The new revenue recognition
standard
17 July 2014
Agenda
► Overview
and transition
► The five-step model
► Other aspects
► Next steps
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3 July 2014
The new revenue recognition standard
Overview
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FASB and IASB issued a new global revenue recognition
standard on 28 May 2014
Standard replaces nearly all existing US GAAP and IFRS
guidance on revenue recognition
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Virtually every industry is affected
Standard requires entities to make more estimates and
use more judgment than under current guidance
Its effect on financial statements, business processes and
internal controls will likely be significant for some entities
FASB/IASB transition resource group and other
implementation resource groups have been created
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3 July 2014
The new revenue recognition standard
Overview
A converged standard?
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The FASB and IASB each issued new standards
The standards are substantially the same except for five
areas:
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The Boards use the term “probable” for the level of confidence
needed when assessing collectibility, which results in a lower
threshold under IFRS (based on existing definitions of “probable”)
The FASB requires more interim disclosures than IASB
The IASB allows early adoption
The FASB does not allow an entity to reverse impairment losses
on assets recognized
The FASB provides relief for nonpublic entities relating to specific
disclosure requirements and the effective date
3 July 2014
The new revenue recognition standard
Overview and transition
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Effective for annual periods beginning after 15 December
2016 (1 January 2017 for calendar year-end public
entities and IFRS preparers)
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Optional one-year deferral for nonpublic entities under US GAAP
Early adoption prohibited for US GAAP public entities, but
nonpublic entities are permitted to adopt up to the public
entity effective date
Early adoption permitted for IFRS preparers
Standard includes an expanded definition of a public entity
Entities can choose to adopt the standard using either a
full retrospective approach or a modified retrospective
approach
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The new revenue recognition standard
Overview and transition
Adoption methods available
Full retrospective approach
Key Considerations (excludes practical expedients) Modified retrospective approach
Apply to which periods All periods presented
presented?
Only the most current period presented
Apply to which
contracts?
Any contracts existing as of effective
date (as if new standard had been
applied since inception of contract), as
well as any new contracts from that
date forward
All contracts that would have existed
during all periods presented if the new
standard had been applied from
contract inception
Recognition of the
Follow requirements of ASC 250,
effect of adoption in the cumulative effect of changes to
financial statements?
periods prior to periods presented is
reflected in opening balance of
retained earnings
Cumulative effect of changes is
reflected in the opening balance of
retained earnings in the most current
period presented
Adoption disclosure
requirements?
In the year of adoption, disclose the
amount each financial statement line
item was affected as a result of
applying the new standard and an
explanation of significant changes
(effectively requires two sets of books
during the year of adoption)
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3 July 2014
Follow requirements of ASC 250,
including disclosure of the reason for
the change and the method of
applying the change
The new revenue recognition standard
Scope and exceptions
What is in scope
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Contracts with customers
Sale of some nonfinancial assets that are not an output of
the company’s ordinary activities (e.g., property, plant and
equipment, intangibles)
What is not in scope
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Leasing contracts
Insurance contracts
Financial instruments contracts
Certain nonmonetary exchanges
Certain put options on sale and repurchase agreements
Guarantees within the scope of ASC 460
3 July 2014
The new revenue recognition standard
Agenda
► Overview
and transition
► The five-step model
► Other aspects
► Next steps
Page 8
3 July 2014
The new revenue recognition standard
Summary of the model
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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
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Step 1:
Identify the contract(s) with a customer
Step 2:
Identify the performance obligations in the contract
Step 3:
Determine the transaction price
Step 4:
Allocate the transaction price to the performance obligations
Step 5:
Recognize revenue when (or as) each performance obligation is satisfied
3 July 2014
The new revenue recognition standard
Step 1: Identify the contract(s) with a
customer
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Contract defined as an agreement between two or more
parties that creates enforceable rights and obligations
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Arrangement must meet these criteria to be within scope
of standard:
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Can be written, oral or implied
Does not exist if both parties have not performed and can cancel
without penalty
Parties have agreed to terms and are committed to perform
Each parties’ rights and payment terms can be identified
Contract has commercial substance
Collection is probable
Contracts entered into at the same time with the same
customer should be combined if certain criteria are met
Accounting for contracts that are not within the scope of
the model
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The new revenue recognition standard
Step 2: Identify performance obligations
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A performance obligation is a promise (explicit or implicit)
to transfer a distinct good or service to a customer
Performance obligations are identified at contract
inception and determined based on:
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Contractual terms
Customary business practice
Incidental obligations or marketing incentives may be
performance obligations (e.g., “free” maintenance
provided by automotive manufacturers, loyalty points
provided by a hotel)
Does not include activities to satisfy an obligation (e.g.,
set-up activities) unless a good or service is transferred
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The new revenue recognition standard
Step 2: Identify performance obligations
(cont.)
Two-step model to identify which goods or services are distinct
Step 1 - Focus on whether
the good or service is
capable of being distinct
Customer can benefit from
the individual good or service
on its own
OR
Customer can use good or service
with other readily available
resources
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3 July 2014
Step 2 - Focus on whether
the good or service is distinct in
the context of the contract
The good or service is not
integrated with, highly dependent
on, highly interrelated with, or
significantly modifying or
customizing other promised goods
or services in the contract
The new revenue recognition standard
Example 1: Identify performance obligations
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Entity enters into a contract to manufacture and install
customized equipment and provide maintenance services
for a five-year period
Installation services include the integration of multiple
pieces of equipment at the customer’s facility in order for
the equipment to operate as a single unit
Equipment cannot operate without installation
Entity sells equipment and installation services together,
does not sell installation separately
Other vendors can provide the installation services
The maintenance services are sold separately
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The new revenue recognition standard
Example 1: Identify performance obligations
(cont.)
Step 1 – Capable of being
distinct?
Equipment
Installation
Maintenance
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Step 2 – Distinct in the context
of the contract?
Good cannot be used without
installation, but customer can obtain
installation from another source. Good is
distinct. Move to Step 2.
Equipment and installation are highly
interrelated. Significant customization is
required during installation. Good isn’t
distinct on its own because it must be
combined with installation.
Installation can be provided by multiple
vendors, so service is distinct. Move to
Step 2.
See discussion above. Equipment and
installation are not distinct from one
another.
Services have a distinct function
because they are sold separately. Move
to Step 2.
Services are not highly interrelated. No
integration, modification or customization
required. Services are distinct.
In this example, there would be two performance obligations: (1) the equipment and installation
because they are not distinct; (2) maintenance services because they are distinct services in the
contract.
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Step 2: Identify performance obligations
Principal versus agent considerations
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Determining whether an entity acts as a principal or an
agent in a specific arrangement affects the amount of
revenue recognized (gross versus net recognition)
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Appropriately identifying the entity’s performance obligation is
fundamental to the principal or agent determination
Principal
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Agent
Provides goods or services
itself
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Arranges for another party
to provide goods or services
An entity is a principal if the entity controls a promised
good or service before its transfers to a customer
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An entity may not be a principal if it obtains legal title only
momentarily before is transferred to a customer
3 July 2014
The new revenue recognition standard
Step 2: Identify performance obligations
Principal versus agent considerations (cont.)
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Net Indicators:
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An entity is an agent if the entity’s performance obligation
is to arrange for the provision of goods or services by
another party
Indicators that an entity is an agent include:
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Entity is not primarily responsible for fulfilling contract
Entity does not have inventory risk
Entity does not have discretion in establishing prices
Entity’s consideration is in the form of a commission
Entity is not exposed to credit risk
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The new revenue recognition standard
Step 3: Determine the transaction price
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Transaction price is defined as the amount of
consideration to which an entity expects to be entitled in
exchange for transferring promised goods or services to a
customer
Transaction price includes the effects of the following:
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Variable consideration (including application of the constraint)
Significant financing component
Consideration paid to a customer
Noncash consideration
3 July 2014
The new revenue recognition standard
Step 3: Determine the transaction price
Variable consideration
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Transaction price may vary because of variable consideration
(e.g., bonuses, discounts, rebates, refunds, credits, price
concessions, incentives)
The transaction price is estimated using the approach that
better predicts the amount to which the entity is entitled based
on its facts and circumstances (i.e., not a “free choice”)
Expected value
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Sum of the probability-weighted
amounts in a range of possible
outcomes
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Most predictive when the transaction
has a large number of possible
outcomes
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Can be based on a limited number of
discrete outcomes and probabilities
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3 July 2014
Most likely amount
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The single most likely amount in a
range of possible outcomes
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May be appropriate when the
transaction will produce only two
outcomes
The new revenue recognition standard
Step 3: Determine the transaction price
Price concessions
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Entering into a contract expecting to collect less than the
full transaction price may indicate a price concession
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If an entity determines it is not probable of collecting the
estimated transaction price, a valid contract does not exist
(as discussed in Step 1 of the model)
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Price concessions (including implied price concessions) cause
consideration to be variable and should not be included in the
estimated transaction price
When assessing Step 1 (identify the contract), an entity also must
consider Step 3 of the model (determine the transaction price)
Distinguishing between customer credit risk (i.e., bad
debt) and implied price concessions (i.e., reductions of
revenue) will require significant judgment
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The new revenue recognition standard
Step 3: Determine the transaction price
Constraint on variable consideration
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Required to evaluate whether to “constrain” amounts of
variable consideration included in the transaction price
Objective of the constraint – include variable
consideration in the transaction price only to the extent it
is “probable” that a significant revenue reversal will not
occur when uncertainty is subsequently resolved
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“Significant” is relative to cumulative revenue recognized
Estimates of the transaction price that includes variable
consideration should be updated at each reporting date
Specific rule for licensed intellectual property
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Sales- or usage-based royalties should not be included in the
transaction price until the customer’s subsequent sales/usage of a
good or service occurs or the performance obligation is satisfied
3 July 2014
The new revenue recognition standard
Example 2: Determine the transaction price
Variable consideration
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Entity enters into a contract and will receive $100,000
performance bonus if specified performance targets are met
Entity estimates 80% likelihood it will receive entire
performance bonus and 20% likelihood it will receive none
of the bonus
Due to the binary nature of the outcome, entity determines
that the best predictor of the ultimate consideration it will
receive is the “most likely amount” approach
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Therefore, $100,000 is included in the transaction price
Constraint likely has no effect because entity concluded it
was probable that bonus will be received
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3 July 2014
The new revenue recognition standard
Example 3: Determine the transaction price
Variable consideration
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Entity enters into a contract and will receive a performance
bonus up to $100,000 if it meets specified performance targets.
It estimates the likelihood of achieving the targets as follows:
Possible outcomes
Probability
Calculated amount
$100,000
10%
$10,000
$80,000
30%
$24,000
$60,000
35%
$21,000
$40,000
10%
$4,000
zero
15%
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Expected value approach is determined to be the best method –
entity calculates $59,000 using this method
However, entity must consider whether any of the $59,000
should be constrained
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The new revenue recognition standard
Step 3: Determine the transaction price
Significant financing component
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The time value of money is considered when significant, and the
primary purpose of the payment terms is to provide financing to
counterparty
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Evaluation not required if customer is expected to pay within one year of
when control of the goods or services is transferred
Noncash consideration
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Measured at the fair value of the consideration received or promised
Consideration payable to a customer
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Determine whether such amounts are:
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A reduction of the transaction price and revenue
A payment for distinct goods and services
A combination of the two
3 July 2014
The new revenue recognition standard
Step 4: Allocate the transaction price
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Transaction price is generally allocated to each separate
performance obligation on a relative standalone selling
price basis
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When a standalone selling price is not observable, an
entity is required to estimate it
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Model provides two possible exceptions relating to the allocation of
variable consideration and discounts, if certain criteria are met
Maximize the use of observable inputs
Apply estimation methods consistently in similar circumstances
Standard describes three estimation methods but others are
permitted (and a combination of estimation methods is allowed)
Standalone selling prices used to perform the initial
allocation should not be updated after contract inception
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3 July 2014
The new revenue recognition standard
Step 5: Recognize revenue as performance
obligations are satisfied
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Revenue recognized upon satisfaction of a performance
obligation by transferring a good or service to a customer
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A good or service is considered to be transferred when (or as) the
customer obtains control
Performance obligations are either satisfied over time or at a point
in time
The following are indicators of when control is transferred:
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The entity has a present right to payment for the asset
The customer has legal title to the asset
The customer has physical possession of the asset
The customer has the risk and rewards of ownership of the asset
The entity has evidence of the customer’s acceptance of the asset
3 July 2014
The new revenue recognition standard
Step 5: Recognize revenue as performance
obligations are satisfied over time
Control of goods and services is transferred over time
if one of the following three criteria is met:
If none of the criteria are met,
control transfers at a point in time
The customer
simultaneously receives
and consumes the
benefits of the entity’s
performance as the entity
performs
Another entity would not
have to re-perform work
completed to date
(1) Disregard potential limitations that
would prevent the transfer of a
remaining PO to another entity
(2) Assume another entity fulfilling the
remaining PO would not have the
benefit of any asset the entity controls
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3 July 2014
The new revenue recognition standard
“Pure service” contracts
The entity creates or
enhances an asset that
the customer controls as
it is created or enhanced
The entity’s performance
does not create an asset
with alternative use, and
the entity has a right to
payment for performance
completed to date
Step 5: Recognize revenue as performance
obligations are satisfied over time (cont.)
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Revenue is recognized over time by measuring progress
toward completion of performance obligations
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The objective is to most faithfully depict the entity’s performance
Select a single method for each performance obligation based on
facts and circumstances
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Output methods
Input methods
Apply method consistently for all similar arrangements
If unable to reasonably estimate progress, revenue should
not be recognized until progress can be estimated
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However, if entity can determine that no loss will be incurred, it
should recognize revenue up to costs incurred
3 July 2014
The new revenue recognition standard
Agenda
► Overview
and transition
► The five-step model
► Other aspects
► Next steps
Page 28
3 July 2014
The new revenue recognition standard
Other aspects
Warranties
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Two types of warranties (i.e., assurance-type warranties and
service-type warranties)
If the customer has the option to separately purchase the
warranty, it represents a separate performance obligation
If the customer does not have the option to separately
purchase the warranty, it would accrue for the expected
warranty costs unless the services under the warranty are
beyond “quality assurance” services
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Factors to consider when determining whether a warranty promise
provides more than “quality assurance” include:
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Is the warranty required by law
Length of time covered by the warranty
The nature of the tasks to be performed under the warranty promise
Guidance is similar to current US GAAP
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The new revenue recognition standard
Other aspects
Contract costs
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Incremental costs of obtaining a contract are capitalized
if expected to be recovered
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Costs of fulfilling a contract that cannot be capitalized
under another standard are capitalized if they:
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Practical expedient to allow immediate expense recognition if the
asset’s amortization period is one year or less
Relate directly to a contract or an anticipated contract
Generate or enhance resources that will be used to satisfy
performance obligations in the future
Are expected to be recovered
Other applicable literature should be considered first
Assets are amortized over the period the goods or services
are transferred and are subject to impairment test
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3 July 2014
The new revenue recognition standard
Other aspects
Loss contracts
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Guidance on onerous contracts included in previous drafts
of the standard was removed
Boards elected to retain current guidance on loss
contracts, including:
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ASC 440 for firm purchase commitments for goods or inventory
ASC 605-20 for separately priced extended warranty and product
maintenance contracts
ASC 605-35 for construction-type and production-type contracts
ASC 815 for certain derivative contracts
ASC 840 and ASC 420 for operating leases that are subleased
ASC 944 for certain reinsurance contracts
ASC 985-605 for certain software arrangements
3 July 2014
The new revenue recognition standard
Other aspects
Disclosure
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Key principle – to help financial statement users
understand the nature, amount, timing and uncertainty of
revenue and cash flows arising from contracts with
customers
Entity must present qualitative and quantitative
information about:
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Contracts with customers
Significant judgments and changes in judgments made when
applying the guidance to those contracts
Assets recognized from costs to obtain or fulfill a contract
Fewer disclosure requirements for nonpublic entities
For US GAAP entities, most disclosures are required for
annual and interim periods
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3 July 2014
The new revenue recognition standard
Agenda
► Overview
and transition
► The five-step model
► Other aspects
► Next steps
Page 33
3 July 2014
The new revenue recognition standard
Next steps
SAB Topic 11.M disclosures
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Staff Accounting Bulletin (SAB) Topic 11.M requires
disclosure of the effects of recently issued accounting
standards
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An entity’s disclosures on the new standard will likely
evolve as more information about the effect is known
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Includes disclosures of the required adoption date, the allowed and
planned adoption method, effect on the financial statements and
other significant matters resulting from adoption
The SEC staff has requested disclosure of the transition method
as soon as it is known
Entities are required to consider these disclosure
requirements in their next report filed with the SEC
(e.g., quarterly filings)
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Required to provide disclosures until the standard is adopted
3 July 2014
The new revenue recognition standard
Next steps – business considerations
What can you do now?
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Understand the magnitude of the changes to your entity
from both a financial statement and business perspective
Establish a project management plan for adoption of the
standard
Determine training requirements for individuals
responsible for key judgments and estimates
Identify common transactions and potential
implementation issues
Establish a process for gathering appropriate data to
comply with the new standard
Communicate your questions on the guidance through the
planned implementation groups
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3 July 2014
The new revenue recognition standard