PRESENTED BY

LANCE TRAMMELL, CPALANE GORMAN TRUBITT,

PLLCOCTOBER 16, 2014

REVENUE RECOGNITION CHANGE IS GOOD…RIGHT?

INTRODUCE TOPIC 606 NO. 2014-09: REVENUE FROM CONTRACTS WITH CUSTOMERS

IDENTIFY THE REASONS FOR THE CHANGE

PROVIDE OVERVIEW OF THE FIVE STEP RECOGNITION PROCESS

DEFINE KEY TERMS OF THE MODEL

OBJECTIVES

In May 2014 FASB introduced the new standard on revenue recognition.

The overall objective was to develop a standard that would provide a comprehensive model for accounting for revenue on contracts with customers which would help to provide consistency in recognition and presentation of revenue.

Revenue from Contracts with Customers

WHAT WAS WRONG WITH THE EXISTING STANDARD(S)?

TOO MANY OF THEM

BY CREATING A COMPREHENSIVE STANDARD THE HOPE IS THAT WE WILL SEE:

BETTER QUALITY IN REPORTING TIMELY ACTUAL RESULTS

STRENGTHEN REQUIREMENTS BY NOT HAVING SO MANY “SPECIAL INSTANCES OR EXCEPTIONS”

IMPROVE COMPARABILITY

SO WHY THE CHANGE?

A reporting entity that either enters into contracts with customers to transfer goods or services

A reporting entity that enters into contracts for the transfer of nonfinancial assets unless those contracts are within the scope of other standards.

WHO DOES THE NEW STANDARD APPLY TO?

The guidance is based on the overall premise that an entity should recognize revenue in an amount that reflects the actual consideration that the entity expects to be entitled to.

WHAT’S GOING TO CHANGE?

STEP 1: IDENTIFY THE CONTRACT WITH THE CUSTOMER

STEP 2: IDENTIFY THE PERFORMANCE OBLIGATIONS (PROMISES) IN THE CONTRACT

STEP 3: DETERMINE THE TRANSACTION PRICE

STEP 4: ALLOCATE THE TRANSACTION PRICE TO THE PERFORMANCE OBLIGATION IN THE CONTRACT

STEP 5: RECOGNIZE REVENUE WHEN/AS THE REPORTING ENTITY SATISFIES THE PERFORMANCE OBLIGATION

THE PROCESS

STEP 1: IDENTIFY THE CONTRACT

A CONTRACT IS AN AGREEMENT BETWEEN TWO OR MORE PARTIES THAT CREATES ENFORCEABLE RIGHTS AND OBLIGATIONSCAN BE WRITTEN, ORAL OR IMPLIED BY THE ENTITY’S CUSTOMARY BUSINESS PRACTICECAN BE INSTANTANEOUS OR LONG TERMTHE KEY HERE IS CREATING ENFORCEABLE OBLIGATIONS

THE PROCESS

ELEMENTS OF A CONTRACT - MUST CONTAIN AN APPROVAL AND

COMMITMENT OF THE PARTIES IDENTIFY THE RIGHTS OF THE PARTIES INVOLVED IDENTIFY TERMS OF PAYMENT ESTABLISH COMMERCIAL SUBSTANCE PROBABLE THAT THE ENTITY WILL COLLECT THE

CONSIDERATION THAT IS DUE IN EXCHANGE FOR THE GOODS OR SERVICES

STEP 1: IDENTIFY THE CONTRACT

CONTRACTS CAN BE -COMBINED

MULTIPLE CONTRACTS ARE NEGOTIATED WITH A SINGLE OBJECTIVE THE CONSIDERATION IN ONE CONTRACT DEPENDS ON THE OTHER

CONTRACT GOODS/SERVICES ARE PROMISED ARE A SINGLE PERFORMANCE

OBLIGATION

CAN BE MODIFIED DUE TO A CHANGE IN SCOPE OR PRICE

MUST BE MUTUALLY AGREED TO CHANGE IN REVENUE IS PROSPECTIVELY IF THE MODIFICATION

RELATES TO DISTINCT GOODS OR SERVICES TRANSFERRED AFTER MODIFICATION

CUMULATIVE CATCH-UP OF REVENUE IF MODIFICATION IS NOT RELATED TO A DISTINCT GOOD OR SERVICE

STEP 1: IDENTIFY THE CONTRACT

STEP 2: PERFORMANCE OBLIGATIONSA PERFORMANCE OBLIGATION IS A PROMISE IN A CONTRACT WITH A CUSTOMER TO TRANSFER GOODS OR SERVICES

Obligations are goods or services that are distinct or a series of distinct goods or services that are substantially the same and same pattern of transfer

There can be more than one performance obligation within a contract Required to identify how many promises are in the contract to properly determine

the transaction price per obligation

THE PROCESS

ARE DETERMINED BASED ON WHETHER THE GOODS OR SERVICES ARE DISTINCT.

The customer can benefit from the good/service on its own or with other resources that are readily available to the customer.

AND The entity’s promise to transfer the good/service to the

customer is separately identifiable from other promises in the contract.

STEP 2: PERFORMANCE OBLIGATIONS

EXAMPLE NON DISTINCT – CONSTRUCTION CONTRACTOR

A mechanical contractor has entered into a contract to provide the installation of a new HVAC system. The contractor will perform the design configuration, purchase the equipment and provide the labor for installation. Do we have separate performance obligations?

STEP 2: PERFORMANCE OBLIGATIONS

EXAMPLE DISTINCT – SOFTWARE

A software developer enters into a contract with a customer to transfer software license, perform installation, and provide unspecified software updates and technical support for a two year period. In the normal course of business the developer sells these services separately. Each good or service will benefit the customer on their own. Therefore we have 4 separate performance obligations

STEP 2: PERFORMANCE OBLIGATIONS

STEP 3: TRANSACTION PRICETRANSACTION PRICE

IS THE AMOUNT OF CONSIDERATION THAT AN ENTITY EXPECTS TO RECEIVE IN EXCHANGE FOR TRANSFERRING PROMISED GOODS OR SERVICES TO A CUSTOMER.

CAN CONTAIN BOTH FIXED AND VARIABLE COSTS RELATED TO THE TRANSFER OF THE GOODS.

SALES PRICE – VARIABLE CONSIDERATION = TRANSACTION PRICE TRANSACTION PRICE IS WHAT IS REPORTED AS REVENUE AT THE TIME OF SALE

THE PROCESS

VARIABLE CONSIDERATIONVARIABLE CONSIDERATION

FACTORS THAT CAN INFLUENCE THE OVERALL TRANSACTION PRICE. ONLY INCLUDED AS PART OF THE TRANSACTION PRICE TO THE EXTENT THAT IT IS

PROBABLE THAT A SIGNIFICANT REVERSAL IN THE CUMULATIVE AMOUNT OF REVENUE RECOGNIZED WILL NOT OCCUR IN FUTURE PERIODS IF THE ESTIMATES OF VARIABLE CONSIDERATION CHANGE.

EXAMPLE - VOLUME DISCOUNT

OTHER CONSIDERATIONS OF SALE TYPICALLY NOT REVIEWED UNTIL AFTER THE SALE IS COMPLETED (SALES INCENTIVES, REBATES)

SIGNIFICANT FINANCING COMPONENT OF THE REVENUE TRANSACTION ENTITY WILL ADJUST THE AMOUNT OF CONSIDERATION PROMISED TO REFLECT THE TIME VALUE OF MONEY.

IF PROMISED AND IT IS PROBABLE THAT IT WOULD GENERATE A SIGNIFICANT ADJUSTMENT TO REVENUE IF IT IS NOT CONSIDERED, THEN CONSIDER UPFRONT.

THE PROMISE DOES NOT HAVE TO BE IN WRITING, IT CAN ALSO BE PART OF THE ENTITY’S NORMAL BUSINESS PRACTICE

VARIABLE CONSIDERATION PUTS IT INTO A CASH FLOW PERSPECTIVE, MEANING WE ARE RECORDING IN REVENUE WHAT WE ACTUALLY EXPECT TO RECEIVE.

STEP 3: TRANSACTION PRICE

VARIABLE CONSIDERATION – CONTINUED CONSTRAINTS – FACTORS THAT WOULD INCREASE THE

LIKELIHOOD OF A SIGNIFICANT REVENUE REVERSAL. FACTORS OUTSIDE THE ENTITY’S INFLUENCE -3RD PARTIES,

OBSOLESCENCE UNCERTAINTY ABOUT AMOUNT OF CONSIDERATION EXPECTED MAY

NOT BE RESOLVED FOR AN EXTENDED PERIOD OF TIME IN NORMAL BUSINESS PRACTICE, THE ENTITY MAY OFFER A BROAD

RANGE OF PRICE CONCESSIONS OR CHANGE PAYMENT TERMS ON SIMILAR CONTRACTS (I.E. INCONSISTENT)

CONTRACT ITSELF HAS A LARGE NUMBER AND BROAD RANGE OF POSSIBLE CONSIDERATIONS. (I.E. TOO MUCH TO PREDICT)

STEP 3: TRANSACTION PRICE

STEP 4:

ALLOCATION OF PRICE TO PERFORMANCE

OBJECTIVE – ALLOCATE THE TRANSACTION PRICE TO EACH PERFORMANCE OBLIGATION WITHIN THE CONTRACTBASE IT ON STANDALONE SELLING PRICE BASIS

PRICE THE ENTITY WOULD SELL A GOOD OR SERVICE SEPARATELY TO A CUSTOMER.

IF PRICE IS NOT DIRECTLY IDENTIFIABLE, THEN IT WOULD HAVE TO BE ESTIMATED ADJUSTED MARKET ASSESSMENT APPROACH EXPECTED COST PLUS A MARGIN APPROACH RESIDUAL APPROACH

THE PROCESS

MAKE SURE YOU UNDERSTAND THE COMPONENTS OF THE VARIABLE CONSIDERATION AND ONLY APPLY IT TO THE RELATED PERFORMANCE OBLIGATION IF THE CONTRACT CONTAINS MULTIPLE OBLIGATIONS.

CHANGES IN THE TRANSACTION PRICE APPLY TO THE RESPECTIVE OBLIGATIONS. ALLOCATE THE CHANGE IN TRANSACTION PRICE TO THE

PERFORMANCE OBLIGATIONS IDENTIFIED IN THE CONTRACT BEFORE THE MODIFICATION IF THE CHANGE IN TRANSACTION PRICE IS ATTRIBUTABLE TO AN AMOUNT OF VARIABLE CONSIDERATION PROMISED BEFORE THE MODIFICATION.

IF CHANGE CREATES A SEPARATE CONTRACT, THE ENTITY SHOULD ALLOCATE THE CHANGE IN THE TRANSACTION PRICE TO THE PERFORMANCE OBLIGATIONS OF THE MODIFIED CONTRACT THAT WERE NOT FULLY SATISFIED AFTER THE MODIFICATION.

ALLOCATION OF PRICE

STEP 5: RECOGNIZE REVENUEREVENUE IS RECOGNIZED WHEN THE ENTITY SATISFIES THE PERFORMANCE OBLIGATION. THE PERFORMANCE OBLIGATION IS CONSIDERED TO BE SATISFIED WHEN THE CUSTOMER TAKES CONTROL OF THE ASSET. THIS CAN OCCUR EITHER AT A POINT IN TIME OR OVER A PERIOD OF TIME.

THE PROCESS

CONTROL - ABILITY TO DIRECT THE USE OF AND SUBSTANTIALLY ALL OF THE REMAINING BENEFITS OF THE ASSETSCONTROL OVER A PERIOD OF TIME (ONE MUST BE MET):

Customer simultaneously receives and consumes benefits provided by the entity’s performance as the entity performs

Entity’s performance creates or enhances an asset that the customer controls as the asset is created or enhanced

Entity’s performance does not create an asset with alternative use to the entity, and the entity has an enforceable right to payment for performance completed to date.

STEP 5: RECOGNIZE REVENUE

CONTROL OVER A PERIOD OF TIME IS MEASURED BASED ON INPUT OR OUTPUT METHODS INPUT METHOD RECOGNIZES REVENUE BASED ON THE ENTITY INPUTS

(COSTS/EFFORTS) PUT INTO SATISFYING THE PROJECT. EXAMPLES – MATERIALS COSTS, LABOR HOURS, MACHINE HOURS DISADVANTAGE OF INPUT METHOD IS THAT THERE MAY NOT BE A

DIRECT RELATIONSHIP BETWEEN THE INPUTS AND THE CONTROL OF GOODS

OUTPUT METHOD RECOGNIZES REVENUE ON THE BASIS OF DIRECT MEASUREMENTS OF THE VALUE TO THE CUSTOMER EXAMPLES – SURVEYS, APPRAISALS, MILESTONES, UNITS DELIVERED DISADVANTAGE OF OUTPUT METHOD IS THAT YOU HAVE TO MAKE

SURE THAT YOUR METHOD IS A TRUE DEPICTION OF THE ENTITY’S PERFORMANCE TOWARDS COMPLETE SATISFACTION OF OBLIGATION.

CONTROL (CONTINUED)

CONTROL AT A PERIOD IN TIME (NOT LIMITED TO): Entity has a present right to payment of the asset Customer has legal title to the asset Entity has transferred physical possession of the asset Customer has accepted the asset

CONTROL (CONTINUED)

CONTRACT ASSET - AN ENTITY’S RIGHT TO CONSIDERATION IN EXCHANGE FOR GOODS OR SERVICES THAT THE ENTITY HAS TRANSFERRED TO A CUSTOMER BEFORE PAYMENT IS DUE.

CONTRACT LIABILITY - AN ENTITY’S OBLIGATION TO TRANSFER GOODS OR SERVICES TO A CUSTOMER FOR WHICH THE ENTITY HAS RECEIVED CONSIDERATION

NEW TERMS

US GAAP Reporting periods after December 15, 2016 Including interim reporting periods therein

Publicly Traded CompaniesEarly application not allowed

Reporting periods after December 15, 2017Non-publicly Traded

IFRSReporting periods beginning January 1, 2017

Early application allowed

IMPLEMENTATION

US GAAP - FASB – Financial Accounting Standards Boardwww.fasb.org

IFRS - IASB – International Accounting Standards Board www.ifrs.org

TRG – Joint Transition Resource GroupPotential implementation issues email submission form to

revenueTRG@ifrs.org

Public accounting firmswww.lgt-cpa.com

SOURCES

?QUESTIONS?