it’s here: the new revenue recognition standard
DESCRIPTION
It’s Here: The New Revenue Recognition Standard. Presented by: Timothy Wilson, CPA, CCIFP September 26, 2014. Agenda. Where Have We Been? Truth or Myth? The New Recognition Model Disclosures Effective Dates Q&A Session (If Time Allows). - PowerPoint PPT PresentationTRANSCRIPT
IT’S HERE: THE NEW REVENUE RECOGNITION STANDARD
Presented by: Timothy Wilson, CPA, CCIFPSeptember 26, 2014
Where Have We Been? Truth or Myth? The New Recognition Model Disclosures Effective Dates Q&A Session (If Time Allows)
Agenda
2
Revenue from Contracts with Customers―Finally!!ASU 2014-09
3
Revenue Recognition StandardWhere Have We Been?
Revised Exposure Draft Issued November 14, 2011 Goals
Develop a common revenue standard for all industries, jurisdictions & capital markets
Condense 100+ U.S. GAAP rules into one high-quality standard Intended to repeal/replace current accounting & reporting
guidance (including all existing construction-specific revenue & cost guidance)
4
Revenue Recognition StandardWhere Have We Been?
Revised Exposure Draft comes after receiving substantial comment letter input from original exposure draft―nearly 1,000 comment letters
Nearly 350 comment letters from construction industry submitted in response to Revised Exposure Draft
A number of matters that were of consequence & concern to the construction industry remained
Substantial redeliberations took place throughout most of 2013, with additional meetings through early 2014
5
Revenue Recognition StandardWhere Are We Now?
New Accounting Standard issued on May 28, 2014 New definitions, terminology & disclosures Introduces new complexities for construction industry Financial statement users, e.g., lenders & sureties, are
monitoring this closely
6
Revenue Recognition Standard Got a lot of things right that we were expecting
How a performance obligation is defined
Clarifying continuous transfer criteria
No preference for inputs vs. outputs methods on measuring
progress
Relief from disclosures for nonpublic entities But …
7
Revenue Recognition Standard There are some areas that may create unique challenges Examples include
Claims & unapproved change orders
Time value of money
Estimation of variable consideration
Exclusion of inputs that are not reflective of progress toward
completion―waste/rework
Uninstalled materials
8
Revenue Recognition Standard
Revenue Recognition Final Standard
Let’s Start Looking!!
9
Truth or Myth?
Did Percentage of Completion go away? Can you recognize profit on uninstalled materials? Will most contracts have multiple performance obligations?
10
Truth or Myth?
Will I have to recalculate all completed contracts under the new standard?
Is cost to cost still valid to determine percentage complete? Will I have to add 10 pages of footnotes to my audit report?
11
Revenue Recognition StandardRecognition Model – Steps Involved
Recognize revenue when (or as) performance obligations are satisfied
Allocate transaction price to performanceobligations
Determine transaction price
Identify separate performance obligations in contract 2
3
4
5
Identify contract with customer 1
12
Revenue Recognition StandardStep 1: Identify Contract with Customer
Five criteria for existence of a contract
Commercial substance
Approval by both parties
Identifiable rights regarding assets to be transferred
Identifiable payment terms (even if amount is uncertain)
Probable that you will collect consideration you are entitled to
13
Revenue Recognition StandardStep 1: Identify Contract with Customer
Combination of contracts Contracts are negotiated with a single commercial objective Amount of consideration in one contract depends on the other
contract
Goods or services are a single performance obligation Segmenting
Inherent in identification of separate performance obligations
14
Revenue Recognition StandardStep 1: Identify Contract with Customer
Contract modifications New contract if distinct goods or services are at standalone selling
price Prospective accounting
Continuation of contract if remaining goods or services are distinct from existing contract Prospective accounting
Continuation of contract if goods or services are not distinct from existing contract Cumulative catch-up
15
Revenue Recognition StandardStep 2: Identify Separate Performance Obligations in the Contract
Performance obligation: Promise to deliver a good or provide a service
Separately account for a performance obligation if “distinct” Distinct
Customer can benefit from the good/service on its own
Good/service is separable from other goods/services in contract All promises for distinct goods or services must be evaluated
(even if inconsequential)
16
Revenue Recognition StandardStep 2: Identify Separate Performance Obligations in the Contract
A whole contract may be one performance obligation―how? A good or service is not distinct if
Goods & services are highly interdependent & interrelated
Entity provides a significant integration service
Goods or services significantly modify or customize other goods &
services in contractAs a result, expectation is typically one performance obligation for many (not all) construction-type contracts
17
Performance ObligationsFact Pattern
Design/build contract for new high-rise building
Contract includes Engineering
Clearance
Excavation
Soil sampling
Foundation
Procurement of materials
Installation of systems
Overall project management
18
Performance Obligations
One―but why? Goods & services are highly interrelated & interdependent Significant service of integrating goods or services is provided
How many different products & services would you separately account for?
19
Revenue Recognition Standard
Transaction price The amount of consideration to which an entity expects to be
entitled to receive in exchange for transferring goods or services Variable consideration Examples include awards/incentives, liquidated damages,
claims, unpriced change orders Estimate expected value (probability-weighted) or most likely
amount Constraint: Probable that a significant reversal will not occur
Qualitative assessment
Step 3: Determining Transaction Price
20
Revenue Recognition Standard
Time value of money Discounting required only if there is a significant financing
component (receivable or payable) One-year practical expedient Retention?
Collectability Estimate bad debt & present separately as a component of SG&A
expenses
Step 3: Determining Transaction Price
21
Revenue Recognition StandardVariable/Contingent Consideration
Application of constraint concept When are/will the following be recognized on a contract
Performance award incentive for early completion Performance award incentive for quality of construction Performance award incentive for attaining LEED Platinum Cert. Performance award penalty (contract reduction) for delays Performance award penalty (contract reduction) for lower-quality
material substitution
22
Revenue Recognition StandardClaims & Unapproved Change Orders
Requirement for recognition Refer to the five criteria for contract existence Key: Approval by both parties
Contractors make changes on the fly … Contract modifications, including a contract claim, would be
approved when modification creates or changes enforceable rights & obligations of parties to the contract
23
Revenue Recognition StandardClaims & Unapproved Change Orders
If approved as to scope, even if unpriced, company may be able to recognize estimated margin on change orders
What does this mean? More focus on treatment of “approved as to scope”?
More focus on rationale for estimated margin?
24
Revenue Recognition StandardClaims & Unpriced Change Orders
Unpriced change orders Old rule – Generally reflect if recovery is probable & reasonably
estimated New rule – Generally reflect when contractor expects the price
change will be approved & there is not an expectation that the estimate will have a significant reversal in the future
Claims Old rule – Generally reflect when probable & estimable up to the
extent of costs incurred―no margin until realized New rule – Generally include in transaction price when there is
not an expectation that the estimate will have a significant reversal in the future
25
Unpriced Change OrdersFact Pattern
Single performance obligation to construct a hospital Change order is for goods that are a necessary part of
contractor’s service of integrating goods/services to construct the hospital
Typically agree on price shortly after work associated with change order begins
26
Unpriced Change OrdersWhat is the impact to the transaction price? History indicates price will ultimately be approved Therefore, estimate transaction price using variable
consideration principlesHow do you account for this change order? The goods/services associated with this change order are not
distinct Therefore, account for this change order using a cumulative
catch-up adjustment, i.e., “catch up” the amount of revenue recognized as if this change order had been in place since contract inception
27
Revenue Recognition StandardTime Value of Money
Requirement for application/discounting Transaction/contract price adjusted to reflect the time value of
money if a significant financing component exists Considerations
Expected length of time between delivery of goods & services & receipt of payment
Whether amount of payment would differ substantially if cash payment was received in accordance with typical credit terms
28
Revenue Recognition StandardTime Value of Money
Exception Expectation at contract inception Period between payment & performance < 1 year Applicable to contracts > 1 year in duration if period between
performance & payment is < 1 year
29
Revenue Recognition StandardTime Value of Money
Retention Will depend on contract terms & normal practices Retainage is generally intended to protect the customer & is
typically not a form of financing
30
Award FeeFact Pattern
Construct an airport baggage system One-year contract with due date December 31
Contract price $30m fixed fee $2m award fee if completed by October 31
Baggage system is “off the shelf” & has been sold before in substantially same form
Contractor has ability to complete job by October 31
31
Award FeeWhat is the most appropriate estimation method? Most likely amount (best estimate)
Possible outcome is binary―“all or nothing”How much revenue would I recognize & when? $32m ($30m fixed price plus $2m best estimate)
Outcome in contractor’s control History of performing similar contracts
Recognize total amount of transaction price as the baggage handling system is constructed, so long as it’s probable a significant reversal will not take place
32
ClaimsFact Pattern
Customer has caused significant delay on contract Contractor initiates a claim of $5m to recover costs & profit Contractor & customer have history of negotiating claims &
settling for an amount typically different than initial claim
33
ClaimsWhat is the most appropriate estimation method? Expected value
Many possible outcomes likely existWhen would you include this claim in the transaction price? When an amount is not likely to undergo a significant reversal in
the future In its early stages, this might be a portion of the claimWhen would a contractor know to recognize a “minimum amount”? One example is when a contract gives the contractor a right to
recover costs for customer-caused delays
34
Revenue Recognition Standard
Step 4: Allocate Transaction Price to Performance Obligations
Allocate the amount an entity expects to receive in exchange for satisfying each separate performance obligation
Use standalone selling prices of goods or services (estimated if necessary)
35
Allocation of ConsiderationFact Pattern Contract to build a school & an adjacent football field for $100m
Assume the school & field are separate performance obligations Standalone selling price
School: $100m Field: $11m
36
Allocation of Consideration
Field School
Standalone selling price 11M(10%)
100M(90%)
Total combined consideration 100M
Relative standalone selling price 10M 90M
37
Revenue Recognition Standard
Step 5: Recognize Revenue when (or as) Performance Obligations Are Satisfied Recognize revenue over time when
Customer receives benefits as entity performs Cleaning services
Creates or enhances an asset that the customer controls, or Building on land owned by customer
Does not create an asset with alternative use & entity has right to payment for work completed to date Consulting work
38
Revenue Recognition StandardStep 5: Recognize Revenue when (or as) Performance Obligations Are Satisfied Measuring progress toward completion
Output methods or input methods permitted Examples of input methods
Labor hours/dollars, machine hours, costs incurred, time Examples of output methods
Units delivered, surveys completed If input method is used, must exclude inputs that do not depict
performance (owner-provided materials, waste, uninstalled materials―key for contractors)
Zero margin may be appropriate in some circumstances, e.g., early stage of contract, uninstalled materials
39
Revenue Recognition StandardStep 5: Recognize Revenue when (or as) Performance Obligations Are Satisfied
Recognize revenue at a point in time only if control doesn’t transfer over time
Factors to consider Entity has present right to payment Customer has accepted the asset Physical possession of asset transferred Customer has significant risk & rewards Customer has legal title to asset
40
Revenue Recognition StandardUninstalled Materials
Requirement is to exclude the cost of uninstalled materials that are not reflective of contract progress If customer obtains control of goods before they are installed,
recognize revenue equal to cost of goods transferred Impacts input method (cost to cost) of determining progress Effect on bonding/underwriting?
41
Recognize RevenueFact Pattern Two-year contract to build a new football stadium for $600m Estimated contract cost is $500m. Cost incurred at end of year
one is $200m Specifications are customized Interim progress payments are agreed upon to coincide with job
progress Physical possession & title do not pass until completion Contractor determined that there is one performance obligation Contractor concludes that cost is the best measure of control
transfer
42
Recognize RevenueHow much revenue is recognized at the end of year one? $240m
How is that amount calculated?Cost incurred to date: $200mTotal cost: $500mPercent complete: 40%Total consideration: $600mRevenue recognized: $240m
Doesn’t that look like the percent complete calculation I used to do? Now that you mention it―it does look familiar, doesn’t it?
43
Recognize RevenueFact Pattern Assume same fact pattern as in previous example, except Estimated contract cost is $500m, including $75m for specialized
equipment. Cost incurred at end of year one is $200m At the end of year one, $75m of the estimated contract cost
relates to specialized equipment & is not installed, but customer obtained control of equipment upon delivery to construction site
44
Recognize RevenueHow much revenue is recognized at the end of year one? $227m
How is that amount calculated?Cost incurred to date: $200mEquipment cost: ($75m)Total: $125mPercent complete: 29% (125m/425m); ($425 = $500 expected cost less
$75m equip. cost)Total consideration: $600mEquipment cost: ($75m)Total: $525mProgress revenue: $152mEquipment revenue: $75m Total revenue: $227m
45
Revenue Recognition Standard Other items
Contract costs Onerous (loss) contracts Disclosures Effective date & transition
46
Contract Costs Incremental cost to obtain a contract
Must capitalize if expect to recover May be expensed if amortization period is one year or less
Contract fulfillment costs Look to other guidance first (inventory) If not in other guidance, capitalize only if
Relate directly to a contract Relate to future performance & Expect to recover
Revenue Recognition Standard
47
Revenue Recognition Standard
Contract Costs Amortize capitalized costs as control transfers Caution: Will need to consider impairment
48
Revenue Recognition Standard
Onerous (Loss) Contracts As with current guidance, contractors would accrue an
anticipated loss once identified Cost of settling performance obligation is more than transaction
price
49
Revenue Recognition Standard
Onerous (Loss) Contracts Challenge lies with interplay between various provisions Transaction price includes amounts the entity expects to be
entitled to “Expects to be entitled to” can include claim revenue
Even if you don’t yet recognize claim revenue, you might count the claim revenue in the transaction price & in doing so defer a loss
50
Revenue Recognition Standard
Disclosures Disaggregation of revenue by category
Type of good or service Country or region Type of customer Type of contract
Reconciliation of contract balances & costs Narrative disclosures
Some relief for nonpublic entities
51
Revenue Recognition Standard
Effect on Traditional GAAP Benchmarks Bank covenant requirements
Earnings metrics Excess cash flow payments
Employee performance incentives – Bonuses based on revenues &/or net income
52
Revenue Recognition StandardEffective Date & Transition Public companies: Annual periods (& interims within) beginning after
December 15, 2016 (2017 for calendar-year companies) Early adoption is prohibited
Nonpublic companies: Annual periods beginning after December 15, 2017 (2018 for calendar-year companies) Early adoption is permitted, no earlier than public company date
Transition Retrospective application – Restate prior periods upon adoption, or
Apply to existing contracts in progress on the effective date & new contracts going forward Requires cumulative effect adjustment & certain additional transition disclosures
53
Revenue Recognition StandardWhat’s Going on Now?
FASB – Transition Resource Group for Revenue Recognition- http://www.fasb.org/jsp/FASB/Page/LandingPage&cid=1176164065747
AICPA – established task forces to develop content, focus on guidelines for implementation-principles based
Working closely with Aerospace & Defense task force Content reviewed/approved by Revenue Recognition Working Group before
it goes to TRG
54
Revenue Recognition StandardWhat’s Going on Now? AICPA published a Learning and Implementation Plan:
http://www.aicpa.org/InterestAreas/FRC/AccountingFinancialReporting/RevenueRecognition/DownloadableDocuments/2014-09_LIPlan.pdf
AICPA also published a primer for Audit Committees:http://www.aicpa.org/InterestAreas/FRC/AccountingFinancialReporting/RevenueRecognition/DownloadableDocuments/2014-09_ACPrimer.pdf
55
