Understanding & Adopting the New Revenue Recognition Standard

Presented by, Mark Dauberman, CPA CGMA EMBA

Revenue Recognition

fromContracts With

Customers

A Review of Key Provisions

Application

•Effective dates: Nonpublic entities not having adopted standard as of June 3, 2020

Annual periods beginning after December 15, 2019

Interim periods within annual periods beginning after December 15, 2020

Core Revenue Recognition Principle

Revenue recognized upon transfer of

promised goods or services to customers

Amount reflects consideration entity expects to realize in exchange for those goods or services

Five Step Process

Identify contract with customers

Identify separate performance

obligations in contract

Determine transaction price

Allocate transaction price to separate

performance obligations

Recognize revenue when entity satisfies

performance obligations, or while

they are being satisfied

Ste

p 1

– • Contract agreement between two or more parties

• Criteria to be considered contract

• Parties to contract have approved provisions

and are committed to perform

• Rights and payment terms can be identified

• Contract has commercial substance

• Collection is probable

Identify Contracts

With Customers

Ste

p 2

–

Performance obligation is

enforceable promise to transfer

a good or service to a customer

Identify Separate

Performance Obligations

Mu

ltip

le

De

liv

era

ble

s

• Treated as separate performance obligations if distinct

Distinct if both of the following criteria are met:

Customer can benefit from good or service, either on its own or together with other resources readily available to the customer

The promise can be distinguished from other promises in the contract

Always considered not distinct, & accounted for as single performance obligation when any of the following conditions apply:

Goods or services in bundle are highly interrelated & transfer requires significant integration services

Bundle of goods or services significantly modified or customized for contract

The goods or services are highly interrelated

Polling Question #1

• What aspect of the accounting profession are you involved in?

1 – I am a CPA working in public accounting.

2 – I am a CPA working in private industry, government, or for a not-for-profit.

3 – I am a CPA working outside of the profession of accounting, for example as an investment advisor.

4 – Accounting? I must be in the wrong room. Do you know where the Committee for Protecting Everything is meeting?

Ste

p 3

–

•Amount of consideration to which entity expects to be entitled in exchange for transferring goods or services

Excludes amounts collected on behalf of third parties

May include fixed amounts, variable amounts, or both.

Determine

Transaction Price

Includes consideration of various factors

Variable consideration recognized at expected amount

Time value considered if financing component is significant

Noncash consideration measured at fair value

Consideration given to a customer

May be for distinct goods or services

Otherwise, reduces transaction price

• Allocated to all performance obligations in proportion to standalone selling prices

Standalone selling prices as of date of contract inception

Amount estimated when standalone selling prices not known

Allocate

Transaction PriceS

tep

4 –

Polling Question #2

• At what level do you function within your firm or company?1 – I am a decision-maker in relation to the overall operations of my organization.

2 – I make decisions related to my department or division, subject to override by officers or executives.

3 – I supervise other employees, but do not have decision-making authority.

4 – I have responsibilities in relation to my role, but do not supervise others and do not have decision-making authority.

Ste

p 5

–

• Recognized when performance

obligations are satisfied or as they are

being satisfied

Satisfied when entity transfers promised good or service to customer

Transferred when, or as, customer obtains control of goods or services

Revenue Recognized

Customer Control Over Promised Good or Service

Various factors considered in determining when customer obtains control

Entity has present right to payment

Customer has legal title to asset

Entity has transferred physical possession of asset

Customer has significant risks & rewards of ownership

Customer has accepted asset

Performance Obligations Satisfied Over Time

Satisfied over time if promised good or service is transferred over time

Otherwise considered satisfied at a point in time that entity satisfies performance obligation in entirety

To Be Satisfied Over Time, One of Three Criteria Apply

The customer consumes the benefits provided by the seller’s performance as they are received

Performance creates or enhances an asset in control of customer while being created or enhanced

•Performance does not create an asset with an alternative use to the performing entity

AND

•Entity has a right to payment for performance to date & expects to fulfill the contract as promised

Recognition of Revenue Over Time

Based on progress toward satisfying performance obligation

May be measured under inputs or outputs approach

Updated as circumstances change

Variable Revenue That is Recognized Over Time

Cumulative amount

recognized should not

exceed amount to which entity is assumed entitled

• Entity has experience with similar types of performance criteria

• Entity’s experience is predictive

Determined on the basis of meeting two

criteria

Onerous Performance Obligations

Lowest cost of satisfying performance obligation exceeds contract price allocated to it

Entity recognizes liability & corresponding expense

Accounting for Costs

Certain costs may be recognized as assets

Recoverable incremental costs of obtaining a

contract

Costs required by standards to be

capitalized

Costs meeting certain criteria

Costs of obtaining a contract recognized as expense when incurred

Criteria for Capitalizing Costs Associated with Contracts

•Costs must meet all the following three criteria:

They relate directly to a contract or a specific contract under negotiation

They generate or enhance resources that will be used to satisfy performance obligations in the future

They are expected to be recovered

Polling Question #3

Do you believe that closely-held and publicly-held entities, big or smallshould apply the same accounting principles?

1 - Yes. I believe that when 2 entities enter a similar transaction, regardless of size or ownership, the accounting can be the same.

2 – Yes, but nonpublic entities, especially smaller ones, should not be required to provide disclosures with the same level of detail and amount of information.

3 – Yes , but GAAP needs to be made less complex and voluminous for all entities as the cost of compliance exceeds the benefit.

4 – No, publicly-held entities often enter transactions for different reasons and in different amounts than nonpublic entities, especially smaller ones.

ADOPTING THE NEW

REVENUE RECOGNITION

STANDARDA Guide for Nonpublic Entities

Recording the Initial Adoption

Selection of Method Used for

Adoption

Revenue Related Accounts

Reported on the Balance Sheet

Journal Entries for

Adopting the New

Standard

Disclosures

Initial Adoption

Two acceptable

approaches for adopting

the new standard:

Retrospective approach

Partial retrospective approach

Retrospective Approach

• Applied as of beginning of earliest period presented

Cumulative effect recognized as adjustment to beginning retained earnings in earliest period

Each period’s financial statements restated to reflect effects of new standard

• Elections available as practical expedients in period of adoption to allow nonpublic entity to avoid certain requirements.

Would not have to restate contracts initiated and completed in the same period

May use final contract price in place of applying requirements for variable consideration on contracts already completed

The entity would not be required to disclose portion of contract price allocated to performance obligations not yet satisfied, nor when the revenue from them is expected to be recognized

Not required to apply requirements for contract modification retrospectively for modifications made prior to the beginning of earliest period presented

Partial Retrospective

Approach

• Applied as of beginning of period of adoption

Cumulative effect recognized as adjustment to beginning retained earnings in that period

Financial statements for that period and subsequent periods restated to reflect effects of new standard

• Entity may elect which contracts to adjust retrospectively when measuring the cumulative effect

May elect to adjust amounts retrospectively for all contracts

May elect to adjust amounts retrospectively only for contracts not completed on that date

Cumulative Effect

•Net adjustment to opening balance sheet

Recognition issues

Measurement issues

Timing issues

Classification issues

Recognition Issues – All Transactions

• Assets and liabilities potentially applicable to any transaction: Contract receivable

Refund liability

Accrued revenue

Unearned revenue

Contract asset

Contract liability

Recognition Issues –Special Transactions

• Transactions with special provisions that may generate balance sheet accounts: Sale with right of return

Warranties

Entity acting as principal or agent

Options for additional goods or services

Prepayments and unexercised rights of customersNonrefundable upfront fees

Licensing

Repurchase agreements

Consignments

Bill-and-hold arrangements

Methodology

• Identify “open” revenue contracts as of beginning of period of adoption

Determine if criteria are met to qualify as contract with customer

If not, identify and measure balance sheet accounts using liability or deposit approach

If so, identify balance sheet accounts involved and determine if amounts differ

Adjust, create, or eliminate balance sheet accounts so that elements and balances agree

May result from change to requirements

May result from change to how aspects of transactions may be interpreted

May result from availability of more accurate or precise information

Polling Question #4

• When did you decide to become a CPA?1 – I knew I wanted to be an accountant from a very young age.

2 – I did well in bookkeeping and basic accounting classes in high school or early in my college career and pursued it since.

3 – I switched majors after not enjoying or not doing well studying a different field.

4 – I switched from a different career when it was not as rewarding as I had hoped.

Examples of Transactions to Consider Upon Adoption

Example #1 –

Transaction Not Meeting Criterion Related to Collectibility

• Calendar year entity sold used truck from inventory to customer on July 1, X1

Sales price $25,000, cost $18,000 Received $5,000 down payment Scheduled to receive $4,619.50 each

June 30, beginning 6/30/X2 Receivable bears interest at 5%

annually Seller obligated to provide maintenance

until last payment received Title to be transferred to buyer upon

receipt of last payment Collection not reasonably assured –

applied installment sales method under Topic 605, Revenue Recognition

Adopted Topic 606, Revenue from Contracts with Customers in year X3

Applying partial retrospective approach, recognizing cumulative effect adjustment as of 1/1/X3

Journal entries 7/1/X1 – 12/31/X2

Topic 605

See spreadsheet – Example 1 – Schedule #1

Balances at 12/31/X2 – Old

• Net Effect of All Entries Related to Sale Under the Old Standard

Assets

Cash +$9,619.50

Contract receivable +$16,380.50

Inventory – used trucks -$18,000.00

Interest receivable +$409.51

Liabilities

Deferred gross profit +$4,586.54

Income statement

Sales $25,000.00

Cost of sales $18,000.00

Unrealized gross profit $5,600.00

Realized gross profit $1,013.46

Interest income $1,409.51

Retained earnings +$3,822.97

Determining Transition Adjustment

Journal entries under new rule

See spreadsheet – Example 1 –Schedule #2

Desired Balances at 12/31/X2 – New & Transition Adjustment

• Net Effect of All Entries Related to Sale Under the New Standard

Assets

Cash +$9,619.50

Inventory – used trucks -$18,000.00

Inventory in custody of others +$18,000.00

Liabilities

Obligation to transfer truck title +$9,619.50

• Debit to retained earnings is the cumulative effect of the change, before tax

Transition Adjustment – See spreadsheet –Example 1 – Schedule #3

Polling Question #5

• How will the new revenue recognition standard affect your company or your clients?

1 – There will be little or no change to the amount recognized, but the information required for disclosures is difficult and costly to accumulate.

2 – It will significantly change the amount of revenue to be recognized in an individual period, but the amount will not change significantly in the long term.

3 – We have determined it will not have a material effect and are not adopting it.

4 – We have not completed our analysis and cannot yet measure the expected effect.

Example #2

Warranty Equivalent to a Service Contract

• Calendar year entity sold a washer and dryer to customer on October 1, X1 including a 3-year warranty for all service and repair

Sales price for the entire package was $2,000.

Standalone prices for the washer and dryer were $1,200 and $900, respectively. The entity does not sell service contracts.

The washer cost $900 and the dryer cost the entity $600

A local repair shop sells service contracts for the same washers and dryers for $300

Comparable to dealer warranty

Average cost of servicing the warranty is $180 for the 3-year period, including all costs for both appliances

Generally spent uniformly over the 3 years

Adopted Topic 606, Revenue from Contracts with Customers in year X3

Applying partial retrospective approach, recognizing cumulative effect adjustment as of 1/1/X3

Journal entries 7/1/X1 – 12/31/X2

Topic 605

See spreadsheet – Example 2 – Schedule #1

Balances at 12/31/X2 – Old

• Net Effect of All Entries Related to Sale Under the Old StandardAssets

Cash +$2,000.00

Inventory -$1,500.00

Misc. Acct. -$75.00

-Liabilities

Est. Warranty Liab. +$105.00

Income StatementSales $2,000.00

Cost of Sales $1,500.00

Warranty Expense $180.00

Retained Earnings +$320.00

Determining Transition Adjustment Journal entries under

new rule

See spreadsheet –Example 2 – Schedule #2

Desired Balances at 12/31/X2 – New & Transition Adjustment

• Net Effect of All Entries Related to Sale Under the New Standard Assets

Cash +$2,000.00 Inventory – Appliances -$1,500.00 Misc. Acct. -$75.00

Liabilities Unearned Warranty Revenue +$145.84

Income Statement Sales $1,750.00 Cost of Sales $1,500.00 Warranty Revenue $104.16 Warranty Expense $75.00

Retained Earnings +$279.16

• Debit to Retained Earnings is the cumulative effect of the change, before tax

Transition Adjustment – See spreadsheet –Example 2 – Schedule #3

Polling Question #6

• What is your favorite way of obtaining CPE?

1 – I like short (2-4 hour) live seminars that also give me an opportunity to network.

2 – I like live seminars for the networking opportunity, but I’d prefer to get it done in large chunks of 1 or more full days, so I am not as likely to be distracted by unrelated issues.

3 – I like webinars of varying lengths where the instructor can respond to questions, either conducting the class from a remote location or monitoring one that has been pre-recorded.

4 – I like pre-recorded programs of varying lengths approved for self-study, allowing me to study at my own pace and convenience.

Example #3

Long-term Construction Contract

• Calendar year entity entered 3-year contract on July 1, X1 to build sport facility for $45,000,000.

The project was expected to be completed approximately Sept. 30, X5 at a total estimated cost of $36,000,000 based on a budget prepared just prior to beginning the project.

As of 12/31/X1:

Costs of $4,520,000 were incurred and the budget was unchanged.

Under the cost-to-cost approach, used by the company, the project was $4,520,000/$36,000,000 or 12.56% complete. As a result, profit recognized in X1 was $1,130,000.

As of 12/31/X2

Additional costs of $7,675,000 were incurred, increasing the

total to $12,195,000 incurred to date.

Total estimated costs increased by $1,625,000 due to

settlement of a labor contract, bringing total estimated costs

to $37,625,000 and reducing estimated profit to $7,375,000.

The project was $12,195,000/$37,625,000, or 32.41%,

resulting in profit to date of $2,390,382.

Profit to be recognized in X2 is $2,390,382, minus the

$1,130,000 recognized in X1, for a net amount of $1,260,382.

Under the new standard, $1,625,000 of budgeted costs are not

allowed to be capitalized, $875,000 of which was included in

costs incurred to date as of 12/31/X2.

The new

standard was

adopted in X3

and the

transition was

made as of

1/1/X3

Journal entries 7/1/X1 – 12/31/X2

Topic 605

See spreadsheet – Example 3 – Schedule #1

Balances at 12/31/X2 – Old • Net Effect of All Entries Related to

Construction Contract Under the Old Standard

Assets

Contract Rec. +$14,585,382

Misc. Acct. -$12,195,000

Income Statement

Construction Contract Revenue $14,585,382

Cost of Sales $12,195,000

Retained Earnings +$2,390,382

Determining Transition Adjustment Journal entries under

new rule

See spreadsheet –Example 3 – Schedule

#2

Desired Balances at 12/31/X2 – New & Transition Adjustment

• Net Effect of All Entries Related to Construction Contract Under the New Standard Assets

Contract Rec. +$14,818,909 Misc. Acct. -$12,195,000

Income Statement Construction Cont. Rev. $14,818,909 Cost of Sales $11,320,000 G & A Expenses $875,000

Retained Earnings $2,623,909

• Journal entry at transition (see spreadsheet #3)

• Debit to retained earnings is the cumulative effect of the change, before tax

Transition Adjustment – See spreadsheet –Example 3 – Schedule #3

Thank You

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