Performance substantially complete
History
Realized/Realizable
Ongoing/central operations
Complexity (esp. Services)
Earnings Management
Problem s
Complacent auditors
Manifest as
Cut-Off Errors
Recognized but not earned
140 Items of Authoritative Literature
Customary nature of firm's operations
Basic Rules
Persuasive evidence of an arrangement
Substance rather than form
Transfer the risks and rewards of ownership
Transfer the risks and rewards of ownership
Bill and hold requires written instruction from buyer
Goods actually accepted by customer
Multiple deliverables
Delivery has occurred / services rendered
SAB 101
e.g. Tax preparation software delivered in advance
Date of expected Initial use
Large up front fees
No unilateral right for customer to cancel and receive cash refund
Seller's price is fixed/determinable
Reliable estim ate of returns
'Reasonable' estimate of bad debts
Collectability reasonably assured
Gross vs Net
Barter
Significant levels of inventory in distribution channel
Lack of visibility into distribution channel and sales to end users
Expected introduction of new products that will lead to obsolescence and higher returns
Channel Stuffing
Significance of a particular distributor to the company (segment)
Challenges
Newness of the product
Introduction of a competitor's product
Characterize unusual transactions as component of revenue
Characterize as 'arms length' third party
Sale of undervalued assets to generate profits
Deliberate m isstratem ent of % complete
Revenue recognition policy for each material type of transaction
Notes
Methods for each elem ent of multiple element
Material changes in estimates of returns
Disclosure
Sales of tangible products (net)
Income Statem ent
Income from rentals
Revenue from services
Other revenues
WIP accum ulated
Report Actual costs + expected profit - billings as asset/liability
% Complete
No netting of projects
Some have policy of no profit if <10% due to IRS
Accounting Methods
Report actual costs - billings as asset/liability
Completed Contract
Recognition of income deferred until complete
Estim ates reasonably dependable
Contracts contain enforceable rights
Choosing Method (SOP 81-1)
Buyer expected to satisfy obligations
Seller expected to satisfy obligations
Precontract costs expensed (SOP 98-5)
Contract costs identifiable/allocable to specific contract
Permitted to defer costs relating to excess goods if recoverable
Costs Incurred
Based on prices expected when cost is incurred
Estim ated cost to complete
Use latest estimates to determine % com plete (cf. SOP81-1)
If recoverable - reduce WIP and recognize asset
Back Charges
Subcontractor Costs (accumulate in WIP)
If disputed - see SOP 81-1
Contractor bears risk
Fixed price (lump sum)
Fixed DLH + cost of materials
Time & materials
May have spending cap
Reimburse allowable costs + fee as profit
Pricing Arrangem ents
Cost without fee
Cost-type contracts
Variations
Cost + fixed fee
Cost + award fee (i.e. performance)
Specified amount for each unit of work perfomed
Unit price contracts
Inefficiency a problem - also e.g. advance purchase of materials etc
Cost to Cost
Inputs
Revenue Measurement
Most popular and support from ARB 45
Efforts expended
Units of delivery
Outputs
Equal weight? e.g. first floor of a 20 floor
Units of work performed
Record entire expected loss im mediately
Losses
Reverse any profit recognized
Amount recorded as liability
Rebuttable presumption of single profit centre
Long term construction contracts
Negotiated as single package
Constitute agreement to do single project
Combine SOP 81-1
Closely interrelated construction activities
Performed concurrently or continuous sequence under single project management
In substance, a contract with a single customer
Bona fide proposals on separate components and entire project
Case I
Customer has right to accept proposals on either basis
Com bine/Segm ent Contracts
Aggregate amount in components approximates entire project
Terms and scope call for separate elements
Comm on for separate elements negotiated separately in marketplace
Segment SOP 81-1
Different gross profit rates for elements due to risk etc.
Case 2
Contractor history of doing separate elem ents for other customers and higher profit rate
That history is stable with respect to profit rates
Excess of sum of separate to total clearly attributable to cost savings from com bined performance
Documented and verifiable evidence of sale of separate components to other customers
Consistent application to projects with sim ilar characteristics and circumstances
Agree by both parties -> adjust revenue and cost
Completed Contract - Defer if recoverable
Revenue Recognition
If probable that will not recover, include as cost for period
Change Orders
Unpriced orders (SOP 81-1)
% Complete
Recovery probable thru price change - defer costs until agree/include expenditure in current revenue and cost
excess can be reliably estim ated
Recovery probable with profit - may do excess of change order if:
realization is 'probable beyond a reasonable doubt'
Product/service differs from original contract
Contract Options (SOP 81-1) - separate contract if any of:
Price negotiated without regard to original contract
Product sim ilar but relationship between contract cost and price is significantly different
Probable that claim -> additional revenue
Am ount can be reliably estimated
Evidence of legal basis for claim
Claims (unanticipated additional costs) recognize if:
SOP 81-1 Guidance
Due to unforeseen circumstances and not contractor's deficiency
Costs are identifiable, determinable and reasonable relative to work performed
Evidence supporting the claim is objective and verifiable
If unable to meet requirements, a contingent asset under SFAS5
Accounting Changes (APB20)
Change in m ethod requires retroactive treatment and restatement of prior years
Change in % complete is change in estimate therefore prospective
A single act (e.g. Broker's Commission)
Specific performance
Issues
Proportional Perform ance
More than one act to perform
Methods
Completed Performance
Final act is significant to transaction as a whole (e.g. rem oval firm)
Also use if no objective measure of perform ance
Uncertainty surrounding collectability
Collection
Expense (SOP98-5)
Precontract/ engagement costs
Expense as incurred under all revenue recognition methods
Direct costs
Initial direct costs (e.g. materials)
Expense Recognition
Indirect costs
defer as prepayment/inventory
recognize as expense when revenue is recognized
Expense as incurred
Out of pocket costs
Expense as incurred
Related client billing as revenue
Service revenues
Expense as incurred
Overhead
Direct costs to date + estimated direct costs > net realizable revenue from contract?
Losses
Loss first applied to reduce recorded deferred costs to zero
Remaining loss as an estim ated liability
Initiation/Activation
Initiation and Installation Fees (non refundable)
Installation
If objectively determinable value for right then revenue recognized immediately with associated expense
If not, recors as liability for future service and recognize using one of the revenue recognition m ethods
If could be purchased in separate transaction, then revenue
Otherwise an advance charge for future service and recognize over estim ated service period
Service plus Product
If inclusion of one would not change total transaction price, then single
If constitute separate elements, then account for separately
Freight service in process (EITF 91-9)
Other guidance
Reporting reimbursable costs (EITF 01-14) - classify as revenue and not as a reduction in expense
Separately priced extended warranties (FTB 90-1) - defer and recognize on straight line basis (unless
evidence of alternative pattern)
Defer gross profit and recognize as cash comes in
Presentation in financial statements
The Installment Method
Interest on receivables
Uncertain collectability
Bad debts/ repossession
The Cost Recovery Method
Defer gross profit and recognize when cash receipts cover cost of asset
Seller's price is fixed/determinable
Seller is paid/ buyer obligated and not contingent on resale
Meet all of following (FAS 48)
Rights of return
No change in buyer obligation in event of theft, dam age, physical destruction
Buyer has econom ic substance apart from that provided by seller
Seller does not have significant obligations for future performance to bring about resale
Amount of future returns can be reliably estimated
Six conditions m et
If fail to meet FAS 48 defer to earlier of
Return privilege substantially expired
Real estate sales
Real estate operations
Franchising
A principal in the transaction?
Responsible for fulfillment of order, acceptability to customer?
Responsible for arranging transport is not responsibility for fulfillment
General inventory risk (title prior to order)?
Title to the property?
If product returned, who has title?
Physical inventory risk (title post order)? - less compelling
Norm al risks and rewards of ownership
Gross vs Net (EITF 99-19)
Who sets selling price?
Is amount earned by compant fixed?
An agent or broker (fee/com mission)?
Does the com pany change the product or perform a service?
Multiple suppliers for the product?
Is company involved in determining the nature etc. of the product or service ordered by custom er?
Does the com pany bear credit risk?
Extensive guidance and examples in consensus
Other
Measure fair value at earlier of
Grant of equity instrument
When grantee and issuer agree the terms
When grantee's perform ance of the task is complete
If terms depend upon attaining market condition, include fair value of commitm ent to change term s
If terms depend upon performance goals, adjust fair value when goals are met
Multiple Deliverables (EITF 00-21)
Coupons, rebates and other rights for free/discounted goods in a prior exchange transaction accounted for
as a separate deliverable
Scope exclusions
Offer in connection with a current transaction redeem able at a future date (cf 00-21)
Offers based upon cumulative level of future transactions (e.g. loyalty programs)
Consideration given to customer (EITF 01-9)
Vendor (will) receives an identifiable benefit in exchange for consideration
Cash consideration to a customer presumed to be a reduction in selling price and hence deduct from
revenue unless
Identifiable benefit is separable from sale of goods and services (e.g. could acquire from another party)
Vendor can reasonably estimate fair value of benefit
If anything other than cash, characterize as an expense
There is significant additional guidance in the consensus
Consideration received by a customer (EITF 02-16 and 03-10)
Replace Earnings Process Model with Asset/Liability Model
Going Forward
FASB Project
e.g. Revenue is an increase in a contract asset or a decrease in a contract liability (or a com bination of the
two) that results from providing goods and services to a customer.
Aiming to issue Preliminary Views Q2 08