Annual Accounting and
Auditing Update
11 December 2015
Disclaimer
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The views expressed by panelists are not necessarily
those of Ernst & Young LLP.
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These slides are for educational purposes only and are
not intended, and should not be relied upon, as
accounting advice.
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11 December 2015
Annual Accounting and Auditing Update
Agenda
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ASC 606 – New Revenue Recognition Standard
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FASB Developments - Leases
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Restatement Themes
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Annual Accounting and Auditing Update
Introduction to today’s speakers
Drew Nagus
EY - Financial Accounting Advisory
Services
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Annual Accounting and Auditing Update
Matt Schuler
Raytheon
Where are we now?
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The new standard was issued on 28 May 2014, and a number of questions
have arisen in transition.
The Financial Accounting Standards Board (FASB)/International Accounting
Standards Board (IASB) Joint Transition Resource Group for Revenue
Recognition (TRG) and American Institute of Certified Public Accountants
(AICPA) industry task forces are actively discussing issues submitted to them.
Some of the issues discussed by the TRG have resulted in FASB and IASB
activity:
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May 2015 – FASB issued an Exposure Draft (ED) on licenses and performance
obligations
August 2015 – FASB issued an ED covering principal versus agent assessments
September 2015 – FASB issued an ED covering certain transition issues, noncash
consideration, sales taxes, and collectibility
The IASB issued a single ED covering its proposed amendments
The complexity of implementing the new standard should not be
underestimated.
Many companies are appropriately accelerating implementation efforts.
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Annual Accounting and Auditing Update
Effective date deferral
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The FASB issued Accounting Standards Update (ASU)
2015-14 on 13 August 2015, which finalized the one-year
deferral for the new revenue standard:
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It will be effective in 2018 for calendar-year public companies.
Early adoption will be allowed – using original effective dates
(annual periods beginning after 15 December 2016).
The IASB has approved a one-year deferral for IFRS 15:
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Companies will be required to adopt it in 2018.
Early adoption will continue to be allowed.
11 December 2015
Annual Accounting and Auditing Update
Journey to implement the new standard
Before
adoption
You have a choice in transition methods
Reporting
10-K, 10-Q
Footnotes
2015 and prior
2016
2017
Legacy GAAP
Legacy GAAP
Legacy GAAP
2018
(year of adoption)
2019 and
beyond
SAB 74 disclosures
(including transition method and impact)
Full retrospective
Joint Transition Resource Group and industry groups
Reporting
10-K, 10-Q
New GAAP
New GAAP
New GAAP
New GAAP
ASC 250
Footnotes
Expanded
Expanded
Cumulative catch-up adjustment at January 1, 2016
Modified retrospective
After
adoption
Which will you
choose?
After
adoption
Presented in 2018 financial statements
Reporting
10-K, 10-Q
Presented in 2018 financial statements
Legacy GAAP
Legacy GAAP
New GAAP
Legacy GAAP
Footnotes
Expanded
Cumulative catch-up adjustment at January 1, 2018
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Annual Accounting and Auditing Update
New GAAP
Expanded
Revenue recognition
Summary of the model
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.
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
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Annual Accounting and Auditing Update
What makes this complex?
Contracts
Performance
obligations
Transaction price
Allocation
Strict criteria to be a
contract
Identifying promised
goods and services
May not equal
“contractual” price
Estimating standalone
selling prices
Identifying the
customer
Determining
performance
obligations (i.e., distinct
goods and services)
Variable consideration,
incl. bonuses, returns,
concessions, discounts
Exceptions for
allocating variable
consideration and
discounts
Contract modifications
Options granting a
material right
Identify explicit and
implicit contract terms
Established business
practices
Assessing collectibility
Service-type and
assurance-type
warranties
Transfer of control:
point in time or
over time
Measuring progress
over time
Constraint on variable
consideration
Consignment
arrangements
Significant financing
component
Customer acceptance
Noncash consideration
Repurchase provisions
Payments to customers
Licenses
Principal versus agent
Combining contracts
Subsequent changes in
transaction price
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Recognition timing
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Annual Accounting and Auditing Update
Revenue recognition
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 approved the contract and are committed to perform
Each party’s 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
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Annual Accounting and Auditing Update
Revenue recognition
Step 2: Identify the performance obligations
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A performance obligation is a promise (explicit or implicit)
to transfer to a customer either:
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A distinct good or service
A series of distinct goods or services that are substantially the
same and have the same pattern of transfer
Performance obligations are identified at contract
inception and determined based on contractual terms,
customary business practice
Proposed new guidance will allow entity to disregard
promises that are deemed to be immaterial to a contract
Proposed new guidance on shipping and handling
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Annual Accounting and Auditing Update
Revenue recognition
Step 2: Identify the performance obligations (cont.)
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A good or service is distinct if the following criteria are met:
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It is capable of being distinct
It is distinct within the context of the contract
Principal vs. agent considerations
Incidental obligations or marketing incentives may be
performance obligations (e.g., “free” maintenance provided
by auto manufacturers)
Does not include activities to satisfy an obligation (e.g.,
setup activities) unless a good or service is transferred
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Annual Accounting and Auditing Update
Revenue recognition
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 or payable to a customer
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TRG discussions regarding interaction of variable consideration and
“later of” guidance
Noncash consideration
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Annual Accounting and Auditing Update
Revenue recognition
Step 3: Determine the transaction price (cont.)
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Variable consideration is estimated using an “expected
value” or a “most likely amount” approach
An entity is required to evaluate whether to “constrain”
amounts of variable consideration included in the
transaction price
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Amounts are included in the transaction price only if it is “probable”
a significant revenue reversal will not occur when uncertainties are
resolved
11 December 2015
Annual Accounting and Auditing Update
Revenue recognition
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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Annual Accounting and Auditing Update
Revenue recognition
Step 5: Recognize revenue
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Revenue recognized upon satisfaction of a performance obligation by
transferring control of a good or service to a customer
Control transfers over time if one of three criteria is met, otherwise
control transfers at a point in time
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Customer simultaneously receives and consumes the benefits as the entity
performs
Entity’s performance creates or enhances an asset that the customer controls as
the asset is created or enhanced
Entity’s performance doesn’t create an asset with an alternative use to the entity,
and the entity has an enforceable right to payment for performance to date
The following indicators should be considered when determining the
point in time that control transfers:
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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
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Annual Accounting and Auditing Update
Other aspects of the model
Incremental costs of obtaining a contract
Incremental costs of obtaining a contract would be capitalized if they
are expected to be recovered
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Incremental costs are costs that would not have been incurred if the
contract had not been obtained
Practical expedient to allow immediate expense recognition, if the asset’s
amortization period is one year or less
Assets are amortized over the period in which the related goods or
services are transferred and subject to impairment
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If costs are determined to relate to more than one contract (e.g., expected
contract renewals), amortization should consider both current and
anticipated contracts
What’s changing?
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Current US GAAP allows an option to either immediately expense or
capitalize costs of obtaining a contract
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Annual Accounting and Auditing Update
Other aspects of the model
Costs to fulfill a contract
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Other applicable literature is considered first
Costs of fulfilling a contract that cannot be capitalized under another
standard would be capitalized if they meet all of the following criteria:
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Relate directly to a contract
Generate or enhance resources that will be used to satisfy performance
obligations in the future
Are expected to be recovered
Costs of fulfilling a contract that are capitalized would be amortized
consistent with the pattern of transfer of the related good or service
and would be subject to impairment
“Abnormal costs” not considered in the price of the contract would be
expensed as incurred
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Annual Accounting and Auditing Update
Revenue recognition
Disclosure
Excerpt from Accounting Standards Codification
Example 41 —Disaggregation of Revenue —Quantitative Disclosure
Consumer
Products
Segments
Primary Geographical Markets
North America
Europe
Asia
$
$
Major Goods/ Service Lines
Office Supplies
Appliances
Clothing
Motorcycles
Automobiles
Solar panels
Power plant
$
$
990
300
700
1,990
600
990
400
–
–
–
–
1,990
Transportation
$
$
2,250
750
260
3,260
$
–
–
–
500
2,760
–
–
3,260
Energy
$
Total
$
$
5,250
1,000
–
6,250
8,490
2,050
960
$ 11,500
$
–
–
–
–
–
1,000
5,250
6,250
600
990
400
500
2,760
1,000
5,250
$ 11,500
1,000
5,250
6,250
$
Timing of Revenue Recognition
Goods transferred at a point in time
Services transferred over time
$
$
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11 December 2015
1,990
–
1,990
$
$
3,260
–
3,260
Annual Accounting and Auditing Update
$
$
6,250
5,250
$ 11,500
Revenue recognition
Disclosure (cont.)
Excerpt from Accounting Standards Codification
Example 42 —Disclosure of the Transaction Price Allocated to the Remaining Performance Obligations
20X8
Revenue expected to be recognized
on this contract as of December 31, 20X7
(a)
(b)
$1,575 (a)
20X9
$788 (b)
Total
$2,363
Transaction price = $3,150 ($100 x 24 months + $750 variable consideration) recognized evenly over 24
months at $1,575 per year
$1,575  2 = $788 (that is, for 6 months of the year)
• On June 30, 20X7, an entity enters into two-year noncancellable
contract.
• The customer pays fixed consideration of $100 per month and a onetime variable consideration payment ranging from $0 - $1,000 (that is,
a performance bonus).
• The entity estimates that it will be entitled to $750 of the variable
consideration.
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Annual Accounting and Auditing Update
What are we learning?
Key observations and lessons learned from diagnostics
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Understanding the standard’s complexity is necessary for adequate planning
Leveraging a top down strategic scoping approach may reduce the number of
detailed contract reviews required
The process of identifying revenue streams should include consideration of
multiple different categories to disaggregate a company’s business
Surveying can be challenging and time consuming, but may save time in the
long run
Working closely with local management, operations and legal when reviewing
contracts is essential for a comprehensive understanding of the revenue
streams
Templates for gap analysis and contract reviews should include information
beyond the technical accounting details
Extrapolating the impacts of changes in revenue recognition patterns of one
or more individual contracts across a larger revenue stream population can
be time consuming and may require significant estimates and data inputs
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Annual Accounting and Auditing Update
Program overview
Business processes and system enablement – critical path
2015
2016
Accounting
policy
Transition
and
disclosures
Accounting and reporting
PMO
governance
and change
management
Diagnostic
Business processes,
control environment and
data capture
2018
2017
Solution development
Governance
objective and plan
2019 and beyond
Implementation
Sustain
Program governance structure, ongoing management, budget and resource management, dependency analysis, risk management
Communication structure, approach, routine work sessions with stakeholders
Revenue stream
identification and
scoping
Awareness, education and change management
Individual contract
selection and review
Preliminary accounting
policy decision
Expanded contract review to support
changes and lack thereof
Training and implement new policy
Finalize
new policy
Accounting and disclosure
gap analysis
Transition method
evaluation
Analyze accounting differences
and potential financial impacts
Transition method selection
Evaluate enhanced disclosure
requirements and data to support
Follow TRG, FASB and IASB activities, AICPA and peer group implementation developments
Understand and assess current
transaction processing by revenue stream
Develop systems and
business processes
requirements
Design systems and
processes enhancements
Implement systems and
processes enhancements
Design and implement I/C changes
Go live in future state environment
Test and remediate I/C changes
Sustain I/C environment
Full retrospective -- interim processing environment, including
cumulative adjustment and “look-back” transaction processing
Transition contract and data approach, consideration and capture until future state environment is live
Modified retrospective -- interim processing environment,
including cumulative adjustment
Maintain legacy processing environment
for modified retrospective disclosures
Tax
Identify new or different temporary differences
Document, train and execute new tax policies and procedures
Identify tax method changes and finalize new policy
File method changes and adjust transfer pricing
Other
Other considerations – I/C prices,
transfer pricing and indirect taxes
Assess and implement changes to customer contracting process, legal terms or business practices, finance planning and analysis, and investor relations
Timely discussion of key implementation considerations with external audit team
* Dates assume early adoption not elected
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Annual Accounting and Auditing Update
Critical path
Sample full vs. modified retrospective timelines
Full retrospective sample timeline
2015
J
F
M
A
M
J
J
2016
A
S
O
N
D
J
F
M
A
M
J
2017
J
A
S
O
N
D
J
F
M
A
M
J
J
2018*
A
S
O
N
D
Go-live
Accounting
Diagnostic
(3 months)
System
Design**
enablement (3 months)
evaluation
(1 month)
Implementation
(6 months)
Testing
(6 months)
Parallel accounting
and audit
(6 months)
Data conversion
cumulative catch-up
and reprocessing
transaction activity
from January 2016 to
April 2017 (5 months)
Dual
reporting for
2016 and
2017
Turn off old
GAAP
Start year-end
close
Record cumulative
effect adjustment
Modified retrospective sample timeline
2015
J
F
M
A
M
J
J
2016
A
S
O
N
D
J
Accounting
Diagnostic
(3 months)
F
M
A
System
enablement
evaluation
(1 month)
M
J
J
Design**
(3 months)
2017
A
S
O
N
D
Implementation
(6 months)
J
F
M
A
M
J
Testing
(6 months)
J
2018*
A
S
O
N
D
Dual
reporting for
footnote
disclosure
Go-live
Data
conversion
and cumulative Start yearend close
catch-up
(5 months)
Record cumulative
effect adjustment
*Timelines assume a January 2018 effective date
**Includes solution approach for revenue forecasting
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Phase timeline
Annual Accounting and Auditing Update
Typical system blackout dates
FASB developments - Leases
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Annual Accounting and Auditing Update
Leases
Overview
Q3 2010
Exposure
draft (ED)
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2014–Q2 2015
Redeliberations
on second ED
Q4 2015
Final standard
The FASB and the IASB have substantially completed redeliberations
on the new leases standards
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2011–2013
Redeliberations
and second ED
Key remaining item – effective date
Key changes to today’s US GAAP guidance include:
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Lessees would recognize assets and liabilities for most leases
New presentation and disclosure requirements for lessees
Real estate-specific guidance would be eliminated
Leases would be classified using a principle similar to IAS 17, Leases
Only costs that would not have been incurred if a lease had not been
executed would qualify as initial direct costs
Final standards are not likely to be effective before 1 January 2018
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Annual Accounting and Auditing Update
Leases
Definition of a lease
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A contract is a lease if it both:
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Depends on the use of an identified asset (explicitly or implicitly)
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Conveys the right to control the use of an identified asset – that is, the
customer has the right to (both):
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No identified asset if the supplier has a substantive substitution right
Direct the use of the identified asset
Obtain substantially all of the potential economic benefits from directing the use
Non-lease components of a contract would be accounted for
separately under other applicable GAAP
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Subject to practical expedient for lessees
11 December 2015
Annual Accounting and Auditing Update
Leases
Lease classification
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Lessees and lessors would classify leases using a classification
principle similar to IAS 17, Leases
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Lessees would classify most leases as either:
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Similar to US GAAP but without bright lines
Today’s real estate-specific guidance would be eliminated
Today’s additional lessor classification criteria would be changed
Type A – similar to today’s capital leases
Type B – similar to today’s operating leases
Optional exemption for short-term leases
Lessors would classify all leases as either:
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Type A – similar to today’s sales-type or direct financing leases
Type B – similar to today’s operating leases
11 December 2015
Annual Accounting and Auditing Update
Leases
Lessee accounting
Type A lease
.
Type B lease
Initial recognition
and measurement
Initially measure the right-of-use (ROU) asset and lease liability at present value of
lease payments. Initial measurement of the ROU asset also includes the lessee’s
initial direct costs and prepayments made to the lessor less lease incentives
received from the lessor.
Subsequent
measurement –
Accrete the lease liability based on the
interest method using discount rate
determined at lease commencement*
and reduce the lease liability by the
payments made
lease liability
Subsequent
measurement –
Measure the lease liability at the present
value of remaining lease payments
using discount rate determined at lease
commencement
ROU asset
Amortize the ROU asset, generally on a Measure ROU asset at amount of lease
straight-line basis over shorter of lease liability and adjust for cumulative prepaid
term or useful life of ROU asset
or accrued rents (i.e., non-straight-line
rent payments), any lease incentives
received and lessee initial direct costs
Income statement
effect
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Generally “front-loaded” expense
Separate interest and amortization
* As long as a reassessment and a change in the discount rate has not been triggered.
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Annual Accounting and Auditing Update
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Generally straight-line expense
Single line of lease or rent expense
Leases
Lessor accounting
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Many aspects of today’s lessor accounting would remain the same
Type A leases – similar to today’s sales-type or direct financing leases
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Selling profit (if any) would be deferred if lease does not transfer control of
underlying asset to lessee (and collection of lease payments is probable)
Lessors can recognize profit for Type A leases that meet all of the
following:
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Selling profit is included (fair value is greater than carrying value)
Control of the underlying asset is transferred to the lessee
Collectibility of lease payments is probable
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If collectibilty is not probable: defer income recognition (similar to ASC 606)
Type B leases – similar to today’s operating leases
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Annual Accounting and Auditing Update
Restatement themes
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Annual Accounting and Auditing Update
Learning objectives
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Determine whether the accounting topics that most
commonly gave rise to restatements in recent years could
require action on your part
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11 December 2015
Annual Accounting and Auditing Update
Restatement themes
Top three topics – 2014
%
Top three topics – 2013
%
Income taxes
17
Income taxes
15
Revenue recognition
13
Revenue recognition
10
Statement of cash flows
10
Statement of cash flows
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6
Accounting for income taxes, revenue recognition and statement of
cash flows continue to be leading causes of annual restatements
Correct identified errors as soon as practicable to avoid restatement
due to an accumulation of individually immaterial errors
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Annual Accounting and Auditing Update
Restatement themes
General observations
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Restatements in 2014 not concentrated by issue
General observations
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Identify and account for key contractual terms
Focus on changes in business and effects on estimates on a timely basis
Track tax basis of assets and liabilities beyond rollforward of basis
differences
Consider implications on internal controls
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Annual Accounting and Auditing Update
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