FASB IASB Project on Revenue Recognition

1. FASB IASB Project on Revenue Recognition Chris Carlson, CPA

2. During today's presentation, keep in mind: • Subjectivity of proposed changes • Costs and Benefits of Implementation • Reliability of information • Consistency of reporting • Impact on surety credit

3. Background • FASB / IASB Convergence • Started (Norwalk Agreement) September 2002 • Memorandum of Understanding (MOU) February 2006 • G20 2009 goal to complete Memorandum by 2011 • 8 Major projects scheduled for completion by June 2011 • Impossible • Why this revenue recognition project exists • Reduce US revenue industry standards from 100+ to 5 or less • Converge US and International Standards • International Standard • IAS 11 – Construction Contracts • IAS 18 – Revenue

4. Background • Discussion paper issued December 2008 • May 2009 • Richard Forrestal and John Armour met with project managers to provide background on construction industry • 200 comment letters received from US and International parties including • CFMA • AGC of America • Surety Association of America • NASBP • Several national/international contractors

5. Background • December 2009 • Working session with Board member and project managers • John Armour representing AGC of America • Jerry Hendrickson representing CFMA • URS Engineering, Lane Construction, Northrup Grumman, Raytheon, Others presented case studies • Exposure Draft Issued June 24, 2010 – Revenue Recognition (Topic 605) Revenue from Contracts with Customers • Comment deadline October 22, 2010 • Goal • Develop a common revenue standard for industries, jurisdictions and capital markets

6. Exposure Draft – 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

7. Exposure Draft • What changes for long-term contracts • “Profit center” is replaced with “performance obligations” • A single contract may have multiple performance obligations. • The profit margin objective of a contract is replaced with various margins for each performance obligation • Standards for severing a contract are reduced • Contract costs are redefined • Preference to output measurement of percent complete • Gross margin method of recognition replaced. • Costs and revenue de-bundled • Warranty and pre-construction cost recognition change

8. Exposure Draft - Superseded • SOP 81-1 • Codification Subtopics • 605-15 Revenue Recognition – Products • 605-20 Revenue Recognition – Services • 605-25 Revenue Recognition – Multiple-Element Arrangements • 605-28 Revenue Recognition – Milestone Method • 605-30 Revenue Recognition – Right to Use • 605-35 Revenue Recognition – Construction-Type and Production-Type Contracts • 605-45 Revenue Recognition – Principal Agent Considerations

9. Exposure Draft - Superseded • Codification Subtopics • 910-605 Contractors – Construction – Revenue Recognition • 912-210 Contractors – Federal Government – Balance Sheet • 912-275 Contractors – Federal Government – Risks and Uncertainties • 912-606 Contractors – Federal Government – Revenue Recognition • 970-605 Real Estate – General – Revenue Recognition • 976-605 Real Estate – Retail Land – Revenue Recognition • 430-10 Deferred Revenue – Overall • 360-20 Property Plant & Equipment – Real Estate Sales • Plus many other subtopics along with other subtopics being amended

10. Exposure Draft • New recognition model process • Identify the contract(s) with a customer • Identify the separate performance obligations in the contract • Determine the transaction price • Allocate the transaction price to the separate performance obligations, and • Recognize revenue when the entity satisfies each performance obligation • A good or service is transferred when the customer obtains control of that good or service (as defined in AFRIC 15) • May result in completed contract reporting • May have continuous transfer of goods or services

11. Exposure Draft • Most construction contracts will have continuous transfer of goods or services • Consistent application of the one method that best depicts the transfer of goods or services • Suitable methods • Output methods • Often result in the most faithful depiction of the transfer of goods or services • Will auditors be required to engage consulting engineers to validate output methods?? • Input methods • Passage of time

12. Exposure Draft • Contract eligible for revenue recognition – • May be written, oral, or implied • Contract has commercial substance • Parties to the contract have approved the contract and are committed to satisfying their respective obligations • The entity can identify each party’s enforceable rights regarding the goods or services being transferred • The entity can identify the terms and manner of payment for those goods or services

13. Exposure Draft • Performance Obligation – • Total contract • Segmenting or combining contracts • Distinct segments of the contract • Distinct function • Distinct profit margin • Change orders • Warranty

14. Exposure Draft • Transaction price • Total contract • Probability-weighted amount of consideration that an entity expects to receive from the customer in exchange for the goods or services • If the transaction price cannot be reasonably estimated, an entity shall not recognize revenue from satisfying a performance obligation • Consider the effects of • Collectibility • Time value of money • Noncash consideration • Consideration payable to the customer

15. Exposure Draft • Determination and Allocation of Transaction Price • Standalone selling price • Not based on prices in contract • i.e. schedule of values • i.e. bid sheets • Discount of combined pricing from individual standalone pricing is to be allocated to all performance obligations • Changes in scope and change orders • Onerous (loss) performance obligations

16. Exposure Draft • Cost guidance • Pre-contract costs • Capitalize as an asset only if - • Relate directly to a contract (or specific anticipated contract) • Generate or enhance resources of the entity that will be used in satisfying performance obligations • Are probable of recovery

17. Exposure Draft • Cost guidance • Cost related directly to a contract • Direct labor • Direct materials • Allocations of costs that relate directly to the contract or contract activities • Costs that are explicitly chargeable to the customer under the contract • Other costs that were incurred only because the entity entered into the contract

18. Exposure Draft • Cost guidance • Cost recognized as expenses when incurred • Costs of obtaining a contract • Costs that relate to satisfied performance obligations in the contract • Costs of abnormal amounts of wasted materials, labor, or other resources used to fulfill the contract

19. Exposure Draft • Disclosures • Qualitative/Quantitative information • Its contracts with customers • The significant judgments, and changes in judgments, made in applying the proposed guidance to those contracts • Aggregation/Disaggregation • Consider the level of detail necessary to satisfy the disclosure requirements and how much emphasis to place on each of the various requirements. An entity shall aggregate or disaggregate disclosures so that useful information is not obscured by either the inclusion of a large amount of insignificant detail or the aggregation of items that have different characteristics.

20. Exposure Draft • Disclosures • Topic 280 – Segment reporting • Contracts with customers – amount, timing, uncertainty of revenue, and cash flows • Type of good or service • Geography • Market or type of customer • Type of contract

21. Exposure Draft • Disclosures • Reconciliation of contract balances • Amounts recognized in statement of comprehensive income • Revenue from performance obligations satisfied during the reporting period • Revenue from allocating changes in the transaction price to performance obligations satisfied from the previous reporting periods • Interest income and expenses, and • The effect of changes in foreign exchange rates • Cash received • Amounts transferred to receivables • Non-cash consideration received • Contracts acquired in business combinations and contracts disposed

22. Exposure Draft • Disclosures • Reconciliation of contract balances • Reconcile the opening and closing aggregate balance of contract assets and contract liabilities to the amounts presented in the statement of financial position.

23. Exposure Draft • Disclosures • Performance Obligations • The goods and services the entity has promised to transfer, highlighting any performance obligations to arrange for another party to transfer goods or services (acting as an agent – CM) • When the entity typically satisfies its performance obligations (as services are rendered, or completion) • Significant payment terms • Obligations for returns, refunds, and other similar obligations, and • Types of warranties and related obligations

24. Exposure Draft • Disclosures • Performance Obligations • Contracts with original expected duration of more than one year – disclose the amount of the transaction price allocated to the performance obligations remaining at the end of the reporting period that are expected to be satisfied in each of the following periods • Not later than one year • Later than one year but not later than two years • Later than two years but not later than three years • Later than three years

25. Exposure Draft • Disclosures • Onerous performance obligations • The amount of any liability recognized for onerous performance obligations together with a discussion of • The nature and amount of the performance obligations for which the liability has been recognized • Why those performance obligations have become onerous, and • When the entity expects to satisfy the liability

26. Exposure Draft • Disclosures • Onerous performance obligations • Reconciliation from the opening to closing balance of the liability recognized for onerous performance obligations – show amounts recognized in statement of comprehensive income for • Performance obligations that became onerous during the period • Performance obligations that ceased to be onerous during the period • Amount of the liability that was satisfied during the period • The time value of money; and • Changes in the measurement of the liability that occurred during the reporting period

27. Exposure Draft • Disclosures • Significant judgments – Entity shall disclose the judgments, and changes in judgments, made in applying the proposed guidance that significantly affect eh determination of the amount and timing of revenue • Determining the timing of satisfaction of performance obligations; and • Determining the transaction price and allocating it to performance obligations

28. Exposure Draft • Disclosures • Timing of satisfaction of performance obligations – for performance obligations satisfied continuously • The methods (inputs, outputs, passage of time) used to recognize revenue; and • An explanation of why such methods are a faithful depiction of the transfer of goods or services

29. Exposure Draft • Disclosures • Determining transaction price and allocating it to performance obligations – information about the methods, inputs, and assumptions used • To determine the transaction price • To estimate standalone selling prices of promised goods or services • To measure obligations for returns, refunds, and other similar obligations • To measure the amount of any liability recognized for onerous performance obligations (including information about the discount rate)

30. Exposure Draft • What matters in comment letters • Identify commentator as • Preparer • Auditor • User/Investor • Standard Setter • Professional Organization • Good ammunition in comment letters • Cost – benefit

31. Other Pending Projects • Multi-employer plan disclosures • Lease accounting

32. Letters of Comment – Robert Duke, Director of Underwriting/Assistant Counsel, SFAA • “The proposed standard set forth in the Discussion paper disregards many of the unique aspects of revenue recognition in construction, and would create unnecessary expense and complexity.” • “The proposed approach in the Discussion Paper is a departure from this well-established standard and likely will cause detrimental effects: increased audit costs, less consistency, increased training costs for users and a decrease in the usefulness of financial statements.”

33. Letters of Comment – Jerry Henderson & Peter Schwarts, Co-Chairs of the Emerging Issues Subcommittee, CFMA • “CFMA believes the proposed guidance will actually result in greater inconsistency in revenue recognition compared to current practices for the construction industry.”

34. Letters of Comment – Jeffrey D. Shoaf, Senior Executive Director Government & Public Affairs, AGC of America • “If the revenue recognized in a given period significantly differs from that which would be recognized under SOP 81-1, it is likely that the principle is flawed.”

35. Letters of Comment – Robert J. Pasterick, Vice President & Corporate Controller, Boeing • “We believe a percentage-of-completion revenue recognition model is more reflective of the underlying economics of long-term construction/production contracts than the proposed model.” • “While this may result in some inconsistency, we believe the benefits of providing more decision useful information outweigh the disadvantages of having more than one revenue recognition model.”

36. Letters of Comment – Patrick T. Pribyl, Chair of NASBP Industry Relations Committee • “NASBP believes that the paper proposes a model-a completed contract method of revenue recognition-which would considerably complicate, and even hamper, the underwriting of construction firms by surety professionals.”

37. Don’t Kill the Messenger! Questions ?