Revenue recognition Refresher Final

8/7/2019 Revenue recognition Refresher Final

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Revenue RecognitionRefresher

August 2009

R. A. Maue

VP Controller and Chief Accounting Officer


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RESOLUTIONMADE BY

RICHARD TELLER CRANEFOUNDER OF

CRANE CO.ON JULY 4, 1855

AM RESOLVED TO CONDUCT MY BUSINESS IN THE

STRICTEST HONESTY AND FAIRNESS; TO AVOID ALL

DECEPTION AND TRICKERY; TO DEAL FAIRLY WITH BOTHCUSTOMERS AND COMPETITORS; TO BE LIBERAL AND JUST

TOWARD EMPLOYEES; AND TO PUT MY WHOLE MIND UPON

THE BUSINESS.

THE ESSENCE OF THIS RESOLUTION IS THE BUSINESS POLICY OF CRANE CO. TODAY

I


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Contents

A Few Opening Remarks General Recognition Criteria

Persuasive Evidence of an Arrangement Side Agreements Channel Stuffing

Delivery and Performance Fixed or Determinable Sales Price Collectibility

Important Questions to Ask In All Revenue Arrangements Long Term Contracts

Overview

Applicability Measuring Percentage of Completion

Other & Questions


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A Few Opening Remarks

Critical to the accuracy of Crane Co. financial reporting is the need to ensure sound revenuerecognition processes and related internal controls are designed and operating effectively atyour respective businesses. This document serves as a refresher over the key revenuerecognition principles at Crane Co. As mentioned later in this document, understandingspecific revenue recognition criteria can, at times, be difficult and/or unclear. Not everytransaction is created equally and, therefore, having deep knowledge of specific contractterms, delivery requirements, specific performance obligations as well as payment terms,

among other things, are all critical elements that must be well understood before revenue canbe recognized.

In addition, being mindful of what could go wrong is equally as important. By way ofexample, as referenced in this document, we must be aware of the risk of side agreementsbeing executed as well as the risk of potential channel stuffing at our distributors.

Lastly, after reading through these materials, we ask that you and your teams re-familiarizeyourselves with CP-220, Revenue Recognition, and we strongly encourage (which meansrequire) contacting the Controllers Office for unique or non-standard transactions whendetermining appropriate revenue recognition.

We must be vigilant in the pursuit of continuous improvement over our revenue

recognition processes and related internal controls


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Persuasive Evidence of an Arrangement

Written contracts, agreements, purchase orders, forms,electronic evidence must be in place in order for revenue to berecognized, even if goods have been delivered/servicesperformed.

Impact of side agreements on revenue recognition indicatesthat the original agreement was not final and revenuerecognition was not appropriate

The Companys business practice is to document itsarrangements with customers using formal contracts/purchaseorders

Controls must be in place to ensure side agreements do notoccur


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Side Agreements

A separate agreement between some member or members of acompanys management and the customer (oral or written)

They effectively neutralize the purchase transaction between theCompany and the customer Because they are maintained outside of normal reporting channels and are

typically used to negate some or all terms of the disclosed agreement Which establishes evidence that, in fact, a true sales arrangement was not

originally in effect Which precludes revenue recognition

Stipulations of an improper side agreement might include: liberal rightsof return; rights to cancel orders at any time; being excused from

payment if goods purchased are not resold; extending payment terms;committing company sales personnel to find customers for resellers(examples only)

Sales people have inherent incentive to consider side agreements forcommission generation (fraud risk management)


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Channel Stuffing

Channel Stuffing is a perfect example of this issue, where sales are actuallymade prior to the period-end cutoff, but are stimulated by side agreements suchas a promise to customers of extended return privileges or more liberal paymentterms

Channel stuffing is the business practice where a company, or a sales force within acompany, inflates its sales figures by forcing more products through a distributionchannel than the channel is capable of selling.

The seller is effectively borrowing sales from a later period (which is not sustainable) Channel stuffing can occur in the absence of side agreements (just because there isnt

a side agreement doesnt necessarily mean you dont have channel stuffing)

Channel stuffing has a number of long-term consequences for the company.

Distributors will often return any unsold goods to the company, incurring a carryingcost and also developing a backlog of product inventory.

Even mild channel stuffing can spiral out of control as sales works to make up for priorover-selling.

Discounts used to drive channel stuffing can adversely affect profits

Channel stuffing is illegal

Extended rights of return should be strictly prohibited


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Delivery and Performance

Delivery - Delivery must be demonstrated by the customer takingtitle and assuming the risks and rewards of ownership. Thisprecludes revenue recognition in consignment transactions andalmost every bill-and-hold arrangement you can think of. - Robert

Bayless, SEC

Nonrefundable payments - Even if the cash is in your pocket andyou will never have to give it back, its not revenue for accountingpurposes until the earnings process is complete.


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Delivery and Performance:Customer Acceptance

Presumption is that contractual acceptance terms are substantive, thereforegenerally no revenue recognition until customer acceptance occurs or termslapse

This presumption is overcome in the following cases:

Acceptance provisions grant a right of replacement on the basis of seller specified

objective criteria provided the seller has previously demonstrated that the productmeets these criteria, provisions would be accounted for as warranty

Acceptance provisions are based on customer-specified objective criteria providedthe seller reliably demonstrates that the delivered products or services meet all criteriaprior to customer acceptance.

If provisions are non-standard, seller may not be able to demonstrate compliancewith criteria

If product is for demonstration or evaluation purposes, presumption generallycannot be overcome


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Fixed or Determinable Sales Price

Customer cancellation or termination clauses may be indicative of anincomplete transaction.

Short-term rights of return, such as customary rights to return

products, are not considered to be cancellation privileges


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Collectibility

Revenue must be realized or realizable

In determining collectibility, revenue recognition is notappropriate where:

Unusual credit terms are granted, or Terms are offered to customers outside the normal credit

terms of the business;

If unable to support collectibility, revenue can only be

recognized under another appropriate method (e.g. cash basis)


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Important Questions to AskIn All Revenue Arrangements

What is being delivered in the arrangement and who is responsiblefor delivering?

What are the terms of delivery?

Is the fee fixed or determinable?

What is the economic substance of the arrangement? Always read the final contract

When asking these questions: (1) all negotiated terms are presumedto be significant, and (2) be alert to side deals/agreements.


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Accounting for Performance of Construction-

Type and Certain Production-Type Contracts


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Overview

Revenue recognition for long-term contracts contract represents a binding agreement between a buyer and seller

where the seller agrees, for compensation, to perform a service to abuyers specifications;

performance often extends over long periods; and,

payment is dependent upon performance.

Percentage of completion vs. completed contract

Percentage of Completion used when there is an enforceableagreement between the contracting parties who can each fulfill theirobligations and there are reasonably dependable estimates of totalcontract revenues, total contract costs, and the progress toward

completion of each contract. Completed Contract use when you cannot develop reasonable

estimates.

Without a contractyou cannot recognize revenue.(and you should not have any deferred

costs on the balance sheet).


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Applicability of Long Term Contract Accounting

Contracts for which such accounting is applicable include, but are notlimited to, the following:

Contracts in the construction industry;

Contracts to design and build ships and transport vessels;

Contracts to design, develop, manufacture, or modify complexaerospace or electronic equipment to a buyer's specification or toprovide services related to the performance of such contracts*;

Contracts for construction consulting service;

Contracts for services performed by architects, engineers, or

architectural or engineering design firms.

*Category substantially relevant to Crane Long Term Contract Accounting


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Measuring Percentage of Completion

Input Measures (efforts expended)

Costs incurred (cost-to-cost)

Efforts expended labor hours, labor dollars, machine hours

Output Measures (results achieved)

Units produced, units delivered, contract milestones, valueadded


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Measuring Percentage of Completion

Estimates to complete (ETCs) and estimates at completion (EACs) areforecasted costs to complete a job or contract. This process is essential toensure losses are not built-up in inventory.

They must be performed at least on a monthly basis and should beprepared in the same manner as the original job estimate

If an ETC/EAC exceeds the value of its respective contract, an adjustmentmust be recorded immediately (for the difference between the contractvalue and the ETC/EAC).this is a loss contract

Key personnel involved: Business/Program Manager, Operations Manager, Accounting/Finance,

Supply Chain, Engineering


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Other & Questions

There are additional revenue recognition considerations for other types oftransactions that are beyond basic revenue recognition criteria (software sales, saleswith multiple deliverables, etc.)

Contact the Controllers Office with any questions that you might have regarding thecontents included herein, or for any transactions where you might be uncertain as tohow to proceed with revenue recognition

There are a lot of considerations and hurdles that you need to understand and assessbefore recognizing revenue..and it can be complicated, so,dont guess!

Controls must be designed and operating effectively to ensure compliance with thevarious revenue recognition criteria relevant to your respective businesses. As requiredby Sarbanes-Oxley, we must continuously evaluate our internal controls to ensure theyare appropriately mitigating the risk of financial misstatement.so

Inspect and ask yourself, What could go wrong?

Ensure you understand the key concepts discussed herein as well as the

provisions of CP-220, Revenue Recognition


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Appendix


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What Can (and did) Go Wrong

A case of channel stuffing involved Symbol Technologies. Robert Asti, aformer Symbol vice president of sales, conceded in a federal court thathe was behind a scheme to inflate Symbol's revenue by stuffing thechannel. According to Asti, he persuaded third parties to buy scannersand readers that they did not need. He promised that Symbol wouldbuy back the equipment later.

When it was obvious that fourth-quarter sales would be lower thanpublished estimates, Lucent increased the use of customer discounts,one-time credits, and other incentives designed to bolster fourth-quarter sales. The result was that Lucent booked sales for goods thatwere shipped merely to distribution channels and not to customers, apractice commonly called channel stuffing.

This was classic fraud regarding revenue recognition, old as the hills. Itslike a Ponzi scheme and eventually falls apart or gets uncovered in anaudit.


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Contact Information

Richard MaueVP Controller and Chief Accounting Officer203-363-7240

Curtis Baron

Assistant Controller203-363-7342

Anette SavastanoDirector of Financial Policy and Compliance203-363-7235

Diana QuachExternal Reporting203-363-7215

Please dont hesitate tocontact Anette for any

assistance with respectto key controls that

should be operating inyour respective

businesseswe arehere to help!


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Revenue recognition Refresher Final

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