcomes and probabilities
Most likely amount
Single most likely amount in a range of possible outcomes
Most predictive when transaction will produce few outcomes
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STEP 3: DETERMINE THE TRANSACTION PRICE CONSTRAINT ON VARIABLE CONSIDERATION
An entity should include an amount of variable consideration in the transaction price only to the extent that it is probable that a significant reversal in the amount of the cumulative revenue recognized will not occur when the uncertainty associated with the variable consideration is resolved.
– Probable threshold for US GAAP – Highly probable threshold for IFRS
“Significant” is relative to the cumulative revenue recognized.
At each reporting date, an entity should update its estimate of a transaction price that includes variable consideration.
Consider both the likelihood and magnitude of a revenue reversal.
Common types and events that cause consideration to be variable Bonuses Incentive payments Penalties Refunds Market-based fees Discounts Returns Money-back guarantees Price concessions
Volume rebates Service level agreements Liquidating damages
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STEP 3: DETERMINE THE TRANSACTION PRICE VARIABLE CONSIDERATION
The most current GAAP limits the amount of revenue allocable to the amount not contingent on the future satisfaction of performance obligations. The new model would allow variable consideration to be allocated to performance obligations, provided that the amount is not subject to significant reversals.
Because the fixed or determinable criterion goes away, treatment of variable consideration under the model may result in “sell-through” arrangements being treated as “sell-in,” leading to revenue being recognized sooner.
While clients may currently estimate the impact of volume discounts and other incentives, the requirement to look forward instead of at history and the variable consideration constraint rules will create differences, particularly when entering new markets or rolling out new products to customers.
Potential impact
STEP 4: ALLOCATE THE TRANSACTION PRICE TO THE PERFORMANCE OBLIGATION
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STEP 4: ALLOCATE THE TRANSACTION PRICE TO THE PERFORMANCE OBLIGATIONS Transaction price is allocated to each separate performance obligation in “an amount that depicts the
amount of consideration to which the entity expects to be entitled in exchange for transferring the promised goods or services.”
– Transaction price generally allocated based on relative stand-alone selling prices – When stand-alone selling price is not observable, entity is required to estimate it
• Maximize the use of observable inputs • Apply estimation methods consistently in similar circumstances • Use of residual technique is allowed in limited situations
– Standalone selling prices used to perform the initial allocation are not updated after contract inception
Determine the stand-alone selling price of each performance obligation
Best indication of the stand- alone selling
price
Existence of an observable selling price?Yes No
Page 32
STEP 4: ALLOCATE THE TRANSACTION PRICE TO THE PERFORMANCE OBLIGATIONS
Standalone selling price
Possible estimation methods
Mazars USA LLP is an independent member firm of Mazars Group.
When stand-alone selling price is not observable, entity is required to estimate it. The following methods can be used:
33
• Estimated price in relevant markets that a customer would be willing to pay for the good or service.
Adjusted Market Assessment Approach
• Forecasted total costs plus an appropriate margin for the good or service.
Expected Cost Plus Margin Approach
• Subtract the sum of observable stand-alone selling prices of other goods or services from the total contact price.
Residual Approach (approach of last resort)
STEP 4: ALLOCATE THE TRANSACTION PRICE TO THE PERFORMANCE OBLIGATIONS
Page 34
STEP 4: ALLOCATE THE TRANSACTION PRICE TO THE PO EXAMPLE 1 Entity A enters into an agreement to sell hardware, professional services and maintenance
services for $200,000
Entity A determines that each of the promised goods or services represents a separate performance obligation
Because Entity A frequently sells professional services and maintenance on a standalone basis, it uses those transactions to determine standalone selling prices of $25,000 and $15,000, respectively
Entity A rarely sells the hardware on a standalone basis, so it estimates the standalone selling price at $185,000 based on the hardware’s underlying cost, Entity A’s targeted margin and the amount of margin that Entity A believes the market will bear (i.e., the expected cost plus margin approach)
Performance obligation
Hardware $185,000 82.2 $(20,600) $164,400 Professional services 25,000 11.1 (2,800) 22,200 Maintenance services 15,000 6.7 (1,600) 13,400 Total $225,000 100.0 $(25,000) $200,000
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STEP 4: ALLOCATE THE TRANSACTION PRICE TO THE PO EXAMPLE 2 Assume the same facts as Example 1, except the arrangement also includes software for a
total fee of $250,000
Entity A determines the software deliverable is also a separate performance obligation
Entity A never sells the software on a standalone basis
Entity A has bundled the software into a number of different arrangements, with the pricing for that element ranging from $15,000 to $125,000
Calculation of the standalone selling price of the software using the residual technique:
Arrangement consideration $250,000 Less estimated standalone selling prices: Hardware (185,000) Professional services (25,000) Maintenance services (15,000) Standalone selling price of software $25,000
STEP 5: RECOGNIZE REVENUE WHEN (OR AS) EACH PERFORMANCE OBLIGATION IS SATISFIED
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STEP 5: RECOGNIZE REVENUE WHEN (OR AS) EACH PERFORMANCE OBLIGATIONS IS SATISFIED
Model is based on transfer of control Control is the ability to direct the use of, and obtain substantially all of the remaining
benefits from, the asset
Control includes the ability to prevent other entities from directing the use of, and obtaining the benefits from, an asset
The benefits of an asset are the potential cash flows that can be obtained directly or indirectly in many ways, such as by:
– Using the asset to produce goods or provide services – Using the asset to enhance the value of other assets – Using the asset to settle liabilities or reduce expenses – Selling or exchanging the asset – Pledging the asset to secure a loan – Holding the asset
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STEP 5: RECOGNIZE REVENUE WHEN (OR AS) EACH PERFORMANCE OBLIGATIONS IS SATISFIED
Revenue is recognized upon satisfaction of a performance obligation by transferring the promised good or service to a customer
Performance obligations are either satisfied over time or at a point in time
To help make this determination, the standard includes criteria for determining when control transfers over time
– If a performance obligation does not meet any of those criteria, control transfers at a point in time
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STEP 5: RECOGNIZE REVENUE WHEN (OR AS) EACH PERFORMANCE OBLIGATIONS IS SATISFIED
Control of goods and services is transferred over time if one of the following three criteria is met:
Entity creates or enhances an asset that the customer controls as it is
created or enhanced
Entity’s performance does not create an asset with alternative use, and entity has an enforceable right
to payment for performance completed to date
Services Contracts
Customer is receiving and consuming benefits of the entity’s
performance as the entity performs
If no criteria are met, control transfers at point in time
Construction Contracts Consultants Services, Custom Products
Page 40
STEP 5: RECOGNIZE REVENUE WHEN (OR AS) EACH PERFORMANCE OBLIGATIONS IS SATISFIED TRANSFER OF CONTROL
• Is the entity restricted contractually from directing the  asset for another use during the creation or  enhancement of that asset? (contractual restriction must  be substantive) OR
• Is the entity limited practically from directing the asset in  its completed state for another use? (e.g. design  specifications that are unique to a customer or asset  located in remote areas) – Consider the asset that is  ultimately transferred
How to determine that the  created asset has no 
alternative use to the entity?
Assessment is made at  contract inception
• Consider the terms of the contract as well as any laws  that apply to the contract that could supplement those  contractual terms AND
• At all times throughout the duration of the contract,  the  entity must be entitled to an amount that at least  compensates the entity for the performance completed  to date (if the contract is terminated by the customer or  another party for reasons other than the entity’s failure  to perform as promised)
How to determine that the  entity has an enforceable 
right to payment for  performance completed to 
date?
Right to payment need not be  a present unconditional right
Both aspects in the  context of § 35(c)!
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STEP 5: RECOGNIZE REVENUE WHEN (OR AS) EACH PERFORMANCE OBLIGATIONS IS SATISFIED EXAMPLE 1
Issue: – An entity enters into a contract with a customer to build an equipment. – Payment schedule in the contract is as follows:
• 10% of the contract price at contract inception (advance payment) • 50% of the…