Preparing Your Company: Best Practices for the New Revenue Recognition Standards

Why are we here today? The changes to Revenue Recognition Standards will cause: Companies to put a structure in place to analyze the changes and follow it through the implementation process Companies to review their contracts and understand the impacts of the standards on current and future contracts Virtually all companies to experience some level of change Timetable for compliance: Revenue Recognition: January 1, 2018 is the effective date for public companies. Nonpublic organizations, after December 15, 2018. Grant Thornton LLP. All rights reserved. 2

Learning Objectives Define the revenue and implications related to recently revised FASB standards. Develop and utilize an awareness of common implementation issues. Determine if and how your company is affected by the new standards. Identify next steps. Grant Thornton LLP. All rights reserved. 3

Getting you up to speed Joint project between FASB and IASB to issue a single comprehensive revenue recognition model Supersedes virtually all revenue recognition guidance in US GAAP and IFRS, including prescriptive guidance and industry-specific practices Utilizes more principles and requires more estimates and greater judgment. Requires evaluation of the policies, processes, systems and controls by which revenue is recognized and disclosed Grant Thornton LLP. All rights reserved. 5

The clock is ticking Issuance of ASU 2014-09 Early adoption available for all calendar year-end entities Mandatory adoption for calendar yearend public entities May 2014 1/1/17 1/1/18 3 months 15 months Grant Thornton LLP. All rights reserved. 6

The changes to the standard will likely drive five key tactical actions The core principle of the new Revenue Recognition standard Recognize revenue to depict the transfer of promised 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 1 2 3 4 5 Tactical steps to implement the new standard Identify the contract(s) with a customer Identify the performance obligations Determine the transaction price Allocate the transaction price to the performance obligations Recognize revenue when or as an entity satisfies performance obligations Grant Thornton LLP. All rights reserved. 7

Scope exceptions ASC 606-10-15-2 includes the following scope exceptions: Lease contracts within scope of Topic 840, Leases. Insurance contracts within scope of Topic 944, Financial Services Insurance. Financial instruments within specific Topics. Guarantees within scope of Topic 460, Guarantees. Grant Thornton LLP. All rights reserved. 8

Step 1: Identify the contract with the customer Does the contract have commercial substance? y Have the parties approved the contract? y Can the entity identify the payment terms and each party's rights and obligations? y Is it probable that the entity will collect "substantially all" of the consideration to which it will be entitled? y Proceed to Step 2 n n n n Do not proceed to Step 2 Recognize revenue only when one of the following occurs: (1) The entity's performance is complete, substantially all of the consideration has been collected and is non-refundable (2) The contract has been terminated and the consideration received is non-refundable (3) Entity stopped shipping, does not have to resume, cash received is non-refundable and relates to prior shipments Grant Thornton LLP. All rights reserved. 9

Step 2: Identify the performance obligations A performance obligation is a promise to transfer either: a) A distinct good or service b) A series of distinct goods or services that are substantially the same and have the same pattern of transfer to the customer Grant Thornton LLP. All rights reserved. 10

Performance obligation Two step process Step 1: Identify the individual goods or services Step 2: Which of those goods or services are performance obligations? Grant Thornton LLP. All rights reserved. 11

Promised goods or services A contract with a customer generally explicitly states the goods or services that an entity promises to transfer to a customer. However, the promised goods and services identified in a contract with a customer may not be limited to the goods or services that are explicitly stated in that contract. This is because a contract with a customer also may include promises that are implied by an entity s customary business practices, published policies, or specific statements if, at the time of entering into the contract, those promises create a reasonable expectation of the customer that the entity will transfer a good or service to the customer. Grant Thornton LLP. All rights reserved. 12

Performance obligations Step 1: Capable of being distinct? YES Step 2: Distinct in the context of the contract? The following factors would indicate the promises are not distinct in the context of the contract: Entity significantly integrates the promises One or more of the promises modifies or customizes another The promises are highly interdependent or highly interrelated YES NO NO NO: If a promised good or service is not distinct, it is required to be combined with other promised goods or services until a distinct bundle of goods or services exists. This could result in combining a good or service that is not considered distinct with another good or service that, on its own, would have met the criteria to be considered distinct. YES: The promise is distinct and must be identified as a separate performance obligation. Grant Thornton LLP. All rights reserved. 13

Optional goods or services Material rights A material right provides the customer the option to purchase additional goods or services at a discount that it would not have received if it had not entered into the contract. Requires significant judgment because the guidance does not provide a bright line about what constitutes a material right. Should consider quantitative and qualitative factors. Material rights are considered separate performance obligations. Grant Thornton LLP. All rights reserved. 14

Step 3: Determine the transaction price Consideration payable to customer Time value of money Transaction price Noncash consideration Variable consideration Transaction price: The amount of consideration an entity expects to be entitled to in exchange for transferring promised goods or services to a customer, excluding amounts collected on behalf of third parties. Grant Thornton LLP. All rights reserved. 15

Step 3: Determine the transaction price (continued) Variable consideration Discounts Rebates Refunds Credits Price concessions Bonuses Penalties Estimate amount Expected value (sum of probability weighted amounts) Most likely amount (single most likely outcome) Include if probable that there will not be a significant revenue reversal Highly susceptible to factors outside entity's influence Limited predictive experience Large number of possible amounts Grant Thornton LLP. All rights reserved. 16

Step 4: Allocate the transaction price to the performance obligations Allocate based on the relative standalone selling price (SASP) of each performance obligation. Allocate discounts/variable consideration to one or more POs if certain criteria met. Step 4 Observable price is the best evidence of SASP. If no observable price, estimate maximizing the use of observable data. Do not reallocate transaction price to reflect changes in standalone selling price. Allocate changes in transaction price on same basis as at contract inception. Grant Thornton LLP. All rights reserved. 17

Step 4: Example An entity enters into a contract with a customer to sell products A, B and C in exchange for $100. The entity will satisfy the performance obligations for each of the products at different points in time. The entity regularly sells Product A separately, and therefore the standalone selling price is directly observable. The standalone selling prices of Products B and C are not directly observable. Grant Thornton LLP. All rights reserved. 18

Step 4: Example -continued Because the standalone selling prices for Products B and C are not directly observable, the entity must estimate them. The entity uses the adjustment market assessment approach for Product B and the expected cost plus a margin approach for Product C. Product Standalone selling price Method Product A $ 50 Directly observable Product B $ 25 Adjusted market assessment approach Product C $ 75 Expected cost plus a margin approach Total $ 150 Grant Thornton LLP. All rights reserved. 19

Step 4: Example -continued The customer receives a discount for purchasing the bundle of goods because the sum of standalone prices ($150) exceeds the promised consideration ($100). The entity considers whether it has observable evidence about the performance obligation to which the entire discount belongs and concludes it does not. Thus discount is allocated proportionately across Products A, B and C. Allocated Product transaction price Product A $ 33 ($50/$150*$100) Product B $ 17 ($25/$150*$100) Product C $ 50 ($75/$150*$100) Total $ 100 Grant Thornton LLP. All rights reserved. 20

Step 5: Recognize revenue over time or at a point in time Does customer receive and consume the benefits as the entity performs? Does customer control the asset as it is created or enhanced? N N Does asset have an alternative use to the entity? Y Y N Control is transferred over time Y Does entity have the enforceable right to receive payment for performance to date? N Control is transferred at a point in time Grant Thornton LLP. All rights reserved. 21

Additional considerations

Contract modifications Is the amendment a contract modification? Defined as a change in the scope or price (or both) of a contract that is approved by the parties to the contract. May have a contract modification prior to reaching an agreement on the scope or pricing. Must consider all relevant facts and circumstances NO Standalone contract. Apply the five step model in ASC 606 YES Proceed to roadmap Grant Thornton LLP. All rights reserved. 23

Contract modifications -Roadmap Is the contract modification for additional goods and services that are distinct AND at their standalone selling price?* YES Account for the new goods and services as a separate contract. NO Are the remaining goods and services distinct from those already provided? NO Update the transaction price and measure of progress for the single performance obligation (recognize change as a cumulative catch-up to revenue) YES BOTH YES AND NO Treat the modification as a termination of the existing contract and the creation of a new contract. Allocate the total remaining transaction price (unrecognized transaction price from the existing contract + additional transaction price from the modification) to the remaining goods and services (both from the existing contract and the modification). Update the transaction price and allocate it to the remaining performance obligations (both from the existing contract and the modification). Adjust revenue previously recognized based on an updated measure of progress for the partially satisfied performance obligations. Do not adjust the accounting for completed performance obligations that are distinct from the modified goods or services. Grant Thornton LLP. All rights reserved. 24

Selected disclosure areas Disaggregated Revenue Disaggregation of revenue into categories that show how economic factors affect the nature, amount, timing, and uncertainty of revenue and cash flows. Reconciliation of Contract Balances Opening and closing balances and revenue recognized during the period from changes in contract balances Qualitative and quantitative information about the significant changes in contract balances Performance Obligations Descriptive information about an entity's performance obligations Information about the transaction price allocated to remaining performance obligations and when revenue will be recognized Significant Judgements Method used to recognize revenue for performance obligations satisfied over time and why the method is appropriate Significant judgements related to transfer of control for performance obligations satisfied at a point in time Information about the methods, inputs, and assumptions used to determine and allocate transaction price Grant Thornton LLP. All rights reserved. 25

Selected disclosure areas Costs to Obtain or Fulfill a Contract Judgements made to determine costs to obtain or fulfill a contract, and method of amortization Closing balances of assets and amount of amortization/impairment Practical Expedients The practical expedient regarding the existence of significant financing component The practical expedient for expensing certain costs of obtaining a contract Grant Thornton LLP. All rights reserved. 26

Transition options Option 1 2016 2017 2018 Current GAAP New GAAP Full Retrospective New GAAP(restated) New GAAP Cumulative Effect Effective date 1/1/18 Option 2 2016 2017 2018 Modified Retrospective Current GAAP Disclose impact on each line item New GAAP Grant Thornton LLP. All rights reserved. 27

Transition approach considerations Preference Ability Market needs for comparative f/s Industry/peer approach Impact on amount and timing of tax payments Relative difference in cost and business impacts Magnitude of expected changes Resource availability to drive change Historical data availability Effective PMO capabilities Grant Thornton LLP. All rights reserved. 28

Action steps Identify an implementation team Identify areas of change Document new accounting policies and controls Communicate with your auditors Understand new disclosure requirements and IT needs Identify tax implications Educate your people cross-functionally Communicate with stakeholders Follow the TRG / AICPA Consult with the SEC as necessary Grant Thornton LLP. All rights reserved. 29

Implementing the new revenue standard Impacted areas of your business Contract environment Sales and operations Information technology Internal audit Accounting and finance Organization wide impact Tax accounting and methods Grant Thornton LLP. All rights reserved. 30

Challenge ahead -more than an accounting change What should you be asking yourself about the new Revenue Recognition standard? Accounting & Finance How will we make updates to forecasted revenue and internal profit reporting? Sales & Operations How does this impact my sales team's focus? Do we need to change our contract language? MD&A Information How are my disclosure requirements impacted? Investor Relations How do I communicate the impact of the standard to investors? Contract Environment Can we identify the five components of the new revenue standard? Information Technology Will our legacy systems create challenges for us? Employee Incentives What modifications do we need to make to our existing bonus structure? Tax Accounting & Methods Is my tax department (or provider) aware of these changes? Training & Communication What kind of training should I provide to my employees? Grant Thornton LLP. All rights reserved. 31