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CBIZ & MHM Executive Education Series

Top Issues in the New Revenue Recognition Guidance Manufacturers Should Consider Mark Winiarski, Peter Gold August 25, 2016

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About Us

Together, CBIZ & MHM are a Top Ten accounting provider Offices in most major markets Tax, audit and attest* and advisory services Over 2,900 professionals nationwide

A member of Kreston International A global network of independent accounting firms

*MHM is an independent CPA firm providing audit, review and attest services, and works closely with CBIZ, a business consulting, tax and financial services provider.

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Before We Get Started

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use the Q&A feature at the bottom of your screen

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CPE Credit

This webinar is eligible for CPE credit. To receive credit, you will need to answer periodic participation markers throughout the webinar External participants will receive their CPE certificate via email immediately following the webinar

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Disclaimer

The information in this Executive Education Series course is a brief summary and may not include all

the details relevant to your situation.

Please contact your service provider to further discuss the impact on your business.

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Presenters

Located in our Kansas City office, Mark is a member of MHMs

Professional Standards Group (PSG). Mark's role includes instructing in

our national training program, presenting as a subject matter expert at

webinars and conferences, and preparing MHM publications on

accounting and auditing issues.

As a PSG member, Mark consults with clients and engagement teams

across the country in many areas of accounting and auditing. Mark has

served clients as an auditor, consultant and advisor in numerous

industries including manufacturing, distribution, mining, retail sales,

services and software.

816.945.5614 mwiniarski@cbiz.com @KCWini

MARK WINIARSKI, CPA MHM Shareholder

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Presenters

Peter is a Shareholder located in our Boston office. He is a member of

the Accounting and Auditing Group and joined CBIZ Tofias in 1992. Peter

has extensive experience in the manufacturing, distribution, insurance,

investment funds, private equity, and professional services industries.

Peter specializes in performing audits and reviews of financial

statements, internal control system evaluations, management advisory

services and consulting on various management, operational, and

financial related matters.

617.761.0739 pgold@cbiz.com PETER GOLD, CPA MHM Shareholder

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Agenda

Bill and Hold

Warranties

Topic 606 Overview

Long-Term Contracts

Variable Consideration

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TOPIC 606 OVERVIEW

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New Five-Step Process

Five steps to apply the core principle:

1 Identify the contract(s) with a customer

2 Identify the performance obligations in the contract

3 Determine the transaction price

4 Allocate the transaction price to the performance obligations

in the contract

5 Recognize revenue when (or as) the entity satisfied a

performance obligation

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Increased Presentation and Disclosure Requirements - Examples

The disclosure requirements are significantly in excess of what is currently required under U.S. GAAP.

Delineation between contract assets, contract liabilities and receivables

Quantitative disclosures showing over-time and point-in-time revenues

Qualitative discussion about economic factors impacting revenues and

cash flows Customer types

Geographical locations Types of contracts

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Preparing for the Standard

Calendar year entity: Public Business Entity: December 31, 2018 All other entities: December 31, 2019

Adoption methods Retrospective

Retroactive to all years presented Modified retrospective

Retroactive to the first day of the year of adoption Disclose revenues under old guidance

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BILL AND HOLD

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Bill and Hold Arrangements

Bill-and-hold arrangements arise when a customer is billed for goods that are ready for delivery, but the entity does not ship the goods to the customer until a later date.

Existing GAAP does not specify when revenue for a

bill-and-hold arrangement can be recognized. SEC staff established seven criteria, including a

requirement for a fixed delivery schedule.

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Bill and Hold Arrangements

A bill-and-hold arrangement must meet four criteria for control to have transferred and revenue recognized while the

goods have not been physically transferred

The reason for the bill-and-hold

arrangement must be substantive

(for example, the customer has requested the arrangement)

The product must be identified separately as

belonging to the customer

The product currently must be ready for physical

transfer to the customer

The entity cannot have the ability to use the product or

to direct it to another customer

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Bill and Hold Arrangements

Substitution of the goods for use in other orders indicates that the goods are not controlled by the customer and therefore revenue should not be recognized until the goods are delivered, or the criterion is satisfied.

An entity that has transferred control of the goods and met the bill-and-hold criteria to recognize revenue needs to consider whether it is providing custodial services in addition to providing the goods. If so, a portion of the transaction price should be allocated to each of the separate performance obligations.

Shipping and handling may be elected to be treated as fulfillment cost, fulfillment costs are accrued when revenue is recognized.

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Bill and Hold Arrangements - Example

Toy Manufacturer enters into a contract during 20X7 to supply

100,000 Superman action figures to Target. The contract contains specific instructions from Target about where the action figures

should be delivered. Toy Manufacturer must deliver the

action figures in 20X8 at a date to be specified by Target. Target

expects to have sufficient shelf space at the time of delivery.

As of December 31, 20X6, Toy Manufacturer has inventory of

120,000 action figures, including the 100,000 relating to the

contract with Target. The 100,000 action figures are stored with the

other 20,000 action figures, however, Toy Manufacturer will not deplete its inventory below

100,000 units.

When should Toy Manufacturer recognize revenue for the

100,000 action figures to be delivered to Target?

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Bill and Hold Arrangements

Toy Manufacturer should not recognize revenue until the bill-and-hold criteria are met or if Toy Manufacturer no

longer has physical possession and all of the other criteria related to the transfer of control have been met. Although the reason for entering into a bill-and hold transaction is

substantive (lack of shelf space), the other criteria are not met as the action figures produced for Target are not

separated from other products.

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LONG-TERM CONTRACTS

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Long-Term Contracts - Considerations

Defining the contract, such as when to combine contracts, and when and how to account for change orders and other modifications

Defining the contract price, including variable consideration, customer-furnished materials, claims, and financings

Recognition methods, determining when control transfers. If over-time recognition is appropriate establish an input/output method to measure performance

Accounting for contract costs, such as pre-contract costs and costs to fulfill a contract

Accounting for loss-making contracts

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Long-Term Contracts - Financing

An entity shall consider all relevant facts and circumstances in assessing whether a contract contains a financing component and whether that financing component is significant to the contract, including both of the following: The difference, if any, between the amount of promised

consideration and the cash selling price of the promised goods or services

The combined effect of both of the following: The expected length of time between when the entity

transfers the promised goods or services to the customer and when the customer pays for those goods or services

The prevailing interest rates in the relevant market

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Long-Term Contracts - Financing

A contract with a customer would not have a significant financing component if any of the

following factors exist

The customer paid for the goods or services in advance, and the timing

of the transfer of those goods or services is at the discretion of the

customer.

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).

The difference between the promised consideration and the cash selling price of the good or servicearises for reasons other than the provision of finance to

either the customer or the entity, and the difference between those

amounts is proportional to the reason for the difference. For

example, the payment terms might provide the entity or the customer

with protection from the other party failing to adequately complete some or all of its

obligations under the contract.

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Long-Term Contracts - Costs

Capitalize or dont capitalize costs? Costs to obtain a contract Pre-contract costs Costs to fulfill a contract

Learning curves For example, custom manufacturers often incur costs

relating to the design and testing of products and manufacturing techniques when preparing to provide service under a new contract. Set-up costs may include labor, overhead, or other specific costs. Some of these costs might meet the definition of assets under other standards, such as property, plant, and equipment.

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Long-Term Contracts

Costs to fulfill a contract are costs directly related to a contract but are not

a performance obligation, design, set-up, tooling etc.

Can be capitalized and

amortized if certain conditions are met.

Pre-contract costs include costs incurred in

anticipation of a contract.

Can be capitalized and

amortized if certain conditions are met.

Costs to obtain a contract are costs

incurred as a result of signing a contract. Direct commissions, legal fees contingent upon signing

a specific contract.

Costs are capitalized and amortized.

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Long-Term Contracts Capitalizing Costs

Inventory Internal-use software Property, plant and equipment Software to be sold Costs to fulfill a contract

Cost relates directly to a contract/anticipated contract Cost generates or enhances resources to satisfy future

performance obligations Costs are expected to be recovered

FASB has proposed eliminating the guidance on capitalizing pre-production costs for long-term supply contracts in ASC 340-10

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Long-Term Contracts Costs To Be Expensed

General n administrative costs Unless explicitly chargeable to the customer

Costs of wasted materials, labor or other resources not reflected in the price of the contract

Costs that relate to satisfied performance obligations Costs that cannot be distinguished between unsatisfied and

satisfied performance obligations

Production contracts may have a learning curve where costs are higher for the first units produced. Costs related to learning curves

must be carefully analyzed to determine if they should be capitalized or expensed as incurred.

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WARRANTIES

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Accounting for Warranties

Topic 605 (existing US GAAP)

Included warranty is accounted for under guidance for guarantees

Separately priced warranty is

accounted for as a service

Topic 606

Assurance-type warranty accounted for under guidance

from guarantees

Service-type warranty accounted for as a performance obligation

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Service Type Warranty

When is a warranty a separate performance obligation? Customer has the option to purchase separately, or Warranty provides a service beyond assurance that the

product complies with agreed-upon specifications, weight factors such as Is the warranty required by law? What is the length of warranty coverage? What types of tasks are promised?

Dont forget about non-contractual customer retention/service

activities that might result in implied warranties

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Service Type Warranty - Example

An entity manufactures fork-lifts used in

warehouses

It sells the fork-lift for $10,000 and includes a 1 year warranty on parts and labor as required by law Typically incur $500 in

warranty costs in year 1

In the past customers have come back after 1 year and requested to

buy an additional 5 years of warranty for

on average $5,000

A new customer contracts to buy a fork-lift and 5 additional years of warranty Fork-life is priced at

$10,000 Warranty is priced at

$4,000

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Service Type Warranty - Example

How many performance obligations exist? Does an assurance-type warranty exist? Does a service-type warranty exist?

Has the customer financed the service-type warranty?

How much consideration should be allocated to the fork-lift and to

the service-type warranty?

Standalone Selling Price Relative Price

Allocated Revenue

Fork-Lift 10,000$ 67% 9,333$ Warranty 5,000 33% 4,667 Total 15,000$ 100% 14,000$

Sheet1

Standalone Selling PriceRelative PriceAllocated Revenue

Fork-Lift$ 10,00067%$ 9,333

Warranty5,00033%4,667

Total$ 15,000100%$ 14,000

Sheet2

Sheet3

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Service Type Warranty - Example

When should revenue be recognized? Year 1 Journal Entry

DebitAccount receivable 14,000$

Revenue (9,333)Contract liability (4,667)To record sale of fork-lift and service-type warranty

Warranty expense 500Accrued warranty (500)To record liability for assurance-type warranty guaranty

Sheet1

Standalone Selling PriceAllocated Revenue

Fork-Lift$ 10,000ERROR:#REF!

Warranty5,000ERROR:#REF!

Total$ 15,000$ 14,000

Debit

Account receivable$ 14,000

Revenue(9,333)

Contract liability(4,667)

To record sale of fork-lift and service-type warranty

Warranty expense500

Accrued warranty(500)

To record liability for assurance-type warranty guaranty

Sheet2

Sheet3

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VARIABLE CONSIDERATION

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Variable Consideration

Variable consideration is estimated using either: Most likely amount Expected value

Forms of variable consideration common for manufacturers:

Coupons Rebates Volume discounts Price protection Rights of return Price concessions

Constraint: variable consideration is only recognized to the extent it is not probable that a significant reversal will occur

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Contract Approach vs Portfolio Approach

Topic 606 is a contract based model However, as a practical expedient, the guidance may be applied to a

portfolio of contracts or performance obligations with similar characteristics Reasonably expect that the accounting for the portfolio would not differ

materially from a contract based application

Example:

How might it compute the transaction

price?

The agreed upon price is $10,000,

based on past history it expects that it will

offer a price concession when it

collects the final payment.

A manufacturer sells a piece of equipment in

China.

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Contract Approach vs Portfolio Approach

Portfolio based approach, assume all outstanding sales to China total $1,000,000 The past three years the price concession on sales to China have averaged 10%,

11% and 9% No significant changes that would impact the amount of price concessions Compute the transaction price as $900,000 ($1,000,000 * 90%)

Amount Expected to be

Received Probabi l i ty

10,000$ 10% 1,000$

9,500 30% 2,850

9,000 35% 3,150

8,500 20% 1,700

7,000 5% 350

Tranasction Price: 9,050$

Probability that the entity will receive at least $9,000 is 75%

$10,000 10%

$9,500 30%

$9,000 35%

Contract based approach

Sheet1

Amount Expected to be ReceivedProbability

$ 10,00010%$ 1,000

9,50030%2,850

9,00035%3,150

8,50020%1,700

7,0005%350

Tranasction Price:$ 9,050

Sheet2

Sheet3

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Rights of Return - Example

A manufacturer of medical testing equipment sells a good worth $1,000 and

estimates that 5% is expected to be returned.

The cost of good was $800

There is no significant

restocking cost

How should the manufacturer

account for the right of return?

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Distributor/Retailer

Accounting for Returns Journal entry

Account Debit

Cash $1,000

Right of return asset 40

Cost of sales 760

Revenue (950)

Inventory (800)

Refund liability (50)

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? QUESTIONS

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If You Enjoyed This Webinar

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THANK YOU CBIZ & Mayer Hoffman McCann P.C. cbizmhmwebinars@cbiz.com

Slide Number 1About UsBefore We Get StartedCPE CreditDisclaimerPresentersPresentersAgendaTopic 606 OverviewNew Five-Step ProcessIncreased Presentation and Disclosure Requirements - ExamplesPreparing for the StandardBill and HoldBill and Hold ArrangementsBill and Hold ArrangementsBill and Hold ArrangementsBill and Hold Arrangements - ExampleBill and Hold ArrangementsLong-Term ContractsLong-Term Contracts - ConsiderationsLong-Term Contracts - FinancingLong-Term Contracts - FinancingLong-Term Contracts - CostsLong-Term ContractsLong-Term Contracts Capitalizing CostsLong-Term Contracts Costs To Be ExpensedWarrantiesAccounting for WarrantiesService Type WarrantyService Type Warranty - ExampleService Type Warranty - ExampleService Type Warranty - ExampleVariable ConsiderationVariable ConsiderationContract Approach vs Portfolio ApproachContract Approach vs Portfolio ApproachRights of Return - ExampleDistributor/RetailerSlide Number 39If You Enjoyed This WebinarConnect with UsSlide Number 42