Course Materials. Revenue Recognition: New Standard Implementation Considerations NASBA INFORMATION

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1 RRRRRADP Lunch & Learn Course Materials Revenue Recognition: New Standard Implementation Considerations NASBA INFORMATION SmartPros Ltd. is registered with the National Association of State Boards of Accountancy (NASBA) as a sponsor of continuing professional education on the National Registry of CPE Sponsors. State boards of accountancy have final authority on the acceptance of individual courses for CPE credit. Complaints regarding registered sponsors may be addressed to the National Registry of CPE Sponsors, 150 Fourth Avenue North, Suite 700, Nashville, TN Web site: ADP has partnered with SmartPros to provide this program and SmartPros has prepared the material within A

2 segment four segment four segment four 4. Revenue Recognition: New Standard Implementation Considerations Learning Objectives: Segment Overview: Field of Study: Expiration Date: Course Level: Course Prerequisites: Advance Preparation: Recommended Accreditation: Required Reading (Self-Study): Video Transcript: Running Time: 4 1 Upon successful completion of this segment, you should be able to: Recognize what companies are doing to implement the revenue recognition standard; Identify the factors to be considered in determining performance obligations; Recognize the judgment issues relative to the new revenue recognition standard that companies are encountering; Recognize best practices that companies are using to apply the new revenue recognition standards. The new revenue recognition standard has everyone talking. What are companies doing to implement this standard? How are they evaluating it, and what are some of the judgment issues they re encountering? In this panel discussion, we hear from senior accounting and financial executives from NBC Universal, Boeing, Microsoft, Raytheon and PricewaterhouseCoopers who share their experiences and what they have learned from implementing the new standard. Accounting April 14, 2016 Update Work experience in financial reporting or auditing, or an introductory course in accounting None 1 hour group live 2 hours self-study Revenue from Contracts with Customers ASU (Excerpts) Excerpted from SmartPros Advantage course 99FLE23-tx: Revenue from Contracts with Customers ASU For additional information, go to: See page See page minutes CPAR/ FEB. 15

3 outline outline outline outline outline Outline I. Thought Leaders on Revenue A. Executive Panel 1. Many referring to the new revenue recognition standard as a milestone standard 2. High level panel of accounting and finance executives answered questions about new revenue recognition standard a. Moderator Ken Bement i. Director of Financial Reporting and Corporate Accounting at Raytheon b. Allan Cohen i. Senior Vice President and Corporate Controller of NBC Universal c. Mindy Henbest i. Director of Accounting Policy at the Boeing Company d. Dusty Stallings i. Partner, National Professional Services Group, PricewaterhouseCoopers e. Stacy Harrington i. Director, Corporate Revenue Assurance with Microsoft B. How Do Companies Implement, Evaluate? 1. Our job as a preparer community has changed in the last 6 months 2. Up to preparer community to figure out how to implement the standard a. What are great companies doing to implement the standard? b. How are they evaluating the standard? c. What are some of the judgment issues they re encountering? d. How might we all benefit from the sharing of these best practices and other differences? C. Standard Objective 1. Objective have a principled single framework a. That could be applied across various transactions, industries, countries i. In order to get relevant neutral accounting 2. Big culture shock a. In the US in particular b. Challenging a lot of our thinking 4 2

4 Outline (continued) 4 3 outline outline outline outline outline II. Microsoft: Slicing and Dicing Analysis A. Accounting Evaluation: Forgetting the Old Rules 1. Really an accounting-driven change 2. Important to evaluate the accounting impacts a. Not just the delta b. Really understand what accounting will look like under the new model c. Feeds into other downstream teams, such as systems and FP&A, etc. When we break down our accounting evaluation, again, we re trying to forget all the rules that we re accustomed to now... Stacy Harrington B. Analysis in Three Different Sections 1. Revenue products and services a. What are the performance obligations? b. What are the triggers and the delivery pattern? c. What are the values? 2. Sales programs a. How are you selling it? Are you bundling it? b. Did the way that you sold it change the nature and revenue recognition? 3. Contract level a. Did I promise something in the contract that would change the nature and recognition pattern? C. Contract Level Analysis 1. Amount of work depends on how standard your contracts are 2. Themes and performance obligations at a standard program level? a. Or a term level? 3. If you have a lot of non-standard terms and customizations a. Go down to each individual contract to understand the accounting implications 4. Systems folks want to understand what you specifically need the systems to do a. Trying to put it in three buckets i. We know it s an impact ii. We know there s no impact iii. Maybe there s an impact CPAR/ FEB. 15

5 outline outline outline outline outline Outline (continued) 4 4 III. Approach to Contracts A. Boeing: Long-Term Contract Accounting 1. Use long-term contract accounting a. So the unit of account for defense business is the contract 2. Spent a lot of time evaluating if that unit of account will still be the contract a. Or will it be each individual production unit within the contract? So we ve been looking at several of our contracts, drilling down into them and really thinking about, what will the performance obligations really be? Mindy Henbest B. Contract as Unit of Account? 1. Worked with FEI CCR s (Committee on Corporate Reporting) Revenue Recognition Working Group a. Focused on long-term contracts with about 5 different companies represented 2. Each took an example situation in the organization a. Took it through the model b. Looked at whether or not we felt like contract would be used as unit of account i. Or it would be at a lower level than the contract 3. Came up with varying answers 4. Looking into the evaluation of what really constitutes a performance obligation C. Judgments Around Performance Obligation Model 1. A lot of judgments around identifying performance obligations a. Creating a one size fits all model doesn t work i. It s got to be flexible 2. Differences in economics lead to different accounting conclusions 3. Customer specific factors related to delivery of goods or services play a role 4. General paralysis in the system a. Fear of making a judgment and then being second guessed down the road 4 4 D. Identifying Distinct Performance Obligations 1. Example: Boeing designing and delivering six fighter jets a. Is the design for the prototype of the fighter jets a performance obligation? b. Should you recognize revenue when you complete the design? c. Should you recognize more revenue when you first do the first prototype? d. How should revenue be recognized for the other five fighter jets? 2. Standard says that a contract has dependent performance obligations a. The service of installation is dependent on buying the product E. Including Insignificant Services 1. Certain services are insignificant or perfunctory a. Didn t have to account for them in the past b. Have to consider those 2. Make sure you are identifying distinct performance obligations a. Timing could be significantly affected

6 Outline (continued) 4 5 outline outline outline outline outline IV. License-Related Issues A. Intellectual Property Rights 1. Guidance says either license revenue should be recognized up front or over time a. Depends on significant activities that the licensor is doing to the licensed product 2. Example from standard Boston Red Sox licensed logo to a T-shirt manufacturer a. $2 million for a 2-year license b. Example concluded that you get $2 million of revenue over the license period 3. FASB ISB board say the value of the intellectual property has to change a. In order for revenue recognition to change B. Timing of Revenue Recognition 1. Do you recognize revenue up front or over time? 2. Example: license The Sound of Music to Netflix a. Netflix can show The Sound of Music only on December 25th each year for 4 years b. Do we get up-front revenue recognition? c. Do we have one performance obligation or four performance obligations? d. Unclear how to evaluate that in the standard C. Guidance is Unclear on the Edge Cases 1. Definitely a chunk of licenses where it is clear how you would account for them 2. Edge cases are not as clear a. Hosted functionality b. On-premise software 3. With principles-based guidance you have a big spectrum where it s clear a. Then stuff on the fringes that s unclear D. Need to Forget the Old Rules 1. People desperately trying to keep the same revenue recognition pattern 2. Forget the rules and forget what you do today a. Look at it with a fresh set of eyes i. If I follow this guidance and this model, what is the outcome? CPAR/ FEB. 15

7 4 6 outline outline outline outline outline Outline (continued) V. Working Without Precedents A. Different Inputs from Auditors, SEC, FASB, IASB 1. Usually there s somebody somewhere that s seen an issue in the past a. There might be some precedent b. No database of precedent under the new standard 2. Auditors have been a little bit gun shy to put out guidance 3 Supposed to be a principle-based standard a. SEC/others don t want firms putting out very specific rulebased guidance B. Aligning with Auditors 1. High-level impact assessment a. Where are the revenue streams where we don t think there will be any change? b. Where are the revenue streams where we know there s definitely going to be a change? c. Where are the revenue streams that are kind of in between? 2. Process of beginning to establish new accounting policies a. Expect to really engage our auditors and make sure that our thinking is aligned C. Everyone Learning Together 1. One thing we have in common with the preparer community is that we are all going through an education process 2. We know where the SEC s historically been and where other firms have historically been a. Have to step back and go a bit more slowly

8 Outline (continued) 4 7 outline outline outline outline outline VI. Implementation A. Be Prepared for Disclosures, Consideration 1. Come up with an interpretation do your best to evaluate and implement it a. Talk to your industry b. Talk to your auditors 2. Disclosure requirements significantly enhanced 3. EITF-019 Consideration Payable to a Customer B. Policy and Quantification Phase 1. Looked at about 50 contracts across major revenue streams a. Tried to apply the five-step model to each contract b. Identify where we think we won t have any changes, where we might have some changes, where do we know for sure we re going to have a change? 2. Dive deeper into the business and come up with our new accounting policies 3. Need to quantify the impact a. Pro forma financial statements under new rules b. Create a set of disclosures under the new rules C. Executing New Policies 1. Phase two will involve a lot of education 2. Phase three putting in place systems and processes a. To execute new accounting policies 3. Making decision are we going to be able to practically be able to do the retrospective application? a. Or are we going to have to do the modified prospective? D. Organizing Implementation Team 1. Team is centralized under the Corporate Controllers Group a. Since it s an accounting-driven change 2. Not going to do everything and then hand it off at the end a. Going to hand off requirements around data and system requirements as we go along those phases 3. Systems people are who will enable the change 4. Operations people will get embedded in the process as the products go to market a. Then bring along the impacted by folks a little bit later on i. Tax, investor relations and FP&A 5. Then the impact to sales organization a. How we think about accountabilities and metrics b. What will be unintended behavior changes because of the way we ll be recognizing revenue? E. Using Outside Consultants 1. Expect to continue to use outside consultants to help us a. Really going to be educating folks in the businesses that do revenue accounting 2. Outside consultants will be invaluable a. Helping us think through things b. Just having that sounding board c. Sense-check your judgments F. Wait Until You Have a Plan 1. Have told divisions to really hold off until we figure out our plan 2. We ll start to build out the plan and communicate to our division it s hard to communicate what the impact is until you really understand what the impacts are. Allan Cohen CPAR/ FEB. 15

9 discussion questions discussion questions Group Live Option Instructions for Segment For additional information concerning CPE requirements, see page vi of this guide. As the Discussion Leader, you should introduce this video segment with words similar to the following: In this segment, a panel of senior accounting and finance executives at the CFRI Conference share their experiences and what they have learned from implementing the new revenue recognition standard. Discussion Questions Show Segment 4. The transcript of this video starts on page 4 18 of this guide. After playing the video, use the questions provided or ones you have developed to generate discussion. The answers to our discussion questions are on page 4 9. Additional objective questions are on pages 4 10 and After the discussion, complete the evaluation form on page A Revenue Recognition: New Standard Implementation Considerations You may want to assign these discussion questions to individual participants before viewing the video segment. 1. What are we and our clients doing to deal with the new revenue recognition standard? 2. What were the three sections identified by Microsoft in their approach to the new revenue recognition standard? What were Ms. Harrington s observations on contracts? 3. What were Boeing s implementation considerations? What are our clients implementation considerations? 4. What are the factors to consider when identifying performance obligations? 5. What were the questions identified with regards to identifying performance obligations in the example of selling six fighter jets to the U.S. Army? 6. What is the answer to the example of the Boston Red Sox licensing their logo to a T-shirt manufacturer? Do you agree with the conclusion? If so, why? If not, why not? 7. What are the judgments issues our clients are encountering in implementing the new revenue recognition standard? 4 8

10 suggested answers to discussion questions Suggested Answers to Discussion Questions 4. Revenue Recognition: New Standard Implementation Considerations 1. What are we and our clients doing to deal with the new revenue recognition standard? Participant response is based on your organization and your clients 2. What were the three sections identified by Microsoft in their approach to the new revenue recognition standard? What were Ms. Harrington s observations on contracts? Revenue recognition: Three different sections Performance obligations Sales programs Contract level Harrington s observations The amount of work on contracts depends on how standard your contracts are If you have a lot of non-standard contracts, you have to look at individual contracts 3. What were Boeing s implementation considerations? What are our clients implementation considerations? Boeing s implementation considerations Is the unit of account the contract? Or is it the individual production unit within the contract? Participant response is based on your clients 4. What are the factors to consider when identifying performance obligations? Identifying performance obligations: Consideration factors Extent to which company is integrating goods or services into combined output Level of interdependencies of goods or services How customer specific is contract How separable are risks and resources related to delivery of goods or services 5. What were the questions identified with regards to identifying performance obligations in the example of selling six fighter jets to the U.S. Army? Identifying performance obligations: Questions Is the design a performance obligation? Should you recognize revenue when design is completed? Should you recognize more revenue when you do the first prototype? How should revenue be recognized for the other jets? 6. What is the answer to the example of the Boston Red Sox licensing their logo to a T-shirt manufacturer? Do you agree with the conclusion? If so, why? If not, why not? Boston Red Sox licensing example Do you recognize $2 million when license takes place? Or do you recognize over license period? Example concluded: recognize over license period 7. What are the judgments issues our clients are encountering in implementing the new revenue recognition standard? Participant response is based on your clients 4 9 CPAR/ FEB. 15

11 objective questions objective questions Objective Questions Revenue Recognition: New Standard Implementation Considerations You may want to use these objective questions to test knowledge and/or to generate further discussion; these questions are only for group live purposes. Most of these questions are based on the video segment, a few may be based on the required reading for self-study that starts on page The culture shock that Ken Bement mentions regarding the implementation of the new revenue recognition standard in the U.S. pertains to: a) the IT investment necessary to support new accounting policies b) the changes to disclosure requirements c) a principled, rather than rule-based standard d) the strict requirements of the standard 2. How is Stacy Harrington approaching the new revenue recognition guidance at Microsoft? a) by putting aside the existing rules and applying the five-step model to see where the changes will be b) by identifying performance obligations in the products and services offered c) by considering sales programs and determining how that influences revenue recognition d) all of the above 3. With respect to implementation of the new revenue recognition standard at Boeing, Mindy Henbest notes that the company is rethinking: a) performance obligations and the unit of account b) how licensing deals will be handled c) how they will work with their auditors going forward on the issue of revenue recognition d) their use of consultants to drive this change throughout the organization 4. What does Allan Cohen point to as an ambiguity inherent in the new revenue recognition guidance? a) unclear disclosure requirements b) confusion regarding when some of the steps within the five-step process would need to be followed c) difficulty in determining when performance obligations are distinct d) none of the above 5. Who does Ken Bement note is likely the most uncomfortable with the new principles-based revenue recognition standard? a) preparers b) auditors c) the audit committee d) IT 6. The Boston Red Sox example was used by Allan Cohen to demonstrate: a) why the revenue recognition standard cannot be applicable to all industries b) the difficulty in identifying performance obligations c) the difficulty of determining when licensing revenue should be recognized d) that the accounting for most licensing deals will not change under the new revenue recognition standard 7. What are some best practices with respect to the revenue recognition standard that can be gleaned from the panelists? a) taking advantage of specific guidance put out by public accounting firms b) the use of external consultants to drive the change is not recommended c) ensuring that a company s accounting mirrors industry standards d) getting comfortable with making interpretations regarding gray areas

12 4 11 objective questions objective questions Objective Questions (continued) 8. ASU would apply to: a) construction contracts b) lease contracts c) financial instruments d) non-monetary exchanges 9. For purposes of ASU , a contract would still exist if: a) the contract had price concessions b) collection is not probable c) each party has the right to terminate a wholly unperformed contract without compensating the other party d) all of the above 10. With respect to price concessions under ASU , the required reading notes that: a) the new standard is silent on this issue b) price concessions would be considered impairment losses c) there is no change with respect to their treatment from current accounting guidance d) the timing of when they will be recognized will be tied to the completion of specific performance obligations CPAR/ FEB. 15

13 4 12 required reading required reading Self-Study Option Instructions for Segment When taking a CPA Report segment on a self-study basis, an individual earns CPE credit by doing the following: 1. Viewing the video (approximately minutes). The transcript of this video starts on page 4 18 of this guide. 2. Completing the Required Reading (approximately minutes). The Required Reading for this segment starts below. Required Reading (Self-Study) 3. Completing the online steps (approximately minutes). Please see pages iii to v at the beginning of this guide for instructions on completing these steps. REVENUE FROM CONTRACTS WITH CUSTOMERS ASU (EXCERPTS) Excerpted from SmartPros Advantage course 99FLE23-tx: Revenue from Contracts with Customers ASU For additional information, go to: Section 2: Introduction to Revenue from Contracts with Customers 2.3: Revenue Objectives The objective of ASU is to establish the principles that an entity must apply to report useful information to users of financial statements about the nature, amount, timing, and uncertainty of revenue and cash flows arising from contracts with customers. An entity will recognize revenue to depict the transfer of promised goods and services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods and services. For a public entity, this ASU is effective for annual periods beginning after December 15, 2016, including interim periods within that reporting period. For non-public entities, this ASU is effective for annual reporting periods beginning after December 15, 2017 and interim periods within annual periods beginning after December 15, : Scope and Scope Exceptions In general, ASU applies to any entity that enters into contracts with customers, excluding contracts that are within the scope of other ASC topics. Contracts within the scope of other ASC topics include: Lease contracts ASC 840. Insurance contracts ASC 944. Financial instruments ASC topics: 310, 320, 323, 325, 405, 470, 815, 825, and 860. Guarantees ASC 460.

14 4 13 required reading required reading Non-monetary exchanges ASC 845. A contract with a customer may be partially within the scope of ASU and partially within the scope of other ASC topics. If other ASC topics specify how to separate and/or initially measure one or more parts of the contract, then an entity must first apply those separation and/or measurement requirements. If other ASC topics do not specify how to separate and/or initially measure one or more parts of the contract, then the entity must apply ASU to separate and/or initially measure the part(s) of the contract. Section 3: Recognition 3.1: Overview In order to apply the core principle in ASU , entities are required to apply the following revenue process to all revenue contracts with customers. 3.2: Step 1 Identify the Contract(s) with a Customer Step 1 of the five step process requires entities to identify contracts with customers. Revenue cannot be recognized by an entity in the absence of an identified contract with a customer. A contract is defined as an agreement between two or more parties that creates enforceable rights and obligations. Contracts may be: Written. Verbal. Implied based on the entity s customary business practices. An entity would account for a contract with a customer that is within the scope of ASU only when all of the following criteria are met: The parties to the contract have approved the contract and are committed to perform their respective obligations. The entity can identify each party s rights regarding the goods or services to be transferred. A contract does not exist if each party to the agreement has the unilateral right to terminate a wholly unperformed contract without compensating the other party. The entity can identify the payment terms for the goods or services to be transferred. The contract has commercial substance (commercial substance refers to the risk, timing, or amounts of the entity s future cash flows that are expected to change as a result of the contract). It is probable that the entity will collect the consideration it will be entitled to for the goods or services that will be transferred to the customer. Collection is the amount that the customer has the ability and intent to pay when the considerations is due. This criterion acts as a collectability threshold. Partial payment for performance may indicate a contract exists and the difference is simply a price concession. However, the partial payment may suggest an impairment loss and the arrangement would not be considered a contract. EXAMPLE Is the Agreement a Contract? An entity enters into an agreement with a newly created start-up business that plans to develop and sell television conversion sets to enable televisions to be converted into computers with high speed internet connections. The entity will provide to the start-up business $1,500,000 of shell castings to house the conversion sets. While the owners of the start-up business have experience developing these conversion sets they have no experience in marketing and selling these products and they also are poorly financed. In addition, it is expected that television cable providers such as Comcast will see this start-up initiative as competition and will establish road blocks to its success. The start-up business pays a non-refundable deposit of $150,000 at inception of the CPAR/ FEB. 15

15 4 14 required reading required reading contract and enters into a long-term financing agreement (without any meaningful collateral) with the entity for the remaining $1,350,000 of the promised consideration. In assessing whether the agreement meets the criteria above, the entity concludes that it is not probable that the entity will collect the consideration in the agreement due to the start-up having limited marketing and selling experience, no collateral loan, and the expected competition from cable companies. The entity will therefore account for the $150,000 payment as a deposit liability as well as any other future payments until such time as the criteria for a contract are met that is, collection is probable. If this agreement does not ever meet the criteria for a contract, any consideration received by the entity should be recognized as revenue only when either of the following events has occurred: The entity has no remaining obligations to transfer goods to the start-up, and all, or substantially all, of the consideration promised by the start-up has been received by the entity and is nonrefundable. The agreement has been terminated and the consideration received from the start-up is non-refundable. Note: Probable is defined in U.S. GAAP as the future event or events are likely to occur; but in IFRS is has a lower threshold more likely than not. Transaction prices may be lower than contract prices due to price concessions offered by the entity. Since these price concessions will be applied to specific performance obligations and not always the total contract, they may impact revenue recognition as performance obligations are satisfied, not as in the current revenue guidance in ASC 605, based on the completed contract when the earnings process is substantially complete : Variable Consideration When considering the probability of collecting the consideration the entity is entitled to, the transaction price must be determined and any variable consideration evaluated to determine probability. Variable consideration could consist of discounts, rebates, refunds, credits, price concessions, incentives, performance bonuses, or penalties. The promised consideration also can vary if an entity s entitlement to the consideration is contingent on the occurrence or non-occurrence of a future event. We will discuss variable consideration further in Step 3 of this revenue approach. EXAMPLE Variable Consideration An entity enters into an agreement with a customer to provide the customer with 100,000 pounds of raw material X for a new product the customer is developing. The customer expects that once this new product is available in retail stores, demand will accelerate and the customer expects to need as much as 1,000,000 pounds of this raw material product annually. There are three other providers capable of providing this raw material product to the customer. The 100,000 pounds has an agreement price of $600,000 ($6 dollars a pound). The entity, recognizing that if the new product is successful, will have the opportunity to grow revenue with this customer by a significant amount. As a result, it adds to the agreement that if the customer purchases 1,000,000 pounds of raw material X in the next 12 months (including the initial 100,000 pounds), the price will be discounted to $5 a pound. The probability of this price concession must be evaluated to determine what amount of the agreement price should be recognized as the transaction price : Combination of Contracts An entity is required to combine two or more contracts with a customer entered into at or near the same time (or related parties of the customer) and account for the contracts as a single contract if one or more of the following criteria are met: The contracts are negotiated as a package with a single commercial objective.

16 4 15 required reading required reading The amount of consideration to be paid in one contract depends on the price or performance of the other contract. The goods or services promised in the contracts (or some goods or services promised in each of the contracts) are a single performance obligation. We will discuss performance obligations in Step 2 of the revenue approach : Contract Modifications Unlike existing U.S. GAAP, ASU provides specific guidance on the effect of contract modifications on revenue recognition. A contract modification is a change in the scope or price (or both) that is approved by the parties to the contract. A contract modification exists when the parties to a contract approve a modification that either creates new or changes existing enforceable rights and obligations of the parties to the contract. Approved change in scope only: If the parties to a contract have approved a change in the scope of the contract but have not yet determined the corresponding change in price, the seller should reconsider its revenue accounting when the entity has an expectation that the price of the modification will be approved. Approved change in price only: If an approved contract modification results only in a change to the contract s transaction price, the seller should account for the modification as a change in the transaction price, as it would if the transaction price were to change for a reason other than a contract modification. Additional contract: Under some circumstances, a seller will be required to account for a contract modification as a separate additional contract for revenuerecognition purposes. Specifically, a seller shall account for a contract modification as a separate additional contract if the contract modification has both of the following conditions: The scope of the contract increases because of the addition of promised goods or services that are distinct; and The price of the contract increases by an amount of consideration that reflects the entity s standalone selling price of the additional promised good(s) or service(s) along with any appropriate adjustments to that price to reflect the circumstances of the particular contract. EXAMPLE Contract Modification A seller and a customer agree to add on a distinct product to an existing contract, with the seller being willing to charge less than the usual standalone price of the product as a result of having already incurred the cost of establishing a relationship with the customer. Such a modification would meet the criteria to be treated as a separate additional contract for revenue-recognition purposes. Not an additional contract: For a contract modification that does not give rise to a separate additional contract as described above, the seller must evaluate the remaining goods or services in the modified contract (that is, the promised goods or services not yet transferred at the date of the contract modification) and is required to account for the modified contract in whichever of the following ways is applicable: If the remaining goods or services are distinct from the goods or services transferred on or before the date of the contract modification, then the entity shall allocate to the remaining separate performance obligations the amount of consideration received from the customer but not yet recognized as revenue plus the amount of any remaining consideration that the customer has promised to pay. In effect, an entity shall account for the contract modification as a termination of the original contract and the creation of a new contract. CPAR/ FEB. 15

17 4 16 required reading required reading If the remaining goods or services are not distinct and are part of a single performance obligation that is partially satisfied at the date of the contract modification, then the entity shall update the transaction price and the measure of progress toward complete satisfaction of the performance obligation. The entity shall recognize the effect of the contract modification as revenue (or as a reduction of revenue) at the date of the contract modification on a cumulative catch-up basis. In effect, the entity shall account for the contract modification as if it were a part of the original contract. If the remaining goods or services are a combination of items (a) and (b), then the entity shall allocate to the unsatisfied (including partially unsatisfied) separate performance obligations the amount of consideration received from the customer but not yet recognized as revenue plus the amount of any remaining consideration that the customer has promised to pay. For a performance obligation satisfied over time, an entity shall update the transaction price and the measure of progress toward complete satisfaction of the performance obligation. An entity shall not reallocate consideration to, and adjust the amount of revenue recognized for, separate performance obligations that are completely satisfied on or before the date of the contract modification. EXAMPLE Contract Modification An entity enters into a three-year services contract. The customer promises to pay $120,000 at the beginning of each year. The standalone selling price of the services at contract inception is $120,000 per year. At the end of the second year, the contract is modified and the fee for the third year of services is reduced to $100,000. In addition, the customer agrees to pay an additional $250,000 to extend the contract for 3 additional years (that is, 4 years remain after the modification). At the date of modification, the entity evaluates the remaining services to be provided and concludes that they are distinct. The entity would then allocate the remaining consideration of $350,000 to the remaining services to be provided and would therefore recognize revenue of $87,500 per year in each of the remaining 4 years : Costs to Obtain a Contract Incremental costs of obtaining a contract are those costs that an entity incurs that it would not have incurred in the contract had not been obtained. An example might be a sales commission. An entity is required to recognize as an asset the incremental costs of obtaining a contract with a customer if the entity expects to recover those costs. These costs should be amortized on a systematic basis that is consistent with the transfer to the customer of the goods or services related to the asset. An entity should recognize an impairment loss for the costs to obtain a contract to the extent that the carrying amount of the asset exceeds: The remaining amount of consideration that the entity expects to receive in exchange for the goods or services related to the asset, less The costs that relate directly to providing those goods or services that have not been recognized as expenses. The ASU includes a practical expedient permitting an entity to recognize incremental costs of obtaining a contract as an expense when incurred if the amortization period of the asset is one year or less : Costs of Fulfilling a Contract ASU indicates that an entity must recognize an asset from the costs to fulfill a contract only if those costs meet all of the following criteria: The costs relate directly to a contract or to an anticipated contract that the entity can specifically identify. The costs generate or enhance resources of the entity that will be used in satisfying, or continuing to satisfy, performance obligations in the future. The costs are expected to be recovered.

18 4 17 required reading required reading These costs should be amortized on a systematic basis that is consistent with the transfer to the customer of the goods or services related to the asset. An entity should recognize an impairment loss for the costs to fulfill a contract to the extent that the carrying amount of the asset exceeds: The remaining amount of consideration that the entity expects to receive in exchange for the goods or services related to the asset, less The costs that relate directly to providing those goods or services that have not been recognized as expenses. CPAR/ FEB. 15

19 video transcript video transcript Video Transcript 4. Revenue Recognition: New Standard Implementation Considerations QUINLAN: HARRINGTON: Many in the accounting profession are referring to the new revenue recognition standard as a milestone standard. What are companies doing now to implement the standard? What are some of the judgment issues they are encountering? In this segment a high level panel of accounting and finance executives answered these questions and more about the new revenue recognition standard. The moderator of the panel was Ken Bement, Director of Financial Reporting and Corporate Accounting at Raytheon. Also on the panel were Allan Cohen, Senior Vice President and Corporate Controller of NBC Universal; Mindy Henbest, Director of Accounting Policy at the Boeing Company; Dusty Stallings, Partner, National Professional Services Group, PricewaterhouseCoopers; and Stacy Harrington, Director, Corporate Revenue Assurance with Microsoft. The panel s moderator Ken Bement made the opening remarks. Before we begin, I think it s worth you know, I m no accounting historian. I didn t know that was a profession until earlier, but I think it is worth pausing and sincerely commending the two boards for this accomplishment. I think, when we look back at the history of standard setting, I think that the issuance of this standard certainly is a milestone standard, and I know the boards have wrestled with it for many years. Their job isn t quite done, but certainly our job as a preparer community has changed in the last six months. Now that the standard is in our hands, I think it s really on us to try and figure out how we can implement the standard successfully and as reasonably as possible, and so that this session today, I think that s part of our purpose, it s to talk about what are some of the thought leaders on revenue? You know, this panel here, what are these great companies doing to implement the standard? How are they evaluating the standard? What are some of the judgment issues they re encountering? You know, and how might we all benefit from the sharing of these best practices and other differences. This new accounting standard, I think it s interesting that the boards have been working on this for over a decade, and the objective of this standard has always been to have a principled single framework that could be applied across various transactions, industries, countries in order to get relevant neutral accounting. I like how Mark Segal put it this morning. That s a big culture shock, I think for us in the US, in particular. It s really challenging us in a lot of our thinking, and so I want to kick it off and maybe we ll start with Stacy. I want to hear, how is this process going for you? What are you doing now to evaluate the standard? Because, really, everything starts with that evaluation of the accounting standard. Everything else in a project plan to implement it is dependent on that evaluation. You re exactly right, Kenny, and because we acknowledge the fact that this is you know, in the revenue space, a lot of our big projects are because we re launching a new product, or a way that we re selling it, 4 18

20 4 19 video transcript video transcript and this is really an accounting-driven change. And so it s really important for us to evaluate the accounting impacts and not just, you know, the delta, but really understand what the accounting will look like under the new model, compared to the old model, identify the areas of differences, and then that feeds into all the other downstream teams, such as systems and FP&A, etc. So, when we break down our accounting evaluation, again, we re trying to forget all the rules that we re accustomed to now and, especially, in the software industry, there are a lot of rules. And, so really forgetting that, going into the new model and the principles-based model, and running through transactions. And how we are thinking about it, again, is that it s in three different sections one is our revenue products and services. So, by the nature of the product that we offer, or the services that we offer, what are the performance obligations? What are the triggers and the delivery pattern, and then what are the values? Again, and then, we look at then what we consider the sales programs around how are you selling it? Are you bundling it? And the way that you sold it, did it just change the nature and the revenue recognition of the product? Then, we get down to the lowest level, which is a contract level. Did I promise something in that specific contract that would, again, change the nature and the recognition pattern? And, you know, starting from the very highest level, you can identify your performance obligations, and then down to the contract level. That s a lot of volume, and so we ve started with the revenue products and services, and some of the revenue sales programs, and we re really getting into the contracts now. And the amount of work, it really depends on how standard your contracts are. Can you identify themes and performance obligations at a standard you know, I guess, a program level? Or a term level? And to the extent that you have a lot more non-standard terms and customizations, you know, you re going down to each individual contract to understand the accounting implications. So, and then we also look, again, across topics that cross. So, for example gross versus net, cash back to customers, sales returns. And, because we need this, and because it s accounting driven, and our systems folks are eagerly awaiting, let s just say that, the code, they want to understand what are you specifically asking the systems to do? We re trying to put it in three buckets, which is, we know it s an impact, we know there s no impact and then, possibly, there s an impact, maybe because it s around licenses or distinct within the context of a contract. Some of these terms and concepts are still being actively discussed, actively, passionately discussed. So, that way, we can identify the areas that we know, get that going, and then really sit and, I guess, debate still on the ones that are open. I think that s very helpful. So, from what I heard you say, you re looking at you re almost slicing and dicing the analysis in a lot of ways. CPAR/ FEB. 15

21 4 20 video transcript video transcript HENBEST: HENBEST: One, you re looking at what you re actually selling, is it a product, is it service. You re looking at how you re selling it. You re looking at anything specific in the contract, so maybe a flag for non-standard terms and conditions, but then, in addition to all that, you re also thinking by issue or by topic. I think that s a great way to slice and dice the analysis of the contracts. I m curious. How does that process compare to some others at the table, Mindy? Allan? On our defense side of the business, right now we use long-term contract accounting, so the unit of account for our defense business is the contract. And one of the things that we ve been spending a lot of time on in our implementation cycle is really evaluating if that unit of account will still be the contract, or will it be each individual production unit within the contract? That area of implementation is getting a lot of focus in our industry and the aerospace and defense industry. So we ve been looking at several of our contracts, drilling down into them and really thinking about, what will the performance obligations really be? I think that s a great issue. I d like to pull a little bit more information from you on that. This question of identifying performance obligations, where you look at a contract and identify all the goods and services. Which ones should be accounted for separately? Mindy did some great work with FEI CCR s (Committee on Corporate Reporting) Revenue Recognition Working Group. It s a bit of a mouthful. Do you mind sharing some of that experience, when sort of you pulled together the views of companies representing various industries on that question of, is something distinct? Is it not distinct? What did you learn from that exercise? Sure, Kenny. So we actually have a subgroup of the FEI CCR (Committee on Corporate Reporting) Rev Rec Working Group that s focused on long-term contracts. And so, there s about five different companies represented on that group, and each one of us took an example situation in our organization and took it through the model and looked at whether or not we felt like we would get the contract as our unit of account, or we would be at a lower level than the contract. And it s interesting that it really depends upon the unique facts and circumstances surrounding your situation and applying judgments to those facts and circumstances. And I think, you know, as reasonable people, we can all come up with what we think the right conclusion is and then, you know, share that analysis and think through it. And it was interesting because we, as a group, actually came up with varying answers but as we stepped back from it, we all felt as though we had gotten to, you know, what a reasonable person would have concluded would have been a reasonable answer. So I know that s an area of focus, I know the TRG is looking into the evaluation of what really constitutes a performance obligation and diving deeper into that analysis. I think that, you know, overall, you know, it s an area that involves a lot of judgment and looking at your specific facts and circumstances to come to the best conclusion.

22 4 21 video transcript video transcript COHEN: Thanks, Mindy. And I thought that was a great discussion that the Revenue Working Group had as part of CCR and that s what stood out to me, the point you emphasized. That there are a lot of judgments around that step of the model in identifying performance obligations but it s really by design. I think the board s always intended it to be that way, because creating a one size fits all model, you know, it s got to be flexible. And when we laid out, you know, all these companies sort of laid out their specific facts and circumstances, it became apparent that there were differences in the economics, in my view, that would lead to different accounting conclusions. So that was a good thing. I think some of the companies were taking the liberty to look at factors not listed specifically in the standard, because the standard has a few that are listed and these are indicators. They re not all inclusive, including things like the extent to which the company is integrating, you know, all of the goods or services into a combined output for which the customer s contracted level of customization or modification of those goods and services, and also the level of interdependencies and interrelationships of those goods or services. Those are some of the factors, but this group, they got together and listed maybe some other factors, you know, how customer specific is it, how separable are the risks and the resources related to the delivery of those goods or services? We found that when you expand the list of factors and think in terms of the objective that s laid out in the basis, it seemed to get reasonable answers. But there seems to be, I d say, a general paralysis in the system. There s a lot of fear in the system of making that judgment and then down the road being second guessed, is what I noticed. And so maybe the auditors in the room were less comfortable than the preparers. Maybe it s because of the influence of the PCAOB or the SEC. So before we wrap up this, I want to ask the rest of the panel. On this question of identifying performance obligations, what other issues or points have you come across? OK, I guess I ll start here. I think there are a number of issues with identifying performance obligations. As you noted, it s not only identifying the performance obligations but determining what s distinct, meaning, are two performance obligations separate? So let me give you a couple of simple examples that right now a lot of people are struggling with. And I think once I give you these examples, hopefully you can understand what some of the issues are. So let s say you re Boeing, I guess, and you re going to develop six fighter jets, maybe for the U.S. Army. And you have to design what the fighter jets are going to be able to do. And then you re going to deliver the six fighter jets. So is the design that you re making for the prototype of the fighter jets, is that a performance obligation? Should you recognize revenue when you complete the design? Should you recognize more revenue when you first do the first prototype, because that was the most significant part to develop? And how should revenue be recognized for the other five fighter jets that you re delivering? So those are all some basic questions. I think you can get into a very simple example of performance obligations and distinct, as well. Let s say I manufacture HVAC systems. So I CPAR/ FEB. 15