READY FOR REVENUE RECOGNITION?

BDO USA, LLP, a Delaware limited liability partnership, is the U.S. member of BDO International Limited, a UK company limited by guarantee, and forms part of the international BDO network of independent member firms.

READY FOR REVENUE RECOGNITION? Implementation Lessons Learned for Tech Companies

June 21, 2018

READY FOR REVENUE RECOGNITION? 2

AFTABJAMIL

Assurance Partner & Global Technology Practice Leader

[email protected]

KENGEE

National Assurance Practice Partner

[email protected]

HANK GALLIGAN

Assurance Director & Software Leader in BDO’s Technology

Practice

[email protected]

CONNIE CUNNINGHAMNational Tax Office Accounting Methods Managing Director

[email protected]

MICHAEL STEVENSON

National Assurance Practice Partner &

National Accounting and Reporting

Advisory Services Practice Leader

[email protected]

WITH YOU TODAY


Revenue Recognition Overview

Differences Between the Old & New Rules

Implementation “Lessons Learned”

Tax Accounting Method Implications

Preparing for Adoption

Questions & Answers

AGENDA

REVENUE RECOGNITION OVERVIEW: OVERVIEW OF THE NEW STANDARD

WHAT: ASC 606, Revenue From Contracts With Customers

WHO: Financial Accounting Standards Board (FASB) & International Accounting Standards Board (IASB)

WHEN: Released May 28, 2014

WHY: Develop a single principle-based revenue standard for U.S. GAAP &International Financial Reporting Standards (IFRS)

Revenue standard aims to improve accounting for contracts with customers by: Providing a robust framework for addressing revenue issues as they arise Increasing comparability across industries and global capital markets Requiring better disclosure

5 New Revenue Recognition Guidance

WHAT IS REVENUE RECOGNITION (ASC 606)?

The standard impacts ALL contracts with customers, except:


REVENUE RECOGNITION: THE SCOPE

Lease contracts

Insurance contracts

Financial instruments

Guarantees

Non-monetary exchanges in the same line of business to facilitate sales to customers

PUBLIC ENTITIESFirst interim period within annual reporting periods beginning after Dec. 15, 2017

NONPUBLIC ENTITIESAnnual reporting periods beginning after Dec.15, 2018 and interim periods within annual periods beginning after Dec. 15, 2019


REVENUE RECOGNITION: THE DEADLINES

REVENUE RECOGNITION RESOURCE CENTER: https://www.bdo.com/services/assurance/revenue-recognition/overview

TECHNICAL GUIDANCE


REVENUE RECOGNITION: RESOURCES

ARCHIVED WEBINARS

Revenue from Contracts with Customers – Software Industry

Revenue from Contracts with Customers – Hardware Industry

ASC Topic 606: Revenue from Contracts with Customers[Practice Aid]

Revenue Recognition Readiness Checklist: A Guide for Privately Held Tech Companies

https://www.bdo.com/services/assurance/revenue-recognition/overview

https://www.bdo.com/insights/industries/tech-life-sciences/bdo-knows-software-(1)

https://www.bdo.com/insights/industries/tech-life-sciences/bdo-knows-hardware

https://www.bdo.com/getattachment/5fee3ad8-c8b8-4c8e-bbe6-d86a6c5d8eea/attachment.aspx?Revenue-Recognition-Practice-Aid.pdf

https://www.bdo.com/insights/industries/tech-life-sciences/revenue-recognition-readiness-checklist

DIFFERENCES BETWEEN THE OLD & NEW RULES


• New standard will impact ALL tech companies following U.S. GAAP

• Companies in subsectors with specialized guidance or industry practices, such as software and semiconductors, will be especially impacted.

• Tech companies will encounter new opportunities and challenges related to the standard.

• There may not be dramatic changes, but the fundamental thinking around accounting has changed, and companies will need to investigate and document the impact.

CONSIDERATIONS FOR TECHNOLOGY COMPANIES


WHAT HAS CHANGED: TOP CONSIDERATIONS FOR TECH

Transaction with Probable Change Existing GAAP Accounting ASC 606 Accounting

Elimination of Sell-Through Accounting

Companies must defer revenue recognition if they cannot reasonably estimate product returns or price concessions until those rights lapse or an estimate can be made. As a result, many companies do not recognize revenue on sales to distributors until the distributor has sold the product “through” to the end users, which is the point at which uncertainty around returns and concessions has ceased.

Companies must estimate the transaction price and recognize revenue for the portion of this estimated transaction price for which it is probable that there will not be a significant reversal.

Vendor-Specific Objective Evidence (VSOE)

Special accounting rules for companies that sell bundled software and/or software-related deliverables.

Eliminates these guidelines. In particular, companies will no longer be required to have VSOE to separate elements (now distinct performance obligations) in a bundled software arrangement, which will be a big change in practice.

Term/Perpetual Licenses Revenues from term/perpetual software licenses may be recognized upon delivery, provided the license can be unbundled from other deliverables in the arrangement, such as post-contract support (PCS).

Contains a different approach to determining whether revenues from any license agreement—term or perpetual—should be recognized over time or at a point in time.


WHAT HAS CHANGED: TOP CONSIDERATIONS FOR TECH

Transaction with Probable Change Existing GAAP Accounting ASC 606 Accounting

Extended Payment Terms Deferral of revenue recognition if payment terms extend more than 12 months from the date of delivery of a software license.

No longer has “bright-line” or prescriptive requirements like the 12-month extended payment restrictions in current GAAP.

Specified Upgrades and Product Roadmaps

Somewhat punitive rules when companies offer “specified upgrade rights” to customers. No VSOE for the specified features fully defer all revenues under the arrangement until the upgraded software features are delivered to the customer.

Software licenses and the specified upgrades could be viewed as distinct performance obligations.

Cost of Contracts/Amounts Billed to Customers

Decision left to company policy. Specific guidelines and rules provided.

IMPLEMENTATION “LESSONS LEARNED”


There’s a reason why FASB has given tech companies such a long runway to prepare.

Companies often:

• Wait too long to get started

• Fail to build a project plan with dates and project leads

• Assume they already know the end result or that it will not change

• Oversimplify certain aspects of the new standard

Note: All companies should go through the 5-step model, regardless of what they think their end result will be.

PLANNING


Companies often:

• Overlook required changes to their commission expense accounting

• Struggle with figuring out whether revenue should be recognized over time or a point in time

• Struggle to prepare required disclosures

• Overlook the need to have an active dialogue with their auditors

IMPLEMENTATION


Existing GAAP Accounting ASC 606 Accounting

Companies typically expense their commissions in two ways: 1) as a period cost at the time of sale; or 2) over the life of the contract.

Many companies currently capitalize costs as contracts are closed and/or expense their commissions at the time of payment.

Capitalized contract costs are amortized as the performance obligations in the contract are transferred to the customer.

In other words, companies that enter into multi-year contracts with their customers are required to amortize the commission expenses for their sales teams over the entire length of the contract and contract renewals to which the commission relates.

This will require significant judgments and estimates on the part of accounting—for example, regarding the expected customer life.

Companies typically only need to manage and account for sales commissions at the sales representative level.

Companies will need to account for commissions to a much higher level of detail, including capturing all the relevant characteristics of a transaction and more.

This may require investment in new systems and processes that can help companies capture this higher level of transactional detail.

IMPLEMENTATION: Commission Expense Accounting



• Company sells testing equipment bundled with a 1-year support contract, which provides for unspecified updates on the equipment’s embedded firmware for a total price of $100,000.

• The testing equipment and the support contract are distinct performance obligations.

• Revenue allocated to the testing equipment will be recognized upon delivery to the customer.

• SSP of the equipment is $80,000 and SSP of the support contract is $20,000.

• The support contract is considered a stand ready obligation for which its allocated revenue will be recognized ratably over the 1-year contract term.

• A commission liability is incurred at the time of product delivery equal to 6% of the total transaction price of $6,000.

• No commissions are paid upon renewal of the support contract.

• The support contract is renewable at a price of $20,000 per year.

• Experience has shown that customers typically renew the support contract for two additional years.

EXAMPLE



Distinct Performance Obligations Recognition Amount Commission Expense

Equipment $80,000 $3,429 Point in Time

Support contract $20,000 $857 Overtime

Anticipated Renewals (Years 2 & 3) $20,000$20,000

$857$857 Overtime

Total $140,000 $6,000

Description of transactions

Different acceptable methods exist for performing this calculation.

The new standard requires significantly expanded disclosures about revenue recognition, including both quantitative and qualitative information about:

• The amount, timing, and uncertainty of revenue (and related cash flows) from contracts with customers

• The judgment, and changes in judgment, used in applying the revenue mode

• The assets recognized from costs to obtain or fulfill a contract with a customer


HEADS UP: EXPANDED DISCLOSURES


Going through FASB’s 5-step revenue recognition model may help companies rethink their approach to:

BUSINESS OPERATIONS IMPLICATIONS

• Pricing

• Sales commission plans

• Information governance or data collection

• Contract deals

• Term licenses

TAX ACCOUNTING METHOD IMPLICATIONS


• Tax revenue recognition is governed by Section 451, which generally requires income recognition the earliest of when it is earned, due, or received.

• Existing “book” [i.e. accounting]/tax differences resulting from tax rules vs. old GAAP rules will likely change as a result of ASC 606 (or new “book”/tax differences will be created).

• Limited “book” conformity rules so far.

TAX REVENUE RECOGNITION: IN GENERAL


• Common tax method for timing of revenue recognition: “Tax follows books.”

• If “tax follows books,” and “books” makes changes to comply with ASC 606, then tax has 3 options:

1. Tax stays put (possible method change required for advance payments).

2. Tax shifts to follow the new book treatment (method change required).

3. Tax shifts to something completely different (method change required).

• Which option a company decides on depends on whether the proposed “book method” is consistent with the tax law.

• Note: Tax preparers must be familiar with the accounting changes resulting from the new standard in order to properly assess the subsequent impact on their tax accounting methods, if any.

TAX ACCOUNTING METHOD IMPLICATIONS


• Tax has been lagging behind.

• The IRS is seeking feedback re: tax issues from companies, but companies are not yet prepared to give it.

• Additional guidance is still needed after the IRS’ release of Revenue Procedure 2018-29.

• Taxpayers should also consider additional complexities related to interaction with the new revenue recognition rules under tax reform.

• Tax professionals must be prepared to face many challenges ahead.

TAX & ASC 606: CHALLENGES TODAY

PREPARING FOR ADOPTION

PHASE 1 – SCOPING AND GAP ANALYSISTake an inventory of revenue streams identifying those to be impacted. Prepare a “gap analysis” of ASC 605 vs. ASC606 for those revenue streams addressing:

PHASE 2 - TECHNICAL ANALYSISDetermine specific application of issues identified in Phase 1, including method of determining standalone selling price, pricing controls, identifying specific contracts costs to be capitalized, amortization periods and methodologies and lookback periods for revenue contracts and contract costs. Identify broad systems and business process requirements.

PHASE 3 – SYSTEMS CONFIGURATION AND BUSINESS PROCESSESReconfigure systems and business processes based on Phase 2 findings.

PHASE 4 – TESTING/TRANSACTION AUDITING INTERNAL CONTROLSRun historical transactions through parallel systems and business processes reconfigured for ASC 606. Auditors to perform detail transaction testing.

TRANSITION METHOD/ISSUES

5 STEPS OF ASC 606

CONTRACT COSTS

DISCLOSURES

PHASE 5 – FINANCIAL REPORTING AND DISCLOSURESAssess results of Phase 4, record ASC 606 adoption entries and develop disclosures including contract liability rollforwards, summary of remaining performance obligations,etc.


5-PHASE PROCESS FOR ADOPTION

PHASE 1 – SCOPING AND GAP ANALYSISTake an inventory of revenue streams identifying those to be impacted. Prepare a “gap analysis”of ASC 605 vs. ASC 606 for those revenue streams addressing:





5 STEPS OF ASC 606

CONTRACT COSTS

DISCLOSURES

PHASE 5 – FINANCIAL REPORTING AND DISCLOSURESAssess results of Phase 4, record ASC 606 adoption entries and develop disclosures includingcontract liability rollforwards, summary of remaining performance obligations,etc.


ADOPTION TIMETABLE: DEC. 31, 2019 YEAR-END

Sept-Dec

2018

Jan-May

2019

June-Aug

2019

Sept-Dec

2019

Timeline

PHASE 1 – SCOPING AND GAP ANALYSISTake an inventory of revenue streams identifying those to be impacted. Prepare a “gap analysis”of ASC 605 vs. ASC 606 for those revenue streams addressing:





5 STEPS OF ASC 606

CONTRACT COSTS

DISCLOSURES

PHASE 5 – FINANCIAL REPORTING AND DISCLOSURESAssess results of Phase 4, record ASC 606 adoption entries and develop disclosures includingcontract liability rollforwards, summary of remaining performance obligations,etc.


ADOPTION TIMETABLE: JUNE 30, 2020 YEAR-END

Mar-June2019

July–Nov 2019

Dec 2019–Feb2020

Mar – June2020

Timeline


KEY TAKEAWAYS

• The new standard affects EVERY company.

• Don’t wait to start the adoption process.

• Initiate discussions early between accounting, auditors, and tax personnel. Reach out to professionals for assistance with technical positions.

• Pay particular attention to how ASC 606 affects your commission expense accounting, tax accounting, and other atypical scenarios.

• Put all the necessary processes, systems, and resources needed for compliance in place.

Benefits to Starting Today:

• Distributor issues and principal vs. agent considerations

• Contract negotiations to achieve desired results

• Avoidance of lost revenue

30

QUESTIONS & ANSWERS


AFTABJAMIL

Assurance Partner & Global Technology Practice Leader

[email protected]

KENGEE

National Assurance Practice Partner

[email protected]

HANK GALLIGAN

Assurance Director & Software Leader in BDO’s Technology

Practice

[email protected]

CONNIE CUNNINGHAMNational Tax Office Accounting Methods Managing Director

[email protected]

MICHAEL STEVENSON

National Assurance Practice Partner &

National Accounting and Reporting

Advisory Services Practice Leader

[email protected]

CONTACT INFORMATION

READY FOR REVENUE RECOGNITION?

Documents

Transcript of READY FOR REVENUE RECOGNITION?