Revenue Recognition – Proposed Agenda • Effective date and transition • A single model for revenue • Scope • Core principle and five steps • Presentation and disclosure • Other issues • Differences from IAS 18 and U.S. GAAP • What companies should be doing now • Summary
Revenue Recognition – Proposed Agenda. Effective date and transition A single model for revenue Scope Core principle and five steps Presentation and disclosure Other issues Differences from IAS 18 and U.S. GAAP What companies should be doing now Summary. Effective date and transition. - PowerPoint PPT Presentation
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Revenue Recognition – ProposedAgenda
• Effective date and transition• A single model for revenue• Scope• Core principle and five steps• Presentation and disclosure• Other issues• Differences from IAS 18 and U.S. GAAP• What companies should be doing now• Summary
Effective date and transition
January 1, January 1, January 1 January 1 January 1January 1
2010 2011 2012 2013 2014 2015
Exposure Draft
Issued
June 24, 2010
Exposure Draft
Issued
June 24, 2010
FULL RETROSPECTIVE APPLICATION
Comments Ending
October 22, 2010
Comments Ending
October 22, 2010
Standard Issued
Second half of 2011
Standard Issued
Second half of 2011
Effective Date
End of 2014
A single model for revenue
• Single model• Contract-based• Asset and liability approach• Transfer of control to customer
Scope
• Inclusive – all entities in all industries• Excludes:– Lease contracts– Insurance instruments– Financial instruments– Certain nonmonetary transactions
• Must be contract with customer• Could be part in, part out
Core principle and five steps
Core principle: An entity shall recognize revenue to depict the transfer of goods or services to customers in an amount that reflects the consideration the entity receives, or expects to receive, in exchange for those goods or services.
(ED par. 2)
The five stepsThe five steps
Identify the contract with the customer
Identify the contract with the customer
Identify the separate
performance obligations
in the contract
Identify the separate
performance obligations
in the contract
Allocate the transaction price to the
separate performance obligations
Allocate the transaction price to the
separate performance obligations
Recognize revenue
when the entity
satisfies each performance
obligation
Recognize revenue
when the entity
satisfies each performance
obligation
Determine the
transaction price
Determine the
transaction price
Step 1: Identify the contract with the customer
Contract: An agreement between two or more parties that create enforceable rights and obligations. (ED Appendix A)
Contract elements:•Commercial substance•Approval and commitment•Identifiable and enforceable rights of parties•Identifiable terms and manner of payment
Wholly unperformed, no termination penalty = no contractCustomer: A party that has contracted with an entity to obtain goods or services that are an output of the entity’s ordinary activities.(ED Appendix A)
Step 1: Identify the contract with the customerCombination, segmentation, and modification of contracts
Price interdependence: The amount of consideration in one contract is dependent on the amount of consideration in another contract. (ED par. 13)
Indicators of interdependence:•The contracts are entered into at the same time•The contracts are negotiated as a package with a single commercial objective•The contracts are performed either concurrently or consecutively
Step 1: Identify the contract with the customerCombination, segmentation, and modification of contracts, continued
Contracts interdependent pricing – combine
Contract elements lack interdependent pricing – segment if meet two conditions:1.The entity, or another entity, regularly sells identical or similar goods or services separately, and2.The customer does not receive a significant discount for buying some goods and services together with another goods or services in the contract (ED par. 15)
Step 1: Identify the contract with the customerCombination, segmentation, and modification of contracts, continued
Example – segmenting contracts
Company A enters into agreement with customer•Equipment and maintenance together = $500•Equipment sold separately = $470•Maintenance sold = $40
Step 1: Identify the contract with the customerCombination, segmentation, and modification of contracts, continued
A contract modification is any change in the scope or price of a contract, such as changes in:•Nature or amount of goods or services to be transferred•Method or timing of performance•Previously agreed pricing
Contract modifications may be initiated by either the customer or the entity
The five steps continuedThe five steps continued
Identify the contract with the customer
Identify the contract with the customer
Identify the separate
performance obligations
in the contract
Identify the separate
performance obligations
in the contract
Allocate the transaction price to the
separate performance obligations
Allocate the transaction price to the
separate performance obligations
Recognize revenue
when the entity
satisfies each performance
obligation
Recognize revenue
when the entity
satisfies each performance
obligation
Determine the
transaction price
Determine the
transaction price
Step 2: Identify the separate performance obligations in the contract
Performance obligation: An enforceable promise (whether explicit or implicit) in a contract with a customer to transfer a good or service to the customer. (ED App. A)Distinct: A good or service is distinct if either:a.The entity, or another entity, sells an identical or similar good or service separately, or b.The entity could sell the good or service separately, because the good or service meets both of the following conditions:
i. It has a distinct function – a good or service has a distinct function if it has utility either on its own or together with other goods or services that the customer has acquired from the entity or are sold separately by the entity or by another entity, and
ii. It has a distinct profit margin – a good or service has a distinct profit margin if it is subject to distinct risks and the entity can separately identify the resources needed to provide the good or service (ED par. 23)
Step 2: Identify the separate performance obligations in the contract, continued
Example – sale of product with option for additional product The entity, or another entity, sells an identical or similar good or service separately, or •Entity A sells product to Customer B for $500•A also provides B with a voucher for a 30 percent discount on future purchases for 60 days (up to $500)•A regularly provides a voucher for a 10 percent discount on sales within 60 days
Is the voucher a separate performance obligation?
The five steps continuedThe five steps continued
Identify the contract with the customer
Identify the contract with the customer
Identify the separate
performance obligations
in the contract
Identify the separate
performance obligations
in the contract
Allocate the transaction price to the
separate performance obligations
Allocate the transaction price to the
separate performance obligations
Recognize revenue
when the entity
satisfies each performance
obligation
Recognize revenue
when the entity
satisfies each performance
obligation
Determine the
transaction price
Determine the
transaction price
Step 3: Determine the transaction price
Transaction price: The amount of consideration that an entity receives, or expects to receive, from a customer in exchange for transferring goods or services, excluding amounts collected on behalf of third parties (for example, taxes). (ED Appendix A)
Step 3: Determine the transaction priceExample – determining the transaction price
Entity A grants Company B exclusive access to licensefor $200,000 plus royalties of 5% of B’s sales
Possible product sales
Possible royalties at 5%
Probability Expected consideration
1,000,000 50,000 15% 7,500
2,000,000 100,000 25% 25,000
3,000,000 150,000 40% 60,000
4,000,000 200,000 15% 30,000
5,000,000 250,000 5% 12,500
100% 135,000
What is the transaction price in this arrangement?
Step 3: Determine the transaction priceAdditional considerations
• Collectability• Time value of money• Non cash consideration• Consideration payable to the customer
Step 3: Determine the transaction priceAdditional considerations -- collectability
Unconditional
Right to Receive Payment
Reasonably Assured
Reasonably Assured
Measurement (probability-weighted
amount)
Measurement (probability-weighted
amount)
Revenue Recognition
Guidance
Revenue Recognition
Guidance
Measurement (probability-weighted
amount)
Measurement (probability-weighted
amount)
Step 3: Determine the transaction priceAdditional considerations – time value of money
• Payment due significantly before or significantly after transfer of goods or services
• Material financing component is recognized separately• Discount rate as if separate financing transaction with that
customer– Time value of money– Credit risk
Step 3: Determine the transaction priceAdditional considerations – time value of money, continued
Example – time value of money –Prepayment for future goods delivery
• Entity A sells product to customer for $100,000• Delivery in one year• Payment today• Entity A recognizes $100,000 contract liability• Discount rate of 10% equals a material financing
component
Step 3: Determine the transaction priceAdditional considerations – time value of money, continued
Example – time value of money continued
Day one journal entry:Dr. Cash 100,000
Cr. Contract liability 100,000
Monthly journal entry before delivery:Dr. Interest expense 833
Cr. Contract liability 833
Journal entry on delivery – after one year:Dr. Contract liability 110,000
Cr. Revenue 110,000
Step 3: Determine the transaction priceAdditional considerations – time value of money, continuedStep 3: Determine the transaction priceAdditional considerations – time value of money, continued
Example – time value of money –payment in the future for goods delivered now
• Entity A sells product to customer • Immediate delivery of goods• $110,000 to be paid in one year• Entity A recognizes $100,000 of revenue• Discount rate of 10% equals a material financing
component
Step 3: Determine the transaction priceAdditional considerations – time value of money, continued
Example – time value of money continuedDay one journal entry:
Dr. Accounts receivable 100,000Cr. Revenue 100,000
Monthly journal entry before delivery:Dr. Interest receivable 833
Cr. Interest revenue 833Journal entry on delivery – after one year:
Dr. Cash 110,000Cr. Accounts receivable 100,000Cr. Interest receivable 10,000
Step 3: Determine the transaction priceAdditional considerations – noncash consideration
• Measure at Fair value• If Fair value not available– Indirect measurement– Reference stand-alone selling price of goods or services
transferred
If you pay consideration to the customer, it would be:1.A reduction of the transaction price2.A payment for distinct goods or services received from the customer3.Some combination of 1 and 2
If (3) reduce transaction price for amount that exceeds the fair value of goods or services received
If (3) but cannot reasonably estimate fair value, default to (1)
Step 3: Determine the transaction priceAdditional considerations – consideration payable to customer
Step 3: Determine the transaction priceAdditional considerations –consideration payable to customer, continued
Example – slotting fees
Entity A sells 1000 units of product to reseller for $10,000Entity A pays reseller $1,000 for product placement serviceFair value of product placement service if $600
Step 3: Determine the transaction priceAdditional considerations – right of return
Example – refund liabilityEntity A sells 500 products for $50 eachEach product costs $35Customer may return any unused product within 30 days for a full refund
Returns Probability Expected returns10 25% 2.5
25 50% 12.5
40 25% 10
100% 25
Step 3: Determine the transaction priceAdditional considerations – right of return, continued
For how many products does Entity A recognize revenue?
475 (25 estimated returns)
What is the refund liability? 1,250 (25 x 50 sales price)What is the return asset? 875 (25 x 35 cost)Journal entry on delivery:
Dr. Accounts receivable 25,000Cost of sales 16,625Return asset 875Cr. Revenue 23,750 Refund liability 1,250 Inventory 17,500
The five steps continuedThe five steps continued
Identify the contract with the customer
Identify the contract with the customer
Identify the separate
performance obligations
in the contract
Identify the separate
performance obligations
in the contract
Allocate the transaction price to the
separate performance obligations
Allocate the transaction price to the
separate performance obligations
Recognize revenue
when the entity
satisfies each performance
obligation
Recognize revenue
when the entity
satisfies each performance
obligation
Determine the
transaction price
Determine the
transaction price
Step 4: Allocate the transaction price to the separate performance obligations
• Relative stand-alone selling price• No default to list price or contract price• Observable price (sold separately)• Estimate stand-alone selling price
– Expected cost plus margin– Adjusted market assessment
Example – allocating transaction price to separate performance obligations
Relative stand-alone selling price ($)
Ratio Allocated amounts ($)
Medical devicecost plus margin)
225,000 75%(225/300)
187,500
Maintenance support (stand alone selling price)
50,000 17%(50/300)
42,500
Specified software upgrade (market assessment)
25,000 8%(25/300)
20,000
Total 300,000 100% 250,000
Step 4: Allocate the transaction price to the separate performance obligations, continued
Step 4: Allocate the transaction price to the separate performance obligations, continued
• Changes in transaction price– Variable consideration– Changes in estimates
• No redo of allocation percentages– Reallocate per original allocation– Adjust period revenue if performance obligation already
satisfied
The five steps continuedThe five steps continued
Identify the contract with the customer
Identify the contract with the customer
Identify the separate
performance obligations
in the contract
Identify the separate
performance obligations
in the contract
Allocate the transaction price to the
separate performance obligations
Allocate the transaction price to the
separate performance obligations
Recognize revenue
when the entity
satisfies each performance
obligation
Recognize revenue
when the entity
satisfies each performance
obligation
Determine the
transaction price
Determine the
transaction price
Step 5: Recognize revenue when the entity satisfies each performance obligation
Satisfy performance obligation = transfer control
Control: A customer obtains control of a good or service when the customer has the ability to direct the use of, and receive the benefit from, the good or service. Control includes the ability to prevent other entities from directing the use of, and receiving the benefit from, a good or service. (ED par. 26)
• Continuous transfer– Construction contracts– Services contracts
• Recognize revenue in manner that best depicts transfer– Output methods (preferred)– Input methods– Passage of time
Step 5: Recognize revenue when the entity satisfies each performance obligation, continued
Statement of Financial Position (SOFP)• Contract asset – entity performs but not the customer• Contract liability – customer performs and not the entity• Unconditional right to consideration– Only passage of time before receive payment– Receivables (ASC 310 or IAS 32/39)Disclosures• Qualitative and quantitative• Amount, timing, uncertainty• Significant judgments
Presentation and disclosure
• Explicit• Implicit – customary business practices• Not a separate performance obligation• Recognize refund liability• Recognize asset (separate from inventory)• Probability-weighted estimate of refund• If cannot estimate – all liability no revenue
Other issues
Rights of return
• Latent defects – not separate PO• Defects after customer controls –separate PO• Either way – revenue deferral
Other issues
Product warranties
• Nonexclusive = sale• Exclusive– Substantially all rights = sale– Not substantially all rights = revenue over license term
Other issues
Licenses and rights to use
• PV of probability-weighted costs > price allocated to that PO• Update liability each reporting period• At PO level, not contract level