latest issues in revenue recognition - presented by mcgladrey at december 2011 eei conference on...

1 ©2011 McGladrey & Pullen, LLP. All Rights Reserved.

Brian Marshall, Partner, McGladrey & Pullen, LLP December 2011

Latest issues in revenue recognition


McGladrey overview

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professionals


Agenda

Revised revenue recognition Exposure Draft Updated multiple deliverable arrangements

guidance


Revised revenue recognition Exposure Draft - “Revenue from

Contracts with Customers”


Overview

Preliminary Views document issued in December 2008 Exposure Draft issued in June 2010 Revised Exposure Draft issued in November

2011 Final standard expected in late 2012


Overview

Scope - Applicable to all industries & entities - Specific contracts with customers outside of scope:

• Financial instruments • Guarantees (other than warranties) • Insurance • Leases • Certain nonmonetary exchanges

- Contracts with performance obligations in multiple standards


Overview

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


Overview

Approach to comply with this core principle 1. Identify the contract with a customer 2. Identify the separate performance obligations in the

contract 3. Determine the transaction price 4. Allocate the transaction price to the separate

performance obligations 5. Recognize revenue when (or as) each separate

performance obligation is satisfied


1. Identify the contract with a customer

Contract is an enforceable agreement between parties Can be written, oral or implied Contract combination

- Required for contracts entered into at or near the same time if certain other criteria are met

Contract modifications - Treat separately if separate performance obligation

is added with consideration consistent with standalone selling price

- Otherwise combine with original contract


2. Identify separate performance obligations

Promise in a contract to transfer a good or service Account for separately if distinct based on meeting

either of the following criteria: - Good or service is regularly sold separately by the entity; or - Customer can benefit from good or service on its own or

together with other readily available resources

However, bundle of promised goods or services is accounted for as one performance obligation if: - Highly interrelated and require significant integration service;

and - Significantly modified or customized to fulfill contract


3. Determine the transaction price

Amount of consideration to which an entity expects to be entitled to from a customer Variable consideration

- Estimate based on probability-weighted or most-likely amount

Time value of money - Only affects transaction price if significant financing

component - Can ignore if time between payment and transfer of

goods or services is one year or less


3. Determine the transaction price

Noncash consideration - Measure at fair value or by reference to standalone

selling price of related goods or services Consideration payable to a customer

- Reduction of transaction price unless in exchange for distinct good or service

Collectibility - Not considered in transaction price - Record allowance adjacent to revenue


4. Allocate the transaction price

Generally based on relative standalone selling price of performance obligations Standalone selling price

- Observable price when sold separately (best) - Otherwise estimate:

• Cost plus margin • Adjusted market assessment • Residual technique allowed if highly variable or uncertain • Others?

Subsequent changes allocated on a relative standalone selling price basis unless certain criteria are met


5. Recognize revenue

Recognize revenue as performance obligations are satisfied based on transfer of control Determine if satisfied (and revenue recognized)

over time, based on whether entity’s performance: - Creates or enhances an asset the customer controls; or - Does not create an asset with an alternative use and one

of following criteria is met: • Customer receives a benefit as entity performs tasks • Another entity would not need to reperform tasks performed to

date • Vendor has right to payment for performance to date

Select method of progress toward completion (output or input)


5. Recognize revenue

If prior criteria not met then satisfied at a point in time Recognize revenue when customer obtains control

based on following indicators: - Entity has right to payment - Entity has transferred physical possession - Customer has legal title and risks and rewards of ownership - Customer has accepted goods or services

Recognize amount allocated to performance obligation except for certain variable consideration, which is limited to reasonably assured amount based on: - Experience with similar performance obligations - Whether that experience is predictive of outcome


Onerous performance obligations

Only applicable to performance obligations satisfied over period > 1 year Recognize liability if allocated transaction price is

less than lower of: - Direct costs to satisfy performance obligation; or - Amount to be paid to exit the performance obligation Direct costs include:

- Direct labor & materials - Allocated costs directly related to contract - Costs explicitly chargeable to the customer - Other costs incurred only because contract entered into


Contract costs

Capitalize direct costs of fulfilling a contract or anticipated contract if those costs: - Generate or enhance a resource that will be used to

satisfy performance obligations in the future (e.g., setup costs); and

- Are expected to be recovered Capitalize incremental costs to obtain contract if

expected to be recovered Practical expedient to expense costs as

incurred if amortization period would have been less than one year


Return rights

Defer revenue and record refund liability for goods expected to be returned Adjust refund liability (and revenue) for changes

in return expectations Record asset (rather than cost of sales) for right

to recover products at former carrying amount less costs of recovery


Warranties

Customer option to purchase separately - Separate performance obligation (warranty service) No customer option to purchase separately and

warranty does not provide an additional service - Recognize revenue and accrue expected costs - Consider following in determination of whether

additional service is being provided: • Whether warranty is required by law

• Length of warranty period

• Nature of tasks to be performed


Optional goods or services

Considered a performance obligation if provides a material right customer otherwise would not receive Estimate standalone selling price of option

using: - Directly observable option price, - Option discount adjusted for likelihood of exercise

and discount available without the option


Other issues

Customers’ unexercised rights (“Breakage”) - Relatively consistent with current US GAAP Licensing and rights to use

- Same guidance as for other goods or services - Revenue recognized at point in time if separate

performance obligation Repurchase agreements

- Entity obligation (forward) or right (call option) to repurchase asset

- Customer right to require entity to repurchase (put option)


Treatment similar to current US GAAP

Nonrefundable upfront fees Principal vs. agent considerations Consignment arrangements Bill-and-hold arrangements Customer acceptance


Balance sheet presentation

Asset/liability based on comparison of entity’s performance to customer’s performance Entity > customer = asset Entity < customer = liability Receivables are classified separately from other

asset - Unconditional right to receive consideration


Disclosures / transition / effective date

Disclosure objective: - Quantitative and qualitative information regarding

nature, amount, timing and uncertainty of revenue and related cash flows

Retrospective transition with certain practical expedients Effective date no earlier than 2015 for public

entities and 2016 for nonpublic entities. Comments due by March 13


Updated multiple deliverable arrangements guidance

(ASU 2009-13 & 14)


ASU 2009-13 (EITF 08-1), “Revenue Arrangements with Multiple Deliverables” Response to criticisms of EITF 00-21 (ASC 605-

25) - Often unable to separate into multiple units of

accounting (lack of fair value of the undelivered items)

- Accounting often did not match economics Allows more flexibility in determining values of

separate elements Effective for arrangements entered into or

materially modified in fiscal years beginning on or after 6/15/2010


ASU 2009-13 - Separation guidance

Delivered item is a separate unit of accounting if the following criteria are met: - The delivered item has value to the customer on a

standalone basis • Does vendor sell the item separately? • Can customer resell item on a standalone basis?

- There is objective and reliable evidence of the fair value of the undelivered item(s)

- If the arrangement includes a general right of return, delivery or performance of the undelivered item(s) is probable and within control of vendor


ASU 2009-13 - Allocation guidance

Allocate consideration using relative selling price method - Eliminates requirement for objective and reliable

evidence of FV of undelivered items - Eliminates use of residual method; probably results in

earlier recognition Hierarchy of evidence to use for allocation

- Vendor specific objective evidence (VSOE) of selling price

- Third-party evidence (TPE) of selling price - Best estimate of standalone selling price

• No practicality exception provided


ASU 2009-13 - Estimating standalone selling price

No specific methodology prescribed Gather all reasonably available data points Adjust based on:

- Market conditions - Entity-specific factors Consider all information that is reasonably

available without undue cost or effort to determine estimated selling price


ASU 2009-13 - Disclosures

Ongoing disclosures - Quantitative and qualitative information about significant

judgments used in applying ASU 2009-13 and changes in those judgments or in the application that may significantly affect the allocation of revenue

- Inputs, methods, and significant assumptions used in evaluating arrangements and the significant deliverables in those arrangements

Transition disclosures (if adopt prospectively) - Qualitative description of how the ASU was adopted - Supplement with quantitative disclosures if material


ASU 2009-14 (EITF 09-3), “Certain Revenue Arrangements that Include Software Elements”

EITF consensus in ASU 2009-13 (EITF 08-1) led to this Issue Effective date mirrors ASU 2009-13 Should scope of ASC 985-605 (SOP 97-2)

and/or criteria be eased? - ASC 985-605 seen as very conservative

• No VSOE = no separation; defer until established or delivered

- Does scope capture more arrangements than intended? • Are underlying economics being distorted as a result?


ASU 2009-14 - Overview

EITF agreed to amend scope of ASC 985-605 - Tangible products containing software components and non-

software components that function together to deliver the product's essential functionality should be considered non-software deliverables

The following are excluded from ASC 985-605 scope: - Non-software components of software-reliant tangible products - Software components bundled with tangible products if the

software components and non-software components function together to deliver the product’s essential functionality

- Undelivered elements that relate to software that is essential to the above described tangible product’s functionality


ASU 2009-14 - Determining “Function Together to Deliver the Product’s Essential Functionality”

Rebuttable presumption that software elements are essential to the functionality of the tangible product if sales of the tangible product without the software elements are infrequent

The evaluation to determine whether or not the tangible product and software are functioning together is done at the product level, not the model level

The separate standalone sale of the software does not cause a presumption that the software is not essential to the functionality of the tangible product


ASU 2009-14 - Determining “Function Together to Deliver the Product’s Essential Functionality”

Software elements do not need to be embedded on a device to be considered essential to the device’s functionality

The non-software elements of the tangible product must substantively contribute to the tangible product’s essential functionality

Entities will need to evaluate existing product lines to determine which software stays within the scope of ASC 985-605 and which does not


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latest issues in revenue recognition - presented by mcgladrey at december 2011 eei conference on...

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