ASC 606 - Revenue from contracts with customers and ASC 842 - Leases

1. ASC 606 - Revenue from contracts with customersandASC 842 - Leases RMA Texas Chapter Spring Conference 2019 April 25, 2019

2. Agenda • Introduction • Melanie Marshall • RSM Technical Accounting Consulting (“TAC”) • Overview of ASC 606: Revenue from Customers • Overview of ASC 842: Leases • Comparison of Significant Changes • Questions

3. New Standards: Why should we care? • New framework for analyzing transactions, requires more: • Both ASC 606 (Revenue) and ASC 842 (Leasing) require additional support, analysis and documentation required by management • Financial statement metrics and debt covenants are impacted, so trends and forecasting changes must be considered • Historical valuation multiplesand trends will change. Recasting is difficult. Public companies under 606 and private companies legacy GAAP. • Timing of liquidity events must be considered and evaluated to determine adoption methods and transaction structuring in light of new rules • Implementation time is significant so performing an assessment of the impact and having a detailed implementation plan is critical to a smooth and successful transition • Auditors will be required to test judgements and review supporting documentation so their involvement in the implementation process is needed • Standards can require changes in IT to comply with accounting and disclosure requirements

4. Overview of ASC 606: Revenue From contracts with customers

5. Scope of ASC 606 • ASC 606 applies to all contracts with customers unless the customer contract is specifically within the scope of other guidance, such as: −Leases (ASC 840 or ASC 842) −Certain insurance contracts (ASC 944) −Various contractual rights and obligations related to financial instruments −Guarantees other than product or service warranties (ASC 460) −Certain nonmonetary exchanges −Contracts with a collaborator or a partner that has contracted with the entity to share in the risks and benefits that result from the collaborative activity or process (ASC 808) −Certain R&D funding arrangements (ASC 912-730; ASC 730-20) −Service concession arrangements (ASC 853) • May be applied to only part of a contract if only some elements are in the scope of other guidance • Industry: −No industry is scoped out −Replaces nearly all of the industry-specific revenue guidance under legacy US GAAP

6. ASC 606: Adoption Methods and Key dates for private companies INITIATION AND PLANNING

7. ASC 606 Core Principle

8. 5-Step model for Revenue Recognition Under ASC 606 Contract with the customer is similar to legacy GAAP. Arrangements negotiated as a package must be combined. Identify the contract with the customer Identify the performance obligations in the contract Performance obligations are similar to deliverables, but they must be both capable of being distinct and distinct within the context of the contract. Determine the transaction price Transaction price includes variable consideration, i.e. usage based fees, milestone payments, refunds, concessions, discounts, etc. Allocate the transaction price Transaction price is allocated to each item based on its relative stand alone selling price (SSP). Discounts are allocated proportionately to all items. Recognize revenue Revenue is recognized at a point in time (i.e. delivery) or over time (as services are provided) based on certain criteria.

9. ASC 606: What are the significant changes? Contractsmust still be legally enforceable, but can be oral or implied based on business practices. Cash basis revenue recognition is not available when collectability is uncertain. Revenue deferral beyond cash collection may occur. Performance obligations (products/services) are based on customer expectations of the promises to be provided. Must meet two criteria: capable of being distinct and distinct in the context of the contract. Could reach different conclusions under different contracts. Returns are still estimated, but an estimate of value of the returned goods is recorded as an asset. Optionsin contracts will result in revenue deferrals if price does not represent stand alone selling price for the good or service. Stand alone selling prices (SSP)must be estimated for each performance obligation based on management’s estimate.

10. ASC 606: What are the significant changes? (cont.) • Revenue deferral is not required if the ultimate transaction price is not fixed. Must estimate variable consideration and changes in estimates impact revenue throughout the term of the contract. • Straight line amortization cannot be defaulted to for revenue recognition for items recognized over time. Revenue is recognized based on the pattern of performance. • Completed contract method is not available in situations where estimates of performance cannot be made. However, if an entity does not have a reasonable basis to measure its progress, revenue should not be recognized until progress can be measured. • Over time recognition is based on certain criteria and is required if criteria are met. Pattern of measurement of progress must be selected based on method that best depicts transfer of value and cannot change method until performance obligation fully satisfied.

11. ASC 606: What are the significant changes? (cont.) • Royaltiesrelated to licenses of IP are recognized upon the later of when the sale or usage occurs or the satisfaction of the performance obligation related to the IP. Guidance only applies to license of IP and cannot defer recognition until reporting received (must estimate once sales or usage has occurred). • Warranties that provide service in addition to the assurance that the product conforms to specifications will be a separate performance obligation and requires revenue allocation. • Costs related to customer contracts including costs to obtain a contract (i.e. commissions) and costs to fulfill a contract (i.e. direct labor) must be capitalized in certain circumstances. • Balance sheet presentation requires separate recognition of contract liabilities, accounts receivable and contract assets. • Disclosure requirements are significant and likely involve tracking (and disclosing) a variety of information not historically tracked or disclosed.

12. Tax implications • Change in tax accounting methodand approval from taxing authorities may be required if the method of revenue recognition and/or related costs changes for financial reporting purposes. • Changes in temporary differences will result in a change to deferred tax assets and liabilities. • Valuation allowances may require adjustments due to: • Changes in the timing of temporary difference reversals. • Changes in timing of future taxable income. • Disclosure requirements are significant and tax impacts associated with the adoption of the new standard must be disclosed for each financial statement line item.

13. Audit implications RULES are being replaced by PRINCIPLES • Increased subjectivity necessitates changes in: • Financial processes • Increased controls (especially over the adoption of the standard) • Extensive documentation • Auditors and regulators will scrutinize management’s judgments (often with the benefit of hindsight) • Auditors will likely expect: • Increased involvement throughout the entire implementation process • Testing and review of company documentation related to: • Contract reviews • Revenue streams • Standalone selling price methodology • Updated policies and procedures • Footnote disclosures • And much more… • Control testing over the adoption itself as well as new controls to mitigate the risks involved with implementing such a pervasive accounting standard

14. Contract costs • Significant changes and impacts on contract acquisition (i.e. sales commissions) and fulfillment costs (i.e. professional services costs) • Amortization period could extend beyond the contractual term • Commissions must be aligned with revenue arrangements and allocated among the deliverables • May require analysis of historical commissions and plans may change over time • Limited relief from practical expedient • If amortization period is one year or less can expense as liability is incurred • Requires careful consideration of renewal options, as well as, commission rates upon renewal • Accounting for sales commissions • Expected to be one of the most significant impacts as no longer can expense as liability is incurred unless practical expedient is met

15. Presentation and Disclosure • Application of the guidance in ASC 606 may result in the recognition and presentation on the balance sheet of a contract asset or liability for the difference between the entity’s performance (i.e., the goods or services transferred to the customer) and the customer’s performance (i.e., the consideration paid by, and unconditionally due from, the customer). • Many new qualitative and quantitative disclosure requirements are included in ASC 606. The objective of the disclosure requirements is to help financial statement users understand the nature, amount, timing and uncertainty of revenue and related cash flows.

16. Key 606 changes: Industry hot points

18. Overview of ASC 842: Leases

19. ASC 842: Adoption Methods and Key Dates Private companies are required to adopt ASC 842 starting in 2020. There is an optional transition method to use the effective date of ASC 842 as the date of initial application on transition. Companies that elect this transition option will not adjust their comparatives or make the new required lease disclosures for periods before the effective date. Advantages Disadvantages • Cost relief and reduced complexity from the application of the transition requirements • Lack of comparability to prior years

20. Scope and definition of a lease

21. Comparison to Legacy GAAP Asset is identified explicitly or implicitly Legacy GAAP New Standard Guidance does not address substitution rights Guidance says that there is no identified asset if the supplier has substantive substitution rights The customer has both: • The right to substantially all (>90%) the economic benefits from the use of the identified asset throughout the period of use • The right to direct how and for what purpose the identified asset is used throughout the period of use Any one of the following criteria is met: • The customer operates the PP&E • The customer controls physical access to PP&E • It is remote that other parties will take more than a minor amount of the output and certain pricing criteria are met Customer has right to control the use of the identified asset

22. Lease classification criteria: Operating vs. Finance Note: Although quantitatively not defined, major part and substantially all are viewed similar to the today’s lease guidance which would be 75% and 90%, respectively.

23. Lease ClassificationLessees and Lessors

24. Lessee accounting

25. Lessee accounting – short-term leases

26. Overview of key changes - Lessees

27. Overview of key changes - Lessees

28. Lessee presentation

29. Lessee presentation (cont.)

30. Other key changes

31. Lessee quantitative disclosure example

32. Lessor recognition and measurement

33. Lease ClassificationLessees and Lessors

34. Overview of key changes - Lessors

35. Overview of key changes - Lessors

36. Need for technology solution: Why not use Excel? • Variable Rent • CAM • Base Rent • Taxes / Insurance • Components • Purchase • Subleasing • Clauses • Options • Maintenance • Extension • Termination • Use

37. Need for ASC 842 technology solution A technology solution can help centralize all leases onto a single platform, perform calculations, assist with lease administration and provide necessary information for reporting:

38. Audit implications RULES are being replaced by PRINCIPLES • Increased subjectivity necessitates changes in: • Financial processes • Increased controls (especially over the adoption of the standard) • Extensive documentation • Auditors and regulators will scrutinize management’s judgments (often with the benefit of hindsight) • Auditors will likely expect: • Increased involvement throughout the entire implementation process • Testing and review of company documentation related to: • Lease identification • Lease liability and ROU calculations • Updated policies and procedures • Footnote disclosures • And much more… • Control testing over the adoption itself as well as new controls to mitigate the risks involved with implementing such a pervasive accounting standard

39. ASC 842: Industries impacted

41. Comparison of significant changes

42. Comparison of significant changes

43. Comparison of significant changes

44. Comparison of significant changes

45. Transition challenges Transition to new standards brings with it certain challenges. The list below are some of the key challenges that companies may encounter as they transition to the new standards.

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