The new revenue standard

Transcription

1 The new revenue standard Why is it so important? June 8, 2016

2 Agenda Overview Why should you care? The five step model Implementation challenges What should Companies be doing? Page 2

3 Overview Page 3 The new revenue recognition standard for life sciences companies

4 Revenue recognition Overview 1 FASB and IASB issued a new global revenue recognition standard on 28 May 2014 that will replace existing US GAAP and IFRS guidance on revenue recognition 2 Virtually every industry is affected 3 Standard requires entities to use more judgment and make more estimates than under current guidance 4 Its effect on financial statements, business processes and internal controls will likely be significant for some entities 5 Implementation landscape and ongoing standard setting FASB/IASB Joint Transition Resource Group for Revenue Recognition (TRG) Other Groups Page 4

5 What s the change? Service Revenue (ASC ) General (CON 5) Multiple Element Arrangements (ASC ) Existing standards Product Revenue (SAB Topic 13) Industry Guides (e.g., Government Contractors) Construction (ASC , e.g., Completed Contract, POC) Leasing (ASC 840) Software Revenue (ASC ) Single global framework More principles than prescriptive, anti-abuseoriented rules Potential changes: More performance obligations (identify, track, allocate revenue) Disconnect between billing and revenue recognition More estimates included in revenue Timing of revenue recognition could change significantly Page 5

6 Effective date Adoption timeline: Effective date Early adoption years beginning years beginning Public entities January 1, 2018 January 1, 2017 Non- public entities January 1, 2019 January 1, 2017 or January 1, 2018 Transition permitted either through a retrospective method or prospectively with adjustment to opening reserves Page 6

7 Why should you care? Page 7 The new revenue recognition standard for life sciences companies

8 Why should you care? Revenue is the single biggest focussed indicator of financial performance A major change in accounting The timing/manner of revenue recognition could change significantly Greater application of judgments and estimates required Expands both qualitative and quantitative disclosures Companies need to dedicate significant resources to implement the standard Accounting policies Accounting processes and internal controls IT systems Contracts with customers, Incentive plans, debt covenants, financial projections, may need revision as a result of revenue recognition changes Page 8

9 The five step model Page 9 The new revenue recognition standard for life sciences companies

10 Introducing the five step model Summary of the model Core principle Recognize revenue to depict the transfer of goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services Step 1: Identify the contract(s) with the customer Step 2: Identify the separate performance obligations in the contract Step 3: Determine the transaction price Step 4: Allocate the transaction price to the separate performance obligations Step 5: Recognize revenue when each performance obligation is satisfied Page 10

11 Step 1 Identify the contract A contract is an agreement between parties that creates enforceable rights and obligations All of the following must be met: Parties have approved the contract; Each party s rights can be identified; Payment terms can be identified; Contract has commercial substance; Collection of consideration is probable. Page 11 What s changing? Focus is on enforceability and not on form Collectability a gating question Liability classification for collections without contract

12 Step 1 Practical issues The focus of contract identification is on enforceability The manner of evaluating collectability is judgmental. Companies recognizing revenues on a cash basis would be required to defer collections until contract is concluded. Page 12

13 Step 2: Identify performance obligations A performance obligation is a promise to transfer a distinct good or a service to a customer Is capable of being distinct? Is distinct in the context of the contract? If customer can benefit on its own OR With other resources No significant service of integrating Modifying or customizing Not highly inter-related with other goods or services What s changing? Applying these indicators will require significant judgment Could impact systems and processes Page 13

14 Step 2 Practical issues Is license a distinct performance obligation when: Is Software distinct from significant implementation services? Is the license of a Biotech distinct from the ongoing R&D/manufacturing services? Services are being performed under a hosting model? Is a customer option required to be viewed as a separate PO because it conveys a material right? Page 14

15 Step 3: Determine the transaction price Transaction price is the amount that an entity expects to be entitled to in exchange for transferring good or service Transaction price reflects the effects of the following: Variable consideration (to be estimated and subject to constraints) Significant financing component should be adjusted Noncash consideration Consideration paid to a customer to be reflected as a reduction from revenue unless for a distinct service and priced at fair value. What s changing? Variable consideration will introduce a new world of estimates Advance payments would be required to be present valued Will require lots of judgment and hence would impact systems and processes Page 15

16 Step 3 Practical issues Variable consideration is likely to change practice: Sell through method is likely to be replaced by a Sell In method It may be possible to estimate sales returns in more situations Fixed and determinability no longer a requirement Systems and processes need to be developed to measure variable consideration Extended payment terms may no longer gate revenue recognition in software transactions Lots of judgment in concluding whether or not there is a significant financing element Advance payments considered a source of financing and in certain cases, interest costs would be accrued. Page 16

17 Step 4: Allocate the transaction price to performance obligations Transaction allocated to separate performance obligations based on relative standalone selling prices: Maximize use of observable inputs (VSOE or Third Party Prices) Apply estimation methods consistently Exception for discounts meeting certain criteria What s changing? Relatively consistent with current multiple element guidance in US GAAP Software revenue recognition guidance, may reach different conclusions as VSOE is no longer a requirement Page 17

18 Step 5: Recognize revenue Control of goods and services is transferred over time if one of the following three criteria is met: The entity creates or enhances an asset that the customer controls as it is created or enhanced Performance obligations satisfied over time Service contracts The entity s performance does not create an asset with alternative use and the entity has an enforceable right to payment The customer is receiving and consuming the benefits of the entity s performance as the entity performs Transfers at a point in time If none of the above criteria are met, control transfers at a point in time: Present right to payment Customer has accepted Customer has legal title Physical possession transferred Significant risks and rewards Page 18

19 Step 5 Practical issues Contract manufacturers, in some situations, are likely to recognize revenues using an over-time model. Functional licenses in the software, media technology and life sciences industry likely to be accounted upfront. Symbolic licenses (eg. Franchisors) likely to recognize revenues over time. VSOE no longer a requirement for undelivered elements in software transactions. Specified upgrades/ road maps may not gate revenue recognition Term licenses would be more frequently recognized upfront Page 19

20 Costs to obtain a contract Incremental costs of obtaining a contract (e.g., sales commission) are capitalized if recovery is anticipated Practical expedient allows immediate expense recognition if the asset s amortization period would be one year or less. Assets are amortized over the period the goods or services are transferred and subject to impairment If costs relate to more than one contract (e.g., expected contract renewals), amortization should consider both current and anticipated contracts What s changing? Sales commission costs would have to be evaluated to determine whether those are costs to obtain a contract and potentially capitalized Page 20

21 Disclosure requirements Performance obligations Contract balances Significant judgments Disaggregation of revenue Understand nature, amount, timing, and uncertainty of revenue and cash flows Costs to obtain or fulfill a contract Page 21

22 Transition approaches Transition approach 2016/ Date of cumulative effect adjustment Retrospective Restate for all contracts Apply to all contracts January 1, 2016 Retrospective Using One or More Practical Expedients Restate for all contracts except for contracts or estimates covered by the practical expedients elected by the entity Apply to all contracts January 1, 2016 Cumulative Effect at the Date of Adoption No contracts restated; reported on the basis of legacy guidance Option to apply to either all contracts or only to apply to open contracts January 1, 2018 Page 22

23 Implementation challenges Page 23 The new revenue recognition standard for life sciences companies

24 The challenge ahead key questions for companies Determine financial impacts: Determine financial impacts: What revenue streams and unique contracts exist? What is the magnitude of the financial impact to KPIs, such as revenue growth, margin and EBITDA? Address transition considerations: Address transition considerations: How long will the transition take, and when should you start? What resources and budget are required? What other internal projects overlap? Does your organization have a preferred transition method? Evaluate organizational and system impacts: Evaluate organizational and system impacts: Does this affect the structure of your contracts with customers? Will you need to reconfigure your enterprise resource planning (ERP) systems to generate different revenue, cost of goods sold and other journal entries, including those required for transition? Do you have the ability to accurately capture the contractual and other required data points? Will the standard create new book/tax differences and/or method changes? How do your company s implementation plans benchmark against your competitors? How and when will you communicate to internal and external stakeholders? Page 24

25 What should Companies be doing? Page 25 The new revenue recognition standard for life sciences companies

26 Getting Started - What should Boards/ Audit Committees be doing? Discuss timeline for adoption Could impact transition approach Slowing down preparedness perhaps is not the right answer Perform a diagnostic Potential messaging to banks, lenders and other investors Are there are alternatives? One time vis-à-vis continuing adjustments Explore possibility of restructuring customer arrangements to obtain preferred results Discuss management s estimates and level of preparation with external auditors Oversee implementation In-house vs external help PMO function to provide oversight Address ERP/ systems considerations Make decisions regarding discounting maintenance and service for software companies Relook at commission policies and management incentive plans Internal controls Page 26

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