Summary of New Revenue Recognition Standard and Its Implications
This article discusses the new revenue recognition standard introduced in May 2014 under Topic 606. It outlines the significant changes, including the removal of inconsistencies and the introduction of a principles-based approach to recognizing revenue from customer contracts. Key steps for implementation and the effective dates for adoption are also covered, alongside the benefits of improved disclosures and comparability.
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Presentation Transcript
Jessie Kanter, CPA Jkanter@BlumShapiro.com www.BlumShapiro.com 1
Summary of new revenue recognition standard, Topic 606 Latest developments Implementation what you need to be doing now 2
Issued May, 2014 Introduced new revenue recognition topic to codification Topic 606: Revenue from Contracts with Customers Convergence project with International Accounting Standards Board Supersedes current guidance in Topic 605: Revenue Recognition Supersedes industry specific guidance 3
Why the new standard? Remove inconsistencies More robust framework Comparability Improved disclosures Simplification 4
Introduces a new principles based revenue recognition standard Core principle is that an entity should recognize revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expect to be entitled in exchange for those goods or services 5
ASU 2015-14 deferred the effective dates for one year Public companies Annual periods beginning after December 15, 2017 and interim periods within that period All others Annual periods beginning after December 15, 2018 and interim periods beginning after December 15, 2019 Early adoption permitted for periods beginning after December 15, 2016 6
5 Steps to Revenue Recognition Identify the contract(s) with the customer Identify the performance obligations in the contract Determine the transaction price Allocate the transaction price to the performance obligations in the contract Recognize revenue when (or as) the entity satisfies a performance obligation New disclosures required 7
Guidance defines a contract as an agreement between two or more parties that creates enforceable rights and obligations and has commercial substance Written Verbal Implied 8
Requirements: Approval and commitment of the parties Identification of rights of parties Identification of payment terms Commercial substance Probable that the entity will collect the consideration that it is entitled in exchange for goods/services 9
The customer is a party that has contracted with an entity to obtain goods or services that are the output of that entity s ordinary operations Guidance is applied to each contract with a customer May have multiple contracts to apply the guidance Evaluate for combination 10
Contract combination Evaluate whether contracts should be combined when more than one contract exists between the customer and the entity only if they are entered into at or near the same time and one or more criteria are met: Contracts negotiated as a package with single objective Amount of consideration paid related to one contract depends on the amount to be paid or performance on another contract Goods or services promised in separate contracts are considered a single performance obligation 11
Contract modifications May be considered a separate contract Results in addition of separate performance obligation and price reflects the stand alone selling price of the separate performance obligation May be considered an adjustment to the original contract Any other modifications that don t result in the addition of a separate performance obligation Accounted for prospectively or cumulative catch-up 12
Performance obligation defined as: Promise in contract with a customer to transfer goods and/or services to the customer Account for each performance obligation if it is distinct Capable of being distinct Distinct within context of the contract A good or service that is not distinct should be combined with other goods/services until the entity identifies a bundle that is distinct 13
Capable of being distinct The customer can benefit from the good/service on its own or together with other resources readily available to customer Distinct within context of contract Promise to transfer good/service is separately identifiable from other promises within contract Customer is able to purchase or not purchase the good/service without significantly affecting other promised goods/services Good/service does not significantly modify or customize another good/service in the contract 14
Transaction price is defined as the amount of consideration to which the entity expects to be entitled in exchange for transferring promised goods/services to customer (excluding amounts collected on behalf of third parties) 15
Variable consideration Determine the amount to include by estimating the expected or most likely amount Significant reversal should not be probable of occurring Some examples include: Discounts Rebates Credits Incentives Royalty 16
Time value of money Adjust the transaction price for the effects of time value of money when contract contains a significant financing component Practical expedient for contracts for which consideration is expected within one year Considerations: Length of time between transfer of goods/services and payment If consideration would substantially differ if customer paid cash at time of transfer Interest rate in contract and/or prevailing market rates 17
Non-cash consideration Measured at fair value If fair value is uncertain, measure consideration indirectly by reference to standalone selling price(s) of goods/services 18
Must allocate transaction price when more than one performance obligation Allocation is based on relative stand-alone selling prices of the specific goods/services promised under the contract. If estimates used management should maximize the use of observable inputs Expected cost plus reasonable profit margin Consideration of market prices of similar goods/services Residual approach (be cautious) 19
Revenue is recognized when a good or service is transferred to the customer and the customer obtains control (point in time or over time) Customer has the ability to direct the use of asset Entity has right to payment Entity transferred legal title Entity transferred physical possession Customer has significant risk and reward of ownership Customer has accepted asset 20
Performance obligations satisfied over time Customer receives and consumes benefit of the entity s performance as the entity performs Entity s performance creates or enhances asset that customer controls as the asset is created or enhanced Entity s performance does not create an asset with alternative use to the entity and the customer does not have control over the asset created, however, the entity has a right to payment for performance completed to date 21
Measuring progress toward satisfying a performance obligation Recognize revenue in a manner that depicts the transfer of control Example methods: Units produced or delivered Control milestones Cost incurred Labor hours Machine hours 22
Licenses Access to IP: performance obligation satisfied over time (dynamic IP) Right to use IP: performance obligation satisfied at a point in time (static IP) Costs to obtain/fulfill contract Capitalized unless the amortization period is less than one year Must be expected to be recovered 23
New disclosures meant to assist the reader in understanding the amount, timing and judgments related to revenue recognition and related cash flow Current guidance contains very little related to revenue recognition requirements 24
Disaggregation of revenue Categories that depict how the nature, timing and amount, as well as uncertainty of revenue and cash flows are affected by economic factors. Contract balances Opening and closing balances of contract assets and liabilities (mainly related to performance obligations settled over time) Remaining performance obligations Amount related to remaining performance obligations expected to be recognized in future 25
Costs to obtain or fulfill contracts Closing balance of capitalized costs Amortization recognized Method of amortization Significant judgments affecting the amount and timing of revenue recognized Variable consideration Practical expedients (including transition period) 26
Task force charged with handling transition issues as they are brought to the boards attention Several ASU s issued during 2016, more in exposure draft form 27
ASU 2016-08: Principal vs Agent Consideration Principal record revenue gross Agent record revenue net A principal maintains control and transfers goods/services to the customer An agent arranges with another party to transfer goods/services 28
ASU 2016-10: Identifying Performance Obligations and Licensing Performance Obligations: Entity is not required to assess whether promised goods/services are performance obligations if they are immaterial to contract Entity can make accounting policy election to account for shipping and handling activities occurring after customer has obtained control of good as activity to fulfill the promise/transfer the good rather than separate obligation Licensing: Clarification licenses satisfied over time or point in time Stand-alone functionality vs continued support/maintenance 29
ASU 2016-12: Narrow-Scope Improvements and Practical Expedients Assessing collectability Presentation of sales taxes/other taxes collected Non-cash consideration Contract modifications at transition Completed contracts at transition Technical corrections 30
Assess how you recognize revenue currently Assess your current contracts with customers Assess any variable consideration Update policies and procedures manuals for changes in revenue recognition Significant judgments Systems used to track open balances (contract assets/liabilities, performance obligations, capitalized costs) Accumulation of disclosures required Keep an eye out for implementation guidance Industry groups Large accounting/business consulting firms 31
Q&A Thank you! 32
