FSA Consortium - PowerPoint Presentation

Slide1

FSA ConsortiumPrinciples Under the New Revenue Recognition Standard

May 2015

Deloitte

Foundation/Federation of Schools of Accountancy Faculty ConsortiumMay 2015

Slide2

Course IntroductionSlide3

AgendaCourse flow

New Revenue Recognition Standard ReviewCase Studies & Discussion

Session I: Step 1: Identification of a contract with a customer & Step 2:

Identifying the performance obligationsSession II: Step 3: Determining the transaction price & Step 4: Allocating the transaction priceSession III: Step 5: Recognizing revenue & other issuesSlide4

New Revenue Recognition Standard ReviewSlide5

Preparing for Change - Key ParticipantsSlide6

Joint Transition Resource Group (TRG)

Purpose

To seek feedback on potential implementation issues that will

help the boards determine whether to take additional action Hot Topics

Licenses of intellectual property

Identification of performance obligations

Collectability

Gross versus net presentation

Customer options

Variable consideration

Noncash consideration

Effective dateSlide7

Applies to an entity’s contracts with customersSome key aspects apply to transfers of non-financial assets that are not businessesDoes not apply to:Lease contractsInsurance contractsTransfers of financial assets/ contractual rights within financial assets

GuaranteesScopeRevenue RecognitionSlide8

The five steps revenue recognition process

Core principle: Recognize revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration the entity expects to be entitled in exchange for those goods or services

This revenue recognition model is based on a control approach

which differs from the risks and rewards approach applied under current U.S. GAAP.Slide9

Step 1: Identifying the contractA legally enforceable contract (oral or implied) must meet all of the following requirements:

A contract will not be in the scope if:

The contract has commercial substance

The parties have approved the contract and are committed to performThe entity can identify each party’s rights regarding goods or servicesThe entity can identify the payment terms for the goods or services to be transferred

The contract is wholly unperformed

Each party

can unilaterally terminate the contract without compensation

It is probable the entity will collect the consideration to which it will be entitled in exchange for the goods or services that will be transferred to the customer

AND

Collectibility thresholdSlide10

Identifying the Contract - Tentative FASB Decisions:FASB ClarificationsCollectability

The standard would be amended to clarify that:An entity would not simply assess the probability of collecting all the consideration in a contract. Rather, collectibility would be assessed on the basis of the amount to which the entity will be entitled in exchange for the goods or services that will transfer to the customer (i.e., collectibility is not assessed on those goods or services

that will not transfer because

the customer fails to pay).A contract is considered terminated if the entity has the ability to stop (or has actually stopped) transferring additional goods or services to the customer.Slide11

Step 2: Identifying performance obligations

Are promised goods and services distinct from other goods and services in the contract?Can the customer benefit from the good or service on its own or together with other readily available resources?

Is the good or service separately identifiable from other promises in the contract?

ANDAccount for as a performance obligationCombine 2 or more promised goods or services & reevaluateYES

NO

The ASU defines a

performance obligation

as a promise

to transfer to the customer a good or service (or a bundle of goods or services) that is

distinct

.

CAPABLE OF BEING DISTINCT

DISTINCT IN CONTEXT OF CONTRACT

Identify all (explicit or implicit) promised goods and services in the contract

A series of goods

or services with the same pattern of transfer may

be a single obligationSlide12

Step 2: Identifying performance obligations Distinct in the context of the contractIn order for a promised good or service to be distinct it must be “separately identifiable from other promises in the contract.”Factors that indicate that a promised good or service is distinct include:

No significant service of integrating the good or service (i.e., the entity is not using the good or service as an input to produce or deliver the combined output specified by the customer)The good or service does not significantly modify or customize another good or service promised in the contract.The good or service is “” other promised gnot highly dependent on, or highly interrelated withoods or services in the contract.

The

FASB is providing clarification around identifying performance obligations.Slide13

Identifying Performance Obligations- Tentative FASB Decisions:FASB ClarificationsTo clarify the meaning of a promise that is separately identifiable, due to complexity and judgment in application, the FASB has tentative plans

to:Expand upon the articulation of “separately identifiable,” Reframe the separation criteria to focus on a bundle of goods or services, andAdd examples to the standard’s implementation guidance

ASU 2014-09: Distinct in the Context of the Contract

In order for a promised good or service to be distinct it must be “separately identifiable from other promises in the contract.”Factors that indicate that a promised good or service is distinct include:No significant service of integrating the good or service (i.e., the entity is not using the good or service as an input to produce or deliver the combined output specified by the customer)The good or service does not significantly modify or customize another good or service promised in the contractThe good or service is “not highly dependent on, or highly interrelated with” other promised goods or services in the contractSlide14

Identifying Performance Obligations- Tentative FASB Decisions:FASB ClarificationsImmaterial

Promised Goods or Service Amend the standard to permit entities to evaluate the materiality of promises at the contract level and that, if the promises are immaterial, the entity would not need to evaluate such promises further.Shipping and H

andling Services

Add guidance that clarifies: Before Control Transfers - Shipping and handling activities that occur before control transfers to the customer are fulfillment costs. After Control Transfers - When costs are incurred after control transfers, allow entities to elect a policy to treat shipping and handling activities as fulfillment costs if they do not represent the predominant activity in the contract and they occur after control transfers.Slide15

Step 3: Determining the transaction priceTransaction price shall include…fixed considerationvariable consideration (estimated and potentially constrained)noncash considerationadjustments for significant financing componentadjustments for consideration payable to customer

Transaction price does NOT include…effects of customer credit riskPrinciple: The transaction price is the amount of consideration to which an entity expects to be entitled in exchange for transferring promised goods or services to a customer (which excludes estimates of variable consideration that are constrained).

Need to consider whether adjustments are for concessions or credit riskSlide16

Variable consideration includes all consideration that is subject touncertainty for reasons other than collectability.Examples include discounts, rebates, refunds, credits, incentives, performance bonuses/penalties, contingencies, price concessions, or other similar items

When accounting for variable consideration an entity shall…Estimate using expected value (probability weighted) or most likely amount methodsSubject to the following “constraint”:Include some or all of the amount of variable consideration in the transaction price to the extent that it is “probable” that a subsequent change in the estimate would not result in a significant revenue reversal Consider the following factors in assessing whether the estimated transaction price is subject to significant revenue reversal:Highly susceptible to factors outside entity’s influence

Uncertainty not expected to be resolved for a long time

Entity’s experience is limitedEntity typically offers broad range of price concessions/payment termsBroad range of possible outcomesStep 3: Determining the transaction price Variable considerationException for sales or usage based royalties of IP

The

FASB is providing clarification around

application of the royalty constraint.Slide17

FASB ClarificationsNoncash ConsiderationThe FASB decided to amend the standard to clarify that:An entity should measure FV of noncash consideration at contract inception.

The constraint would not apply to variability in the form of consideration. Thus for noncash consideration, the constraint would apply only to variability resulting from reasons other than the form of consideration.Sales and Usage-Based RoyaltiesThe FASB agreed that an entity would apply the royalty constraint if the license is the “predominant” feature to which the royalty relates.Implications of the tentative decision include:Permits broader application of the royalty constraint (than if it were limited to royalty arrangements that contain only licenses) and

would eliminate the potential need to apply variable consideration and royalty constraint guidance to different portions of a single royalty.Requires judgment to determine whether a license of IP, when “bundled” with other goods or services (i.e., the license is not a distinct performance obligation

), is the predominant item to which the royalty relates. Determining the transaction price - Tentative FASB DecisionsSlide18

Allocate transaction price on a relative standalone selling price basis (estimate standalone selling price if not observable).The expected cost-plus margin method, adjusted market assessment method, or residual method (only if price is highly variable or uncertain) are acceptable.Allocate consideration (and changes) in the transaction price to all performance obligations (based on initial allocation) unless a portion of (or changes in) the transaction price relate entirely to one (or more) obligations and certain criteria are met.

Do not reallocate for changes in standalone selling prices.If certain criteria are met, a discount or variable consideration may be allocated to one or more, but not all, of the performance obligations in a contract.Step 4: Allocating the transaction priceSlide19

Step 5: Recognizing revenueEvaluate if control of a good or service transfers over time, if not then control transfers at a point in time.An entity satisfies a performance obligation over time if… OR OR

Measure progress toward completion using input/output methodsPerformance does not create an asset with an alternative use and the entity has an enforceable right to payment

for performance completed to date.

Performance creates or enhances a customer controlled asset. (e.g., home addition)The customer receives and consumes the benefit as the entity performs. (e.g., cleaning service)ORORSlide20

Step 5: Recognizing revenueFor performance obligations satisfied at a point in time, indicators that control transfers include, but are not limited to, the following:

The entity has a present right to payment.The customer has legal title.

The entity has transferred physical

possession.The customer has the significant risks and rewards of ownership.The customer has accepted the asset.Slide21

Implementation Guidance - licenses

License is distinct. Account for as a performance obligation

License is not distinct. Combine two or more promised goods or services

Is the consideration in the form of a sales- or usage-based royalty?YES

NO

Recognize revenue when subsequent sales or usage

occurs

Does the license provide

access

?

Step 2: Identifying the performance obligations

Recognize revenue over time

YES

NO

Recognize revenue at a point in time

Contract requires, or customer reasonably expects, the entity will undertake activities that significantly affect the IP.

Rights granted by license directly expose customer to positive or negative effects of the activities.

Those activities do not result in the transfer of a good or service as those activities occur.

Hosted software may

not represent a distinct license

See next slide

New Revenue StandardSlide22

Nature of IP License- Tentative FASB Decision

Functional IPForm or functionality of IP expected to change as a result of activities of licensor that do not transfer a promised good or service to the customer,

and the customer has the right only to the most current version of the IP?

Symbolic IPEntity will undertake activities to support and maintain the IP; activities significantly affect the utility of the IPRight to Access LicenseRecognize revenue over time

Right to Use License

Recognize revenue at a

point in time

Does the IP have significant standalone functionality?

YES

NO

YES

NO

Right to Access License

Recognize revenue

over time

Sales

and Usage-Based

Royalties-

An

entity would apply the royalty constraint if the license is the predominant feature to which the royalty relates (i.e. an entity would

not

split a royalty and

apply

both the royalty and general constraints to it).

FASB ClarificationsSlide23

Contract costs- Costs to obtain a contractCosts to fulfill a contractAmortization/impairmentTransitionRetrospective or modified retrospectiveOther proposed clarificationsContract

Modifications – permits hindsight in transitionSales Taxes Presentation – Gross versus NetA practical expedient would be added to the standard that permits entities to present sales taxes on a net basis. Other aspectsNew Revenue Recognition StandardSlide24

FASB ClarificationsPractical Expedients Upon Transition - Contract Modifications A practical expedient would be added to the standard that permits entities to use hindsight in determining contract modifications for transition purposes (i.e. to determine the transaction

price and allocate the transaction price to all satisfied and unsatisfied performance obligations on the basis of historical stand-alone prices) as of the CMAD (see below). A new term, “contract modification adjustment date” (CMAD), would be added to the standard and defined as the beginning of the earliest year presented upon initial adoption of the standard. Sales Taxes Presentation – Gross versus Net

A practical expedient would be added to the standard that permits entities to present sales taxes on a net basis. The expedient’s scope would apply to the same sales taxes as those under existing U.S. GAAP

. Transition and Sales Taxes Presentation - Tentative FASB DecisionsSlide25

Public entities: Annual reporting periods beginning after December 15, 2016, including interim reporting periods therein (FY 2017)Early application not permitted Nonpublic entities: Mandatory effective date:Annual reporting periods beginning after December 15, 2017 and interim reporting periods

thereafter (FY 2018)Option to use public entity effective date:What is the effective date for public and non-public entities?

The FASB is

proposing a one year delay

of effective date

(option to adopt as of original effective date).Slide26

Things are changing. Read publications to keep up to date on latest information.

Stay tuned!FASB, IASB, TRG, SEC, AICPA, and accounting firms are still in the process of interpreting the guidance in the standard.Practice may evolve out of industry interpretations.Newest developments at FASB may result in the ASU

being revised before it comes effective.

Stay Tuned!USGAAPplus.com contains the latest news in financial reportingSlide27

Case Studies Slide28

Session I Slide29

Step 1: Identifying the ContractSlide30

Activity overview

Total time: ~20 minutesFor this activity, we will:Review guidance on Step 1Review case facts and questionDiscuss at tables (5 minutes)

Debrief as a group (10 minutes)Slide31

Step 1: Identifying the contractA legally enforceable contract (oral or implied) must meet all of the following requirements:

A contract will not be in the scope if:

The contract has commercial substance

The parties have approved the contract and are committed to performThe entity can identify each party’s rights regarding goods or servicesThe entity can identify the payment terms for the goods or services to be transferred

The contract is wholly unperformed

Each party

can unilaterally terminate the contract without compensation

It is probable the entity will collect the consideration to which it will be entitled in exchange for the goods or services that will be transferred to the customer

AND

Collectibility thresholdSlide32

Case facts

Entity A enters into 1000 homogenous contracts with different customers for fixed consideration of $1,000

each.

Before entering into a contract with a customer, Entity A performs procedures designed to determine whether it is probable that the customer will pay the amount owed under the contract (e.g., a credit check) and only enters into the contract if the entity concludes that it is probable that customer will pay.During the previous three years, Entity A has collected 98% of the amounts it has billed to customers.Based on an analysis of industry and historical collection data, Entity A has concluded that the collection rate from the past three years is the probable outcome for future contracts.Entity A intends to enforce its rights to the consideration

to which

it is

entitled

(i.e., it will not offer any concessions to its customers

).

Accordingly, the only variability in the contract is due to customer credit risk.

Case

study: Assessing

collectability

of

contracts

Question

How should Entity A assess identification of contracts for revenue recognition?

View A:

Each of the 1,000 contracts qualify; resulting in $1,000,000 in revenue and $20,000 in bad debt expense upon satisfaction of the performance obligation.

View B:

Only 98% of the portfolio of contracts is probable of collection; thus revenue should be $980,000 when the performance obligation is satisfied.

?Slide33

Relevant resources

Relevant Guidance in ASC 606

ASC 606-10-25-1

ASC 606-10-25-5 through 25-8ASC 606-10-10-4 Relevant Sections in Deloitte’s Roadmap

3.1.1 Portfolio Approach

5.1 Collectibility

Case

study:

Assessing collectability of contracts Slide34

Case study answer: Assessing collectability of contracts

How should Entity A assess collectability of the contracts? View A: Each of the 1,000 contracts qualify; resulting in $1,000,000 in revenue and $20,000 in bad debt expense upon satisfaction of the performance obligation.At the January 26, 2015 Transition Resource Group (TRG) Meeting, the TRG members generally agreed that when collectability is probable for a portfolio of contracts, the expected amount should be recognized as revenue and the uncollectible amount should be recognized as an impairment loss in accordance with ASC 310.Slide35

Step 2: Identifying the Performance ObligationsSlide36

Activity overview

Total time: ~60 minutesFor this activity, we will:Review guidance on Step 2Review cases facts and question

Discuss at tables (5 minutes for each case)

Debrief as a group (10 minutes for each case)Slide37

Step 2: Identifying performance obligations

Are promised goods and services distinct from other goods and services in the contract?Can the customer benefit from the good or service on its own or together with other readily available resources?

Is the good or service separately identifiable from other promises in the contract?

ANDAccount for as a performance obligationCombine 2 or more promised goods or services & reevaluateYES

NO

The ASU defines a

performance obligation

as a promise

to transfer to the customer a good or service (or a bundle of goods or services) that is

distinct

.

CAPABLE OF BEING DISTINCT

DISTINCT IN CONTEXT OF CONTRACT

Identify all (explicit or implicit) promised goods and services in the contract

A series of goods

or services with the same pattern of transfer may

be a single obligationSlide38

Entity T

,

a

TV manufacturer, enters into contract to ship 100 TVs from San Francisco to a customer in London for fixed consideration. The shipment from SF to London, by a 3rd party carrier, will take approximately 3 weeks.Terms are FOB shipping point. Legal title of the TVs transfers to the customer upon delivery to carrier. Entity T arranges shipping and charges customer for shipping.TVs were delivered to carrier 9 days before year end. Payment is due 30 days after receipt of goods.Entity T is not obligated to but has a history of replacing (or crediting customer’s account for) any TVs damaged during shipment. Entity T historically pursue claims against the carrier/insurance provider.Entity T has not elected the (proposed) practical expedient for shipping.

Case study: Synthetic FOB destination

Question

Is shipping a separate performance obligation?

Bonus for Session III – when does control of TVs transfer?

Case

Facts

?Slide39

Case study answer: Synthetic FOB destination

Is shipping a separate performance obligation?View A: Shipping is a separate performance obligationTitle to the TVs transfer to customer at shipping point. Accordingly, shipping the customer’s goods from the port (and potentially providing insurance on such goods) represents a separate performance obligation.View B: There is only one performance obligation, the delivery of undamaged TVs.Slide40

Entity M, a

parts supplier,

enters into contract with

an OEM (i.e., M’s customer) for fixed consideration of $30 million to (1) construct equipment for the customer that M will use to make parts for the customer and (2) supply 30 million parts to the customer.Legal title of the equipment transfers to the customer upon completion of the construction of the equipment (i.e., prior to M beginning production of the parts).M is one of many companies that have the ability to both construct the equipment and subsequently produce the parts.

Case study:

Identifying

performance obligations

for a

manufacturer

Question

Does the contract have one

or more than one

performance

obligation?

Case

Facts

?Slide41

Relevant resources

Relevant Guidance in ASC 606

606-10-25-20

606-10-25-21 Relevant Sections in Deloitte’s Roadmap6.3 Distinct Goods or Services

Case

study:

Identifying performance obligations for a manufacturer Slide42

Case study answer: Identifying performance obligations for a manufacturer

Does the contract have one or more performance obligations?The contract has multiple performance obligations because:The customer is able to benefit from the equipment and the parts on their own.The equipment could be used by Entity M or another manufacturer to produce parts for the customer and the parts are themselves an input in the customer’s production process.Therefore, the equipment and parts are each

capable of being distinct.

The equipment and parts are not being used to produce a combined item that is a distinct good that M has promised The entity’s promise to provide the parts does not significantly affect the customer’s ability to derive benefit from the equipment. Therefore, the equipment and the parts are distinct in the context of the contract (i.e., separately identifiable).Slide43

An entity

enters into monthly contract with its customer to provide a service (e.g., fitness center) and

charges

monthly service fees. It also charges a one-time $50 nonrefundable upfront fee (equal to one-half of one month’s service fee of $100) payable at contract signing.Customers are under no obligation to continue to purchase the monthly service after the first month. And the entity has not committed to any pricing levels for the service in future months.The activity of signing up a customer does not result in a transfer of a good or service to the customer, as such, it does not represent a separate performance obligation. The upfront fee should therefore be deferred and recognized as the future service is provided.Historical data indicates that the average customer life is two years.

Case

study: Material

right

(Nonrefundable

upfront fees

)

Questions

Case

Facts

Does the renewal option create a material right

(gives rise to a performance obligation) for

a customer to renew the monthly service?

How should the entity account for the upfront fee based on your answer to the first question?

?Slide44

Relevant resources

Relevant Guidance in ASC 606

ASC 606-10-55-50 through 55-53

ASC 606-10-55-41 through 55-45Relevant Sections in Deloitte’s Roadmap6.3.3 Nonrefundable Up-Front Fees6.3.2 Customer Options for Additional Goods or Services

Case study:

Material

right

(Nonrefundable

upfront fees

) Slide45

Case study answer: Material right (Nonrefundable upfront fees)

Does the renewal option create a material right (gives rise to a performance obligation) for a customer to renew the monthly service?How should the entity account for the upfront fee based on your answer to the first question?Yes, the renewal option creates a material rightWhen comparing the renewal rate ($100) to the amount that a new customer would be required to pay ($150), the upfront fee is material (q

uantitative factor). The entity’s historical renewal

experience suggests that not having to pay the upfront fee is one of the factors customers consider when deciding whether to renew their monthly contract (qualitative factor).As a result, the contract contains two performance obligations (1) one month of service and (2) a material right representing a prepayment for future services by the upfront fee. The upfront fee would be recognized over the service periods during which the customer is expected to benefit from not having to pay an upfront fee upon renewal of service. Determining the expected period of benefit often will require judgment.*This issue was discussed at the October 2014 and January 2015 TRG Meetings. See Deloitte’s October 2014 and January 2015 TRG Snapshot for additional information.Slide46

Session II Slide47

Step 3: Determining the Transaction PriceSlide48

Activity overview

Total time: ~40 minutesFor this activity, we will:Review guidance on Step 3Review case facts and questionDiscuss at tables (5 minutes for each case)

Debrief as a group (10 minutes for each case)Slide49

Step 3: Determining the transaction priceTransaction price shall include…fixed considerationvariable consideration (estimated and potentially constrained)noncash considerationadjustments for significant financing componentadjustments for consideration payable to customer

Transaction price does NOT include…effects of customer credit riskPrinciple: The transaction price is the amount of consideration to which an entity expects to be entitled in exchange for transferring promised goods or services to a customer (which excludes estimates of variable consideration that are constrained).

Need to consider whether adjustments are for concessions or credit riskSlide50

How much revenue should the entity recognize upon transferring control of the equipment to the customer

? What should Entity P record on 1/2/20X1?

Case facts

On

1/2/20X1

, Entity P, a manufacturer, sells a large piece of equipment to a customer for consideration equal to five percent of the customer’s future net sales for the next five years.

The entity has determined that the transaction meets the criterion in Step 1 to be accounted for as a contract with a customer.

Control of the equipment transfers to the customer on the date of

sale (1/2/20X1).

The consideration is payable after the

customer

issues its audited financial statements for each

year (and after Entity P issues financial statements each year).

Entity P has determined after careful analysis that there is not a significant financing component in the transaction.

Based on the customer’s audited financial statements, the customer’s sales for the last ten years have fluctuated from $1.4 million to $2.2 million with

the probability weighted average amount being

$2.0 million.

Entity

P is highly confident that the customer’s sales will not be less than $

1.6

million in any of the next five years.

Case study:

Accounting for

contingent revenue

Question

?Slide51

Relevant resources

Relevant Guidance in ASC 606

606-10-32-5

through 32-9606-10-32-11 through 32-13 606-10-32-15 through 32-20 606-10-45-1 through

45-5

Relevant Sections in Deloitte’s Roadmap

7.1.1

Variable Consideration

7.2

Constraining Estimates of Variable Consideration

7.3.2

Existence and Significance of a Financing Component

7.3.3

Circumstances That Do Not Give Rise to a Significant Financing Component

Case

study:

Accounting for contingent revenue Slide52

Case study answer: Accounting for contingent revenue How much revenue should the entity recognize upon transferring control of the equipment to the customer?

The entity should recognize $400,000

$1.6 million

Estimated annual sales (for which it is probable that there will not be a significant revenue reversal) x 5 years Years for which the customer will pay a royalty$8.0 million

x 5 percent

Royalty percentage per the contract

$400,000

Transaction Price

Dr Contract Asset $400,000

Cr Revenue $400,000Slide53

Case study answer: Accounting for contingent revenue BTW- How

did Entity P arrive at the conclusion that there is not a significant financing component in the transaction?Entity P considered the guidance in ASC 606-10-32-17(b) which states that a contract with a customer would not have a significant financing component if “a substantial amount of the consideration promised by the customer is variable, and the amount or timing of that consideration varies on the basis of the occurrence or nonoccurrence of a future event that is not substantially within the control of the customer or the entity (for example, if the consideration is a sales-based royalty).”Slide54

Should the constraint on variable consideration be applied at the contract level ($10.01 million) or the performance obligation level ($10,000)?

Case facts

An entity enters into a contract with a customer to provide

the customer

with

equipment and a consulting service. The contractual price for the equipment is fixed at $10 million. The contract does not include a fixed price for the consulting service, but if the customer’s manufacturing costs decrease by 5% over a one-year period, the entity will receive $10,000 for the consulting

service. Also

assume the following:

The equipment and the consulting service are separate performance obligations.

The standalone selling prices of the equipment and consulting service are determined to be $10 million and $10,000, respectively.

The entity concludes $10,000 is the consideration amount for the consulting service using the most likely amount method under ASC 606-10-32-8.

The entity allocates the performance-based fee of $10,000 entirely to the consulting service in accordance with ASC 606-10-32-40.

Case study:

Insignificant

variable

c

onsideration

at

contract

l

evel

Question

?Slide55

Should the constraint on variable consideration be applied at the contract level ($10.01 million) or the performance obligation level ($10,000)?The constraint on variable consideration should be applied at the contract level because the unit of account for determining the transaction price (Step 3 of the new standard) is the contact, not the performance obligation.

Case study answer: Insignificant variable consideration at contract level Slide56

How should the entity measure the transaction?

Case facts

On September 1, Entity W

enters into a contract with a

Customer C

to provide

the customer with 100 widgets on December 15. In return, Customer C promises to transfer to Entity W, upon inspection and acceptance of the widgets, but no later than December 28, 10 shares of C stock. Customer C is a private company. The transaction occurs as contracted and stock is delivered on December 28. Assume these additional facts:

On September 1 the selling price of a widget is $10. On November 1, Entity W institutes a price increase of $0.55 per widget.

The estimated fair value of a share of Customer C stock, based on limited private transactions, is as follows:

September 1 = $100

November 1 = $95

December 15 = $102

December 28 = $105

Case study: Widgets for Stock

Question

?Slide57

How should Entity W measure the transaction?View A = $1000

View B = $950View C = $1020View D = $1050View E = $1055View A - $1000. The FASB is proposing to clarify that non-cash consideration is measured at contract inception. [The IASB is not proposing a similar clarification; other views are to measure when the non-cash consideration when received ($1050) or when the performance obligation is satisfied ($1020)]

Case study answer: Widgets for StockSlide58

Step 4: Allocating the Transaction PriceSlide59

Activity overview

Total time: ~30 minutesFor this activity, we will:Review guidance on Step 4Review case facts and questionDiscuss at tables (10 minutes)

Debrief as a group (15 minutes)Slide60

Allocate transaction price on a relative standalone selling price basis (estimate standalone selling price if not observable).The expected cost-plus margin method, adjusted market assessment method, or residual method (only if price is highly variable or uncertain) are acceptable.Allocate consideration (and changes) in the transaction price to all performance obligations (based on initial allocation) unless a portion of (or changes in) the transaction price relate entirely to one (or more) obligations and certain criteria are met.

Do not reallocate for changes in standalone selling prices.If certain criteria are met, a discount or variable consideration may be allocated to one or more, but not all, of the performance obligations in a contract.Step 4: Allocating the transaction priceSlide61

Case

study:

Allocating a discount

Case f

acts

Entity

W

sells

three items A, B, and C, respectively. The

standalone selling prices of A,

B, and C are

as

shown to the right:



Product

Standalone Selling Price

Item

A

$30

Item

B

$70

Item

C

$50

Consider the following

scenarios

:

SCENARIO 1

On January 1, 20X1, the entity enters into a contract with a customer to provide the customer with one of each item for consideration of $135 (a $15 discount) based on the schedule to the right:



Date

Deliverable

03/31/X1

Item

A

06/30/X1

Item

B

09/30/X1

Item

C

The following bundles are also regularly sold at the following combined prices

:



Bundle

Price

Combined Standalone Selling Price

Discount in Bundle

A + B

$85

$30

+

$70

=

$100

$15

A + C

$65

$30

+

$50

=

$80

$15

B

+

C

$105

$70

+

$50

= $

120

$15

Question

For Scenario

1,

how would the entity allocate the discount in the

contract?

?Slide62

Relevant resources

Relevant Guidance in ASC 606

606-10-32-28

through 32-30606-10-32-31 through 32-35606-10-32-36 through 32-38606-10-32-39 through 32-41

Relevant Sections in Deloitte’s Roadmap

8.1

Allocation Based on Stand-Alone Selling Price

8.2

Allocation of a Discount

8.3

Allocation of Variable Consideration

Case

study:

Allocating a discountSlide63

Case study answer: Allocating a discount

For Scenario 1, how would the entity allocate the discount in the contract?The entity does NOT have sufficient evidence to demonstrate that the discount in the contract relates to any specific performance obligation (i.e., the evidence does not support that the discount is not just a volume-based discount attributable to a customer buying a bundle of items). Accordingly, the discount of

$15 should be allocated pro-rata to each of the performance obligations based on their individual stand-alone selling prices

. The entity would recognize revenue as follows:When A is transferred, recognize revenue of $27 (30 – 3)When B is transferred, recognize revenue of $63 (70 – 7)When C is transferred, recognize revenue of $45 (50 – 5)

Total

revenue recognized on contract = $135

Item

SSP

% of Total SSP

Total Discount to Allocate

Discount Allocated

Item A

$30

20.0%

$15

$3

Item B

$70

46.7%

$15

$7

Item C

$50

33.3%

$15

$5

$150

$15Slide64

Case

study:

Allocating a discount

Case facts

SCENARIO 2

On January 1, 20X1, the entity enters into a contract with a customer to provide the customer with one of each item for consideration of $135 (a $15 discount) based on the schedule to the right:



Date

Deliverable

03/31/X1

Item

A

06/30/X1

Item

B

09/30/X1

Item

C

The following bundles are also regularly sold at the following combined prices:



Bundle

Price

Combined Standalone Selling Price

Discount in Bundle

A + B

$85

$30

+

$70

=

$100

$15

A + C

$65

$30

+

$50

=

$80

$15

B + C

$120

$70

+

$50

=

$120

$0

Question

For Scenario 2, how would the entity allocate the discount in the contract?

?

As a reminder, the standalone selling prices of A, B, and C are as shown to the right:



Product

Standalone Selling Price

Item

A

$30

Item

B

$70

Item

C

$50Slide65

Case study answer: Allocating a discountFor

Scenario 2, how would the entity allocate the discount in the contract?In this scenario, the evidence supports that there is a discount of $15 when the entity sells a bundle of two items that includes A and a discount of $0 for all other bundles that contain products other than A. Accordingly, it is reasonable to conclude that the discount of $15

should be allocated entirely to item A in accordance with ASC 606-10-32-37.

The entity would recognize revenue as follows:When A is transferred, recognize revenue of $15 [$30 (SSP of A) – $15 (full discount)]When B is transferred, recognize revenue of $70When C is transferred, recognize revenue of $50Total revenue recognized on contract = $135Slide66

Session III Slide67

Step 5: Recognizing RevenueSlide68

Activity overview

Total time: ~40 minutesFor this activity, we will:Review guidance on Step 5Review case facts and question

Discuss at tables (5 minutes for each)

Debrief as a group (10 minutes for each)Slide69

Step 5: Recognizing revenueEvaluate if control of a good or service transfers over time, if not then control transfers at a point in time.An entity satisfies a performance obligation over time if… OR OR

Measure progress toward completion using input/output methodsPerformance does not create an asset with an alternative use and the entity has an enforceable right to payment

for performance completed to date.

Performance creates or enhances a customer controlled asset. (e.g., home addition)The customer receives and consumes the benefit as the entity performs. (e.g., cleaning service)ORORSlide70

Step 5: Recognizing revenueFor performance obligations satisfied at a point in time, indicators that control transfers include, but are not limited to, the following:

The entity has a present right to payment.The customer has legal title.

The entity has transferred physical

possession.The customer has the significant risks and rewards of ownership.The customer has accepted the asset.Slide71

Case

study

:

Right to

payment

(Over

time

vs.

point

-in

-time

)

Case f

acts

January

1, 20X1, Entity X

enters

into two

contracts

with

customers that are similar except for termination provisions. Each is for the

sale of 10,000 customized parts at $100 per

part. The

parts have no alternative use to

Entity X (ASC 606-10-25-28).

On March 31, 20X1,

Entity X produced

and

held a total of 4,000

parts

of finished goods

and

an additional

100 parts

in WIP

with

costs-to-date

of $

5,000.

The total cost to produce each part is $90.

Contract

A

Contract A states

that if the contract is terminated, the customer

is

required to pay the full price for all finished

goods on hand. For parts

in

process, the customer is required to pay Entity X

its

cost plus 10%

which

is the expected margin on the finished

goods (and

therefore a reasonable margin

).

As such, if the contract is terminated on March 31, 20X1, Entity X would be entitled to $405,500 ($100 for the 4,000

finished

goods and cost

of $5,000

plus 10% for the 100 parts in

WIP).

Contract

B

C

ontract B states

that if the contract is terminated, the customer is required to pay the full price for all finished goods on hand and

only Entity’s

X’s cost

for

any parts in process. As such, if the contract is terminated on March 31, 20X1, Entity X would be entitled to $405,000 ($100 for the 4,000

finished

goods and cost

of $5,000

for the 100 parts in

WIP).

Question

How should

Entity X

recognize revenue

for

contract A

and B

– i.e., over time or at a point-in-time?

?Slide72

Relevant resources

Relevant Guidance in ASC 606

ASC 606-10-25-27(c)

ASC 606-10-25-29ASC 606-10-55-11 through 55-15Relevant Sections in Deloitte’s Roadmap

9.2.4 Right to Payment for Performance Completed to Date

Case study:

Right to

payment

(Over

time

vs.

point

-in

-time

) Slide73

Case study answer: Right to payment (Over time vs. point-in-time

) How should Entity X recognize revenue for contract A and B – i.e., over time or at a point-in-time? Entity X needs to assess whether it has an enforceable right to payment for performance completed to date under the context of ASC 606-10-25-27(c). Contract B only allows entity X to recover its cost (without a margin) on parts in

process upon termination. Therefore, Contract B

would not be considered to have “an enforceable right to payment for performance completed to date” at all times during the contractual term. As such, Contract B does not meet the requirement to recognize revenue over time (i.e., recognized at point in time when parts are transferred). Contract A does meet criteria for recognition of revenue over time. As a result, the financial statement impact differs as follows on March 31, 20X1:  Contract A

Contract B

Balance Sheet

Finished goods

-

$360,000

Work in Process

-

5,000

Contract asset

$405,500

-

Income Statement

Revenue

$405,500

-

Cost of goods sold

$365,000

-Slide74

Case

study

: Nature of a license

Case f

acts

Scenario 1: A film distribution entity licenses a new hit film to a movie theater for showing over a 3 month period (December through February) for fixed consideration of $50,000. Historically, the entity has marketed the film (e.g., via television, radio, print advertising, and billboards) in all regions in which it licenses the film.

Scenario 2: An entity licenses to licensee for fixed consideration of $50,000 the right to use the trademark of a professional sports team that no longer exists.

Question

How should licensor recognize revenue– i.e., over time or at a point-in-time?

?Slide75

Case study answer: Nature of a license

How should licensor recognize revenue– i.e., over time or at a point-in-time? Is nature of license functional or symbolic?Scenario 1 – Functional. Revenue for the license should be recognized at the point that control transfers.Scenario 2 – Symbolic. Revenue for the license should be recognized over the license period.Slide76

Gross versus Net PresentationSlide77

Activity overview

Total time: ~20 minutesFor this activity, we will:Review guidance on contract costReview case facts and question

Discuss at tables (5 minutes)Debrief as a group (

10 minutes)Slide78

Gross versus Net Indicators

Presumption:

Principal if control promised good or service before the transfer to the customer

Indicators to consider in determining gross or net reporting:Primarily responsible for fulfilling the contractLatitude in establishing priceConsideration in form of a commissionHas physical loss inventory risk—after customer order or during shippingCredit riskIs nature of the performance obligation to provide the specified goods/services itself of arrange for another party to provide?Slide79

Should ABC Company report as revenue the gross amounts received from Customers for vacation rentals?

Would

net revenue presentation be more appropriate?

What information do you think is relevant / needed for the analysis?

ABC Company (the “Company”) provides a vacation rental program to individuals (“Customers”) seeking to rent vacation homes and utilize the amenities (e.g., golf courses, tennis courts, etc.) through the Company’s club and resort facilities. The Company does not own the properties that it rents but rather enters into agreements with the homeowners that allow the Company to rent their homes as part of a vacation package. Homeowners received a percentage of the net rental income collected by the Company.

The Company does not market or promote a specific house/unit but rather markets/promotes a vacation experience, manages all interactions with Customers and is the only entity with an agreement with Customers. The Company has full discretion in determining the rental fee and is primarily responsible for the entire customer experience (including housekeeping services, concierge services, amenities, etc.). If a Customer is not satisfied with the house/unit, the Company is responsible for finding a suitable replacement.

Case

study

: Gross versus Net

Case

facts

Questions

?Slide80

Question 1: Should ABC company report revenue gross or net?

ABC company should report gross revenue.Indicators pointing towards gross presentation:Primarily responsible for fulfilling the contractLatitude in establishing priceCredit risk 

Case study answer: Gross versus Net Slide81

Contract CostsSlide82

Activity overview

Total time: ~20 minutesFor this activity, we will:Review guidance on contract costReview case facts and question

Discuss at tables (5 minutes)Debrief as a group (

10 minutes)Slide83

Contract costsCosts to obtain a

contractCapitalize costs of obtaining a contract if they are incremental and expected to be recovered (e.g., sales commissions)1 year practical expedient

Capitalized costs are amortized on a systematic basis consistent with the transfer of the related goods or services

82Costs to fulfill a contractRecognize assets in accordance with other Topics (inventory, PP&E, software, etc.), otherwise capitalize costs that:relate directly to the contract (or specific anticipated contract);

generate/enhance a resource that will be used to satisfy obligations in the future; and

are expected to be recovered

Costs that relate to satisfied performance obligations (or partially satisfied performance obligations) must be expensed when incurred

Impairment

Recognize immediately if costs not deemed recoverableSlide84

Question

1: What amount(s) should

Entity G capitalize

upon initial signing of the contract and upon contract renewal? Question 2: What is the amortization period for both the initial commission and the renewal commission?

Case

study

:

Costs to

obtain

a

contract

Case

facts

Entity G, a janitorial services provider, enters into a contract with a customer to provide cleaning services for a two year period.

Upon the initial signing of the contract, Entity G pays a salesperson a $200 commission for obtaining the new customer contract. An additional

commission of $120

is paid each time the customer renews the contract for an additional two years.

The $120 renewal commission is not commensurate with the $200 initial commission (i.e., a portion of the $200 initial commission relates to future anticipated contract renewals)

Based on its historical experience,

98%

of customers renew their contract for at least two more

years or four years total (i.e., the contract renewal represents a specific

anticipated

contract).

The average customer relationship is

four

years.

Questions

?Slide85

Relevant resources

Relevant Guidance in ASC 606

340-40-25-1

through 25-4 340-40-35-1 through 35-2 Relevant Sections in Deloitte’s Roadmap12.1 Costs of Obtaining a Contract

12.3

Amortization and Impairment of Contract Costs

Case

study:

Costs to obtain a contract Slide86

Question 1: What amount(s) should Entity G capitalize upon initial signing of the contract and upon contract renewal?

Entity G should capitalize the $200 paid for the new customer contract at contract inception as the commission represents an incremental cost of obtaining a contract that would not have been incurred unless the contract was obtained and the obligating event occurred (i.e. the contract was obtained which requires the commission to be paid to the salesperson). The Entity should not recognize any portion of the $120 at contract inception as it does not yet meet the definition of a liability and also does not meet the requirements to be capitalized as an incremental cost of obtaining a contract. Instead, Entity G should capitalize the $120 when the contract is subsequently renewed.  

Case study answer:

Costs to obtain a contract Slide87

 Question 2: What is the amortization period for both the initial commission and the renewal commission?

There are two views that could be acceptable under ASC 340-40. Amortization of Initial Commission:View A – Amortize the initial amount capitalized over the contract period that includes the specific anticipated renewals - that is, over the

four year period. View B –

Bifurcate the initial $200 commission into two components and amortize: (1) $120 over the original contract term (i.e., the amount commensurate with renewal commissions) and (2) $80 over the contract period that includes the specific anticipated renewals.Amortization of Renewal Commission ($120):In either case, the renewal commission is amortized over renewal period ( additional $60 in each years 3 & 4).

Case study answer:

Costs to

obtain

a

contract

Year 1

Year 2

Year 3

Year 4

View A

$50

(=$200/4)

$50

(=$200/4)

$50

(=$200/4)

$50

(=$200/4)

View B

$80

(=$120/2 + $80/4)

$80

(=$120/2 + $80/4)

$20

(=$80/4)

$20

(=$

80/4)Slide88

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