Beratung
Revenue Recognition under IFRS
IAS 18
Revenue
IAS 11
Construction Contracts
IFRIC 13 Customer Loyalty Programs
© Douglas Nelson 2007
AGiG Seminar – 8 November 2007
Schulung
Umstellung
IAS 18: Agenda
Basic principles of IAS 18
Special rules under US-GAAP (SAB 101/104)
that are often applied under IFRS
– Bill & Hold transactions
– Up-front fee arrangements
– Multiple-element arrangements
© Douglas Nelson 2007
AGiG Seminar – 8 November 2007
Revenue Recognition
1
Basic principles of IAS 18
Special rules under US-GAAP (SAB 101/104)
that are often applied under IFRS
– Bill & Hold transactions
– Up-front fee arrangements
– Multiple-element arrangements
© Douglas Nelson 2007
AGiG Seminar – 8 November 2007
Revenue Recognition
2
IAS 18: Basic principles
Types of revenue-generating transactions
Revenue
is the gross inflow of economic benefits during the period arising in the course of the
ordinary activities of an entity when those inflows result in increases in equity, other than
increases relating to contributions from equity participants.
Classification of revenues under IAS 18:
Sale of goods;
Rendering of services;
Interest, royalties and dividends.
For each of these groups IAS 18 specifies under what conditions revenue is to be
recognized.
© Douglas Nelson 2007
AGiG Seminar – 8 November 2007
Revenue Recognition
3
IAS 18: Basic principles
Measurement of Revenue
“Revenue shall be measured at the fair value of the consideration received or
receivable” (IAS 18.9)
Revenue is normally in the form of cash or cash equivalents
If payment is deferred, fair value of consideration may be less than nominal amount
– Transaction constitutes a financing transaction;
– Fair value is determined by discounting all future receipts using an imputed rate of
interest, using
a) prevailing rate of interest for a similar instrument of an issuer with a similar credit
rating, or
b) a rate that discounts the nominal amount of the instrument to the current cash
sales price of the goods or services.
Where goods or services are swapped for goods or services which are of a similar
nature
The exchange is not regarded as a transaction which generates revenue
© Douglas Nelson 2007
AGiG Seminar – 8 November 2007
Revenue Recognition
4
IAS 18: Basic principles
Identification of the transaction
Recognition criteria in IAS18 usually applied separately to each transaction
It may be necessary, however, to apply the recognition criteria to the separately
identifiable components of a single transaction to reflect substance of transaction
– Example: Sales price of a product includes subsequent servicing for a specific period
of time
Two or more transactions may linked in a way that the commercial effect is that of one
transaction and must be accounted for together
– Example: An entity sells goods and in a separate contract agrees to repurchase
them (thus negating the substantive effect of the transaction)
Problem: IAS 18 provides little guidance regarding the accounting for multiple element
arrangements
© Douglas Nelson 2007
AGiG Seminar – 8 November 2007
Revenue Recognition
5
IAS 18: Basic principles
Revenue recognition on sale of goods
Revenue from the sale of goods recognized when: (IAS 18.14)
Significant risks and rewards of ownership have been transferred to buyer;
Seller retains neither:
– continuing managerial involvement normally associated with ownership, or
– effective control over goods sold
Amount of revenue can be measured reliably;
Flow of economic benefits to seller is probable
Related costs can be reliably measured.
© Douglas Nelson 2007
AGiG Seminar – 8 November 2007
Revenue Recognition
6
IAS 18: Basic principles
Revenue recognition upon rendering services
When the outcome of a service transaction can be estimated reliably, revenue should
be based on stage of completion. Reliable estimate requires: (IAS 18.20)
Amount of revenue can be measured reliably;
Flow of economic benefits to seller is probable;
Stage of completion at the balance-sheet date can be measured reliably
Costs incurred to date and costs to complete transaction can be measured reliably.
When this is fulfilled then the amount of revenue is recognized based on the stage of
completion (percentage of completion method) as specified in IAS 11.
Exception:
When services represent an „indeterminate number of acts“ over a specified period of
time, revenue is recognized on a straight-line basis over the period, unless some other
method better reflects the stage of completion. (IAS 18.25)
– Example: providing an office cleaning service for a specified period of time.
© Douglas Nelson 2007
AGiG Seminar – 8 November 2007
Revenue Recognition
7
IAS 18: Basic principles
Interest, royalties and dividends
Revenue arising from the use of others of assets yielding interest, royalties and
dividends recognized only if:
Flow of economic benefits to entity is probable, and
amount of revenue can be measured reliably.
Revenue is to be recognized as follows:
Interest to be recognized according to the effective interest method.
Royalties to be recognized on an accrual basis in accordance with the substance of the
agreement.
Dividends to be recognized when the shareholder‘s right to receive payment is
established.
© Douglas Nelson 2007
AGiG Seminar – 8 November 2007
Revenue Recognition
8
IAS 18: Basic principles
IAS 18: Required disclosures
Minimum disclosures include:
Accounting policies adopted for revenue recognition, including
– Methods adopted to determine the stage of completion of service transactions
Amount of each significant category of revenue recognized during the period, including
revenue from:
a) Sale of goods
b) Rendering of services
c) Interest
d) Royalties
e) Dividends, and
Amount of revenue arising from exchanges of goods or services included in each
significant category of revenue
© Douglas Nelson 2007
AGiG Seminar – 8 November 2007
Revenue Recognition
9
Basic principles of IAS 18
Special rules under US-GAAP (SAB 101/104)
that are often applied under IFRS
– Bill & Hold transactions
– Up-front fee arrangements
– Multiple-element arrangements
© Douglas Nelson 2007
AGiG Seminar – 8 November 2007
Revenue Recognition
10
Influence of US GAAP on the application of revenue recognition rules
under IFRS
US GAAP rules for revenue recognition are highly detailed and voluminous (approx.
200 different sources of revenue recognition!).
IAS 18, however, contains only very general rules
As a result, the US GAAP rules are often applied in reporting under IFRS, representing
best practice. (Companies reporting und both US GAAP and IFRS generally have
identical revenue recognition policies.)
Examples of special rules under US-GAAP that are often applied under IFRS include:
– Bill & Hold transactions
– Up-front fee arrangements
– Multiple-element arrangements
© Douglas Nelson 2007
AGiG Seminar – 8 November 2007
Revenue Recognition
11
Basic principles of IAS 18
Special rules under US-GAAP (SAB 101/104)
that are often applied under IFRS
– Bill & Hold transactions
– Up-front fee arrangements
– Multiple-element arrangements
© Douglas Nelson 2007
AGiG Seminar – 8 November 2007
Revenue Recognition
12
Important US GAAP revenue recognition rules:
Bill & Hold Transactions
„Bill & hold“ transactions refer to sales, where amounts have been invoiced and recognized
in revenue, but the related goods sold have not yet been delivered to the buyer and remain
with the buyer.
Rules represent opinions of the SEC as codified in Staff Accounting Bulletins (SAB‘s) No.
101 and 104.
Selected criteria for revenue recognition:
Sales contract stating bill & hold treatment should generally be in written form.
Seller has no further performance requirements.
Product must be complete and ready for shipment.
The customer must request bill & hold treatment and must have a „substantial business
purpose“ for the bill & hold basis.
© Douglas Nelson 2007
AGiG Seminar – 8 November 2007
Revenue Recognition
13
Basic principles of IAS 18
Special rules under US-GAAP (SAB 101/104)
that are often applied under IFRS
– Bill & Hold transactions
– Up-front fee arrangements
– Multiple-element arrangements
© Douglas Nelson 2007
AGiG Seminar – 8 November 2007
Revenue Recognition
14
Important US GAAP revenue recognition rules:
Upfront fees
Non-refundable cash payments are not necessarily considered to be revenue.
Examples:
Utility "hook-up„ fees
One-time initiation fees for fitness-centre membership
Technology "access fees„
Upfront fees are to be deferred and recognized over a period (representing the
average life of the customer relationship)
© Douglas Nelson 2007
AGiG Seminar – 8 November 2007
Revenue Recognition
15
Basic principles of IAS 18
Special rules under US-GAAP (SAB 101/104)
that are often applied under IFRS
– Bill & Hold transactions
– Up-front fee arrangements
– Multiple-element arrangements
© Douglas Nelson 2007
AGiG Seminar – 8 November 2007
Revenue Recognition
16
Important US GAAP revenue recognition rules:
Multiple Element Arrangements (EITF 00-21)
Definition – multiple element arrangements:
An arrangement containing multiple revenue-generating activities that has been
negotiated as a package.
A total price for all activities (delivery of goods and services) may have been agreed to.
As of the balance-sheet date, certain revenue-generating activities may not yet have
been performed.
Example: Sale of a software together with services that are required by the customer to
use the software.
Problem:
Identification of the unit or units of accounting that are to be considered in applying revenue
recognition rules. (Does the arrangement represent a single unit of accounting, or are there
multiple units of accounting to be separately considered.
Note: EITF 00-21 governs the identification of accounting units within a multiple-delivery
arrangement, but does not specify how revenue for those units is to be recognized.
© Douglas Nelson 2007
AGiG Seminar – 8 November 2007
Revenue Recognition
17
Multiple-element arrangements
Overview
A single transaction (contract) is to be accounted for as separate units of accounting
if the elements (deliverables) meet the requirements for separation under EITF 00-21
Transaction
Unit of
accounting
1
© Douglas Nelson 2007
Unit of
accounting
2
AGiG Seminar – 8 November 2007
Unit of
accounting
3
Revenue Recognition
18
Multiple-element arrangements
Example
Transaction:
Providing an individual customer IT solution
(an arrangement might include)
Sale of Software
Software
1
© Douglas Nelson 2007
Software
2
Providing services
(Training, Callcenter, etc.)
Providing services
(Software Updates)
Software
3
AGiG Seminar – 8 November 2007
Revenue Recognition
19
Multiple-element arrangements
Separation
Question:
When is a multiple-element arrangement to separated into components (units of
accounting) for purpose of revenue recognition?
Answer:
A separation into units of accounting is required (reflecting substance over form), if:
– the components already delivered under the arrangement have „stand-alone value“
for the customer.
„Stand-alone value“ for a component (according to EITF 00-21) exists if it is sold
separately by any vendor or the customer could resell the delivered item(s) on a
stand-alone basis“
and
– There is reliable evidence of the fair value for the components which have not yet
been delivered under the arrangement.
– The US-GAAP rules under EITF 00-21 are considered to be in conformity with
the provisions of IAS 18.13, requiring the identification of transactions
© Douglas Nelson 2007
AGiG Seminar – 8 November 2007
Revenue Recognition
20
Multiple-element arrangements
Revenue allocation and revenue recognition
If the above-mentioned conditions are not all met, the components of the
arrangement are to be considered as one unit of accounting for purposes of revenue
recognition (no separation).
The requirements for recognition of revenue must be applied to the entire arrangement
as a single unit of accounting.
If the conditions are all met and a separation into more than one unit of accounting is
appropriate, then fulfillment of applicable revenue recognition criteria is to be
determined separately for the individual units of accounting.
The revenue applicable to a unit of accounting is determined using the relative fair value
method, as follows:
Fair value of individual accounting unit
Sum of all individual unit fair values
© Douglas Nelson 2007
x Total arrangement price
AGiG Seminar – 8 November 2007
Revenue Recognition
21
Multiple-element arrangements
Example (1/3)
Software 1
Software 2
Software 3
Call Center,
Training
Performance made as of balance
sheet date?
Yes
Yes
No
Partially
performed
Standalone value to customer?
Yes
Yes
Yes
Nein
Fair value reliably estimable?
Yes
Yes
Yes
No (Yes)
50
80
20
(50)
Fair value amount
160
Total arrangement price
Note: ( ) = Alternative scenario
© Douglas Nelson 2007
AGiG Seminar – 8 November 2007
Revenue Recognition
22
Multiple-element arrangements
Example (2/3)
Revenue recognition in initial example:
Revenue recognition could be considered for the delivered Software 1 and 2 and the
partially performed services (call center, training) as of the balance-sheet date.
However, in the initial example no revenue recognition is permitted through the date of
the balance sheet, since the fair value of the contract elements which have not been
(completely) performed at the balance-sheet date cannot be reliably established.
The revenue recognition for the entire arrangement therefore is deferred until
the completion of the call-center and training services.
© Douglas Nelson 2007
AGiG Seminar – 8 November 2007
Revenue Recognition
23
Multiple-element arrangements
Example (3/3)
Revenue recognition: alternative scenario
The contract elements already delivered have standalone value to the customer and
there is reliable evidence of fair value for the elements to be completed after the
balance-sheet date.
– For the software items 1 and 2 (assuming recognition of applicable revenue
recognition criteria) revenue is to be recognized.
– The revenue amount is determined based on the relative fair value method, as
follows:
Sum of the individual fair values
200
Total arrangement price for software and services
160
Software 1 and 2 share of total fair value = (50+80)/200
Revenue to be recognized = 65 % x 160 (arrangement price)
© Douglas Nelson 2007
AGiG Seminar – 8 November 2007
65%
104
Revenue Recognition
24
Beratung
IAS 11 Construction contracts
© Douglas Nelson 2007
AGiG Seminar – 8 November 2007
Schulung
Umstellung
IAS 11: Agenda
Revenue recognition on construction contracts
Typical features of construction contracts
Construction contracts: Types of contracts and timing of
revenue recognition
Ability to reliably estimate contract result
Construction contracts: Definition of revenues and costs
Stage of completion
Amounts included in contract costs
Combining and segmenting construction projects
Balance sheet presentation
Example
© Douglas Nelson 2007
AGiG Seminar – 8 November 2007
Construction contracts
26
Revenue recognition on construction contracts
IFRS requires use of percentage of completion („PoC“) method for construction
contracts
However, certain preconditions must be met for the application of PoC:
– Among others, costs still to come must be reasonably estimable (s. slide 5)
On a loss contract, entire loss is recognized immediately upon becoming known.
If final result of a contract cannot be reasonable estimated:
– Revenues are recorded in the amount of contract costs
PoC method to be applied when a contract extends over more than one period.
© Douglas Nelson 2007
AGiG Seminar – 8 November 2007
Construction contracts
27
Typical features of construction contracts
1.
1.
2.
2.
Completion
Completion period
period extending
extending over
over at
at least
least 22 periods
periods
Individual
Individual construction
construction projects
projects based
based on
on customers
customers specifications;
specifications;
no
no serial
serial production
production
3.
3. Normally
Normally relatively
relatively complex
complex production
production processes
processes
Examples:
Industrial engineering projects, shipbuilding, real estate construction, construction of
satellites, software development, film production
© Douglas Nelson 2007
AGiG Seminar – 8 November 2007
Construction contracts
28
Construction contracts
Types of contracts and timing of revenue recognition
Type of contract
Treatment under HGB
Treatment under IFRS
Contracts with „milestone“
agreements, where
performance of total contract is
broken down into legally
separate contractual elements
Revenue and profit realization is
according to the completed
milestones
In many cases, similar to HGB
(but only if result approximates
PoC revenue and profit
recognition)
Contracts without milestone
agreements
Revenue and profit realization
upon completion of entire
contract
Revenue and profit realization
based on stage of completion
= Percentage of Completion
Method
= Completed Contract
Method
© Douglas Nelson 2007
AGiG Seminar – 8 November 2007
Construction contracts
29
Ability to reliably estimate contract result
Ability to reliably estimate contract result requires following: (IAS 11.23)
Reliable estimate of total contract revenue
Probable flow of economic benefits to entity from contract
Reliable estimate at balance-sheet date of costs to complete contract and stage of
completion
Reliable identification and measurement of contract costs, so that actual costs can be
compared with prior estimates.
© Douglas Nelson 2007
AGiG Seminar – 8 November 2007
Construction contracts
30
Construction contracts
Definition of revenues and costs
Revenues on construction contracts
Originally agreed contract sales price
+/- Increases and decreases resulting from
subsequent contract variations
+ Claims resulting from, e.g., incorrect
information supplied by buyer
+ Special payments provided by buyer
(Incentive payments) e.g. for completion
ahead of schedule
= Total revenue
Cost of sales on construction contracts
Direct expense of material
+ Material overheads
+ Direct labour
+ Indirect labour and construction overhead
+ (Only if specifically included under terms of
contract: allocated general & administrative
expenses, sales expenses, and research &
development expenses)
= Total contract costs
Generally excluded from contract costs:
General, administrative and selling costs and
research & development expenses that are not
specifically to be reimbursed under the terms of
the contract
© Douglas Nelson 2007
AGiG Seminar – 8 November 2007
Construction contracts
31
Stage of completion
The stage of completion to be determined by a method that reliably measures work
performed. (IAS 11.30)
Examples:
Proportion of costs incurred to date to total estimated contract costs („cost to cost“
method)
Comparison of performance through the balance-sheet date, compared to total contract
performance (for example, direct labour hours)
Completion of a physical portion of a total contract
Progress payments received from customers do not reflect the work performed!
© Douglas Nelson 2007
AGiG Seminar – 8 November 2007
Construction contracts
32
Amounts included in contract costs (1/2)
Examples of costs directly related to specific contracts:
Direct material costs
Direct labour costs
Normal depreciation on equipment used for the contract
Rental costs of machines and equipment
Costs of technical support
Estimated rework and guarantee costs
Examples of attributable overhead costs:
Insurance
Construction overheads
Capitalized interest (optional)
© Douglas Nelson 2007
AGiG Seminar – 8 November 2007
Construction contracts
33
Amounts included in contract costs (2/2)
Costs not attributable to contracts:
Selling, general and administrative expenses not explicitly reimbursable under the terms
of a contract
Research and development costs not explicitly reimbursable under the terms of a
contract
Depreciation on machinery and equipment which is not utilized for a specific contract
© Douglas Nelson 2007
AGiG Seminar – 8 November 2007
Construction contracts
34
Combining and segmenting construction projects
The provisions of IAS 11 are normally applied to individual construction contracts.
However, when looking from an economic point of view (substance over form), a
different treatment may be required :
– Individual components of a contract are to be segmented and separately accounted
for when: (IAS 11.8)
Separate proposals have be submitted for each asset,
Each asset has been subject to separate negotiations, and
Costs and revenues of each asset can be identified.
– A group of contracts is be combined and treated as a single contract when: (IAS
11.9)
The group of contracts is negotiated as a single package,
The contracts are so closely interrelated that they are, in effect, part of a single
project with an overall profit margin, and
The contracts are performed concurrently or in a continuous sequence.
© Douglas Nelson 2007
AGiG Seminar – 8 November 2007
Construction contracts
35
Balance sheet presentation
For each contract in progress the amount due to or due from customers is
determined as the net amount of:
Total costs incurred and recognized profits to date
Total advances received.
In the balance sheet there is a separate presentation of:
Gross amount due from customers as an asset
Gross amount due to customers as a liability
– This means there is a netting of assets and liabilities at the individual contract level,
but the sums of contract net assets and net liabilities are not offset in the balance
sheet.
© Douglas Nelson 2007
AGiG Seminar – 8 November 2007
Construction contracts
36
Construction contracts - Example (1/3)
Assumptions:
To construct a bridge a contract is entered into with a fixed price of 9,000. The total
contract costs are estimated at the beginning of the project to be 8,000. The estimated
construction period is 3 years.
At the end of the first period the estimate of total contract costs is revised to 8,050.
In the 2nd period a contract variation is authorized by both parties that will increase
contract revenues by 200 and increase contract costs by 150.
Actual costs incurred amount to 2,093 in the 1st period, 4,075 in the 2nd period and
2,032 in the 3rd period.
In the 2nd period material is purchased which is not processed until the 3rd period.
The stage of contract completion is to be determined using the „cost-to-cost“ method.
Note: Example from IAS 11, Appendix, (slightly modified)
© Douglas Nelson 2007
AGiG Seminar – 8 November 2007
Construction contracts
37
Construction contracts – Example (2/3)
Assumptions:
Period 1
1 Original contract price
Period 2
Period 3
9.000
9.000
9.000
--
200
200
3 Total revenue
9.000
9.200
9.200
4 Originally estimated total contract costs
8.000
8.000
8.000
5 Revision in period 1
50
50
50
Revision in period 2
-
150
150
6 Total contract costs
8.050
8.200
8.200
7a Costs incurred to date at period end
2.093
6.168
8.200
7b Thereof actual construction costs
2.093
6.068
8.200
950
1.000
1.000
26 %
74 %
100 %
2 Revision in period 2
8 Estimated gross profit (row 3 - row 6)
9 Percentage of completion (row 7b : row 6)
© Douglas Nelson 2007
AGiG Seminar – 8 November 2007
Construction contracts
38
Construction contracts – Example (3/3)
Revenue, cost of revenue and gross profit in the income statement
Period 1
Revenue (9.000 x 0,26)
2,340
2,340
Cost of revenue
2,093
2,093
247
247
Revenue (9.200 x 0,74)
6,808
4,468 (=6,808 – 2,340)
Cost of revenue
6,068
3,975 (=6,068 – 2,093)
740
493
Revenue
9,200
2,392 (=9,200 x 0,26)
Cost of revenue
8,200
2,132
Gross profit
1,000
260
Gross profit
Period 2
Gross profit
Period 3
© Douglas Nelson 2007
AGiG Seminar – 8 November 2007
Construction contracts
39
Beratung
IFRIC 13 Customer Loyalty Programs
(June 2007)
© Douglas Nelson 2007
AGiG Seminar – 8 November 2007
Schulung
Umstellung
IFRIC 13: Agenda
Scope of IFRIC 13
Issues
Consensus in IFRIC 13
Effective date and transition
© Douglas Nelson 2007
AGiG Seminar – 8 November 2007
Customer loyalty programs
41
Scope of IFRIC 13
IFRIC 13 Interpretation applies to customer loyalty award credits that:
a) An entity grants to its customers as part of a sales transaction (a sale of goods,
rendering of services or use by a customer of entity assets); and
b) subject to meeting any further qualifying conditions, customers can redeem in the
future for free or discounted goods or services.
IFRIC 13 addresses only the accounting by the entity granting awards
© Douglas Nelson 2007
AGiG Seminar – 8 November 2007
Customer loyalty programs
42
Issues
Issues addressed in IFRIC 13 are:
a) Whether entity’s obligation to provide free or discounted goods or services (“awards”) in
future is to be recognised by and measured by:
i.
Allocating a portion of consideration received from sales transaction to the award
credits and deferring the recognition of revenue; or
ii. Providing for estimated future costs of supplying awards.
b) If consideration is allocated to award credits:
i.
How much should be allocated to them?
ii. When should revenue should be recognised? and
iii. If a third party supplies the awards, how should revenue be measured?
© Douglas Nelson 2007
AGiG Seminar – 8 November 2007
Customer loyalty programs
43
Consensus in IFRIC 13 (1/3)
Entity shall account for award credits as a separately identifiable component of sales
transaction(s) in which they are granted (“initial sale”).
– Fair value of consideration received on initial sale is to be allocated between the
award credits and other components of sale.
– Consideration allocated to award credits is measured at their fair value (the amount
for which the awards could be separately sold).
If entity supplies awards itself:
– It should recognize consideration allocated to award credits as revenue when award
credits are redeemed and entity fulfils its obligations to supply awards.
– Amount of revenue recognised based on number of award credits redeemed relative
to total number of credits expected to be redeemed.
© Douglas Nelson 2007
AGiG Seminar – 8 November 2007
Customer loyalty programs
44
Consensus in IFRIC 13 (2/3)
If a third party supplies awards:
Entity must assess whether it is collecting the consideration allocated to the award
credits on its own account (as principal) or on behalf of third party (as agent).
a) If entity is collecting consideration as agent on behalf of third party, it shall:
i.
Measure revenue as net amount retained on its own account ((i.e., difference
between consideration allocated to the award credits and amount payable to
third party for supplying awards); and
ii. Recognise this net amount when third party becomes obligated to supply the
awards and entitled to receive consideration.
© Douglas Nelson 2007
–
These events may occur as soon as award credits are granted;
–
Alternatively, if customer can choose to claim awards from either entity or a
third party, the events may occur only when customer chooses to claim
awards from third party.
AGiG Seminar – 8 November 2007
Customer loyalty programs
45
Consensus in IFRIC 13 (3/3)
b) If entity is collecting consideration on its own behalf, it shall:
i.
Measure revenue as the gross consideration allocated to the award credits and
ii. Recognise the revenue when it fulfils its obligations in respect of the rewards
If unavoidable costs of meeting obligations to supply awards are expected to exceed
consideration received (i.e., consideration allocated to award credits upon initial sale not
yet recognized as revenue, plus any additional consideration receivable at time of
redemption), this represents an onerous contract.
–
Liability must be recognized for the excess in accordance with IAS 37.
© Douglas Nelson 2007
AGiG Seminar – 8 November 2007
Customer loyalty programs
46
Effective date and transition
IFRIC 13 to be applied for annual periods beginning on or after 1 July 2008.
–
Earlier application is permitted;
–
If applied for a period beginning before 1 July 2008, this is to be disclosed.
Changes in accounting to be accounted for in accordance with IAS 8.
© Douglas Nelson 2007
AGiG Seminar – 8 November 2007
Customer loyalty programs
47
Beratung
SEC Staff Accounting Bulletins
(SAB) Nos 101 and 104:
Revenue Recognition in Financial Statements
And selected significant EITF Issues
© Douglas Nelson 2007
AGiG Seminar – 8 November 2007
Schulung
Umstellung
Why Focus on Revenue Recognition?
Increasing risk for companies listed in the US
High profile accounting failures
SEC highly focused on revenue recognition
Over 50% of restatements required by SEC result from improper revenue recognition
Market valuations as multiple of revenues
© Douglas Nelson 2007
AGiG Seminar – 8 November 2007
Revenue recognition
49
Revenue Recognition
Authoritative Literature Has Been Added to Address Misapplications of Basic
Concepts
8 FASBs and
1 Technical Bulletin
Approx. 30 EITFs
and 15 SOPs
FASB
C o n c e p t St a t e m e n t s
N o . 5 a n d 6
SEC guidance
(e.g., SAB 101,
104 and AAER 108)
© Douglas Nelson 2007
Over 200 sources of
US GAAP on revenue
recognition!
Other: numerous
practice bulletins,
FASB staff positions
and Q&A’s, SAS’s
and audit guides
AGiG Seminar – 8 November 2007
Revenue recognition
50
EITF 99-19: "Reporting Revenues Gross as a Principal versus Net as an
Agent"
Indications for “gross” or “net” presentation of revenues
– Who has primary responsibility for providing product or service?
– Who has inventory risk prior to delivery?
– Does seller have pricing discretion?
– Who has credit risk?
– Does seller have discretion in supplier selection?
No individual factor is deciding in determining net or gross reporting of revenues
© Douglas Nelson 2007
AGiG Seminar – 8 November 2007
Revenue recognition
51
Other important "EITF Issues"
00-10: "Accounting for Shipping and Handling Fees and Costs"
– Shipping billed to customer must be shown as revenue
– No guidance regarding treatment of freight costs – if amounts are material, the
handling should be disclosed
00-14: "Accounting for Certain Sales Incentives"
– Coupons und rebates are netted from revenues
– Free goods provided are considered part of cost of sales and should not be netted
from revenues
© Douglas Nelson 2007
AGiG Seminar – 8 November 2007
Revenue recognition
52
SAB 101
"Revenue Recognition in Financial Statements"
Published: December 1999
© Douglas Nelson 2007
AGiG Seminar – 8 November 2007
Revenue recognition
53
Revenue is Recognized When it is...
Realized
or
Realizable
Evidence of an arrangement
Collectibility
and
Earned
Performance/delivery
Fixed or determinable price
© Douglas Nelson 2007
Based on SOP 97-2 Criteria
AGiG Seminar – 8 November 2007
Revenue recognition
54
Persuasive Evidence of Arrangement
Customary business practices:
Written Contracts:
– Must be signed by BOTH parties prior to recognition of revenue.
Other allowable documentation:
– Signed customer purchase order;
– Online authorization of purchase;
– Some oral agreements.
© Douglas Nelson 2007
AGiG Seminar – 8 November 2007
Revenue recognition
55
Persuasive Evidence of Arrangement – Consignment Arrangements
Title is transferred but:
Buyer has the right to return product and
– Buyer not obligated to pay at date of sale;
– Payment contingent upon resale;
– Buyer has no economic substance from seller.
Seller has to repurchase the product or goods of which the product is a component
– Seller provides non-standard financing;
– Seller pays interest costs under 3rd party financing.
The product is delivered for demonstration purposes.
© Douglas Nelson 2007
AGiG Seminar – 8 November 2007
Revenue recognition
56
Delivery and Performance – FOB Terms and Title Transfer
FOB Terms
FOB shipping point
FOB destination
International Issues – Romalpa Provisions
Self-Insurance/Other security interests
© Douglas Nelson 2007
AGiG Seminar – 8 November 2007
Revenue recognition
57
Delivery and Performance – Bill & Hold Arrangements
AAER No. 108 sets conditions for recognition of revenue in bill and hold
transactions.
SAB 101 repeats conditions
Buyer request for Bill & Hold generally should be in writing
Seller must not retain ANY specific performance obligations such that the earnings
process is not complete
The product must be complete and ready for shipment
© Douglas Nelson 2007
AGiG Seminar – 8 November 2007
Revenue recognition
58
Delivery and Performance – Customer Acceptance Issues
Class of Transaction
Accounting
Demonstration/Evaluation
Consignment
Seller Specified Criteria
FAS 48/FAS 5
Subjective Return Provisions
Customer Specified Criteria
© Douglas Nelson 2007
FAS 48
FAS 48/FAS 5
AGiG Seminar – 8 November 2007
Revenue recognition
59
Delivery and Performance – Installation Issues
Two-Tiered Test
Inconsequential/Perfunctory
– FAQ Question 3 lists factors to consider – most important is whether FULL amount
of fee is due
– Accrue costs to complete
– Meeting this test will be rare
Multiple-Element Arrangement
– Follow EITF 00-21 (this was a SAB 104 revision)
IfIf neither
neither test
test can
can be
be met,
met, defer
defer revenue
revenue until
until installation
installation isis complete.
complete.
© Douglas Nelson 2007
AGiG Seminar – 8 November 2007
Revenue recognition
60
Case Study – Installation and Customer Acceptance (1/2)
ABC is an equipment manufacturer that entered into a sales contract with a customer to
sell and install equipment for $5 million.
ABC has experience in the production and successful installation of the equipment.
Installation may take up to 60 days.
ABC has developed internal specifications for the equipment and has previously
demonstrated that the equipment meets those specifications.
The contract also includes customer-specified technical and performance criteria
regarding speed and quality.
Equipment is tested at ABC’s facility prior to shipment.
© Douglas Nelson 2007
AGiG Seminar – 8 November 2007
Revenue recognition
61
Case Study – Installation and Customer Acceptance (2/2)
Continued
Title to the equipment passes to customer upon delivery.
ABC has sold the equipment w/o installation for $4.8 million and routinely sells its
services separately on a time and materials basis. Based on these rates, installation
labor on a stand-alone basis would be approximately $300,000.
The cost for installation is approximately $100,000.
The installation process is generally completed by ABC but could be performed by
others.
100% of the fee is due no later than 90 days after delivery.
© Douglas Nelson 2007
AGiG Seminar – 8 November 2007
Revenue recognition
62
Case Study – Questions
1) Is installation inconsequential or perfunctory?
2) Is there objective evidence to separate equipment element from the installation
element?
3) Is installation essential to the functionality?
4) Which category of customer acceptance provision does this fall into?
© Douglas Nelson 2007
AGiG Seminar – 8 November 2007
Revenue recognition
63
Delivery and Performance – Up-Front Nonrefundable Fees
Nonrefundable cash does not equal revenue
Common situations:
– Health club initiation fees;
– Utility “hookup” or activation fees;
– Technology access fees.
© Douglas Nelson 2007
AGiG Seminar – 8 November 2007
Revenue recognition
64
Biotechnology Arrangements
Typical Arrangements May Include:
Up-front fee for “development to date”
– Fees will be deferred and amortized if there is continuing involvement in R&D or
manufacture/distribution of the product
Milestone payments
– Recognized upon receipt if achievement represents substantive work and
approximates value of achieving that milestone
– EITF 91-6 model
– Added to deferred revenue and amortized over remaining period of involvement
(may not be acceptable because it back-ends revenue significantly)
On-going Royalties
– Generally recognized as earned
© Douglas Nelson 2007
AGiG Seminar – 8 November 2007
Revenue recognition
65
Other Licensing Issues
No Continuing Involvement
Start or Street Dates
Extensions
© Douglas Nelson 2007
AGiG Seminar – 8 November 2007
Revenue recognition
66
Contract Acquisition and Origination – Scope of SAB 101
Footnote 29 – Incremental direct costs associated with acquiring a revenue-producing
contract, unless specifically provided for in authoritative literature, should be accounted
for in accordance with
– FASB Technical Bulletin 90-1 (paragraph 4), or
– FASB Statement 91 (paragraph 5).
© Douglas Nelson 2007
AGiG Seminar – 8 November 2007
Revenue recognition
67
Contract Acquisition and Origination – Scope of SAB 101
Deferral of costs is permitted (not required)
Applies only to the deferral of incremental direct costs for which revenue has been
deferred (FAQ)
Excludes:
– Start-up costs (SOP 98-5);
– Deferral of costs in accordance with SOP 81-1, SFAS 51 or SFAS 60.
© Douglas Nelson 2007
AGiG Seminar – 8 November 2007
Revenue recognition
68
Contract Acquisition and Origination
Policy should be disclosed
Preferability letters
Amortize costs consistent with revenues
© Douglas Nelson 2007
AGiG Seminar – 8 November 2007
Revenue recognition
69
Contract Acquisition and Origination
Deferral of costs in excess of deferred revenue is inappropriate, except when there is a
contractual arrangement (1996 SEC staff speech)
– Recoverability must be evaluated
– Evaluation should consider only estimated cash flows during the contractual period
– Accounting policy decision
© Douglas Nelson 2007
AGiG Seminar – 8 November 2007
Revenue recognition
70
Contract Acquisition and Origination Costs – FTB 90-1
Costs
Costs directly
directly related
related to
to the
the acquisition
acquisition
of
of aa contract
contract
and
and
would
would not
not have
have been
been incurred
incurred but
but for
for
the
the acquisition
acquisition of
of that
that contract
contract
© Douglas Nelson 2007
Excluded:
Indirect costs
Unsuccessful efforts
Advertising
Included:
Commissions
Costs meeting definition in SFAS No. 91
AGiG Seminar – 8 November 2007
Revenue recognition
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Contract Acquisition and Origination Costs – SFAS No. 91
Incremental
Incremental direct
direct costs
costs incurred
incurred in
in
transactions
transactions with
with independent
independent third
third
parties
parties
and
and
certain
certain costs
costs directly
directly related
related to
to
specified
specified activities
activities performed
performed by
by the
the
company
company for
for the
the contract
contract
© Douglas Nelson 2007
Excluded:
Indirect costs
Advertising
Included:
Commissions
Preparing and processing documents
AGiG Seminar – 8 November 2007
Revenue recognition
72
Comparison of Methods
FTB 90-1
Incremental direct costs
Expense costs associated with the
negotiation of a contract that is not
consummated
SFAS No. 91
Incremental direct costs
Costs incurred with independent third
parties
Certain costs directly related to specified
activities performed by the lender for the
contract
© Douglas Nelson 2007
AGiG Seminar – 8 November 2007
Revenue recognition
73
Fixed and Determinable Fees – Refundable Service Fees
SEC believes fees should be accounted for as a deposit in accordance with FAS 140
but will allow analogy to FAS 48 in limited situations
Common situations:
– Commercial lease brokerage fees contingent upon the tenant moving into the facility;
– Talent agent whose fee for arranging a celebrity endorsement is cancelable if the
celebrity breaches contract with customer;
– Insurance agent whose commission is refundable in whole for a 30-day period as
required by law and then declining on a pro-rata basis until the customer makes six
monthly payments.
© Douglas Nelson 2007
AGiG Seminar – 8 November 2007
Revenue recognition
74
Fixed and Determinable Fees – Contingent Fee Arrangements
SEC has verified that guidance in Question 8 of SAB 101 is limited to contingent rent
scenarios
Common situations:
– Consulting fees based on cost savings when it is probable that the savings will be
achieved;
– Investment management fees tied to performance above a market index.
© Douglas Nelson 2007
AGiG Seminar – 8 November 2007
Revenue recognition
75
SAB 101 – Financial Statement Disclosures
Expanded disclosures of revenue recognition policies
– Each material type of transaction (including barter sales)
– For multiple-element transactions, the revenue recognition policy for each element
– For equipment sold on an installed basis, the method of accounting for the
installation
Changes in estimated returns for revenue recognized in accordance with FAS 48
Policy for refundable service fees
Policy for contract acquisition and origination costs
Certain other disclosures
© Douglas Nelson 2007
AGiG Seminar – 8 November 2007
Revenue recognition
76
Thank you for your attention!
DOUGLAS NELSON
Financial Reporting IFRS and US GAAP
www.douglasnelson.de
© Douglas Nelson 2007
AGiG Seminar – 8 November 2007
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