KPMG Revenue Recognition August 2010 Final

CONSUMER MARKETS

KPMG INTERNATIONAL

Proposed New Guidance on Revenue RecognitionThe impact on Food, Drink and Consumer Goods companies

IntroductionWilly Kruh, Global Chair, Consumer Markets, KPMG in Canada

© 2010 KPMG International Cooperative (“KPMG International”), a Swiss entity. Member firms of the KPMG network of independent firms are affiliated with KPMG International. KPMG International provides no client services. No member firm has any authority to obligate or bind KPMG International or any other member firm

vis-à-vis third parties, nor does KPMG International have any such authority to obligate or bind any member firm. All rights reserved.

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Administration

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Agenda

Welcome and AdministrationWilly Kruh, Global Chair – Consumer Markets, KPMG in Canada

Why is the proposed standard important to Food, Drink and Consumer Goods (FDCG) Companies? Mark Baillache, Global Audit Sector Lead – FDCG, KPMG in the UK

FASB/IASB Exposure Draft: Revenue from Contracts with CustomersBrian O’Donovan, KPMG International Standards Group (ASPAC/EMA webcast) Phil Dowad, International Standards Group, KPMG in Canada (Americas/EMA webcast)

Impact of the Revenue Recognition Exposure Draft on the FDCG sectorTrent Duvall, Audit Partner, KPMG in Australia (ASPAC/EMA webcast)Paul Munter, Department of Professional Practice, KPMG in the US (Americas/EMA webcast)

QuestionsModerated by Mark Baillache

POLL QUESTION:Have you read the Exposure Draft yet?

a) Yes

b) No

Why is the proposed standard important to Food, Drink and Consumer Goods (FDCG) companies?Mark Baillache, Global Audit Sector Lead – FDCG, KPMG in the UK



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Diversity in existing practice

IAS 18 is an older standard and very general in its guidance

Objectives of the proposed standard:

Remove weaknesses in existing revenue recognition standards

Provide a more robust framework for addressing revenue recognition issues

Improve comparability of revenue recognition practices

POLL QUESTION:What impact do you expect the Exposure Draft to have on your company’s revenue recognition policies?

a) Significant impact

b) Moderate impact

c) No impact—our current policies are consistent with the requirements of the ED



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Impact on all preparers

An accounting issue and a business issue:

Thorough analysis of a supplier’s relationship with its retailers and distributors will be required

Potentially significant changes for entities currently reporting under IFRS

Suppliers must have systems in place to capture required information to comply with the proposed standard

Must have ability to estimate stand-alone selling prices for all distinct performance obligations



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Consideration needed under proposed standard

Customer incentives Payments to customers Volume rebates / early settlement discounts Free or discounted goods Options for additional goods Customer loyalty programs

Right of return Product warranties Consignment arrangements Bill-and-hold arrangements Collectability / credit risk



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Wider implications to the business from the changes in accounting

For consumer organizations, sales is a key measure in assessing a business’s performance

Companies should consider how the proposed standard, and its impact on revenue reported, will impact::

Organic growth calculations

Operating expenses / margins

Existing contracts (e.g. sales-led contracts such as licensing agreements and debt covenants)

Stakeholder management

POLL QUESTION:To what degree do you expect the proposed standard to impact how your CEO and CFO communicate your company’s performance with the financial markets/investors?

a) Significant impact

b) Some impact

c) No impact

d) I have not yet considered what impact the proposed standard might have on our company’s investor communications

FASB / IASB Exposure Draft:Revenue from Contracts with CustomersBrian O’Donovan, KPMG International Standards Group (ASPAC/EMA)Phil Dowad, International Standards Group, KPMG in Canada (Americas/EMA)



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Scope of the proposals

Revenue arising from contracts with customers:

i.e. enforceable rights and obligations

Entity CustomerContract

Scope exclusions proposed for lease contracts, insurance contracts and financial instruments – subjects of other projects



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A five-step approach to revenue recognition

Step 1: Identify the

contract

Step 2: Identify the separate

performance obligations in the contract

Performance obligation 1

Performance obligation 2

Step 3: Determine the

transaction price

Step 4: Allocate the

transaction price to the separate performance obligations

Transaction price

allocated to performance obligation 1

Transaction price

allocated to performance obligation 2

Step 5: Recognize

revenue as eachperformance obligation is

satisfied

Recognize revenue

Recognize revenue

Contract Transaction price for the

contract



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Step 1: Identify the contract

A contract can be oral or implied by the entity’s customary business practices, but needs to meet all of the following requirements to exist for the purpose of applying the proposed standard:

It has commercial substance The entity can identify each party’s enforceable rights

The parties have approved the contract and are committed to

satisfying their respective obligations

The entity can identify the terms and manner of settlement

Individual contracts may be: Combined – if their prices are interdependent Segmented – if some goods or services are priced independently



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Step 2: Identify the separate performance obligations in the contract

Is promised good or service distinct from other goods or services in the contract ?

Yes

Separate performance obligations

No

Combine good or service with other goods or services

A promised good or service is distinct from others if the entity or another entity sells an identical or similar good or service

separately, or the entity sells the good or service separately, because it has

a distinct function a distinct margin



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Step 3: Determine the transaction price

“The amount of consideration that an entity receives, or expects to receive, from a customer in exchange of transferring goods or services (excluding amounts collected on behalf of third parties)”To determine transaction price, consider: the effect of customer’s credit risk; the effect of time value of money (payment before or after

goods/services transferred) if the contract includes a material financing component;

the fair value of non-cash consideration; the nature of consideration paid to a customer (discount and/or

payment for other goods or services); and the estimates of variable consideration.



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Step 3: Determine the transaction price – estimate variable consideration

Can transaction price be reasonably estimated because the entity has experience with similar types of contracts (or access to

experience of other entities), and the entity’s experience is relevant since the entity does not expect

significant changes in circumstances?

Yes

Variable consideration included in transaction price

No

Only fixed amount included in transaction price

Factors that reduce the relevance of an entity’s experience include: Consideration amount is highly susceptible to external factors; Uncertainty about amount not expected to be resolved before long time; Entity’s experience with similar contracts is limited; and Contract has large number of possible consideration amounts.



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Step 4: Allocate the transaction price to the performance obligations

A

Transaction price allocated based on relative stand-alone selling prices

B C

Performance obligations

How to estimate the stand-alone selling price?

Best evidence

Observable price

If not available

Estimated price

Adjusted market assessment approach

Expected cost plus margin approach

If not available



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Step 5: Recognize revenue when a performance obligation is satisfied

A performance obligation is satisfied when the customer obtains control of a good or service.

The customer has legal title

The customer has an

unconditional obligation to pay

The customer has physical possession

The design or function is

customer-specific

Indicators that the customer has

obtained control of a good or service



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Contract costs

Direct costs that would be eligible for capitalization if other criteria are met

Direct labor (e.g. employee wages)

Direct materials (e.g. inventory to customer)

Allocation of costs that relate directly to the contract (e.g. depreciation and amortization expenses)

Cost that are explicitly chargeable to the customer under the contract

Other costs that were incurred only because the entity entered into the contract (e.g. subcontractor costs)

Costs expensed when incurred

Costs of obtaining a contract (e.g. marketing, bid and proposal, commissions)

Costs that relate to satisfied performance obligation (i.e. transfer of control already occurred)

Abnormal amounts of wasted materials, labour, or other contract costs



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Onerous performance obligations

Onerous test performed at the level of performance obligations

Transaction price allocated to performance

obligationIf <

Present value of probability-

weighted direct costs to satisfy performance

obligation

Performance obligation deemed

onerous and contract loss to be

recognized

Contract loss recognized first as an impairment loss against any recognized asset relating to the contract and then as a separate liability for onerous obligations

Subsequent changes in the liability recognized as an expense or as a reduction of an expense



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Presentation

A contract asset or contract liability is recognized when: the entity performs by transferring goods or services, or the customer performs by paying consideration to entity.

(net) contract assetif rights > obligations

(net) contract liabilityif obligations > rights

Rights and obligations

or

Contract costs capitalized are presented according to their nature and separately from contract assets. Liability for onerous obligations is presented separately from contract liabilities.

Unconditional right to consideration is presented as a receivable and accounted for in accordance with financial instruments standards.



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Disclosure

High level disclosure objective

Intended to assist users to understand amount, timing and uncertainty of revenue and cash flows arising from contracts with customers

Disclosures about contracts with customers

Disaggregation of revenue

Reconciliation from opening to closing aggregate balances of contract assets and liabilities

Information about onerous performance obligations including a reconciliation from opening to closing balance of liability from onerous performance obligations

Information about performance obligations including a maturity analysis of remaining performance obligations in contracts longer than one year

POLL QUESTION:If the Boards publish a new revenue standard in June 2011 based on the ED and require full retrospective application, when would your organization be ready to apply the new standard?

a) Immediately

b) Accounting periods beginning in 2012

c) Accounting periods beginning in 2013

d) Later

Impact of the Revenue Recognition Exposure Draft on the FDCG sectorTrent Duvall, Audit Partner, KPMG in Australia (ASPAC/EMA)Paul Munter, Department of Professional Practice, KPMG in the US (Americas/EMA)



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Key Issues

Two traditional routes to market:

Retailers

Distributors with other routes such as business to business

FDCG companies should thoroughly evaluate all elements of their contracts with retailers

Determination of transaction price will be a key issue, specifically:

Payments made to customers

Potential variability in transaction price



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Customer incentives

Examples of customer incentives

Upfront payments to customers

Volume rebates / early

settlement discounts

Free or discounted goods

or services included in a

sales transaction

Customer options for additional goods or services

Accounting issues

Reduction of transaction

price or payment for

distinct goods or services?

Estimate of the transaction

price

Separate performance

obligations? How to allocate

transaction price?

Does the option provide a

material right to the customer?



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Slotting fees

Payments made to a retailer to secure product placement

Payment is for a distinct good or service

Fair value of good/service reflected as expense or asset, remaining balance treated as a reduction in revenue

If fair value cannot be estimated, the payment is treated as a reduction in revenue



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Slotting fees (continued)

Example

A coffee company sells 1,000 jars of coffee to a retailer for $10,000

The coffee company pays $1,000 to the retailer in exchange for aproduct placement service, including stocking, displaying and supporting the products

FDCG company determines it is receiving a distinct service with a fair value of $600

Expense = $600

Revenue = $9,600 [$10,000 – ($1,000 - $600)]



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Early settlement discounts

Early settlement discounts are an example of variable consideration.

An entity is required to estimate the transaction price by assessing the likelihood of settlement discounts being earned. This is deducted from the consideration.

If the consideration cannot be reasonably estimated (eg due to inherent uncertainty around what deductions will be taken), the FDCG company recognizes those amounts that can be reasonably estimated, e.g. fixed amounts. Effectively, the entire settlement discount would be deferred as a reduction to revenue if an entity can not reliably estimate it at the time of the transaction.

Subsequent adjustments are to revenue



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Early settlement discounts

Example A tobacco manufacturer sells 1,000 packs of cigarettes to retailer at $5 ea. Early settlement discount of 2 percent if payment is made within 30 days of

invoicing Experience with similar contracts is deemed relevant Transaction price is estimated by identifying the following possible

outcomes and related probabilities:

Possible outcomes Probabilities Expected consideration

$5,000 (1,000 x $5) 25% $1,250$4,900 [(1,000 x $5) – (1,000 x $5) x 2%] 75% $3,675Estimated transaction price at contract inception $4,925



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Customer incentives - Option to acquire additional goods or services

The FDCG company grants the customer an option to acquire additional goods or services

Could the customer obtain the right to acquire additional goods or services without entering the sale agreement?

No Yes

Does the option give the customer the right to acquire additional goods or services at their

standalone selling price?

Yes

The option does not give rise to a separate performance obligation

No

The option is a material right that gives rise to a separate performance obligation



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Coupons/discount vouchers

Example

Sell cereal for $5 Voucher for 40 percent off next purchase 80 percent redemption expected Estimated FV of voucher = $1.60 [$5 x 40% x 80%]

If voucher is not redeemed, revenue is recognized at expiration Changes in estimate of redemption rates is reflected as an

adjustment to revenue

$3.79 $5 - $5 x [$1.60/($1.60+$5)] Recognize on sale

$1.21 $5 x [$1.60/($1.60+$5)] Recognize when redeemed



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Customer loyalty programs

Rewards or points granted are an option to acquire additional goods or services

Represent a separate performance obligation A portion of the transaction price must be allocated to the rewards or

points Likelihood of redemption must be estimated Relative fair value method is used to allocate transaction price

between the sale of goods and the rewards or points granted

POLL QUESTION:Do you believe that your current systems for managing and controlling trade spend will provide you with sufficient information for accounting in accordance with the proposed standard?

a) Yes, using our existing systems

b) Yes, with some modification to our systems

c) No, significant modifications will be required

d) I have not yet considered whether our systems will be adequate to comply with the proposed standard



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The power of retailers

Retailers may exert their influence over suppliers by: taking deductions from invoiced amounts assessing penalties based on Service Level Agreements

Consider whether there is an identifiable benefit arising from such payments treat as purchase of good or service

The probability-weighted amount expected to be collected should be recognized as revenue

Deductions from revenue to be estimated by FDCG companies based on historical experience

Subsequent changes in estimates are reflected as adjustments to revenue



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Rights of return

Revenue not recognized for goods expected to be returned

Liability recognized for refunds and credits to customers

Asset recognized for the right to recover goods

Refund liability and asset remeasured at the end of each reporting period



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Not a separate performance obligation. FDCG company determines the likelihood and extent of defective

products.

If FDCG company required to replace defective

products, then related revenue is deferred.

Product warranties and product liabilities

If FDCG company required to repair defective

products, then a portion of revenue related to

components to be repaired is deferred.

Cover for latent defects (quality assurance warranty)

Cover for faults post-delivery

(insurance warranty)

Separate performance obligation

Transaction price allocated is recognized as revenue

when obligations are satisfied (e.g. over the

warranty period).



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Product warranties

Example Sell 1,000 washing machines (cost = $600 each) for $1,000 each Replace defective machines if returned within 90 days 1 percent expected defect rate

Recognize an asset (inventory) of $6,000 (1,000 x $600) for goods not transferred

Revenue recognized $990,000Liability recognized $10,000



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Consignment arrangements

Goods are delivered to an intermediate party

The FDCG company may retain title and/or the right to recover the goods

Dealer/distributor may be a principal or agent

Right to recall products



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Bill-and-hold arrangements

Customer is billed but product is not shipped

When does control pass?

The customer would obtain control of the product before delivery if the arrangement meets all of the following conditions:

The customer has requested the contract to be on a bill-and-hold basis

The product is identified separately as the customer’s

The product is currently ready for delivery at the time and location specified or to be specified by the customer

The FDCG company cannot use the product or sell it to another customer

Custodial services could be a separate performance obligation



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Collectability/credit risk

Consideration of collectability impacts measurement of revenue and would not be a criterion for whether revenue is recognized

Suppliers would have to assess the credit risk of all customers (i.e. retailers and distributors) based on their ability to pay

Contract price of consideration expected to be received, incorporating credit risk, would be recognized as revenue

Subsequent changes to assessment of collectability would be reflected as income/expense rather than revenue



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Collectability / credit risk (continued)

Example

Invoice $1,000 for chocolate bars

10 percent likelihood of non-payment due to credit risk

Revenue of $900 is recognized on satisfying performance obligation [(90% x $1,000) + (10% x $0)]

Subsequent change of collections of receivable recognized as expense/contra-expense – not revenue



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Deferred settlement

The time value of money is required to be taken into account in measuring the fair value of consideration

This will be relevant where an arrangement includes a financing component (implicitly or explicitly) eg extended credit/payment terms

Where the time value of money (effectively impact of discounting) is material to the individual contract it is to be recognised as a reduction to revenue

The applicable discount rate is the rate that would be used in aseparate financing transaction between the entity and the customer (and shall include credit risk)

The reversal of discounting is recognised separately as finance income in the P&L



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Presentation and disclosures

Requirement to disclose:

significant judgements and related changes in judgement

judgements in determining the transaction price and allocating it to performance obligations

the methods, inputs and assumptions used to:

estimate the transaction price

estimate stand-alone selling prices

measure obligations for returns, refunds, etc., and

measure the liability for onerous performance obligations

POLL QUESTION:After attending this webcast, how has your perception of the ED changed?

a) I believe the ED will have more of an impact on my company than initially expected

b) I believe the ED will have less of an impact on my company than initially expected

QuestionsModerated by Mark Baillache



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Presenters

Both sessions:Willy KruhKPMG in Canada

Willy is KPMG’s Global Chairman of Consumer Markets, the Global Head of Food, Drink and Consumer Goods, and the National Leader for High-Growth Markets in Canada.

Mark BaillacheKPMG in the UK

Mark is KPMG's Global Audit Sector Lead for Food, Drink and Consumer Goods, providing audit and advisory services. He led a number of IFRS implementation projects when EU-listed companies were required to transition to IFRS.

ASPAC/EMA session:Brian O’DonovanKPMG International Standards Group

Brian is a partner with KPMG’s International Standards Group, based in London. Brian is a member of KPMG’s global IFRS Revenue Recognition and Provisions leadership team.

Trent DuvallKPMG in Australia

Trent is an audit and advisory partner specializing in the food, drink and consumer goods and retail sectors. He led IFRS implementation projects for a number of retail and consumer products organizations on IFRS transition in Australia in 2005.

Americas/EMA session:Phil DowadKPMG in Canada

Phil is an audit partner in Vancouver and is the leader of KPMG’s global revenue recognition topic team. Phil’s client responsibilities are across Canada and include companies in various segments of the consumer goods industry.

Paul MunterKPMG in the US

Paul serves as the lead technical partner for the US firm’s international accounting and IFRS activities. He is involved in the development of firm positions in response to proposals from the IASB, IFRIC, FASB, SEC and other standard setters.



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Presenters – contact information

Both sessions:

Willy KruhGlobal Chair, Consumer MarketsKPMG in Canada+1 416 777 [email protected]

Mark BaillacheGlobal Audit Sector Lead, FDCGKPMG in the UK+44 20 [email protected]

ASPAC/EMA session:

Brian O’DonovanKPMG International Standards Group+44 20 76948393brian.o'[email protected]

Trent DuvallAudit PartnerKPMG in Australia+61 (2) 9335 [email protected]

Americas/EMA session:

Phil DowadInternational Standards GroupKPMG in Canada+1 604 691 [email protected]

Paul MunterDepartment of Professional PracticeKPMG in the US+1 212 909 [email protected]

mailto:[email protected]

mailto:brian.o'[email protected]





To download the replay or to register for future webcasts visit:www.kpmg.com/CCwebcasts

http://www.kpmg.com/CCwebcasts



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Disclaimer: about this presentation

The information contained herein is of a general nature and is not intended to address the circumstances of any particular individual or entity. Although we endeavor to provide accurate and timely information, there can be no guarantee that such information is accurate as of the date it is received or that it will continue to be accurate in the future. No one should act on such information without appropriate professional advice after a thorough examination of the particular situation.

© 2010 KPMG International Cooperative (“KPMG International”), a Swiss entity. Member firms of the KPMG network of independent firms are affiliated with KPMG International. KPMG International provides no client services. No member firm has any authority to obligate or bind KPMG International or any other member firm vis-à-vis third parties, nor does KPMG International have any such authority to obligate or bind any member firm. All rights reserved.

KPMG and the KPMG logo are registered trademarks of KPMG International Cooperative (“KPMG International”), a Swiss entity.

Documents

KPMG Revenue Recognition August 2010 Final