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Revenue Recognition – Proposed Agenda

Revenue Recognition – Proposed Agenda. Effective date and transition A single model for revenue Scope Core principle and five steps Presentation and disclosure Other issues Differences from IAS 18 and U.S. GAAP What companies should be doing now Summary. Effective date and transition.

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Revenue Recognition – Proposed Agenda

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  1. Revenue Recognition – ProposedAgenda • Effective date and transition • A single model for revenue • Scope • Core principle and five steps • Presentation and disclosure • Other issues • Differences from IAS 18 and U.S. GAAP • What companies should be doing now • Summary

  2. Effective date and transition January 1, January 1, January 1 January 1 January 1 January 1 2010 2011 2012 2013 2014 2015 Exposure Draft Issued June 24, 2010 Comments Ending October 22, 2010 Standard Issued Second half of 2011 Effective Date End of 2014 FULL RETROSPECTIVE APPLICATION

  3. A single model for revenue • Single model • Contract-based • Asset and liability approach • Transfer of control to customer

  4. Scope • Inclusive – all entities in all industries • Excludes: • Lease contracts • Insurance instruments • Financial instruments • Certain nonmonetary transactions • Must be contract with customer • Could be part in, part out

  5. Core principle and five steps Core principle: An entity shall recognize revenue to depict the transfer of goods or services to customers in an amount that reflects the consideration the entity receives, or expects to receive, in exchange for those goods or services. (ED par. 2)

  6. The five steps Determine the transaction price Allocate the transaction price to the separate performance obligations Recognize revenue when the entity satisfies each performance obligation Identify the contract with the customer Identify the separate performance obligations in the contract

  7. Step 1: Identify the contract with the customer Contract: An agreement between two or more parties that create enforceable rights and obligations. (ED Appendix A) Contract elements: • Commercial substance • Approval and commitment • Identifiable and enforceable rights of parties • Identifiable terms and manner of payment Wholly unperformed, no termination penalty = no contract Customer: A party that has contracted with an entity to obtain goods or services that are an output of the entity’s ordinary activities. (ED Appendix A)

  8. Step 1: Identify the contract with the customer Combination, segmentation, and modification of contracts Price interdependence: The amount of consideration in one contract is dependent on the amount of consideration in another contract. (ED par. 13) Indicators of interdependence: • The contracts are entered into at the same time • The contracts are negotiated as a package with a single commercial objective • The contracts are performed either concurrently or consecutively

  9. Step 1: Identify the contract with the customer Combination, segmentation, and modification of contracts, continued Contracts interdependent pricing – combine Contract elements lack interdependent pricing – segment if meet two conditions: • The entity, or another entity, regularly sells identical or similar goods or services separately, and • The customer does not receive a significant discount for buying some goods and services together with another goods or services in the contract (ED par. 15)

  10. Step 1: Identify the contract with the customer Combination, segmentation, and modification of contracts, continued Example – segmenting contracts Company A enters into agreement with customer • Equipment and maintenance together = $500 • Equipment sold separately = $470 • Maintenance sold = $40

  11. Step 1: Identify the contract with the customer Combination, segmentation, and modification of contracts, continued A contract modification is any change in the scope or price of a contract, such as changes in: • Nature or amount of goods or services to be transferred • Method or timing of performance • Previously agreed pricing Contract modifications may be initiated by either the customer or the entity

  12. The five steps continued Determine the transaction price Allocate the transaction price to the separate performance obligations Recognize revenue when the entity satisfies each performance obligation Identify the contract with the customer Identify the separate performance obligations in the contract

  13. Step 2: Identify the separate performance obligations in the contract Performance obligation: An enforceable promise (whether explicit or implicit) in a contract with a customer to transfer a good or service to the customer. (ED App. A) Distinct: A good or service is distinct if either: • The entity, or another entity, sells an identical or similar good or service separately, or • The entity could sell the good or service separately, because the good or service meets both of the following conditions: • It has a distinct function – a good or service has a distinct function if it has utility either on its own or together with other goods or services that the customer has acquired from the entity or are sold separately by the entity or by another entity, and • It has a distinct profit margin – a good or service has a distinct profit margin if it is subject to distinct risks and the entity can separately identify the resources needed to provide the good or service (ED par. 23)

  14. Step 2: Identify the separate performance obligations in the contract, continued Example – sale of product with option for additional product The entity, or another entity, sells an identical or similar good or service separately, or • Entity A sells product to Customer B for $500 • A also provides B with a voucher for a 30 percent discount on future purchases for 60 days (up to $500) • A regularly provides a voucher for a 10 percent discount on sales within 60 days Is the voucher a separate performance obligation?

  15. The five steps continued Determine the transaction price Allocate the transaction price to the separate performance obligations Recognize revenue when the entity satisfies each performance obligation Identify the contract with the customer Identify the separate performance obligations in the contract

  16. Step 3: Determine the transaction price Transaction price: The amount of consideration that an entity receives, or expects to receive, from a customer in exchange for transferring goods or services, excluding amounts collected on behalf of third parties (for example, taxes). (ED Appendix A)

  17. Step 3: Determine the transaction priceExample – determining the transaction price Entity A grants Company B exclusive access to license for $200,000 plus royalties of 5% of B’s sales What is the transaction price in this arrangement?

  18. Step 3: Determine the transaction priceAdditional considerations • Collectability • Time value of money • Non cash consideration • Consideration payable to the customer

  19. Step 3: Determine the transaction priceAdditional considerations -- collectability Unconditional Right to Receive Payment Reasonably Assured Measurement (probability-weighted amount) Revenue Recognition Guidance Measurement (probability-weighted amount)

  20. Step 3: Determine the transaction priceAdditional considerations – time value of money • Payment due significantly before or significantly after transfer of goods or services • Material financing component is recognized separately • Discount rate as if separate financing transaction with that customer • Time value of money • Credit risk

  21. Step 3: Determine the transaction priceAdditional considerations – time value of money, continued Example – time value of money –Prepayment for future goods delivery • Entity A sells product to customer for $100,000 • Delivery in one year • Payment today • Entity A recognizes $100,000 contract liability • Discount rate of 10% equals a material financing component

  22. Step 3: Determine the transaction priceAdditional considerations – time value of money, continued Example – time value of money continued Day one journal entry: Dr. Cash 100,000 Cr. Contract liability 100,000 Monthly journal entry before delivery: Dr. Interest expense 833 Cr. Contract liability 833 Journal entry on delivery – after one year: Dr. Contract liability 110,000 Cr. Revenue 110,000

  23. Step 3: Determine the transaction priceAdditional considerations – time value of money, continued Example – time value of money –payment in the future for goods delivered now • Entity A sells product to customer • Immediate delivery of goods • $110,000 to be paid in one year • Entity A recognizes $100,000 of revenue • Discount rate of 10% equals a material financing component

  24. Step 3: Determine the transaction priceAdditional considerations – time value of money, continued Example – time value of money continued Day one journal entry: Dr. Accounts receivable 100,000 Cr. Revenue 100,000 Monthly journal entry before delivery: Dr. Interest receivable 833 Cr. Interest revenue 833 Journal entry on delivery – after one year: Dr. Cash 110,000 Cr. Accounts receivable 100,000 Cr. Interest receivable 10,000

  25. Step 3: Determine the transaction priceAdditional considerations – noncash consideration • Measure at Fair value • If Fair value not available • Indirect measurement • Reference stand-alone selling price of goods or services transferred

  26. Step 3: Determine the transaction priceAdditional considerations – consideration payable to customer If you pay consideration to the customer, it would be: • A reduction of the transaction price • A payment for distinct goods or services received from the customer • Some combination of 1 and 2 If (3) reduce transaction price for amount that exceeds the fair value of goods or services received If (3) but cannot reasonably estimate fair value, default to (1)

  27. Step 3: Determine the transaction priceAdditional considerations –consideration payable to customer, continued Example – slotting fees Entity A sells 1000 units of product to reseller for $10,000 Entity A pays reseller $1,000 for product placement service Fair value of product placement service if $600

  28. Step 3: Determine the transaction priceAdditional considerations – right of return Example – refund liability Entity A sells 500 products for $50 each Each product costs $35 Customer may return any unused product within 30 days for a full refund

  29. Step 3: Determine the transaction priceAdditional considerations – right of return, continued For how many products does Entity A recognize revenue? 475 (25 estimated returns) What is the refund liability? 1,250(25 x 50 sales price) What is the return asset? 875(25 x 35 cost) Journal entry on delivery: Dr. Accounts receivable 25,000 Cost of sales 16,625 Return asset 875 Cr. Revenue 23,750 Refund liability 1,250 Inventory 17,500

  30. The five steps continued Determine the transaction price Allocate the transaction price to the separate performance obligations Recognize revenue when the entity satisfies each performance obligation Identify the contract with the customer Identify the separate performance obligations in the contract

  31. Step 4: Allocate the transaction price to the separate performance obligations • Relative stand-alone selling price • No default to list price or contract price • Observable price (sold separately) • Estimate stand-alone selling price • Expected cost plus margin • Adjusted market assessment

  32. Step 4: Allocate the transaction price to the separate performance obligations, continued Example – allocating transaction price to separate performance obligations

  33. Step 4: Allocate the transaction price to the separate performance obligations, continued • Changes in transaction price • Variable consideration • Changes in estimates • No redo of allocation percentages • Reallocate per original allocation • Adjust period revenue if performance obligation already satisfied

  34. The five steps continued Determine the transaction price Allocate the transaction price to the separate performance obligations Recognize revenue when the entity satisfies each performance obligation Identify the contract with the customer Identify the separate performance obligations in the contract

  35. Step 5: Recognize revenue when the entity satisfies each performance obligation Satisfy performance obligation = transfer control Control: A customer obtains control of a good or service when the customer has the ability to direct the use of, and receive the benefit from, the good or service. Control includes the ability to prevent other entities from directing the use of, and receiving the benefit from, a good or service. (ED par. 26)

  36. Step 5: Recognize revenue when the entity satisfies each performance obligation, continued • Continuous transfer • Construction contracts • Services contracts • Recognize revenue in manner that best depicts transfer • Output methods (preferred) • Input methods • Passage of time

  37. Presentation and disclosure Statement of Financial Position (SOFP) • Contract asset – entity performs but not the customer • Contract liability – customer performs and not the entity • Unconditional right to consideration • Only passage of time before receive payment • Receivables (ASC 310 or IAS 32/39) Disclosures • Qualitative and quantitative • Amount, timing, uncertainty • Significant judgments

  38. Other issuesRights of return • Explicit • Implicit – customary business practices • Not a separate performance obligation • Recognize refund liability • Recognize asset (separate from inventory) • Probability-weighted estimate of refund • If cannot estimate – all liability no revenue

  39. Other issuesProduct warranties • Latent defects – not separate PO • Defects after customer controls –separate PO • Either way – revenue deferral

  40. Other issuesLicenses and rights to use • Nonexclusive = sale • Exclusive • Substantially all rights = sale • Not substantially all rights = revenue over license term

  41. Other issuesOnerous performance obligations • PV of probability-weighted costs > price allocated to that PO • Update liability each reporting period • At PO level, not contract level

  42. Other issuesOnerous performance obligations

  43. Other issuesSale of non-financial assets • Guidance on transaction price applies • Gain or loss is difference between transaction price and carrying value

  44. Differences from IAS 18 and U.S. GAAP • Variable or uncertain consideration • Collectability • Warranties • Financing • Refunds • Long term contracts • Onerous performance obligations • Capitalized costs • Disclosures

  45. What companies should be doing now • Understanding effects of new model • Controls and processes • Information gathering systems • Budgeting • Metrics • Debt covenants • Compensation arrangements • Merger negotiations

  46. Summary • Full retrospective application • Single model • Goods • Services • All entities • All industries • Limited exceptions • Leases • Insurance • Financial instruments • Nonmonetary transactions

  47. Summary, continued Core principle: recognize revenue for transfer of goods or services to customer at amount of consideration received Determine the transaction price Allocate the transaction price to the separate performance obligations Recognize revenue when the entity satisfies each performance obligation Identify the contract with the customer Identify the separate performance obligations in the contract

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