revenue recognition: mastering today’s issues for tomorrow’s …€¦ · 27-05-2015 · the...

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REVENUE RECOGNITION: MASTERING TODAY’S ISSUES FOR TOMORROW’S TRANSITIONMAY 27, 2015

Margaret F. Gallagher, CPA [email protected] Rhen, CPA [email protected]


2

The information presented in this presentation represents our personal perspectives, and not necessarily the views of WithumSmith+Brown, PC.

It is not necessarily all inclusive, and does not constitute legal or any other

advice.

Today’s Disclaimer


3 MEET YOUR PRESENTERS

Margaret F. Gallagher, CPAWithumSmith+Brown, PCTechnical Resources [email protected]

Jarrod Rhen, CPAWithumSmith+Brown, [email protected]


4 TODAY’S OUTLINEGENERAL PRINCIPLES OF REVENUE RECOGNITION:1. Persuasive evidence of an arrangement2. Delivery and performance:

3. The seller’s price to the buyer is fixed or determinable4. Reasonable assurance of collectability

OTHER MATTERS:1. Gross vs. net2. Product Warranties

Products Services Software arrangements


5 REVENUE - BACKGROUND Single most important financial statement measure

No single authoritative pronouncement Revenue recognition differs by transaction and industry This presentation will not discuss the new ASU 2014-09

Gross vs. Net Product Warranties


6 REVENUE - CONSIDERATIONSDoes the revenue recognition policy fit the substance???? Sale of products Rendering of services Are there multiple elements?

• Are they tangible or intangible? Is there a contract?

• Does it contain important milestones?• Is there a right to use?• Is there a licensing arrangement?


7 REVENUE CONSIDERATIONS

Industry specific

Non-recurring gains/losses

Principal/Agent considerations (gross vs. net)

Customer incentives

Retrospective considerations


8

PERVASIVE CONCEPTS There are two factors that must be achieved in order for a company to recognize revenue:

ONE The

revenue must be Earned

TWO Revenue

must be Realized or Realizable


9 EARNED

So, what does it mean to have earned the revenue? Examples:

You sign one year contract with Verizon FiOSfor cable and internet service

Best Buy delivers TV to your house


10 REALIZED OR REALIZABLE

So what does it mean that revenue is Realized orRealizable?Examples:

Magazine subscriptions

paid in advance

Airlines are paid for tickets

in advance

Restaurant gets paid for

dinner


11 FOUR CONDITIONS OF RECOGNITIONRevenue is generally earned and realized or realizable when the following four criteria are met:

Persuasive evidence of an arrangement exists

Delivery or performance has occurred

Arrangement fee is fixed or determinable

Collectibility is reasonably assured

CRITERIA


12 1. PERSUASIVE EVIDENCE OF AN ARRANGEMENT EXISTS

Persuasive evidence is dictated by the company’s customary business practices:

Online authorization

Purchase order

Written contract or agreement


13 2. DELIVERY OR PERFORMANCE

• A single act of performance• Seller’s fulfillment & customer’s value

Basic Model

• Multiple acts, with the “final act” being most significant• Value received all at once (“final act”)

Completed Performance Model

• Providing service over period of time• Receive value over period of time

Proportional Performance Model


14 DELIVERY OF PRODUCTS Transfer of Title

Review the Contractual TermsFOB (“Free on board”) terms FOB Destination Point: Shipping free to buyer and paid for by seller, title passes when buyer receives goods at predetermined destination point.FOB Shipping Point: Title passes when goods leave the shipping area of the seller, shipping is paid by the buyer


15 DELIVERY OR PERFORMANCE - PRODUCTS

Customer Acceptance ProvisionsCustomer acceptance provisions generally allow customers to cancel the arrangement when the product delivered does not meet the customer’s needs or desires

Types of Acceptance Provisions:1. Evaluation or trial purposes2. Right of return based on customer subjective criteria3. Right of return based on seller-specified objective criteria

Tip: The nature of customer acceptance provisions should be analyzed to determine the appropriate accounting model to apply to the transaction.



Customer Acceptance Provisions1. Was it shipped for trial or evaluation purposes?

• Requires affirmative acceptance• Includes trial periods

2. Is customer acceptance based on meeting standard performance criteria?

• Product is defective• Product fails to meet advertising claims or published

criteria for performance



Customer Acceptance Provisions3. Is customer acceptance based on customer specified

or negotiated criteria• Common example: Equipment sales to be used in

manufacturing plant.• Seller must be able to reliably demonstrate that the

delivered product meets the specified acceptance criteria before revenue can be recognized.



Is there a Right of Return?It is usual and customary to record revenue upon delivery of products sold with a right of return, IF: The terms of the arrangement make it clear that a sale

has occurred There are no contingencies other than a right of return The likelihood of the customer exercising the right of

return can be estimated (allowance established)



Right of Return - Key ConsiderationsRevenue can be recognized under the following conditions: Sales to buyer is fixed or determinable Payment is not contractually or otherwise excused until the

product is resold Buyer holds risks of destruction, damage, theft of the property Buyer has economic substance apart from the seller Seller does not have future obligations Returns can be reasonably estimated


20 REVENUE RECOGNITION FOR SERVICES

Clubs & other membership organizations

Consulting arrangements

Legal & other professional

services

Advertising and marketing

Data processing

Maintenance contracts


21REVENUE RECOGNITION FOR SERVICES

SAME GENERAL PRINCIPLES APPLY

Revenue from service transactions should be recognized when it has been earned and is realized or realizable.

Earned either as the service is performed, over time, or when the services

are complete.

Realizable once the customer has committed

to pay, and the customer’s ability to pay is not in

doubt.


22 APPLYING 4 CRITERIA FOR REVENUE RECOGNITION TO SERVICES • ‘Evidence of an arrangement’ and ‘collectibility’

are the same for service deliverables and other types of revenue transactions.

• ‘Fixed and determinable fees’ – customer cancellation provisions may impact timing of revenue recognition

• Special considerations related to the ‘delivery or performance has occurred’ criteria


23TWO REVENUE RECOGNITION METHODS

FOR SERVICE REVENUES

• Appropriate for when performance is a single act• And sometimes when it involves multiple acts• Recognize 100% of revenue all at once (ie, a haircut, a car wash)

Completed or specific performance

• Recognize revenue over time as the services are rendered. • Only used for certain multiple acts, because the customer receives

value as the services are performed.

Proportional performance

If the arrangement involves multiple deliverables, or software, refer to other specific US GAAP, FIRST.


24 PERFORMANCE INVOLVING MULTIPLE ACTS

The Proportional Performance model is often appropriate because the customer typically receives value as the services are performed.

When there are multiple acts, how do we determine whether revenues should be recognized under the completed or proportional performance methods?

Do not assume that multiple acts = proportional performance method of recognition

HOWEVER The Completed Performance model should be used if services are performed in more than a single act, but the final act is so significant in relation to the overall transaction that substantive performance only takes place when the final act is completed.


25 INDICATORS OF COMPLETED PERFORMANCE

ONE• If the seller fails to perform the final act, the customer (or the customer's new

service provider) would need to "start over"

TWO• Payment terms indicate that no payment is due until the final act is

performed.

THREE• The final act is significantly different in nature from the other acts to be

performed.

FOUR• The contracts underlying the transaction specify only the final act (i.e.,

completion of service) and other acts are performed at the seller's discretion.

FIVE• There is significant uncertainty as to whether the vendor can complete all of

the acts in the arrangement.


26PERCENTAGE OF COMPLETION METHOD & SERVICE REVENUESPOC is universally loved because it is logical (matching of revenues and costs)However, it does not apply to service transactions unless they are:• the construction and/or production of tangible

property, such as architectural and engineering design contracts.

• OR the ‘construction’ of software system that involves significant production and customization


27DELIVERY AND PERFORMANCE –LICENSES


28 REVENUE RECOGNITION FOR LICENSESThe four conditions of revenue recognition apply to licenses of intellectual property (“IP”)

Revenue is generally earned at either the beginning or throughout the license term, depending upon the nature of the license.

Revenue is usually considered realizable once the customer has committed to pay for the license (assuming collection isn’t in doubt).

Partial payments at the inception of the license and additional payments based on performance milestones, use of the property, or the passage of time are common

Delivery - most significant revenue recognition issue for licenses – when does ‘delivery’ occur?

If the transaction is, in substance, a sale of an asset, the CPM should be applied; If the seller/licensor does not transfer all of the risks and rewards at the inception of the

arrangement, a PPM should be applied. (akin to an operating lease arrangement)


29 “DELIVERY” FOR LICENSES DEPENDS ON EXCLUSIVITY & DURATION

Perpetual Term Term <( = Life of License) Life of License

ExclusiveCompleted

performance method

Proportional performance

method

Non-exclusive

Completed or proportional performance

method

Completed or proportional performance

method


30

DELIVERY AND PERFORMANCE MULTIPLE ELEMENTS


31 MULTIPLE - ELEMENT ARRANGEMENTS

Companies often provide more than one product or service in a single arrangement. But does it require multiple element accounting? Key questions to ask are:

Is the other item(s) or service incidental to the primary sale?

If not incidental, is software involved?

If software is involved, apply ASC

985-605 Software Revenue Recognition

for allocating the transaction price


32 ASC 605-25 MULTIPLE-ELEMENT ARRANGEMENTS

Separating multiple deliverables into different units of accounting (separation)

Allocating revenue to the different units of accounting (allocation)

Recognizing revenue when each different unit of accounting meets the 4 conditions (recognition)

Key considerations

for analysis:


33UNITS OF ACCOUNTING – ARE THERE SEPARATE ELEMENTS?A delivered item or items shall be considered a separate element for accounting purposes if both of the following conditions are met:1. The delivered item or items have value to the customer on a stand-alone basis.

2. If the arrangement includes a general right of return related to the delivered item, delivery or performance of the undelivered item or items is considered probable and substantially in the control of the vendor.

Stand-alone value exists if it is sold separately by any vendor

OR the customer could resell the delivered item or items on a stand-alone basis.

If the separation conditions are met, the delivered item(s) must be treated separately for accounting purposes. It is not optional to bundle elements that otherwise satisfy these conditions.


34 MEASUREMENT AND ALLOCATION OF ARRANGEMENT CONSIDERATIONGenerally, consideration shall be allocated at the inception of the arrangement to all deliverables on the basis of their relative selling price (the relative selling price method).

The ‘selling price’ for each deliverable shall be determined using (in this order):

The revenue recognition model shall be considered individually for each separate unit of accounting.

1 - vendor-specific objective evidence (VSOE) of selling

price, if it exists; if not 2 - third-party evidence of

selling price,

3 - If neither 1 nor 2 exists , use best estimate of the

selling price for that deliverable when applying the relative selling price method.


35ASC 985-605 SOFTWARE MULTIPLE-ELEMENT ARRANGEMENTS

First

SEPARATION - apply separation guidance from ASC 605-25 to determine

the units of account

NextALLOCATION - ASC 605-25 is also applied to determine the amount of arrangement consideration to allocate to those non-software-related

elements.

The remaining consideration is allocated to the software-related element(s) in the arrangement. The software-related elements are evaluated for further separation and recognition under ASC 985-605.


36 3. FIXED OR DETERMINABLE FEE

There is no firm definition of fixed and determinableFactors preventing a fee from being fixed or determinable:

Coupons & Rebates

Right of return provisions Penalties Bonuses

Usage Cancellation Success/failure


37 4. COLLECTIBILITY

• Collectibility should only be assessed after the first three criteria are met

• Apply many of the same factors used to determine whether a receivable has become a bad debt

• If collectibility at the outset is questionable, revenue should not be recognized until collectibility is reasonably assured


38 OTHER REVENUE RECOGNITION MATTERS


39 ASC 605-45 (FORMERLY EITF 99-19) Provides indicators for reporting revenue Gross (as a

Principal) versus Net (as an Agent)

Applies to transactions in all industries (except for those governed by specific guidance)

Must apply judgment in analyzing the facts and circumstances of an arrangement


40 INDICATORS OF GROSS REVENUE

The company has credit risk.

The company has physical loss inventory risk

The company is involved in the determination of product or service specifications

The company has discretion in supplier selection

The company changes the product or performs part of the service

The company has latitude in establishing price

The company has general inventory risk

The company is the primary obligor


41 STRONG INDICATORS OF NET REVENUE

The supplier is the primary

obligor

The company earns a fixed

amount

The supplier has the credit

risk


42


43 THANK YOU FOR ATTENDING THIS WITHUM WEBINAR

Margaret F. Gallagher, CPAWithumSmith+Brown, PCTechnical Resources [email protected]

Jarrod Rhen, CPAWithumSmith+Brown, [email protected]

revenue recognition: mastering today’s issues for tomorrow’s …€¦ · 27-05-2015 · the...

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