Revenue Recognition Seminar - Ciuni Panichi · Scott has led US GAAP and IFRS training classes for over 25 years. Before Mind the GAAP, Scott worked at the national office of Arthur

Revenue Recognition SeminarSeptember 6, 2019

© 2019 Mind the GAAP, LLC. All rights reserved.

Today’s Presenter

Scott Ehrlich is the founder and President of Mind the GAAP, LLC.

Scott has led US GAAP and IFRS training classes for over 25 years.

Before Mind the GAAP, Scott worked at the national office of Arthur Andersen.

Scott graduated from Bucknell University as class valedictorian and was awarded the Gold Medal Award in the state of CT for the November 1993 CPA exam.

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Today’s Agenda

Overview of ASC 606

– Walk-through the five-step process

– Challenges companies have faced inadopting ASC 606, each step of the way…

Application Case Study: ASC 606

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Audience Participation!

Throughout today’s training, you’ll use your internet-connected devices to answer some questions

Please go now to http://mtg.participoll.com on your device

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Polling Question

What is your favorite type of food?

a. Italian

b. French

c. Asian-fusion

d. Mexican

e. Middle Eastern

f. Not applicable/None of the above

vote at mtg.participoll.com

0A B C D E F

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OVERVIEW OF ASC 606

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ASC 606 Effective Date and Transition

Calendar-year private companies were required to adopt ASC Topic 606 on January 1, 2019

Can elect the following transition methods:

– Full retrospective

– Cumulative catch-up (a.k.a. as the modified retrospective method in ASC 606)

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Carefully consider choice of transition … full retrospective might be the better alternative for some companies


The Core Principle of ASC Topic 606

Recognize revenue when:

– Promised goods or services are transferred to customers

– In an amount that reflects the consideration a company expects to be entitled to in exchange for those goods and services

Identify the contract with a customer

5 Steps for Revenue

Recognition

Identify the separate performance obligations in the contract

Determine the transaction price

Allocate the transaction price to the separate performance obligations in the contract

Recognize revenue when (or as) entity satisfies a performance obligation

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2

3

4

5

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Polling Question

OEM Inc. sells to distributors. OEM offers generous return rights and price protection. Because the arrangement fee is not fixed or determinable, OEM uses the sell-through method to recognize revenue under today’s GAAP. Can OEM continue to use the sell-through method to recognize revenue after adopting ASC 606?

a. Yes

b. No

c. It depends

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0A B C


Step 1: Definition of a Contract

“A contract is an agreement between two or more parties that creates enforceable rights and obligations”

The contract must be legally enforceable and:

a. The parties to the contract have approved the contract and are committed to perform their respective obligations.

b. The entity can identify each party’s rights regarding the goods or services to be transferred.

c. The entity can identify the payment terms for the goods or services to be transferred.

d. The contract has commercial substance

e. It is probable that the entity will collect the consideration to which it will be entitled

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Polling Question

On January 1, 20X1, Manufacturer and Customer enter into a two-year contract. Over the term of the contract, Manufacturer will supply 10,000 packages of rubber bands for $1/package. The first delivery of rubber bands is scheduled for April 1, 20X1. Customer is very creditworthy and there are no concerns about collectibility. Both Manufacturer and Customer can terminate the contract at any time for convenience without any significant penalty. Does this arrangement meet all of the Step 1 conditions in ASC 606 to have an enforceable contract with a customer?

a. Yes

b. No

c. Not enough information to determine

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0A B C


Polling Question

JKL enters into a purchase order with customer. The order calls for five products to be manufactured, each requiring the same level of effort. The total transaction price is $1 million. The order also includes the right for customer to purchase an additional product for $15,000. JKL indicates that this provision was added at the customer’s request (to make order approval easier) and if the customer exercises this option, JKL would renegotiate the price. Is there an enforceable contract under ASC 606?

a. Yes

b. No


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0A B C


Real Life Challenges

Termination for convenience rights held by just the customer

“Standard” contracts that contain cross-outs/mark-ups

Contract is never actually signed by the customer

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Sometimes, we need to bring in the lawyers to help…


Step 2: Distinct Performance Obligations

In summary, a good or service is distinct if:

– The good or service is capable of being distinct, and

– Nature of the promises within the contract are for individual goods and services, and not for a combined item

Factors that suggest an item is not distinct within the context of the contract are:

– The seller provides a significant service of integrating the good or service with other goods or services promised in the contract

– The good or service significantly modifies or customizes another good or service promised in the contract

– The good or service is highly dependent on, or highly interrelatedwith, other goods or services promised in the contract

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Polling Question

ABC enters into an agreement to deliver 10,000 flux capacitors over a 2-year period to a customer. This type of product has not been developed previously. Accordingly, the customer agrees to pay ABC “non-recurring engineering” or NRE payments to cover ABC’s development cost. After development, ABC will retain all intellectual property rights to the product and can sell variations of it to other customers. How many performance obligations are in this contract?

a. 1

b. 2

c. 10,000

d. 10,001

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0A B C D


Polling Question

MNO sells widgets to distributors. To incentivize its customers to purchase higher volumes of widgets, MNO offers tiered pricing. Specifically, the first 1,000 widgets purchased in a calendar year are priced at $1.00/widget. The next thousand are priced at $0.90/widget. And any purchases thereafter are priced at $0.80/widget. All customer contracts are priced the same way. Yes or No: Each time MNO sells a widget, it should recognize revenue for the invoice price (i.e., $1.00, $0.90, or $0.80)?

a. Yes

b. No

c. It depends – more facts are needed

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0A B C



Material rights (customer options to purchase additional goods and services at a significant incremental discount)

Phased projects

Equipment necessary for an entity to render a service (e.g., security monitoring equipment)

Service vs. assurance warranties

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In practice, applying Step 2 involves tremendous judgment!


Step 3: Determine Transaction Price

Includes

Fixed consideration

Variable consideration

Noncash consideration

Excludes

Collections on behalf of 3rd parties (e.g., sales tax)

Consideration from unexercised customer options to acquire additional goods/services

Credit adjustments (bad debt reserves)

Adjustments for significant financing component

Consideration paid / payable to customer

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Variable Consideration

Variable Consideration represents any portion of the transaction price that can vary upwards or downwards

Variable consideration could be caused by:

• Discounts• Rebates• Refunds/Price

Protection• Return rights• Concessions• Penalties

• Royalties• Performance bonuses• Milestones• Profit sharing

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The “Constraint”

Include in the transaction price some or all of variable consideration only to the extent that it is probable that a significant reversal in the amount of cumulative revenue recognized will not occur when the uncertainty is subsequently resolved

That is, include in the transaction price only that revenue that we feel pretty good is not going to be reversed down the road

Important exception: Exclude all sales or usage royalties associated with an IP

license until sale/usage occurs.

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Polling Question

Contractor enters into a contract to repair a bridge. The fixed fee for the repair work is $10,000,000. However, if the bridge is successfully completed to specifications by December 31, 20X2, Contractor will receive a performance bonus of $500,000. Contractor believes it is 80% likely that it will meet the performance target and earn the bonus. As per ASC 606, what is the transaction price?

a. $10,000,000

b. $10,400,000

c. $10,500,000

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0A B C


Polling Question

Manufacturer routinely offers price concessions to its customers. Based on the table below, what is the transaction price for a $100,000 invoice?

a. $100,000 b. $85,000 c. $75,000 d. $70,000

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Expected Consideration

Individual Estimated Probability

Cumulative Probability

of Occurrence

Extended Value

$100,000 20% 20% $20,000 $99,000 10% 30% $9,900 $98,000 10% 40% $9,800 $97,000 5% 45% $4,850 $96,000 5% 50% $4,800 $95,000 5% 55% $4,750 $90,000 5% 60% $4,500 $85,000 4% 64% $3,400 $75,000 12% 76% $9,000 $70,000 20% 96% $14,000 $ - 4% 100% $ -

$85,000 0A B C D



Significant implicit financing

– You’ll know it when you see it

– However, you still need to assess/document whether there are valid business reasons for timing differences between transfer of goods/services and receipt of payments

Distinguishing variable consideration from optional purchases

– Question to consider: Is the customer making a separate purchasing decision?

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Step 4: Allocate the Transaction Price

Next step: Allocate the transaction price (Step 3) to the

distinct performance obligations (Step 2) using a relative

standalone selling price methodology

Sources for standalone selling prices:

1.Observable prices for the same or similar products and services

2.Internal pricing models

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Polling Question

General contractor has been hired to (a) refurbish a retail storefront and (b) install a jewelry safe in the back office (away from any customers). Thus, there are two performance obligations in the contract. The storeowner has demanded that the refurbishment work be completed by March 31, and the contract includes a liquidated damages (LD) penalty of $1,000 for every day that the work extends beyond the deadline. Should the variable consideration related to LD penalties be allocated to just the refurbishment performance obligation under ASC 606?

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a. Yes

b. No


0A B C


Polling Question

ABC sells equipment and maintenance services to a customer for a total – and discounted – transaction price of $1 million. In practice, ABC prices the equipment at various discounts ranging from 20%-30%. ABC never discounts the list price of the maintenance services? Should ABC allocate 100% of the discount to the equipment performance obligation?

a. Yes

b. No


0A B C

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Step 5: Point in Time vs. Over Time

General Principle: Revenues must be recognized over time if any of the following are true:

1. The customer simultaneously receives and consumes the benefits

2. The entity’s performance creates or enhances an asset (for example, work in process) that the customer controls

3. The entity’s performance does not create an asset with an alternative use to the entity and the entity has an enforceable right to payment for performance completed to date

Otherwise, recognize revenue at a point in time

Additional rules apply to IP licenses …

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Revenue Recognition Over Time

Revenues measured over time are recognized as the entity makes progress towards completion

Input or output measures are permissible

– Should select the measure that is appropriate based on the nature of the performance obligation

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Polling Question

Sheet Metal, Inc. receives an order on December 1 to produce 100 custom shrouds (designed to the customer’s specs). The shrouds have no alternative uses to Sheet Metal as they were designed specifically for the customer. Contractually, Sheet Metal may recover any costs incurred, plus a reasonable margin thereon, if the customer terminates the contract for any reason. What method may Sheet Metal use to recognize revenue under ASC 606?

a. Output measure (units of production)

b. Inputs measure (cost-to-cost)

c. Either method above is acceptable

d. Point in time when all 100 shrouds are transferred

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0A B C D


Polling Question

ABC is an insurance agent. ABC simply matches customers with insurance providers. ABC is in no way responsible for producing quotes, handling claims, underwriting, etc. ABC receives a commission of 3% of the premium if and when a customer purchases insurance through a referred insurance company. ABC will also receive a 1% commission on any renewals if and when they occur. Once a policy is initially signed, ABC recognizes its 3% commission as revenue. Is that correct under ASC 606?

A. Yes

B. Most Likely No

C. Definitely No

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0A B C


Other Challenges in Applying ASC 606

Accounting for costs to obtain/fulfill a contract

Gross vs. net reporting

Contract modifications/amendments

Disclosures

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Recurring Disclosures

ASC 606 requires the following types of disclosures for nonpublic companies (continued on next page)

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Contracts with Customers

• Revenues recognized from customer contracts, separate from other types of revenues (e.g., interest, leasing, etc.)

Disaggregation of Revenue

• Revenue recognized at a point in time vs. revenue recognized over time

• Qualitative information about how economic factors (e.g., customer-type, geographical location of customers, and type of contract) affect the nature, amount, timing and uncertainty of revenue and cash flows

Performance Obligations

• Nature of the goods or services promised, and if the company is acting as an agent

• When the company typically satisfies its performance obligations (e.g., upon shipment/delivery, upon completion of service, ratably over service period, etc.)

• Significant payment terms (e.g., when payment typically is due, whether the contract has a significant financing component, whether the consideration is variable and if it’s typically constrained)

• Obligations for returns, refunds, etc.• Types of warranties and related obligations


Recurring Disclosures (continued)

ASC 606 requires the following types of disclosures for nonpublic companies (continued from prior page)

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Contract Balances

• Opening and closing balances of contract assets, contract liabilities and receivables • Any impairment losses recognized on any receivables or contract assets

Significant Judgments

• The methods used to recognize revenue for performance obligations that are satisfied over time (e.g., a description of the output or input methods used, how those methods are applied, etc.)

• Qualitative information about the methods, inputs and assumptions used for assessing whether an estimate of variable consideration is constrained

• Other judgments (e.g., how performance obligations were determined, how standalone selling price was calculated, etc.)


More on Disclosures

If I had a nickel for each time someone asked me for a “good example disclosure” under ASC 606…

There are no good examples – here’s why:

– Disclosure requirements are very company-specific … by design

– Public company disclosures are not going to be helpful … unless you want to include way more information than you have to!

– Companies know their products, risks, and judgments in applying ASC 606. It will be faster for them to write the disclosure from scratch!

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Wrap-Up: More than an Accounting Exercise

Tax Impacts

TCJA requires taxable income to be reported at earlier of when “all events test” is met or revenue is recognized in the “applicable financial statement”

ASC 606 may accelerate taxable income:

– Over time recognition example

– Variable consideration example

Other possible impacts: Sales/Use Tax and Transfer Pricing

Other Effects

Compensation (e.g., commissions based on sales, or bonuses based on EBITDA)

Systems – almost certainly will need to be updated in some way

Business processes, such as deal quoting

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Q & A

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APPLICATION CASE STUDY: ASC 606

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Let’s Practice

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Purchase Order Continued

This is a DPAS priority order – by law, the supplier must accept the order and prioritize its fulfillment

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Rest of Purchase Order

1. THIS PURCHASE ORDER(S) IS AN OFFER TO THE VENDOR TO CONTRACT ON THE TERMS SET FORTH HEREIN. ANY ADDITIONAL OR DIFFERENT TERMS PROPOSED BY VENDOR ARE SPECIFICALLY REJECTED, UNLESS EXPRESSLY AGREED TO IN WRITING SIGNED BY AN AUTHORIZED CREATOR REPRESENTATIVE.

2. All goods must be Factory New. No substitute is permitted without Creator's written consent.

3. Packaging. All goods shall be packaged and marked (including notice of hazardous substances) in accordance with industry standards and will comply with applicable laws and carrier requirements. Each container will be marked with the applicable purchase order number and shipping papers (i.e. packing slip).

4. Title and Risk of Loss. Title and Risk of Loss of goods purchased hereunder will be borne by Vendor until goods are received.

5. Termination of Convenience. Creator, based on our customer's (i.e., U.S. Government) desires, may at any time prior to delivery terminate this order for convenience, in whole or in part, by written, telegraphic, e-mail or verbal notice confirmed in writing to the Vendor. If Vendor has specifically manufactured the goods to fill this order and is unable to make other commercially reasonable disposition of goods, Creator acknowledges that reasonable cancellation charges may apply for the work performed by Vendor in respect of such goods at the time of Creator's written notification. Creator's liability under this paragraph will not exceed the aggregate price specified in this order. Upon payment of agreed cancellation charges, Creator will assume ownership of goods in whole or part.

6. Inspection. All goods ordered will be subject to Creator's inspection and acceptance within a commercially reasonable time at our facility.

7. Delays. Time is of the essence for performance of this order. Creator may refuse delivery if this order is not fulfilled within a reasonable time frame of the purchase order "Ship by" date.

8. Prices. The prices set forth on this order are all inclusive, including, but not limited to taxes, the cost of packing, crating, materials and delivery to the FOB point. Prices are not subject to revision.

9. Warranties. Vendor warrants that all goods when delivered will be merchantable and free of defects in workmanship and material, will comply strictly to the specifications, drawings, samples, or other description specified herein or furnished herewith, and will be fit for their ordinary intended purposes.

10. DPAS. Vendor is required to comply with the mandatory requirements of the Defense Priorities and Allocations system (DPAS) (15 CFR, Part 350) if a DO/DX priority rating (PRI) is assigned to this Order. In the event of any conflict between the terms and conditions of this order and the Government clauses incorporated by reference, then the terms and conditions of the latter shall prevail.

11. Modifications. No modifications of this order will be binding unless in writing and signed by Creator or its agent.

12. Governing Law. This agreement shall be construed and governed according to the Law of the State of New York.

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CREATOR INDUSTRIES — PURCHASE ORDER TERMS AND CONDITIONS


Question #1: Step 1 of ASC 606

Does Hawk have an enforceable contract that complies with the requirements in ASC 606?

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a. Yes

b. No, because the purchase order was not signed and acknowledged by Hawk

c. No, because we can’t tell the rights and obligations of both parties from just a PO

d. No, because Creator has the right to terminate for convenience

e. No, because we don’t have enoughinformation about Creator’s ability to pay

0A B C D E



How many distinct performance obligations exist with this contract under ASC 606?

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a. One: (for the 40 handle bows)

b. Two: (a) the 40 handle bows and (b) the warranty (section 9 of the T&Cs)

c. Forty: (one for each of the handle bows)

d. Forty-one: (one for each of the handle bows, plus the warranty)

0A B C D



Assume Hawk’s customary practice is to allow customers to return any unused product with 30 days for a full refund? Further assume Hawk estimates that 2 units will be returned, based on historical experience for this product and customer. The cost of each unit is $100, and returned products are resalable at a profit. What is the transaction price under ASC 606?

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a. $8,716 (the full PO amount)

b. $8,516 (PO amount less cost of 2 units)

c. $8,280 (the selling price of 38 handle bows)

d. $0

0A B C D



How should Hawk recognize revenue from this arrangement?

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a. Over time

b. At a point in time

0A B



At what point in time should Hawk recognize revenue from this order?

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a. Upon shipment

b. Upon receipt by Creator

c. After acceptance by Creator

Indicators that customer obtains control:• Customer is obliged to pay• Customer has legal title• Customer has physical possession• Customer has significant risks and rewards

of ownership• Customer has accepted the asset

0A B C


Putting it All Together

Dr. Accounts Receivable $8,716.00Cr. Revenue $8,280.20Cr. Refund Liability 435.80

Dr. Cost of Sales $3,800.00Dr. Refund Asset 200.00

Cr. Inventory $4,000.00

Refund asset and

refund liability must be

presented gross

Journal entries to record revenue and cost of goods sold:

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In Conclusion: Lessons Learned

There are no shortcuts in adopting ASC 606!

Contracts need to be read, cover-to-cover

Often some heavy-duty analysis of ASC 606 is also going to be required, including review of AICPA and other nonauthoritative publications

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Go in with an open mind. And aim to develop sustainable processes – this

should not be viewed as a one-off project!


Q & A

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Important

This presentation is for informational purposes only and does not constitute individual accounting advice. When seeking such accounting advice, you should consult with your independent or internal advisors, in accordance with professional standards.

Also, the materials contained in this presentation are current only as of August 1, 2019, except as otherwise indicated herein. mindthegaapLLC cannot and does not warrant or represent in any way to update these materials after August 1, 2019.

These materials are the copyright of mindthegaapLLC and may not be used, licensed or otherwise reproduced in any way without the express written consent of mindthegaapLLC.

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Documents

Revenue Recognition Seminar - Ciuni Panichi · Scott has led US GAAP and IFRS training classes for over 25 years. Before Mind the GAAP, Scott worked at the national office of Arthur