Faculty Consortium Principles Under the New Revenue Recognition Standard May 2015 Dear Participants We look forward to discussing with you the principles under FASBs new ASU ASU 201409 on revenue recognition also known as ASC 606 in the Accounting Standards Codification ID: 572925
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2015 Deloitte Foundation/Federation of Schools of Accountancy Faculty ConsortiumPrinciples Under the New Revenue Recognition Standard
May 2015Slide2
Dear Participants,We look forward to discussing with you the principles under FASB’s new ASU (ASU 2014-09) on revenue recognition (also, known as ASC 606 in the Accounting Standards Codification). As part of this discussion, we will use case studies to illustrate certain principles. In order to make the most efficient use of our time, this guide contains the cases we will discuss and relevant references within ASC 606. You can also find relevant guidance in Deloitte’s Roadmap on Revenue at:http://www.iasplus.com/en-us/publications/us/roadmap-series/revenuePlease review the cases and relevant Codification cites prior to the conference. You should be prepared to discuss your views on application of the principles to the particular fact patterns.We hope you find this conference and discussion of these cases interesting and helpful.Participant GuidePrinciples Under the New Revenue Recognition StandardSlide3
Course IntroductionSlide4
AgendaCourse flowNew Revenue Recognition Standard Review
Case Studies & DiscussionSession I: Step 1: Identification of a contract with a customer & Step 2: Identifying the performance obligations
Session II: Step 3:
Determining the transaction price & Step 4: Allocating the transaction price
Session III: Step 5: Recognizing revenue
& other issuesSlide5
New Revenue Recognition Standard ReviewSlide6
The five steps revenue recognition processCore 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.Slide7
Case Studies Slide8
Session I Slide9
Step 1: Identifying the ContractSlide10
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.
?Slide11
Relevant resources
Relevant Guidance in ASC 606
ASC 606-10-25-1
ASC 606-10-25-5 through 25-8
ASC
606-10-10-4
Case
study:
Assessing collectability of contracts Slide12
Step 2: Identifying the Performance ObligationsSlide13
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 3
rd
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
?Slide14
Relevant resources
Relevant Guidance in ASC 606
ASC 606-10- 25-14 through 26
Case
study: Synthetic FOB destinationSlide15
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
?Slide16
Relevant resources
Relevant Guidance in ASC 606
606-10-25-20
606-10-25-21
Case
study:
Identifying performance obligations for a manufacturer Slide17
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?
?Slide18
Relevant resources
Relevant Guidance in ASC 606
ASC 606-10-55-50 through 55-53
ASC 606-10-55-41 through 55-45
Case study:
Material
right
(Nonrefundable
upfront fees
) Slide19
Session II Slide20
Step 3: Determining the Transaction PriceSlide21
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
?Slide22
Relevant resources
Relevant Guidance in ASC 606
606-10-32-5
through
32-9
606-10-32-11
through 32-13
606-10-32-15
through 32-20
606-10-45-1
through
45-5
Case
study:
Accounting for contingent revenue Slide23
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
?Slide24
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
?Slide25
Step 4: Allocating the Transaction PriceSlide26
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 1On 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?
?Slide27
Relevant resources
Relevant Guidance in ASC 606
606-10-32-28
through 32-30
606-10-32-31
through 32-35
606-10-32-36
through 32-38
606-10-32-39
through 32-41
Case
study:
Allocating a discountSlide28
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
$50Slide29
Session III Slide30
Step 5: Recognizing RevenueSlide31
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 AContract 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
BC
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?
?Slide32
Relevant resources
Relevant Guidance in ASC 606
ASC 606-10-25-27(c)
ASC
606-10-25-29
ASC 606-10-55-11 through 55-15
Case study:
Right to
payment
(Over
time
vs.
point
-in
-time
) Slide33
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?
?Slide34
Relevant resources
Relevant Guidance in ASC 606
606-10-55-54 through 58
Case
study: Nature of a licenseSlide35
Gross versus Net PresentationSlide36
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 Presentation
Case
facts
Questions
?Slide37
Relevant resources
Relevant Guidance in ASC 606
606-10-55-36 through 40
Case
study: Gross versus Net PresentationSlide38
Contract CostsSlide39
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
?Slide40
Relevant resources
Relevant Guidance in ASC 606
340-40-25-1
through 25-4
340-40-35-1
through 35-2
Case
study:
Costs to obtain a contract Slide41
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!
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