Accounting and Auditing Issues for Small and Mid-Size Businesses

1. Accounting and Auditing Issues for Small and Mid-Size Businesses Staci Brogan, Shareholder Douglas Morally, Senior Manager

2. Agenda • Overview of the Standard Setting Agenda • Current Environment for Private Companies • Revenue Recognition • Other Recently Issued Accounting Standards • Leases

3. Overview of the Standard Setting Agenda

4. Public Company Initiatives • U.S. Securities and Exchange Commission (SEC) • Focusing on Investors, Innovation, and Performance • Improving the effectiveness of disclosures • Recognize significant developments and trends in our evolving capital markets • Continued focus on enforcement • Public Company Accounting Oversight Board (PCAOB) • Improve audit quality • Disruptive technological change • Promote investor protection

5. The Role of FASB • Technical Agenda • Simplification Initiative • Private Company Council • Not-for-Profits

6. Current Environment for Private Companies

7. Economic and Industry Developments • US economy continues to recover • GDP • Unemployment • Federal Funds Rate • S&P 500 and Dow Jones Industrial both reached all-time highs during 2018 • Still some economic uncertainty

8. Private Company Council (PCC) • Formed in 2012 • Responsibilities of the PCC • Projects completed by the PCC • Goodwill • Simplified Hedge Accounting • Variable Interest Entities

9. Revenue Recognition

10. Revenue Recognition Overview Effective Dates • Public Companies • 2018 for calendar year-end companies • Non-Public Companies • 2019 for calendar year-end companies Adoption Methods • Retrospective • Restate the face of the financial statements • Modified Retrospective • Show the cumulative effect of initially applying the standards at the date of adoption • Disclose prior-year impacts in the footnotes

11. 5-Step Model

12. Step 1 Identify Contracts with a Customer Combining contracts Contract modifications

13. Step 1 A contract needs to meet the following criteria: 1. Approval and commitment of the parties (in writing, orally, or in accordance with the other customary business practices) 2. Identification of the rights of the parties 3. Identification of the payment terms 4. The contract has commercial substance 5. It is probable that the entity will collect payment

14. Step 1 An entity should combine contractsand account for them as one contract if the contracts were entered into at or near the same time with the customer and one or more of the following are met: • They were negotiated as a package • The price to be paid for one contract depends on the price of the other 3. The goods or services promised in the contracts are a single performance obligation

15. Step 1 Contract modifications are accounted for as follows: As a separate contractif: • The scope of the contract increases due to additional goods or services that are distinct; and • The price for the additional distinct goods or services represents a standalone selling price. As a termination of the original contract and the creation of a new contract if: • The scope of the contract increases due to additional goods or services that are distinct; but • The price for the additional distinct goods or services does not represent a standalone selling price. As part of the existing contractif: • The scope of the contract changes due to additional goods or services that are not distinct from the original goods or services promised.

16. Step 1: Example Implementation Issues • Identify • contracts • with a • customer Change Orders Modifications

17. Step 2 Identify Performance Obligations Is the good or service distinct? Options to purchase additional goods or services

18. Step 2 A good or service is a performance obligation if it is (1) distinct or (2) a series of distinct goods or services that are substantially the same and have the same pattern of transfer. A good or service is distinct if both of the following criteria are met: • Capable of being distinct—The customer can benefit from the good or service either on its own or together with other resources that are readily available to the customer. • Distinct within the context of the contract—The promise to transfer the good or service is separately identifiable from other promises in the contract.

19. Step 2 Options to purchase additional good or services that provide a material rightto the customer give rise to a separate performance obligation. • An example is a free or discounted good or service. • The performance obligation is the option itself rather than the underlying good or service.

20. Step 2: Example Implementation Issues Design and Build Warranties Maintenance • Identify the • performance • obligations Future Discounts Installation Upfront Fees Custodial Services Loyalty Programs

21. Step 3 Determine the Transaction Price Significant financing component Noncash consideration Consideration payable to the customer Variable consideration

22. Step 3: Variable Consideration Variable Consideration: The vendor should include estimated amounts in the transaction price to the extent it is probable that a significant reversal of cumulative revenue recognized will not occur when the uncertainty associated with the variable consideration is resolved. Two methods to estimate variable consideration: 1. Expected value method– The expected value is the sum of probability-weighted amounts in a range of possible consideration amounts. 2. Most likely method– The most likely amount is the single most likely amount in a range of possible consideration amounts.

23. Step 3: Variable Consideration Common examples include: • Price concessions, volume discounts, rebates, refunds, credits, etc. GAAP includes a constraint on the amount of variable consideration included in the transaction price: • An entity shall include in the transaction price some or all of an amount of variable consideration ONLY to the extent that it is probable that a significant reversal in the amount of cumulative revenue recognized will not occur when the uncertainty associated with the variable consideration is subsequently resolved.

24. Step 3: Significant Financing Component Significant Financing Component: An entity should consider all relevant facts and circumstances in assessing whether a contract contains a financing component and whether it is significant to the contract. The following factors must be considered: • The difference, if any, between the amount of promised consideration and the cash selling price of the promised good or service. • The combined effect of both of the following: • The expected length of time between when the entity transfers the promised goods or services to the customer and when the customer pays for those goods or services. • The prevailing interest rates in the relevant market.

25. Step 3: Significant Financing Component A contract with a customer would not have a significant financing component if any of the following factors exist: • The customer paid for the goods or services in advance, and the timing of the transfer of those goods or services is at the discretion of the customer. • A substantial amount of consideration promised by the customer is variable, and the amount or timing of that consideration varies on the basis of the occurrence or nonoccurrence of a future event that is not substantially within the control of the customer. • The difference between the promised consideration and the cash selling price of the good or service arises for reasons other than the provision of finance and the difference between those amounts is proportional to the reason for the difference.

26. Step 3: Example Implementation Issues Volume Rebates Discounts Coupons • Determine the • transaction • price Right of Return Performance Bonuses Price Protection Guarantees Financing

27. Step 4 Allocate the Transaction Price Standalone selling price Discounts

28. Step 4: Standalone Selling Price For a contract that has more than one performance obligation, an entity should allocate the transaction price to each performance obligation. To allocate an appropriate amount of consideration to each performance obligation, an entity must determine the standalone selling price. Standalone selling price is defined as the price that a Company charges for a good or service when it is sold separately. If a standalone selling price is not observable, an entity must estimate it. Suitable methods for estimating the standalone selling price of a good or service include, but are not limited to, the following: • Adjusted market assessment approach • Expected cost plus margin approach • Residual approach

29. Step 4: Discounts Discounts are typically allocated to all of the performance obligations in an arrangement based on their relative standalone selling prices so that the discount is allocated proportionately to all performance obligations. In some instances, it may be appropriate to allocate the discount to only one or more performance obligations rather than all. In other instances, the discount can be allocated to only one performance obligation.

30. Step 4: Discounts Criteria for allocating a discount entirely to one or more performance obligations: • The entity regularly sells each distinct good or service on a standalone basis. • The entity also regularly sells on a standalone basis a bundle of some of those district goods or services at a discount to the standalone selling price of the goods or services in the bundle. • The discount to each bundle is substantially the same as the discount in the contract and an analysis of the goods or services in each bundle provides observable evidence of the performance obligation to which the entire discount belongs.

31. Step 4: Example Implementation Issues Allocating Unobservable Price Allocating Observable Price • Allocate the • transaction • price Allocating Discounts

32. Step 5 Recognize Revenue Point in time Over time

33. Step 5: Point in Time If a performance obligation is not satisfied over time, an entity satisfies the performance obligation at a point in time. To determine the point in time, the entity would consider indicators of the transfer of control, which include, but are not limited to, the following: • The entity has a present right to payment for the asset. • The customer has legal title to the asset. • The entity has transferred physical possession of the asset. • The customer has the significant risks and rewards of ownership of the asset. • The customer has accepted the asset.

34. Step 5: Over time An entity should recognize revenue when (or as) it satisfies a performance obligation, which could occur over time by transferring control of a good or service over time or at a point in time. An entity recognizes revenue over time if any one of the following criteria are met: • The customer simultaneously receives and consumes the benefits provided by the entity’s performance as the entity performs. • The entity’s performance creates or enhances an asset (for example, work in process) that the customer controls as the asset is created or enhanced. • The entity’s performance does not create an asset with an alternative use to the entity, and the entity has an enforceable right to payment for performance completed to date.

35. Step 5: Example Implementation Issues Customized Product Transportation • Recognize • revenue Stand Ready Obligation Payment Terms Specified Quantity

36. ASU 2016-08 - Net vs. Gross Reporting Improves the operability and understandability of the implementation guidance on principal versus agent considerationsby clarifying the following: • An entity determines whether it is a principal or an agent for each promise to the client. • An entity determines the nature of each specified good or service. • When another party is involved in providing goods or services to a customer, a principal obtains control of the good or asset that it then in turn transfers to the customer, has a right to a service that will be performed by another party, which gives the party the ability to provide the service to the customer on the entity’s behalf, or the good or service from the other party that it combines with other goods or services to provide the specified good to the customer.

37. Other Recently Issued Accounting Pronouncements

38. Accounting Standards Updates (ASUs) • Simplification Initiative • Reduce cost and complexity in financial reporting • Short-term projects to make narrow-scope simplifications and improvements • Implementation of Major Standards • Revenue Recognition • Leases • Credit Losses • Not-for-Profit Reporting Model • Hedge Accounting • Tax Cuts and Jobs Act

39. Leases

40. Overview and Background • Accounting Standard Update 2016-02 – The result of a joint project by the Financial Accounting Standards Board (FASB) and the International Accounting Standards Board (IASB) • The goal of the new standards - transparency and comparability

41. ASU 2016-02 – Leases – (Topic 842)

42. ASU 2018-11 – Leases – Targeted Improvements • The amendments in this Update provide entities with an additional (and optional) transition method to adopt the new leases standard. • The amendments in this Update provide lessors with a practical expedient, to not separate non-lease components from the associated lease component

43. Scope and Definition of a Lease • The new standard applies to leases of all identified assets except: • Leases of inventory, assets under construction, intangible assets and biological assets, including timber • Leases to explore for or use minerals, oil, natural gas, and similar non-regenerative resources (including the intangible right to explore for those resources and the rights to use the land) • A contract is or contains a lease if it conveys the right to control the use of identified property, plant or equipment (an identified asset) for a period of time in exchange for consideration.

44. Scope and Definition of a Lease (cont.) • A contract conveys the right to control an identified asset if: • The right to obtain substantially all of the economic benefits from use of the identified asset. • The right to direct the use of the identified asset. • If the customer has the right to control the use of an identified asset for only a portion of the term of the contract, the contract contains a lease for that portion of the term. • A contract does not convey the right to control an identified asset if the supplier has the substantive right to substitute the asset throughout the period of use.

45. Lease and Non-Lease Components • Many contracts contain leases (lease components) and agreements to purchase or sell other goods or services (non-lease components) • Non-lease components are identified and accounted for separately under other applicable Generally Accepted Accounting Principles (GAAP) • Maintenance activities are considered non-lease components • Lessees allocate consideration in the contract to lease and non-lease components, on a relative standalone price basis, unless practical expedient is elected • Lessees can make a policy election (by class of underlying asset) to account for each lease component and its related non-lease component as a single lease component

46. Lease Term and Lease Payments • Lease term includes any non-cancelable periods • Reasonably certain is a high threshold for including optional periods (e.g., options to extend or terminate a lease) • Reasonably certain = reasonably assured • Lease payments consistent with the lease term determination * Include only if reasonably certain of exercise ** Include unless reasonably certain not to be exercised • Also includes fees paid by the lessee to the owners of a special-purpose entity for structuring the transaction

47. Lease Classification - Operating vs. Finance • At lease commencement, a lessee and a lessor classify a lease using the following criteria: • The lease transfers ownership of the underlying asset to the lessee by end of the lease term • The lease grants the lessee an option to purchase the underlying asset that the lessee is reasonably certain to exercise • The lease term is for the major part of the remaining economic life of the underlying asset* • The present value of the sum of the lease payments and any residual value guaranteed by the lessee that is not already reflected in the lease payments equals or exceeds substantially all of the fair value of the underlying asset • (New criterion) The underlying asset is of such a specialized nature that it is expected to have no alternative use to the lessor at the end of lease term * Not applicable for leases that commence at or near the end of the underlying asset’s economic life

48. Lessee Presentation

49. Lessee Presentation

50. Lessee Financial Statement Disclosures