The Value of Experience
REVENUE RECOGNITION
Accounting Day 2009
May 18, 2009
Wayne R. Pinnell
Managing Partner
Haskell & White LLP
Revenue Recognition
1.
2.
3.
4.
5.
6.
Revenue Recognition Overview
Basic Revenue Recognition Criteria
Multiple Elements in Revenue Recognition
Other Revenue Recognition Considerations
US GAAP vs. IFRS
Conclusion and Q & A
NOTE – Last Year this topic was covered in a three-hour
session. This year we just have an hour.
Ready or not….here we go!
1. Revenue Recognition Overview
I.
There are hundreds of references in authoritative
guidance and interpretations under US GAAP covering
revenue recognition.
II.
There are general standards and numerous standards
written to apply to specific industries or situations.
III. Codification from FASB came out Q1-2008.
(http://asc.fasb.org) You can register and access the
website for free – before July 1, 2009 – then charges.
1. Revenue Recognition Overview
• Some of the more common revenue criteria include:
– FASB Concepts Statement No. 5 (the foundation)
– SEC Staff Accounting Bulletin (“SAB”) 104 applies to public
companies, but is generally considered applicable to all companies
– SFAS 66 applies to real estate
– SOP 97-2 and its related interpretations applies to software
– SOP 81-1 applies to contract accounting
– EITF 99-19 applies to gross revenue as principal vs. net as agent
– EITF 00-10 guidance on accounting for shipping & handling fees
– EITF 00-21 applies to multiple deliverable arrangements
2. Basic Revenue Recognition Criteria
FASB Concepts Statement No. 5 (December 1984):
Revenues of an enterprise during a period are generally
measured by the exchange values of the goods or services.
Recognition of revenues in a given period requires that the
revenues meet two criteria. The revenues must be:

Realized or realizable, and

Earned
2. Basic Revenue Recognition Criteria
When is revenue realized or realizable?


Revenue is realized when products, merchandise or services or other
assets are exchanged for cash or claims to cash
Revenue is realizable when related assets received or held are readily
convertible to known amounts of cash or claims to cash
When is revenue earned?

Revenue is earned when the entity has substantially accomplished
what it must do to be entitled to benefits represented by the benefits of
the revenue. In other words, “the earnings process has been
completed”.
2. Basic Revenue Recognition Criteria
Major “recent” revenue recognition standards:
 In October 1997, the AICPA issued Statement of Position
97-2 on Software Revenue Recognition to address the
evolving practices in the software industry.
 In December 1999, the SEC issued Staff Accounting
Bulletin No. 101 on Revenue Recognition to
“summarize” existing GAAP on the subject – adopting
the basic principles from SOP 97-2. The SEC later
amended SAB 101 with the issuance of SAB 104.
2. Basic Revenue Recognition Criteria
SAB 104 and SOP 97-2 indicate that revenue is generally
realized or realizable and earned when ALL of the following
four criteria are met in:
I.
II.
Persuasive evidence of an arrangement exists
Delivery has occurred or services have been
rendered
III. Seller’s fee is fixed or determinable
IV. Collection is reasonably assured
2. Basic Revenue Recognition Criteria
I.
Persuasive evidence of an arrangement is based on the
Company’s customary and agreed upon business practice
which may require a:




Signed contract
Purchase order
Electronic communication
Credit card authorization
2. Basic Revenue Recognition Criteria
I.
Persuasive evidence of an arrangement exists



Complete = contract is signed by both parties before period
end. If contract is not signed by either party, terms and
conditions are not final, revenue cannot be recognized.
Does contract include all terms and conditions?
Are there any side letters/agreements? Such agreements may
include cancellation, termination, or return provisions that
could affect revenue recognition
No revenue can be recognized unless persuasive evidence of an
arrangement exists, even if delivery has occurred.
SAB 104 Discussion Question (summarized)
Is there Persuasive Evidence of an Arrangement?

Facts: Company A delivers product to Company B prior to quarter
end. Company A’s normal and customary business practice for this
class of customer is to enter into a written sales agreement that
requires the signatures of the authorized representatives of the
Company and its customer to be binding. Company A prepares a
written sales agreement which is signed by their authorized
representative prior to quarter end. Company B’s purchasing
department has orally agreed to the sale and stated the contract will
be approved the first week of the next quarter.
SAB 104 Discussion Question (summarized)


Question: Can Company A recognize revenue in the current
quarter?
Interpretive response: Revenue cannot be recognized in the
current quarter. As a result of Company A’s business practice of
requiring a written sales agreement for this class of customer,
persuasive evidence of an arrangement would require a final
agreement that has been executed. Company B’s execution of
the sales agreement after the end of the quarter causes the
revenue from the transaction to be recognized in the subsequent
period.
2. Basic Revenue Recognition
II.
Delivery has occurred or services have been rendered

Delivery can vary based on the nature of the product
a)
Physical transfer
b)
Electronic transmission
c)
Availability for download
d)
Installation/Training requirements
e)
Customer acceptance

If the undelivered element(s) are essential to the functionality
of the delivered element(s), delivery may not have occurred
2. Basic Revenue Recognition Criteria

Delivery has occurred or services have been rendered
•
•
•
Shipping terms impact revenue recognition, i.e.
FOB shipping point vs. FOB destination
Title and risk of loss must transfer
The Company’s policy of replacing goods damaged
in shipment at no charge to the customer creates
FOB destination terms for revenue recognition
purposes
2. Basic Revenue Recognition Criteria

Delivery has occurred or services have been rendered
(cont.):
•
•
Bill and hold arrangements should be uncommon. It
must be requested by the customer and has several
other conditions specified in SAB 104
Revenue should not be recognized when customers
have an unconditional right of return
SAB 104 Discussion Question (summarized)
Has Delivery Occurred?
 Facts: Company Z has an arrangement to deliver its products to
Company A on a consignment basis. Pursuant to the terms of the
arrangement, Customer A is a consignee, and title to the products
does not pass from Company Z to Customer A until Customer A
consumes the products in its operations. Company Z delivers
product to Customer A under the terms of their arrangement.

Question: May Company Z recognize revenue upon delivery of
its product to Customer A?
SAB 104 Discussion Question (summarized)
 Interpretive Response: No. Products delivered
to a consignee pursuant to a consignment
arrangement are not sales and do not qualify for
revenue recognition until a sale occurs. The staff
believes that revenue recognition is not
appropriate because the seller retains the risks
and rewards of ownership of the product and title
usually does not pass to the consignee.
SAB 104 Discussion Question (summarized)
Has Delivery Occurred?

Facts: Company A receives purchase orders for product. The
customer is not ready to take delivery of the product for various
reasons including lack of space and delays in customers’
production schedules. Company A ships the product to a thirdparty warehouse but retains title to the product and payment is
dependent upon delivery to a customer specified site.

Question: Can company A recognize revenue when the product
is shipped?
SAB 104 Discussion Question (summarized)

Interpretive response: Revenue cannot be
recognized. Delivery generally is not considered to
have occurred unless the customer has taken title
and assumed the risks and rewards of ownership of
the product. This could be considered to be an
inappropriate “bill and hold” transaction.
SAB 104 Discussion Question (summarized)
Has Delivery Occurred?

Facts: Company E is an equipment manufacturer whose main product
is generally sold in a standard model. The contracts for sale of that
model provide for customer acceptance to occur after the equipment is
received and tested by the customer. The acceptance provisions state
that if the equipment does not perform to Company’s E published
specifications, the customer may return the equipment for a full refund
or a replacement unit. Title to the equipment passes upon delivery to
the customer. Company E does not perform installation or other
services on the equipment and tests each piece of equipment it sells
before shipment.
SAB 104 Discussion Question (summarized)

Question: Company E receives an order from a new customer for a
standard model of its main product. When should Company E
recognize revenue from sales of this piece of equipment?

Interpretive response: Revenue should be recognized upon
delivery of the equipment. While the SEC staff presumes that
customer acceptance provisions are substantive provisions that
generally result in revenue deferral, that presumption can be
overcome. Although the contract includes a customer acceptance
clause, acceptance is based on meeting Company E’s published
specifications for a standard model.
SAB 104 Question (paraphrased)
Have all conditions related to Delivery been met?

Facts: Assuming the same facts as the previous example.
Company E enters into an arrangement with a new customer to
deliver a version of its standard product modified as necessary
to be integrated into a customer’s new assembly line while still
meeting all of the standard published vendor specifications.
The customer may reject the equipment if it fails to meet the
standard published performance specifications or cannot be
satisfactorily integrated into the new line.
continued >>>
SAB 104 Question (paraphrased)
Have all conditions related to Delivery been met?

Facts (cont): Company E has never modified its
equipment to work on an integrated basis in the type of
assembly line the customer has proposed. Company has
designed the equipment to meet the standard published
performance specifications with the modifications
necessary, but Company E is unable to replicate the new
assembly line conditions in its testing.
SAB 104 Discussion Question (summarized)

Question: When should Company E recognize revenue from this
transaction?

Interpretive response: The contract includes a customer
acceptance clause that is based in part on customer specific
criterion and Company E cannot demonstrate that the equipment
shipped meets that criterion prior to shipment. Therefore,
Company E should wait until the product is successfully
integrated at its customer’s location and meets the customerspecific criteria before recognizing revenue.
2. Basic Revenue Recognition Criteria
III. Seller’s fee is fixed or determinable
A fee required to be paid in a set amount that is not
subject to refund or adjustment.
If it cannot be concluded that a fee is fixed or
determinable at the outset of an arrangement, revenue
should be recognized as payments from customers
become due (assuming all other conditions for revenue
recognition have been satisfied).
2. Basic Revenue Recognition Criteria
Additional factors impacting the “fixed or determinable” assessment include:

Extended payment terms outside the Company’s customary terms or over
12 months. Can be overcome if Company can show a history of full
payment.

Cancellation privileges

Forfeiture or refund clauses

Customer acceptance clauses/right of return

Concessions reduce the present value of amounts due under the original
terms and can include:
1.
2.
3.
4.
Additional discounts
Future products at no fee or a reduced fee
Extension of payment terms
Additional payment terms
2. Basic Revenue Recognition Criteria
IV. Collection is reasonably assured

An assessment of collectibility should be made prior to
recognition of revenue and should address differences amongst
customers:





Collectibility assessments of new customers should be more diligent
Policy should establish time lines for review of customers
creditworthiness (annually)
It is about the customers ability to pay, not their willingness
Need adequate documentation of assessment
In general, bad debt expense and revenue should not be recorded
for the customer in the same period
Sample Software Company Issues
• Former client, “V” had sales agreements for license
fees of $2.0M. In turn, licensee was to sell and install
the software to an end user. The final price payable to
Z was dependent upon sale to end user, and licensee
did not need to pay until sale was completed with user.
• While there was persuasive evidence of an
arrangement, delivery had not occurred, the price was
not fixed and collection was not reasonably assured in
the absence of an end-user customer.
3. Multiple Elements in Revenue
Recognition Under EITF 00-21
EITF 00-21 was issued to address the increased complexities
that exist when companies offer “bundled” products and
services.
These bundled products and services often:
• Involve delivery of products and services at varying
times
• Have varying payment terms and payment streams
The arrangements could create separate units of accounting
for the elements of the product/services in the package deal.
3. Multiple Elements in Revenue
Recognition Under EITF 00-21
Multiple revenue elements in one arrangement could include:
 the delivery or performance of multiple products, services,
 the rights to use assets
 initial installation, initiation, or activation services
Payment arrangements can include consideration as:
 a fixed fee or fixed fee coupled with a continuing payment stream
corresponding to the continuing performance, and
 the amount of the payments may be fixed, variable based on
future performance, or a combination of fixed and variable
payment amounts.
3. Multiple Elements in Revenue
Recognition Under EITF 00-21
In an arrangement with multiple deliverables, the delivered item(s)
should be considered a separate unit of accounting if ALL of the
following criteria are met:
1. The delivered item(s) have value to the customer on a stand alone
basis
2. There is objective and reliable evidence of the fair value of the
undelivered item(s)
3. If there is a general right of return for the delivered item, delivery
or performance of the undelivered item(s) must be considered
probable and substantially in control of the vendor
3. Multiple Elements in Revenue
Recognition Under EITF 00-21

The arrangement consideration allocable to delivered
item(s) that does not qualify as a separate unit of
accounting within the arrangements should be combined
with the amount allocable to the other undelivered items
within the arrangement.

The appropriate recognition of revenue should then be
determined for those combined deliverables as a single
unit of accounting.
3. Multiple Elements in Revenue
Recognition Under EITF 00-21
The following steps should be followed in reviewing
multiple elements:
1.
2.
3.
4.
Identify deliverables
Determine if there is a higher level of literature
(SFAS’s, SOP’s, FASB Interpretations and Technical
Bulletins)
Measure the arrangement consideration (must be fixed
and determinable)
Separate the deliverables
3. Multiple Elements in Revenue
Recognition Under EITF 00-21
The following steps should be followed in reviewing
multiple elements (cont.):
5.
6.
Allocate the arrangement consideration (should be
based on fair value – contractually stated prices for
individual products and/or services in an arrangement
with multiple deliverables should not be presumed to
be representative of fair value)
Identify the revenue model
EITF 00-21 – Example 1
Facts: CellularCo runs a promotion in which new customer who
sign a two-year contract receive a “free” phone. The contract
requires the customer to pay a cancellation fee of $300 if the
customer cancels the contract. There is one-time “activation fee”
of $50 and a monthly fee of $40 for the ongoing service. The
same monthly fee is charged by CellularCo regardless of whether a
“free” phone is provided. The phone costs CellularCo $100.
Further, assume that CellularCo frequently sells the phone
separately for $120.
continued>>>
EITF 00-21 – Example 1 (cont.)
Facts (cont:) CellularCo is not required to refund any portion of the
fees paid for any reason. CellularCo is a sufficiently capitalized,
experienced, and profitable business and has no reason to believe that
the two-year service requirement will not be met. CellularCo is
considering whether (a) the phone and (b) the phone service (that is,
the airtime) are separable deliverables in the arrangement. The
activation fee is simply considered additional arrangement
consideration to be allocated. The phone and activation are delivered
first, followed by the phone service (which is provided over the twoyear period of the arrangement).
EITF 00-21 – Example 1 (cont.)
Evaluation: The first condition for separation is met for the
phone. That is, the phone has a value on a standalone basis
because it is sold separately by CellularCo. The second
condition for separation also is met because objective and
reliable evidence of fair value exists for the phone service.
Finally, there are no general rights of return in this
arrangement (third condition). Therefore, the phone and the
phone service should be accounted for as separate units of
accounting.
EITF 00-21 – Example 1 (cont.)



The total arrangement consideration is $1,010. The fair value of the phone service is $960
($40 x 24 months), the price charged by CellularCo.
The fair value of the phone is $120, the price of the phone when sold separately by
CellularCo.
Without considering whether any portion of the amount allocable to the phone is contingent
upon CellularCo’s providing the phone service, CellularCo would allocate the arrangement
consideration on a relative fair value basis as follows:



$112.22 [$1,010 x ($120 ÷ [$120 + $960])] to the phone and $897.78 [$1,010 x ($960 ÷
[$120 + $960])] to the phone service.
However, because a “free” phone is provided in the arrangement and the customer has no
obligation to CellularCo if the phone service is not provided, $62.22 (assuming the
customer has paid the nonrefundable activation fee) is contingent upon CellularCo’s
providing the phone service.
Therefore, the amount allocable to the phone is limited to $50 ($112.22 - $62.22), and the
amount allocable to the phone service is increased to $960.
EITF 00-21 – Example 5
Facts: Company S is an experienced home appliance dealer. Company S
offers a number of services with the home appliances it sells. Company S
regularly sells Appliance W on a standalone basis, but they also offer
installation and maintenance services. Company S does not offer installation
or maintenance services for Appliance W unless they sell the appliance.
Their pricing for Appliance W is as follows:




Appliance W only
Appliance W with installation
Appliance W with maintenance only
Appliance W with installation and maintenance$1,000
$ 800
$ 850
$ 975
EITF 00-21 – Example 5 (cont.)
Facts (cont.):
 The amount charged by Company S for installation ($50) approximates the amount
charged by independent third party installers.
 Appliance W is sold subject to a general right of return. If a customer purchases
Appliance W with installation and/or maintenance services, in the event Company S
does not complete the services, the customer is entitled to a refund of the portion of the
fee that exceeds $800.
 Assume that a customer purchases Appliance W with both installation and maintenance
services for $1,000. Company S believes it is probable that the installation will be
performed satisfactorily to the customer. Assuming the delivery of Appliance W and its
installation occur in different accounting periods and that the maintenance services
cover a one year period, how should the $1,000 of revenue be recognized?
EITF 00-21 – Example 5 (cont.)
Evaluation: The maintenance services are separately priced at $175 and
should be accounted for based on the guidance of FTB 90-1 – on a
straight line basis over the maintenance term unless some other basis is
objectively determined to be more appropriate.
Regarding Appliance W and the installation fee, the first condition for
separation is met because it is sometimes sold separately by Company S.
The second condition is met as there is objective and reliable evidence of
the fair value of the installation service. The third condition is met
because performance of the installation service is probable and the
control of Company S.
EITF 00-21 – Example 5 (cont.)
Company S would allocate $175 of the arrangement to
maintenance services and recognize in accordance with
FTB 90-1, as noted above. Company S would allocate the
remainder of the consideration ($825) to Appliance W and
the installation service based on their relative fair values.
Appliance W would be allocated $776 ($825 x (800
divided by [800 +50])) and installation would be allocated
$49 ($825 x (50 divided by [800 + 50])).
EITF 00-21 – Example 8
Facts: Company B sells computer systems. On April 20, a customer
purchases a computer system from Company B for $1,000. The system
consists of a CPU, a monitor, and a keyboard. On April 30, Company B
delivers the CPU to the customer without the monitor or keyboard. Each of
the items can be purchased separately at a cost of $700 for the CPU, $300
for the monitor, and $100 for the keyboard. The CPU could function with
monitors or keyboards manufactured by others, who have them readily
available. The customer is entitled to a refund equal to the separate price of
any item composing the system that is not delivered. The arrangement does
not include any general rights of return. Company B is evaluating whether
delivery of the CPU represents a separate unit of accounting.
EITF 00-21 – Example 8 (cont.)
Evaluation: The first condition for separation is met for the CPU
as it is sold separately by Company B. The second condition for
separation is met because the fair values of the undelivered items
(keyboard and monitor) are objectively and reliably determined
based on the price of that equipment when sold separately by
Company B. The third condition for separation is met because
there are no general rights of return. Therefore, the CPU should be
accounted for as a separate unit of accounting.
EITF 00-21 – Example 8 (cont.)
Evaluation (cont.):
Without considering whether any portion of the amount allocable to the
CPU is contingent upon delivery of the other items, Company B would
allocate the arrangement consideration on a relative fair value basis.
Therefore, the portion of the arrangement fee otherwise allocable to the
CPU is $636.36 ($1,000 × [$700 ÷ $1,100]), of which $36.36 ($636.36 [$1,000 - $400]) is subject to refund if the monitor and keyboard are not
delivered. Therefore, the amount allocable to the CPU is limited to $600,
which is the amount that is not contingent upon delivery of the monitor
and keyboard.
4. Other Revenue Recognition Considerations

SOP 97-2 provides guidance on when revenue should be recognized and in what
amounts for licensing, selling, leasing, or otherwise marketing computer software.
May need to consider 97-2 and EITF 03-05 when there is embedded software in
products that may be essential to the functionality to the product as a whole.
•
As noted previously, 97-2 contained the four basic revenue recognition criteria
now included in SAB 104.

EITF 99-19 provides guidance on reporting revenue gross as a principle versus net as
an agent. Revenue and cost or revenue must be netted when a company acts as an
agent or broker.
•
Key determinants here include consideration of whether Seller ever took title
and risk of loss to inventory in the overall sales process.
•
Net accounting is appropriate when revenue earned is tantamount to a
commission.
4. Other Revenue Recognition Considerations

EITF 00-10 provides guidance on accounting for shipping and handling fees and
costs.
•
Amounts billed for S&H are included in revenues
•
Accounting policy needs to be set for treatment of costs and are generally
included in Costs of Sale. If classified outside of COS and significant,
disclosure of amount and classification is required.

SOP 81-1 provides guidance on accounting for performance of construction and
production type contracts. Generally provides guidance for revenue recognition on
long-term contracts.
•
Generally requires the percentage-of-completion method of accounting.
•
High risk area due to inherent nature of estimates required
•
Common in construction and longer-term development projects including
custom software.
4. Other Revenue Recognition Considerations (cont.)

Bill & Hold – Such are generally not recorded as revenues,
unless meet stringent guidelines of SAB 104 including:
1. Risk of ownership passes to buyer
2. Customer has written commitment to purchase
3. The buyer must request the bill and hold
4. Fixed delivery schedule in line with buyer’s business
5. Seller does not retain specific performance obligations
6. Goods segregated from rest of seller inventory
7. Goods must be complete and ready for shipment
4. Other Revenue Recognition Considerations (cont.)

Channel Stuffing – Sales are boosted or pushed to
customers in amounts higher than they can promptly sell.
(Hint: Watch out for those sales returns after QE/YE)

Side Agreements – Formal or informal agreements that
significantly alter the terms of sale. This also existed at
Software Client “V” discussed previously.
4. Other Revenue Recognition Considerations (cont.)
 Right of Return – (SFAS 48) When a seller gives the buyer the right
to return the product, revenue from the sales transaction shall be
recognized at time of sale only if all of the following conditions (a-f)
are met:
a. The seller's price to the buyer is substantially fixed or determinable
at the date of sale.
b. The buyer has paid the seller, or the buyer is obligated to pay the
seller and the obligation is not contingent on resale of the
product.
4. Other Revenue Recognition Considerations (cont.)
 Right of Return (cont.) –:
c. The buyer's obligation to the seller would not be changed in the
event of theft or physical destruction or damage of the product.
d. The buyer acquiring the product for resale has economic
substance apart from that provided by the seller.
e. The seller does not have significant obligations for future
performance to directly bring about resale of the product by the
buyer.
f. The amount of future returns can be reasonably estimated
5. US GAAP vs. IFRS (it’s coming fast!)
 Hundreds of references in US GAAP vs. ONE
“principle” (IAS 18) under IFRS.
 SEC Roadmap for Conversion (Proposed 11/08)
(comments were due by 4/20/09) –
 The SEC to make final decision in 2011
 Possible (probable?) requirement for 2014 FY filings
for large accelerated filers (YE >= 12/15/14)
 Some of the largest could be on IFRS for 2009!
5. US GAAP vs. IFRS (it’s coming fast!)
• All accelerated filers for FYE on/after 12/15/15
• The balance of public companies for FYE on/after
12/15/16.
• Adoption dependent on several “milestones”
outlined by the SEC.
• What about the private companies? IASB
expected to complete project on “IFRS for Private
Entities” in 2009.
5. US GAAP vs. IFRS (it’s coming fast!)
 IFRS – revenue from the sale of goods
recognized only when risks and rewards of
ownership have been transferred, the buyer
has control of the goods, revenues can be
measured reliably, and it is probable that
the economic benefits will flow to the
company (seller).
5. US GAAP vs. IFRS (it’s coming fast!)
 IFRS – revenue from rendering services
recognized in accordance with long-term
contract accounting, including considering
the stage of completion, whenever revenues
and costs can be measured reliably and it is
probable the economic benefits will flow to
the company (seller).
5. US GAAP vs. IFRS (it’s coming fast!)
 IFRS – Multiple Elements – IAS 18 requires
recognition of revenue on an element of a
transaction if that element has commercial
substance on its own; otherwise, the
separate elements must be linked and
accounted for as a single transaction. (No
other specific guidance, yet.)
5. US GAAP vs. IFRS (it’s coming fast!)
 IFRS – Construction Contracts – IAS 18
requires the use of the percentage-ofcompletion method if certain criteria are
met. Otherwise, revenue recognition is
limited to recoverable costs incurred.
(Completed contract method is not
permitted.)
Conclusion and Questions & Answers
Wayne R. Pinnell
Managing Partner
Haskell & White LLP
16485 Laguna Canyon Road
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