Revenue Recognition PowerPoint
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1. The New Revenue RecognitionStandard and the Potential Impactson the Construction IndustryBy: Billy R. Robinson, [email protected](540) 434-6736 2. Agenda Why change the standards? Facts and Myths What does it say? What does it mean? Transition What should you do now? Questions 3. Why change the standards? Converge US GAAP and IFRS (although this is now lessimportant than when the project began) Standardize revenue recognition reporting acrossindustries and entities Condense numerous standards into one complete andunderstandable standard eliminates significant amountof industry-specific guidance in GAAP today Principles vs. rules based Better application of the matching principal 4. Facts and Myth Percentage completion eliminated False While the thought process and terminology willbe different, revenue recognized may be similar to themethod used today Revenue recognition allowed on uninstalledmaterials True There is specific language where contractorsmay be allowed to recognize revenue equal to the costof the uninstalled materials if the customer obtainscontrol of the goods 5. Facts and Myth All contracts will have multiple performance obligations False many (not all) contracts will have one performanceobligation. Contractors will still need to evaluate eachcontract for difference performance obligations anddocument conclusions Contractors will have to recalculate all completedcontracts under the new standard when implemented False can either restate prior periods presented, oraccount for contracts in progress and all new contractsgoing forward 6. Facts and Myth Cost to cost can still be used to determinepercentage complete True new standard allows for the use of input oroutput methods to determine percentagecomplete There will be significantly more footnotes in theFS Depends New disclosures will be required withsome relief for nonpublic entities 7. What does it say?After over 1,000 comment letters from the originalexposure draft of which over 350 was from theconstruction industry new standard issued 5/28/14.Core PrincipalRecognize revenue in a manner that matches the transfer of goods orservices to customers in an amount that reflects the consideration theentity expects to receive in exchange for thosegoods or services 8. What does it say?Five Step ProcessStep 1 Identify the contract(s) with a customerStep 2 Identify the performance obligations in the contractStep 3 Determine the transaction priceStep 4 Allocate the transaction price to the performance obligations in thecontractStep 5 Recognize revenue when (or as) you satisfy a performanceobligation 9. What does it say? This is very similar to percentage completionmethod in use today You may apply the standard to a group of contractswith similar characteristics rather than to individualcontracts if it does not materially change thefinancial statements 10. Step 1 Identify the contract(s) with a customer Contract An agreement with consideration between two or moreparties that creates enforceable rights and obligations Must have: Both parties approval Identified payment terms Substance and enforceable rights Probable collectability 11. Combination of Contracts If multiple contracts are entered into with the samecustomer at the same time, they should be combinedand accounted for together as one contract if one ofthese is true: They are negotiated as a package with one objective Payment for one contract depends on the price orperformance of another The goods/services in the contracts are a singleperformance obligation 12. Change Orders Account for as a separate contract if: Scope increases as the addition of goods/services are distinct and, Price of contract increases by your standalone selling price ofadditional goods/services provided Account for as termination of current contract and creation of newcontract if: Remaining goods/services are distinct from goods/servicestransferred before contract modification Account for as modification of existing contract if: Remaining goods/services are not distinct 13. Change Orders Unpriced Change Orders If parties have approved a change in the scope, but havenot yet determined the corresponding change in price, theentity should estimate the change to the contract asvariable consideration You will estimate the price based on a probability-weightedor most likely amount approach provided that it is probable. Most change orders will not be accounted for as aseparate contract due to Change orders generally dont provide distinct goods orservices as they are usually interrelated to the originalcontract Change orders are typically based on the goal of obtainingone commercial objective for the overall contract. 14. Step 2 Identify the performance obligations in the contract Performance Obligations A promise to transfer a good or service If there are multiple promises, they should be accountedfor as separate performance obligations if they aredistinct 15. Step 2 Distinct The customer is able to obtain a benefit and the promise isseparately identifiable from other promises Nondistinct items should be bundled together until they aredistinct Most construction contracts will have just one performanceobligation A customer cannot benefit from a partially completed building; notuntil the entire package is completed does it provide a benefit tothe customer 16. Step 3 Determine the transaction price Transaction Price: The amount of consideration(payment) to which an entity expects to receive inexchange for transferring the goods or services Assume the contract will not be renewed, modified, orcancelled More complex when it comes to possible awards orincentive payments if they are probable, they shouldbe included in the transaction price from the beginning 17. Variable Consideration Due to discounts, rebates, refunds, credits, priceconcessions, incentives, performance bonuses,penalties, etc. Use the most likely value or probability-weight theexpected value; whichever is most accurate Refund Liability Must be recognized if you expect to refund some (or all)consideration received from customer 18. Time Value of Money Time Value of Money: A dollar today is not the same as adollar a year from now (likely not a big impact) Must be considered if the project is to extend beyond oneyear and there is a significant financing component to thecontract (retainage not considered here) Adjust for time value of money so that revenue isrecognized at an amount that matches what you wouldhave received if consideration had been paid whengoods/services were transferred to customer 19. Other considerations Noncash Consideration Customer-furnished materials Measure at fair value and include in contract revenue, or if that isnot possible, at the standalone selling price for the good/servicerendered or transferred Payments to a customer Credit, coupons, vouchers; these should reduce the transactionprice Claims Accounted for as variable consideration using the expected valueor most likely amount approach provided that collection isprobable 20. Step 4 Allocate the transaction price to the performanceobligations in the contract. (will require judgment) If there is more than one performance obligation in acontract, allocate in an amount that matches theconsideration you would receive for meeting thatobligation independently Allocate variable consideration or discounts to therelated performance obligations rather than to the entirecontract 21. Step 4 It is a separate performance obligation if it is distinct,meaning The customer can benefit from the good or service eitheron its own or together with other resources that arereadily available to them; and, The entitys promise to transfer the good or service to thecustomer is separable from other promises in thecontract This is more significant if things such as engineering,procurement, construction or design/build are included incontracts 22. Step 4 Determine/estimate standalone selling price at contract inception foreach performance obligation and allocate revenues based onrelative standalone selling price Standalone selling price is price at which good/service would besold separately to a customer; this is not necessarily the pricestated in the contract Allocate any subsequent changes in price on the same basis asat inception If standalone information not available, it should be estimatedusing a reasonable method. Cost plus normal margin forexample Amounts allocated to a satisfied performance obligation should berecognized as revenue (or a reduction of revenue) in the period inwhich the transaction price changes 23. Allocation Example Performance Obligation 1 Build a power plant Standalone Selling Price: $100m Performance Obligation 2 Build nearby command center Standalone Selling Price: $50m Transaction Price: $125m Allocated to power plant: $83m (2/3rd) Allocated to command center: $42m (1/3rd) 24. Step 5 Recognize revenue when (or as) you satisfy aperformance obligation Performance obligation is satisfied when The good/service is transferred to the customer The customer obtains control of the good/service 25. Step 5 If a good/service is transferred over time, recognizerevenue over time If the customer receives and uses benefits from your workwhile you perform You create/enhance an asset (work in process) while thecustomer controls the asset being created/enhanced Your performance doesnt create an asset with an alternativeuse to you, and you have an enforceable right to payment forperformance completed to date 26. Step 5 If performance obligation is not satisfied over time,recognize revenue at a point in time when You have a right to payment for the asset, The customer has title, physical possession, and therisks/rewards of ownership of the asset, AND The customer has accepted risk 27. Measuring Progress Output Methods Recognize revenue on basis direct measurement of value of goods/servicestransferred to date relative to total goods/services promised Appraisal of results to date, units delivered, etc. Input Methods Recognize revenue on basis of efforts to the completion of a performanceobligation Hours expended, costs incurred, etc. Exclude inputs that do not contribute to entitys progress in meeting performanceobligation or costs that are not proportionate to progress (uninstalled materials) Method must accurately depict true progress and hopefully iscontemplated in the contract itself 28. Costs of obtaining contract Costs incurred to obtain contract that would not havebeen incurred if contract not obtained (e.g. salescommission) Recognize as asset if expect to recover costs May expense if amortization is less than a year Costs incurred despite whether contract obtained areexpensed regardless of whether contract obtained or not 29. Costs of fulfilling a contract Recognize costs incurred to fulfill a contract as an asset onlyif: Relate directly to a contract that is specifically identifiable Generate/enhance resources of the entity that will be used inmeeting performance obligations in the future Are expected to be recovered If within scope of another topic (e.g. inventory), look tothat guidance first Should be amortized and evaluated for impairment 30. Warranties If warranty is purchased separately, warranty isdistinct and therefore a separate performanceobligation If not purchased separately, account for usingexisting guidance on warranties 31. Disclosures Contracts with customers Revenue/impairments recognized Disaggregation of revenue No real change in reporting of over/under billings Significant judgments and changes in judgments Over time or point in time recognition Used to determine transaction price and allocation Assets recognized from the costs to obtain or fulfill a contract Relief for nonpublic entities 32. Transition Public Entities Periods beginning after 12/15/16 Nonpublic Entities Periods beginning after 12/15/17 generally calendar year2018 May adopt as early as 12/15/16, but no earlier Applies to all contracts with customers Other than those covered by other standards, such as leases,insurance, financing arrangement, financial instruments, andguarantees 33. Transition Have two options during transition period May restate prior periods (retrospectiveapplication) or May apply new standard only to new contractsgoing forward and continue to apply currentstandards to previous contracts Must show a cumulative effect adjustment andadditional disclosures 34. What should you do now? Companies should begin evaluating the impacton Current business activities, including contractnegotiations Key metrics (debt covenants, surety, pre-qual) Taxes Budgeting Controls and processes, IT requirements 35. Q & ATHANK YOU!