Seg Revenue Recognition Slides

Extreme Makeover -

Revenue Recognition

Joint Project of the

FASB and IASB

Revenue from contracts with customers

Learning Objectives

• Provide history behind and current status of the new revenue accounting rules

• Review the new five-step recognition model

• Illustrate key concepts through examples

• Impact considerations and next steps

History – Why the Shift to a New Framework?

Objectives of the FASB & IASB…

• One global standard for revenue accounting and reporting

• Currently IFRS guidance is not extensive – users often refer to US GAAP for specific guidance

• Currently US GAAP guidance is comprised of 1) over-riding guidelines established by the SEC, and 2) industry specific bright line rules

• Inconsistencies exist between industries

• New standard designed to promote consistency and comparability across industries and capital markets

Timeline & Current Status

• Project began in 2006

• Initial Exposure Draft Issued 2010

• Revised Exposure Draft Issued November 14, 2011

• Final Standard Expected in early 2013

• Effective Date – fiscal years beginning on or after January 1, 2015

• Full Retrospective Application – therefore public companies must start complying in 2013 to facilitate on time adoption

Identify the contract(s) with the customer Step 1

5 Step Revenue Recognition Model

Step 2 Identify separate performance obligations in the contract

Step 3 Determine transaction price and amounts not expected to be collected

Step 4 Allocate transaction price to the separate performance obligations

Step 5 Recognize revenue when goods and services are transferred to the customer and performance obligations are complete

Identify the contract(s) with the customer Step 1

Issue Key Considerations

Combining Contracts

If separate contracts were negotiated together for one purpose

If price interdependence exists between two otherwise separate contractual arrangements

If performance links exist between two separate contracts – one combined performance obligation may exist

Modifications Combine with initial contract, unless… Modification creates new and separate

performance obligation The price = stand-alone selling price for that

performance obligation

Modification – Illustrative Example

•On January 1, Company A contracts to sell 20 truck bodies to Company B at a price of $9,000 per unit for a total transaction value of $180,000 (standard price is $10,000 per unit).

•Truck bodies will be delivered in 2 equal shipments on January 31 and March 31.

•On March 1, Company A modifies the contract to add an additional 10 truck bodies to Company B for $100,000.

Combine or Separate?

Modification was made in close proximity to original contract

Unfulfilled performance obligation remained from original contract

No price interdependence – modification sold at list price

The March 1st modification represents a stand alone performance obligation

Answer: Separate

Modification – Illustrative Example


•Contract defines discount structure for future purchases

•On March 1, Company A modifies the contract to add 10 additional truck bodies to Company B for $80,000 to be delivered June 30th (pursuant to the defined discount structure).

Combine or Separate?

Modification was made in close proximity to original contract

Unfulfilled performance obligation remained from original contract

Price interdependence does exist – original contract defines discount structure

Answer: Combine



How do we identify performance obligations?

If goods and services are “distinct” Distinct means…

Good or service is sold separately Good or service has stand alone value to

customer

When should goods and services be bundled together?

If both of the following criteria are met… Goods and services are highly interrelated

and seller provides significant service of integrating goods and services on customer’s behalf

Seller is engaged by buyer to significantly modify or customize the goods or services for buyer’s use



How are warranties accounted for under the new standard?

Current accounting guidance calls for cost accruals for all warranties

Under new guidance, warranties that are sold separately represent a separate performance obligation

Warranties that meet the definition of performance obligation will be subject to an allocated portion of the transaction price based upon relative stand-alone sales prices



What is the impact of variable consideration on revenue recognition?

Examples include rebates, credits, performance bonuses, contingent consideration (royalties)

Generally, current US GAAP defers recognition until contingency is fulfilled

The new standard will require management to estimate variable consideration

As a result, many organizations will recognize revenue related to variable consideration sooner

Aspect of the new standard that will generally increase revenue

Aspect of the new standard that will generally decrease revenue

Variable Consideration – Illustrative Example

•Company A provides an outsourced service to its customers. Typical contracts include a scaled performance bonus related to efficiency metrics achieved within a defined timeframe.

•Management estimates its performance bonus under a new contract as follows:

50% Chance of $100,000 = $50,000 25% Chance of $50,000 = $12,500 25% Chance of $0 = $0

Probability weighted estimate approach is utilized

Under current US GAAP, Company A would not recognize any revenue related to the performance bonus until the precise amount earned becomes known (fixed and determinable fee requirement)

Under the new standard, Company A will include $62,500 in the total transaction value to be allocated to the performance obligations



How is collection risk accounted for under the new standard?

Under current US GAAP collectibility is a pre-requisite for revenue recognition

Under the new standard, collectibility risk will not preclude revenue recognition

Management will estimate impairment loss on receivables and deduct from gross revenue on face of income statement

Under current US GAAP bad debt expense does not reduce gross margin

Under the new standard, recorded impairment losses will reduce gross margin



Collectibility– Illustrative Example

Current Accounting

•Company A operates as a business to consumer products seller.

•Typical customer sales transactions total $5,000

•Cost of sales per transaction is $3,000

•Historic bad debt write-offs at 10%

New Standard

Revenue $5,000

Cost of Sales $3,000

Gross Margin $2,000

Gross Margin % 40%

Bad Debt Expense $500

Revenue $5,000

Impairment Loss (500)

Net Revenue $4,500

Cost of Sales $3,000

Gross Margin $1,500

Gross Margin % 30%

Bad Debt Expense $0

Step 4 Allocate transaction price to the separate performance obligations


How do we allocate the transaction price?

Based on relative stand alone sales prices If a stand-alone sales price is not available then

management must estimate the price at which it would sell that good or service

Under current US GAAP (in particular in the software sector), absence of VSOE of fair value generally results in revenue deferrals

Estimation methods can include… Cost plus a reasonable margin Market prices for similar goods and services Residual method



Transaction Price Allocation – Illustrative Example

•Company A is a electronics products and services company.

• It has entered into a contract with a customer that includes multiple performance obligations including:

•Electronic component products – Stand-alone price is $100,000

Performance Obligation

Stand-alone price

Discount Factor ($150,000 / $160,000)

Allocated Price

Electronic components $100,000 93.8% $93,750

Design services $50,000 93.8% $46,875

Extended warranty $10,000 93.8% $9,375

Totals $160,000 $150,000

•100 Hours of Design Service – Stand-alone price is $500 per hour ($50,000)

•Extended warranty – Stand-alone price is $10,000

•Contract value is $150,000

Residual Method Example – Illustrative Example

Performance Obligation Stand-alone price

Discount Factor ($175,000 / $175,000)

Allocated Price

Electronic components $100,000 100% $100,000

Design services $50,000 100% $50,000

Extended warranty $10,000 100% $10,000

NEW special component $15,000 100% $15,000

Totals $175,000 $175,000

• Assume the same fact pattern as in the previous example

• In addition to the 3 electronic components noted previously, Company A will also manufacture and deliver a custom component built to the customer’s specifications that it has never before built nor sold separately

•Assume contract value is $175,000

Modification / Price Allocation – Illustrative Example


•Contract defines discount structure for future purchases

•On March 1, Company A modifies the contract to add 10 additional truck bodies to Company B for $80,000 to be delivered June 30th (pursuant to the defined discount structure).

Date Revenue Note

January 31st $90,000 Delivery of first 10 truck bodies

March 31st $83,333 Second 10 trucks delivered (cumulative catch up)

June 30th $86,667 Last 10 trucks delivered

Totals $260,000 Combined transaction value now fully recognized

Impact

Unlike current US GAAP, the new standard’s contract modification feature is likely to result in adjustments to revenue recorded on performance obligations that have already been recognized




When is a performance obligation satisfied?

Promised good or service is transferred to the customer

Control is the key concept to understand Control is the ability to direct the use of and

receive the benefit from the good and service

Practice Aid – Indicators that control has passed to customer

• Customer has unconditional obligation to pay

• Customer has legal title to goods • Customer has physical possession of

the goods

• Customer bears the risks and rewards of ownership

• Customer formally accepts goods or service



How is the passage of control viewed for service companies?

Original exposure draft did not make a distinction on passage of control for service companies

Now the new standard includes the concept of “continuous” passage of control

A performance obligation is satisfied continuously if… Seller’s performance creates or enhances an

asset that the customer controls, or Seller’s performance does not create an asset

with alternative use

Unlike current US GAAP, the new standard requires the capitalization of incremental costs incurred to obtain a contract if they are expected to be recovered

Contract Costs

Other Important Highlights of the New Standard

• Applies to performance obligations satisfied over 1 year or more

• Assessed at performance obligation level – not contract level

• Onerous = lowest cost of settling the performance obligation exceeds the amount of the transaction price allocated

Onerous Performance Obligations

Financial Statement Disclosures

• The disaggregation of revenue into primary categories that depict the nature, amount, timing and uncertainty of revenue and cash flows

• A tabular reconciliation of the movements of the assets recognized from the costs to obtain or fulfill a contract with a customer

• An analysis of the entity's remaining performance obligations including the nature of the goods and services to be provided, timing of satisfaction, and significant payment terms

• Information on onerous performance obligations and a tabular reconciliation of the movements in the corresponding liability for the current reporting period

• Significant judgments and changes in judgments that affect the determination of the amount and timing of revenue from contracts with customers

SAB Topic 13 Impact of IASB / FASB Exposure Draft

Persuasive evidence of arrangement

Contracts may be combined if highly interrelated or price interdependent

Identify performance obligations for distinct goods or services (distinct generally means “sold separately”)

Delivery has occurred or services have been rendered

Satisfaction of performance obligations triggers recognition

Customer must obtain control of the promised good or service

Distinction between goods and services now added in new exposure draft – services subject to continuous control passage guidance

Warranties (that can be purchased) are now treated as a performance obligation not as a liability

Comparison to Staff Accounting Bulletin Topic 13 (formerly SAB No. 104)

SAB Topic 13 Impact of IASB / FASB Exposure Draft

The seller’s price to the buyer is fixed or determinable

Transaction price is the amount of consideration expected to be received from the customer

Allocate the transaction price to all distinct performance obligations proportionally based on stand alone selling price

Estimates of selling prices for distinct goods or services not sold separately will replace vendor specific objective evidence criterion

Estimates will be incorporated when variable consideration exists

Collectibility is reasonably assured

Collection risk reflected as reduction of revenue rather than bad debt – gross margins will be reduced

Transactions falling short of SAB Topic 13 threshold may no longer result in revenue deferrals

Comparison to Staff Accounting Bulletin Topic 13 (formerly SAB No. 104)

Next Steps

• The accounting and disclosure requirements of the new revenue standard are significant

• The impact will be greatest for companies with complex revenue arrangements, bundled contracts and long term engagements

• Stay up to date on the evolving standard requirements and seek out training opportunities

• Conduct an impact assessment in order to prepare for the transition

• The retrospective transition provision means compliance may need to start as soon as 2013

SolomonEdwards At a Glance

SolomonEdwardsGroup, LLC (SolomonEdwards or SEG) is a national

business advisory and professional staffing firm. Our customized solutions

provide our clients with the right combination of talent and expertise to

achieve their business objectives.

With practices specialized in Accounting & Finance and Banking &

Financial Services, our strength lies in our ability to tactically assist clients

with special projects, transaction support & integration, business process

optimization initiatives, and regulatory compliance requirements.

Because we provide both business advisory and staffing services, SEG can

customize a solution for each client we serve. If you need an individual to

fill a role on an interim or permanent basis, a large team to execute a

project initiative, or expert consultation on a technical issue, we can help.

We operate from seven offices in major cities throughout the country and

maintain a global network of partners to serve multinational clients.

Our Services & Solutions

Our core service capabilities encompass business advisory, project

management, interim staffing and professional search. We deliver our

services to our clients across a spectrum of functional and industry verticals

that enables us to provide the specific expertise and methodologies required

to deliver outstanding results.

Our Services & Solutions

Interim CFO & Controller

General Ledger Accounting &

Reporting

Financial Modeling

Financial System Assessment &

Optimization

Business Process Improvement

Policy & Procedure Development

Business Intelligence Tools

Financial Planning & Analysis

Budgeting & Forecasting

Shared Service Center Support

Project Management Office

Due Diligence

Merger Integration

Financial Carve-out

IPO Readiness

Bankruptcy & Turnaround

Technical Accounting

US GAAP & IFRS Advisory

SEC Reporting & Compliance

Sarbanes-Oxley

Internal Audit Services

Technology Risk

Accounting

& Finance

Business

Process

Optimization

Transaction

Support &

Integration

Regulatory

Compliance

The Value of SEG

Client Need Defined…

Ownership Change

Mergers & Acquisitions

IPO’s

Leveraged Buyout

Private Equity investment

Delivering the talent and know-how to execute due

diligence, merger integration, technical accounting,

SEC reporting, IPO readiness, SOX compliance and

more. SEG can mobilize and manage resources for

special projects, provide professionals to back-fill

positions during the change process or recruit talent

to fill roles on a permanent basis.

SEG’s Value…

Representative Clients…

Acqura Loan Services, Inc. Exelon Power Hexion Specialty Chemicals Talk America

Comcast Corporation Frontier Telecommunications PanAmSat Corporation Terra Nova Financial Group

Electro-Motive Diesel, Inc. Graftech, Inc. Olympus Power, LLC Verso Paper, Inc.

The Value of SEG


Compliance

SEC Reporting

Financial Restatements

US GAAP / IFRS

Sarbanes - Oxley

Bank Compliance

SEG’s Value…

Delivering the talent and know-how to enable our

clients to comply with applicable regulations across of

broad spectrum of issues. SEG can serve as a

technical advisor, mobilize and manage resources

for compliance initiatives, provide professionals to

augment client teams during peak compliance

periods, or recruit talent to fill permanent roles.


ABN AMRO E.ON Climate & Renewables Franklin Bank Leo Burnett USA, Inc.

Amerisafe, Inc. FIMAT USA, Inc. GMH Communities Parsons Brinckerhoff

Cambridge Display Tech Foote, Cone & Belding Integra Life Sciences Whitney Bank

The Value of SEG


Business Growth / Downturn -

Start-up Operations

New Management

Resource Constraints

Employee Turnover

Bankruptcy / Turnaround

SEG’s Value…

Delivering the talent and know-how to enable an

organization to evolve with changing business and

economic circumstances. SEG can quickly provide

resources with the right experience to deliver results

on an interim basis, back-fill vacant positions, or

recruit talent to fill permanent positions from staff to

senior executive levels.


Airtricity Corporation Children’s Network, LLC Gamesa Technology Corp. Sandler O’Neill

Ascend Acquisition Corp. CHI-X / Instinet Greatwide Logistics Services Symmetry Holdings

Alaron Futures/Options Foamex International Newtek Business Services Vantium Capital

For More Information

Brian G. Markley, CPA Partner

[email protected] Office: 610-902-0440 Mobile: 484-557-0933

Richard A. Lavinski, CPA Partner

[email protected] Office Phone: 972-505-2002

Mobile: 214-733-6103

SolomonEdwardsGroup, LLC 14755 Preston Road, Suite 400

Dallas, Texas 75254

Seg Revenue Recognition Slides

Design

Transcript of Seg Revenue Recognition Slides