Revenue Recognition & Reporting Financial Performance

1. Revenue Recognition & Reporting Financial Performance Stephenie Fox CA Principal, CICA

2. Revenue Recognition • CICA Handbook Section 3400 REVENUES • Issued 1986 • Revenue generating activities increasingly complex • Current environment – sales figures used as indicator in evaluating stock prices

3. Section 3400 Addresses timing of revenue recognition (not measurement)

4. Revenue Defined Revenue is the inflow of cash, receivables or other consideration arising in the course of the ordinary activities of an enterprise, normally from the sale of goods, the rendering of services and the use by others of enterprise yielding interest royalties or dividends. Revenue is net of items such as trade or volume discounts, returns and allowances, claims for damaged goods, and certain excise and sales taxes.

5. Revenue Recognition • ¶.06 – recognize when performance requirements (¶ 07&08) are satisfied and ultimate collection is reasonably assured

6. Revenue Recognition (cont) • ¶ .07 sale of goods – seller of goods has transferred to the buyer the significant risks and rewards of ownership in that all significant acts have been completed and the seller retains no continuing managerial involvement in or effective control of the goods transferred to a degree usually associated with ownership

7. Revenue Recognition (cont) • ¶.08 rendering of services and long-term contracts – performance determined using percentage of completion or completed contract method – performance achieved when reasonable assurance exists regarding the measurement of the consideration that will be derived from rendering the service or performing the long-term contract

8. Recognition • Transferring risks and rewards of ownership • Need to assess whether these have been transferred – look at circumstances • Usually coincides with transfer of legal title • Do any significant acts of performance remain to be completed

9. Recognition (cont) • Must have certainty of collection • e.g. does payment depend on resale of goods by the buyer • Returns – are they significant and unpredictable

10. Problems of interpretation • What does significant acts mean? • OSC notice 52-701 – review of revenue recognition to determine if appropriate application of Section 3400. • Revenue has direct effect on reported earnings- also becoming an indicator of value and performance especially in tech sector

11. OSC Findings • Need for significant improvement in nature and extent of disclosure • Referred to more detailed literature like SAB 101 – effectively makes this part of Canadian GAAP for public listed companies • Feeling that issuers have not looked at all existing sources of accounting literature when applying Canadian GAAP

12. Transfers of Risks and Rewards • Completion of significant acts • Not always easy to assess • E.g. bill and hold sales, contracts with multiple elements

13. SAB 101 – U.S. SEC • General FASB principles – revenue recognized when realized or realizable and earned • Earned when substantially accomplished what it must do to be entitled to benefits represented by revenues • Problems of uncertainties and interpretation

14. CICA – New EIC’s • EIC 141 revenue recognition • EIC 142 revenue arrangements with multiple deliverables • EIC 143 accounting for separately priced extended warranty and product maintenance contracts

15. EIC 141 Revenue Recognition Performance achieved under 3400.07 when: • Persuasive evidence of an arrangement exists • Delivery has occurred or service have been rendered; and • The seller’s price to the buyer is fixed or determinable Recognize revenue in the period in which all of these criteria are met

16. Persuasive Evidence of an Arrangement Arrangement: final understanding between the parties as to the specific nature and terms of the agreed upon transaction

17. Determining Whether an Arrangement Exists • Customary business practices • Side arrangements • Consignment arrangements • Title passes but revenue recognition precluded

18. Delivery and Performance • Revenue recognized when seller has substantially accomplished what it should do under terms of the arrangement – usually on delivery of product or performance of services

19. Fixed or Determinable Sales Price • Cancellable sales arrangement • Right of return • Price protections/inventory credit arrangements • Refundable fee for service arrangements

20. Disclosure of accounting policies • Always disclose revenue recognition policy • Policy for each type of transaction • If multiple elements, policy for each element

21. EIC 142 Multiple deliverables • Provides guidance for determining if arrangements with multiple deliverables consist of separate units of accounting • Presumption is that separate contracts with same entity entered into at same or near the same time are a package • EIC 142 looks at when these can be separated and accounted for separately

22. EIC 143 Extended warranty and product maintenance contracts • Defer and recognize over life of contract • Costs incurred should be deferred

23. Reporting Financial Performance • Display and presentation of items in the operating statement • Cash flow statement • Should certain items not recognized in income statement be recognized in a statement of financial performance?

24. Background • Concerns with income statement including • Undue emphasis on bottom line • Classification of items • Transparency for gains and losses that don’t go through the I/S • Gains and losses from changes in fair value

25. Comprehensive Income • Change in equity of an enterprise from transactions and events from non-owners. • All changes in equity except those from investments by owners and distributions to owners.

26. Other Comprehensive Income • Revenues expenses gains and losses required by primary sources of GAAP to be included in comprehensive income but excluded from net income

27. Presentation • Net income • Other comprehensive income • Total • One or two statements • Terms may vary

28. Statement of Comprehensive Income

29. Reporting Financial Performance Convergence project

30. Reporting Financial Performance • Maximize predictive value with respect to forecasts of comprehensive income and its components • Bottom line not a useful number – aggregates a range of components of financial performance – goal is useful disaggregation • Ambiguity in definition of operational earnings – companies defining own measures of profit-lack of consistency and comparability between

31. Proposed Format of Performance Report (Preliminary) • Part A – Revenue, Cost of sales (excludes depreciation), Pension expense, Other (selling general and admin) • Part B - Investing (= changes in assets) e.g.Interest Dividends, Depreciation & amortization • Part C – Financing (=changes in liabilities) • +/- Income taxes, Discontinuing operations, Other • Total changes in net assets before transactions with owners

32. Reporting Financial Performance • Work in process • International convergence a goal by all standard setters