Revenue Recognition ASU No. 2014-09, ASC 606.

Revenue Recognition ASU No , ASC 606

Mitch Bean, CPA - Mitch is an accomplished Senior Executive and Board Member, with demonstrated experience with large and small companies across real estate, financial services, government contracting and telecommunications industries. Leveraging extensive and recent experience with wealth management services (including estate and trust taxation) in a large Multi-Family Office setting, he is a valuable asset for emerging growth companies seeking assistance with financial analysis and raising capital. He is also a frequent contributor to Thomson Reuters publications on accounting and auditing issues in the real estate sector. Throughout his executive career, Mitch has held leadership positions at Bean Global Advisors, LLC and Dixon Hughes Goodman, LLP. At Bean Global Advisors, LLC, he was responsible for successfully addressing client accounting issues concerning revenue recognition raised by the SEC’s Office of Corporate Finance, and saving that financial services client hundreds of thousands of dollars in potential financial statement restatement costs. During his time with Dixon Hughes Goodman, LLP, he was responsible for Risk Management and SEC Services in Virginia, saving the firm millions of dollars in litigation costs and monitoring engagement teams on small and large company engagements (including public company SEC reporting assignments). Additionally, he was responsible for helping two of the largest financial institutions in his area become successful. He helped TowneBank and Monarch Bank in their early days, assisting in mergers that ultimately made it one of the most successful independent banks in Virginia. Mitch holds a B.B.A. from the College of William and Mary. He is also a licensed CPA in Virginia. A seasoned Board Member, he has held board positions with the Boys and Girls Club of South Hampton Roads, the Catholic Education Foundation, and Moore Stephens International, an international association of independent accounting firms with world-wide revenue of $7 billion.

Overview - Revenue Recognition
ASU , Revenue from Contracts with Customers (Topic 606) Objective: “… to establish the principles to report useful information to users of financial statements about the nature, timing, and uncertainty of revenue from contracts with customers.” Principles based guidance versus rules based requirements (e.g. six separate methods for real estate sales) Full accrual, deposit, installment, percentage of completion, cost recovery and reduced profit methods).

Scope of the Standard Scope
Standard would apply to all industries and all firms The following contracts are excluded from the scope of revenue recognition: Financial instruments Insurance contracts Lease contracts Guarantees (excluding “extended service” warranties) Two types of warranties are discussed: Assurance warranties (manufacturer’s warranty that comes with a car). A service type warranty that extends beyond the manufacturer’s warranty.

Enforceable rights and obligations
Scope of the Standard Scope of the standard is limited to revenue arising from contracts with customers Customer – party that has contracted with an entity to obtain goods and services that are the output of the entity’s ordinary activities What about contracts with noncustomers? Entity Customer CONTRACT Enforceable rights and obligations Exceptions under the proposed guidance include: - Financial instrument contracts - Insurance contracts - Leasing contracts - Guarantees (other than product warranties) - Nonmonetary exchanges between entities in the same line of business to facilitate sales to customers other than the parties to the exchange (for example, swaps of similar items or an exchange of oil to fulfill demand on a timely basis in a specified location) - Sales of assets that are not an output of the entity’s ordinary activities (recognition and measurement principles of the proposal would apply)

Scope of the standard ASU , Other Income – Gains and Losses from the Derecognition of Nonfinancial Assets (Subtopic ) Covers sales of nonfinancial assets to noncustomers (e.g. sale of an office or plant used in an entity’s business) Many of the principles established in Topic 606, Revenue from Contracts with Customers, are carried over to sales of nonfinancial assets to noncustomers Primary difference is the location where the transactions fall within the income statement

Effective Date Both standards are effective as follows:
Annual reporting periods beginning after December 15, 2018, and interim periods within that period For most non-public companies will first apply to calendar year 2019 financial statements Early application originally prohibited for US Organizations May now adopt for annual periods beginning after December 15, 2016 (on or after January 1, 2017 for nonpublic companies) Nonpublic entities may adopt the guidance earlier, but only as of (a) an annual reporting period beginning after December 15, 2016, including interim reporting periods within that annual period, or (b) an annual reporting period beginning after December 15, 2016, and interim reporting periods within annual reporting periods beginning one year after the annual reporting period in which the entity first applies the new guidance So you might ask why would anyone want to adopt early. In some situations, the recognition of revenue traditionally deferred might be accelerated.

Overview - Revenue Recognition
Core principle: Steps to apply the core principle: Recognize revenue in the accounting period when the performance obligation is satisfied. Recognize revenue to depict the transfer of goods or services in an amount that reflects the consideration expected to be received in exchange for those goods or services 5. Recognize revenue when a performance obligation is satisfied 4. Allocate the transaction price 3. Determine the transaction price 2. Identify the separate performance obligations 1. Identify the contract(s) with the customer

Identify the Contract with the Customer
Step 1: Identify the Contract with the Customer The standard defines a contract as “an agreement between two or more parties that creates enforceable rights and obligations.” To be a contract with a basis for revenue recognition under the standard, the contract must meet the following criteria: Commercial substance; that is, a transfer of good or services will result in future cash flows Approval and commitment by each party to fulfil its obligations Identifiable payment terms and rights to goods or services and Probable collectability Probable: The future event or events are likely to occur. Commercial substance; that is, a transfer of goods or services will result in future cash flows. Approval and commitment by each party to fulfill its obligations. Identifiable payment terms and rights to goods or services. Probable collectibility; that is, it is probable that the entity will collect substantially all of the consideration in exchange for the transfer of the goods or services to the customer. The future event or events are likely to occur. [FAS 005, paragraph 3, sequence 34]

Step 1: Basic Accounting
Revenue cannot be recognized until a contract exists. Company obtains rights to receive consideration and assumes obligations to transfer goods or services Rights and performance obligations gives rise to an (net) asset or (net) liability. Contract asset = Rights received > Performance obligation Contract liability = Rights received < Performance obligation

Step 1 Key element: price interdependence
5. Recognize revenue when a performance obligation is satisfied 4. Allocate the transaction price 3. Determine the transaction price 2. Identify the separate performance obligations 1. Identify the contract(s) with the customer Key element: price interdependence Combine contracts if prices are interdependent Contract modifications accounted for separately if priced at stand alone selling prices depending on the facts and circumstances, the modification would be accounted for: (1) as if the old contract was terminated and a new contract created; (2) as if the modification were a part of the original contract or (3) in a manner consistent with the objectives of FASB ASC if the remaining goods or services are a combination of items (1) and (2). Considerable judgment will be required in applying these provisions.

Step 1: Contract Combinations
Contracts are combined if entered into by an entity (or related parties of the entity) with the same customer (or related parties of the customer) at or near the same time with: Interdependent sales prices or Single commercial objective or Promised goods or services are part of a single performance obligation The entities negotiated the contracts as a package with a single commercial objective. The consideration to be paid in one contract is dependent upon the price or performance of the other contract The promised goods or services in the contracts (or some goods or services promised in each of the contracts) are a single performance obligation (see discussion of identifying performance obligations beginning at paragraph .43). In accordance with FASB ASC , entities are required to combine two or more contracts that are entered into with the same customer (or related parties of the customer) at or near the same time and account for them as a single contract if any of the following criteria are met:

Step 1: Contract Modifications
Change in contract terms while it is ongoing. Companies determine: Whether a new contract (and performance obligations) results or Whether it is a modification of the existing contract.

Separate Performance Obligation Account for as a separate performance obligation if both of the following conditions are satisfied: Promised goods or services are distinct (i.e., company sells them separately and they are not interdependent with other goods and services), and The company has the right to receive an amount of consideration that reflects the standalone selling price of the promised goods or services.

Example: Homebuilder, Inc. has a contract to build a custom home for Family A for $500,000. Family A owns the land. Half way through the construction Family A decides they would really like a pool for their new house. Homebuilder, Inc. agrees to build the pool for an additional $50,000 (which is the standalone selling price for a pool). Homebuilder, Inc. regularly provides this option for its custom homes. Homebuilder, Inc. uses the percentage of completion method for recognizing revenue. Given a new contract, Homebuilder, Inc. will recognize an additional: Original contract [($500,000) x 50%] = $250,000 Separate Contract for Pool = 50,000 Total revenue = $300,000

Example: Assume that Homebuilder, Inc. does not routinely build pools as an option for its custom homes and, therefore, cannot account for the change order as a separate contract. Homebuilder, Inc. also concludes the pool is not a distinct performance obligation and, when the pool is considered, that construction is now only 40% complete. Given the facts and circumstances, Homebuilder, Inc. will have to treat the old contract as terminated and a new contract created to complete the construction of the home with a pool. Therefore, future revenue to be recognized is: Original contract [$500,000 x 60%] = $300,000 Change order for pool = 50,000 Total revenue $350,000

Example: Assume that Homebuilder, Inc. does not routinely build pools as an option for its custom homes and, therefore, cannot account for the change order as a separate contract. Homebuilder, Inc. also concludes the pool is not a distinct performance obligation and, when the pool is considered, that construction is now only 40% complete. Given the facts and circumstances, Homebuilder, Inc. will have to treat the change order as a modification of the original contract created to complete the construction of the home with a pool. Therefore, revenue will be adjusted as follows: Modified contract [$550,000 x 40%] = $220,000 Amount recognized to date of modification = 250,000 Reduction if revenue (debit adjustment) ($30,000)

Step 1 - Contract Modifications
If modification priced at stand alone selling prices and the product or service is distinct, account for the modification separately as a separate contract and performance obligation. Otherwise, account for the modification as if (1) the old contract was terminated and new contract created for undelivered goods or services (if distinct) or (2) the modification were part of the original contract (if not distinct) So how do we know a modification (i.e. performance obligation) is distinct? Not specifically defined in the standard. Marriam Webster’s Definition: Distinct: Distinguishable to the eye or mind as being discrete or not the same. [An entity shall account for the contract modification as if it were a termination of the existing contract, and the creation of a new contract, if the remaining goods or services are distinct from the goods or services transferred on or before the date of the contract modification. The amount of consideration to be allocated to the remaining performance obligations (or to the remaining distinct goods or services in a single performance obligation identified in accordance with paragraph (b) : ) is the sum of: [ASU , paragraph 5]] 1. [The consideration promised by the customer (including amounts already received from the customer) that was included in the estimate of the transaction price and that had not been recognized as revenue and [ASU , paragraph 5]] 2. [The consideration promised as part of the contract modification. [ASU , paragraph 5]] b. [An entity shall account for the contract modification as if it were a part of the existing contract if the remaining goods or services are not distinct and, therefore, form part of a single performance obligation that is partially satisfied at the date of the contract modification. The effect that the contract modification has on the transaction price, and on the entity’s measure of progress toward complete satisfaction of the performance obligation, is recognized as an adjustment to revenue (either as an increase in or a reduction of revenue) at the date of the contract modification (that is, the adjustment to revenue is made on a cumulative catch-up basis). [ASU , paragraph 5]] c. [If the remaining goods or services are a combination of items (a) and (b), then the entity shall account for the effects of the modification on the unsatisfied (including partially unsatisfied) performance obligations in the modified contract in a manner that is consistent with the objectives of this paragraph. [ASU , paragraph 5]]

Step 2 Key Element: distinct goods or services
5. Recognize revenue when a performance obligation is satisfied 4. Allocate the transaction price 3. Determine the transaction price 2. Identify the separate performance obligations 1. Identify the contract(s) with the customer Key Element: distinct goods or services Separate performance obligation is a promise to transfer a distinct good or service to the customer So there is that term distinct again: Distinct: Distinguishable to the eye or mind as being discrete or not the same. Revenue allocated to every good or service in the contract that is distinct telecommunications: revenue allocated to ‘free’ handset post-delivery services (e.g. installation, maintenance) long-term contracts: greater unbundling

Step 2 - Separate Performance Obligations
Are goods/services in the contract provided at the same time, resulting in the same amount and timing of revenue recognition? YES – account for as a single PO NO Are promised goods & services distinct from other goods & services in the contract? If No – account for as a single PO If YES – Separate PO

Step 2 - Separate Performance Obligations
To determine whether a company has to account for multiple performance obligations, it evaluates two conditions. Whether the product or service is distinct in the context of the contract Whether the product or service is capable of being distinct. Why does this make a difference? A distinct product may have an earlier recognition date. For example, if you are a land developer and you identify two separate performance obligations: 1) Transfer of the title to the land to the customer and 2) Construction of roads, utilities, etc…

Identifying Separate Performance Obligations
Separate performance obligations exist if the goods or services are: capable of being distinct because the customer can use the good or service on its own or together with resources readily available to the customer, and distinct in the context of the contract because the good or service is not highly dependent on, or highly interrelated with, other promised goods or services in the contract A firm should combine a good or service with other goods or services in the contract if they are not individually separable until a single performance obligation is identified

Step 2 – Illustration 1 Separate Performance Obligations
XYZ licenses customer-relationship software to LMN Company. In addition to providing the software itself, XYZ promises to provide consulting services by extensively customizing the software to LMN’s information technology environment, for total consideration of $600,000. In this case, XYZ is providing a significant service by integrating the goods and services (the license and the consulting service) into one combined item for which LMN has contracted. In addition, the software is significantly customized by XYZ in accordance with specifications negotiated by LMN. Do these facts describe a single or separate performance obligation? The license and the consulting services are distinct but interdependent, and therefore should be accounted for as one performance obligation.

Step 2 – Illustration 2 Separate Performance Obligations
ABC manufactures and sells computers that include a warranty to make good on any defect in its computers for 120 days (often referred to as an assurance warranty). In addition, it sells separately an extended warranty, which provides protection from defects for three years beyond the 120 days (often referred to as a service warranty). In this case, two performance obligations exist, one related to the sale of the computer and the assurance warranty, and the other to the extended warranty (service warranty). The sale of the computer and related assurance warranty are one performance obligation as they are interdependent and interrelated with each other. However, the extended warranty is separately sold and is not interdependent, and should be treated as a separate performance obligation.

Step 3 Key element: expected amount
5. Recognize revenue when a performance obligation is satisfied 4. Allocate the transaction price 3. Determine the transaction price 2. Identify the separate performance obligations 1. Identify the contract(s) with the customer Key element: expected amount Transaction price is the expected (probability-weighted) or most likely consideration from the customer, and reflects: Reasonable estimates of contingent amounts Implicit financing Reasonable estimates if company has relevant experience Collectability affects how much, rather than whether, revenue is recognized Financing presented separately and it goes both ways (interest income if paid in arrears, expense if paid in advance)

Step 3: Determine the Transaction Price
Amount of consideration that company expects to receive from a customer. In a contract it is often easily determined because customer agrees to pay a fixed amount. Other contracts, companies must consider: Variable consideration Time value of money Consideration paid or payable to the customer

Step 3 - Determining the Transaction Price
Variable Consideration Price dependent on Future events May include discounts, rebates, credits, performance bonuses, or royalties. Companies estimate amount of revenue to recognize. Expected value Most likely amount

Estimating Variable Consideration Expected Value: Probability-weighted amount in a range of possible consideration amounts. May be appropriate if a company has a large number of contracts with similar characteristics. Can be based on a limited number of discrete outcomes and probabilities. Most Likely Amount: The single most likely amount in a range of possible consideration outcomes. May be appropriate if the contract has only two possible outcomes.

Estimating Variable Consideration Facts: Construction Company Z enters into a contract with a customer to build a warehouse for $100,000, with a performance bonus of $50,000 that will be paid based on the timing of completion. The amount of the performance bonus decreases by $5,000 per week for every week beyond the agreed-upon completion date. The contract requirements are similar to contracts that Company Z has performed previously, and management believes that such experience is predictive for this contract. Management estimates that there is a 60% probability that the contract will be completed by the agreed-upon completion date, a 30% probability that it will be completed 1 week late, and only a 10% probability that it will be completed 2 weeks late. Question: How should Company Z account for this revenue arrangement?

$150,000 (the outcome with 60% probability)
Step 3 – Estimating Variable Consideration Question: How should Company Z account for this revenue arrangement? Management has concluded that the probability-weighted method is the most predictive approach: 60% chance of $150,000 = $ 90,000 30% chance of $145,000 = 43,500 10% chance of $140,000 = 14,000 $147,500 Most likely outcome, if management believes they will meet the deadline and receive the $50,000 bonus, the total transaction price would be? $150,000 (the outcome with 60% probability)

Step 3 – Variable Consideration
Only allocate variable consideration if it is reasonably assured that it will be entitled to the amount Companies only recognizes variable consideration if they have experience with similar contracts and are able to estimate the cumulative amount of revenue, and based on experience, they do not expect a significant reversal of revenue previously recognized. If these criteria are not met, revenue recognition is constrained.

Time Value of Money When contract (sales transaction) involves significant financing component. Interest accrued on consideration to be paid over time. Fair value determined either by measuring the consideration received or by discounting the payment using an imputed interest rate. Company reports as interest expense or interest revenue.

Step 3 – Time Value of Money Example
EXTENDED PAYMENT TERMS Facts: On July 1, 2019, SEK Company sold goods to Company Y for $900,000 in exchange for a 4-year, zero-interest-bearing note with a face amount of $1,416,163. The goods have an inventory cost on SEK’s books of $590,000. Questions: (a) How much revenue should SEK Company record on July 1, 2019? Entry to record SEK’s sale to Company Y on July 1, 2019, is as follows. Notes Receivable 1,416,163 Sales Revenue 900,000 Discount on Notes Receivable 516,163 Cost of Goods Sold 590,000 Inventory 590,000

Step 3 – Time Value of Money Example
EXTENDED PAYMENT TERMS Facts: On July 1, 2019, SEK Company sold goods to Company Y for $900,000 in exchange for a 4-year, zero-interest-bearing note with a face amount of $1,416,163. The goods have an inventory cost on SEK’s books of $590,000. Questions: (b) How much revenue should it report related to this transaction on December 31, 2019? Entry to record interest revenue at the end of the year, December 31, 2019. Discount on Notes Receivable 54,000 Interest Revenue (12% x ½ x $900,000) 54,000 Companies are not required to reflect the time value of money if the time period for payment is less than a year.

Step 3 – Consideration Paid or Payable
VOLUME DISCOUNT Facts: X Corp offers its customers a 3% volume discount if they purchase at least $2 million of its product during the calendar year. On March 31, 2019, X Corp made sales of $700,000 to a customer. In the past 2 years, X Corp sold over $3,000,000 to the same customer in the period April 1 to December 31. Questions: How much revenue should X Corp recognize for the first 3 months of 2019? X Corp makes the following entry on March 31, 2019. Accounts Receivable 679,000 Sales Revenue 679,000 X Corp should reduce its revenue by $21,000 ($700,000 x 3%) because it is probable that it will provide this rebate.

Step 4 – Allocating the Transaction Price
5. Recognize revenue when a performance obligation is satisfied 4. Allocate the transaction price 3. Determine the transaction price 2. Identify the separate performance obligations 1. Identify the contract(s) with the customer Key Elements: relative selling price allocation Transaction price allocated to the separate performance obligations on relative stand-alone selling price basis Based on their relative fair values. Best measure of fair value is what the company could sell the good or service for on a stand-alone basis. If not available, companies should use their best estimate of what the good or service might sell for as a stand-alone unit. Allocation based on standalone selling prices - estimated, if not observable software: removal of industry-specific requirements no contingent cap

Allocation of Transaction Price to
Separate Performance Obligations

Allocation of Transaction Price to Multiple Performance Obligations
The allocation would be based on relative selling price of all performance obligations Allocation of variable consideration and discounts to one (or more) performance obligations is permitted In the real estate industry, you may have a company (including its related parties) that provides project development and/or construction services and/or management services after construction is complete.

Step 4 – Allocation of Transaction Price
Questions: How should a real estate developer allocate the transaction price in the following example? Assume that a real estate developer is selling residential homes in a golf course community, and part of the transaction price can cover a golf membership in a country club owned and operated by the developer. Similar homes are sold for $900,000 in the community without the golf membership. The developer is also offering standalone golf memberships for $100,000 in the community. The real estate developer determines that developing and managing golf course communities is part of its ordinary activities, and further concludes that golf membership is not considered an incentive. A home with a golf course membership closes with an unrelated third party for a selling price of $950,000, which represents a discount allocated in accordance with FASB ASC (that is, on the basis of relative stand-alone selling prices). How should the developer allocate the transaction price?

Step 4 – Allocation of Transaction Price
Questions: How should a real estate developer allocate the transaction price in the following example? The developer allocates the transaction price (TP) on a standalone selling price (SP) basis, as follows: Stand Alone Allocation TP Selling Prices Percentage Allocation Golf membership $ 100, % $ 95,000 Residential home , % ,000 Total standalone SP basis $1,000, % $950,000

Step 5 – Recognize Revenue
5. Recognize revenue when a performance obligation is satisfied 4. Allocate the transaction price 3. Determine the transaction price 2. Identify the separate performance obligations 1. Identify the contract(s) with the customer Key Element: transfer based on control The standard notes that in many situations the entity, as the seller, retains some rights to an asset as protection against the customer’s failure to comply with the terms of the contract. These rights would be considered ‘protective rights’ and would not preclude a customer from obtaining control of the asset. The proposed standard provides indicators to determine whether a customer has obtained control of goods or services including: - Unconditional obligations to pay - The customer has legal title The customer has physical possession The design or function of the good or service is customer-specific The proposed guidance states that none of the four preceding indicators would alone be a sufficient indicator of the change in control and some indicators may not be relevant to a particular contract.

Step 5: Recognize Revenue When (or as) Each Performance Obligation is Satisfied
Company satisfies its obligation when the customer obtains control of the goods or service. Change Control Indicators: Company has a right to payment for asset. Company has transferred legal title to asset. Company has transferred physical possession of asset. Customer has significant risks and rewards of ownership. Customer has accepted the asset.

Recognize revenue from a performance obligation over time if one of three criteria are met: Customer simultaneously receives and consumes the benefits provided by the seller as the entity performs The seller’s performance creates of enhances an asset that the customer controls The seller’s performance does not create an asset with an alternative use AND the seller has an enforceable right to payment for performance completed.

Recognize revenue from a performance obligation over time Measure progress toward completion Method for measuring progress should depict transfer of control from company to customer. Input methods (e.g. percentage of costs incurred to total estimated costs) Output methods (percentage of project complete according to an architect’s certification)

Step 5: Recognizing Revenue Example
For purposes of illustrating these concepts, assume a developer constructs an asset but title of the land and/or building transfers to the customer only upon completion. In this situation, the first two criteria for recognizing revenue over time are generally not met, as the customer does not have the ability to consume the benefits from or control the asset until closing. Therefore, revenue recognition depends on whether (1) performance creates an asset with an alternative use to the developer, and (2) the entity has an enforceable right to payment for completion to date.

Step 5: Recognizing Revenue Example – Scenario A
Scenario A: The customer makes a deposit when the contract is signed. The remainder is paid upon completion of the construction when physical possession is obtained (generally, at closing). If the customer defaults on the contract, the developer keeps the deposit but has no right to payment for construction completed to date. Because the developer does not have an enforceable right to payment for work performed to date, the developer may not recognize revenue over a period of time. Instead, the developer would recognize the revenue upon completion and closing of the property.

Step 5: Recognizing Revenue Example – Scenario B
Scenario B: The customer makes progress payments during construction. If the customer defaults on the contract, the developer has an enforceable right to payment, and the legal practices in the area have upheld this right. The contract includes terms that prevent the developer from directing the property to another customer. Because the developer may not direct the property to another customer, it is not creating an asset with an alternative use but, as the developer does have an enforceable right to payment for completion to date, the developer may recognize revenue over a period of time.

Step 5: Recognizing Revenue Example – Residential Condominiums
Under current FASB to 40-59, a developer of residential condominiums is allowed to use the percentage-of-completion method to recognize revenue provided certain criteria are met. Under the new revenue standard for contracts with customers at FASB , revenue can be recognized over time only if one of three criteria above are meet. As the customer (the buyer of condominium unit), does not generally simultaneously receive and consume benefits from owning a condominium unit and does not control the unit until the sale of the unit is closed, developers would only be able to use the percentage-of-completion input method if the two requirements of the third criterion are met. Meeting the second requirement of the third criterion could be difficult in the United States, as many state and local laws prevent developers from enforcing payment on residential condominiums until the sale closes.

Summary of the Five-Step Revenue Recognition Process
Step in Process Identify the contract with customers. Description A contract is an agreement that creates enforceable rights or obligations. Implementation A company applies the revenue guidance to contracts with customers and must determine if new performance obligations are created by a contract modification. A company cannot get around the rules by separating contracts if there is a single commercial objective or the prices in the separate contracts are interdependent.

Step in Process Identify the separate performance obligations in the contract Description A performance obligation is a promise in a contract to provide a product or service to a customer. A performance obligation exists if the customer can benefit from the good or service on its own or together with other readily available resources. Implementation A contract may be comprised of multiple performance obligations. Accounting is based on evaluation of whether the product or service is distinct within the contract. If each of the goods or services is distinct, but is interdependent and interrelated, these goods and services are combined and reported as one performance obligation. Example of transfer of title to land prior to development services.

Step in Process Determine the transaction price. Description Transaction price is the amount of consideration that a company expects to receive from a customer in exchange for transferring goods and services. Implementation In determining the transaction price, companies must consider the following factors: variable consideration, time value of money, noncash consideration, and consideration paid or payable to customer.

Step in Process Allocate the transaction price to the separate performance obligation. Description If more than one performance obligation exists, allocate the transaction price based on relative fair values. Implementation The best measure of fair value is what the good or service could be sold for on a standalone basis (standalone selling price). Estimates of standalone selling price can be based on adjusted market assessment, expected cost plus a margin approach, or a residual approach.

Implementation Companies satisfy performance obligations either at a point in time or over a period of time. Companies recognize revenue over a period of time only if certain conditions are met. Step in Process Recognize revenue when each performance obligation is satisfied. Description A company satisfies its performance obligation when the customer obtains control of the good or service.

Other Revenue Recognition Issues
Right of Return Consignments Repurchase Agreements Warranties Bill and Hold Principle-agent relationships

Right of Return Right of return is granted for product for various reasons (e.g., dissatisfaction with product). Company returning the product receives any combination of the following: Full or partial refund of any consideration paid. Credit that can be applied against amounts owed, or that will be owed, to the seller. Another product in exchange.

Right of Return RIGHT OF RETURN
Facts: ABC Company sells 100 products for $100 each to XYZ Inc. for cash. ABC allows XYZ to return any unused product within 30 days and receive a full refund. The cost of each product is $60. To determine the transaction price, ABC decides that the approach that is most predictive of the amount of consideration to which it will be entitled is the most likely amount. Using the most likely amount, ABC estimates that: Three (3) products will be returned. The costs of recovering the products will be immaterial. The returned products are expected to be resold at a profit. Question: How should ABC record this sale?

Right of Return Question: How should ABC record this sale?
ABC records the sale as follows with the expectation that three products will be returned: Cash 10,000 Sales Revenue [$9,700 x ($100 x 97)] 9,700 Refund Liability ($100 x 3) 300 ABC records the cost of goods sold with the following entry. Cost of Goods Sold 5,820 Estimated Inventory Returns ($60 x 3) 180 Inventory 6,000

Repurchase Agreements
Transfer control of (sell) an asset to a customer but have an obligation or right to repurchase If obligation or right to repurchase is for an amount greater than or equal to selling price, then transaction is a financing transaction.

Facts: LMN Inc., an equipment dealer, sells equipment on January 1, 2019, to PRQ Company for $100,000. It agrees to repurchase this equipment on December 31, 2019, for a price of $121,000. Question: How should LMN Inc. record this transaction? Assuming an interest rate of 10 percent is imputed from the agreement, LMN makes the following entry to record the financing on January 1, 2019. Cash 100,000 Liability to PRQ Company 100,000

Question: How should LMN Inc. record this transaction? LMN Inc. records interest on December 31, 2019, as follows. Interest Expense 21,000 Liability to PRQ Company ($100,000 x 10%) 21,000 LMN Inc. records retirement of its liability to PRQ Company on December 31, 2019, as follows. Liability to Lane Company 121,000 Cash ($100,000 + $121,000) 121,000

Bill-and-Hold Arrangements
Contract under which an entity bills a customer for a product but the entity retains physical possession of the product until a point in time in the future. Result when buyer is not yet ready to take delivery but does take title and accepts billing.

Facts: Alpha Company sells $450,000 (cost $280,000) of brewing equipment on March 1, 2019, to a local coffee shop, Bravo, which is planning to expand its locations around the city. Under the agreement, Bravo asks Alpha to retain the equipment in its warehouses until the new coffee shops that will house the equipment are ready. Title passes to Bravo at the time the agreement is signed. Question: When should Alpha recognize the revenue from this bill-and-hold arrangement? Alpha determines when it has satisfied its performance obligation to transfer a product by evaluating when Bravo obtains control of that product.

Question: When should Alpha recognize the revenue from this bill-and-hold arrangement? For Bravo to have obtained control of a product in a bill-and-hold arrangement, all of the following criteria should be met: (a) The reason for the bill-and-hold arrangement must be substantive. (b) The product must be identified separately as belonging to Bravo. (c) The product currently must be ready for physical transfer to Bravo. Alpha cannot have the ability to use the product or to direct it to another customer. In this case, it appears that the above criteria were met, and therefore revenue recognition should be permitted at the time the contract is signed.

Question: When should Alpha recognize the revenue from this bill-and-hold arrangement? Alpha makes the following entry to record the sale. Accounts receivable 450,000 Sales Revenue 450,000 Alpha makes an entry to record the related cost of goods sold as follows. Cost of Goods Sold 280,000 Inventory 280,000

Principle-Agent Relationships
Agents performance obligation is to arrange for principle to provide goods or services to a customer. Example Travel Company (agent) facilitates booking of cruise for Cruise Company (principal). Priceline (agent) facilitates sale of various services such as car rentals at Hertz (principal). Amounts collected on behalf of the principal are not revenue of the agent. Revenue for agent is amount of commission received.

Warranties Two types of warranties to customers
Product meets agreed-upon specifications in contract at time product is sold Warranty is included in sales price (assurance-type warranty) Not included in sales price of product (service-type warranty). Recorded as a separate performance obligation.

Warranties WARRANTIES
Facts: A-1 Company sold 1,000 Widgets during 2019 at a total price of $6,000,000, with a warranty guarantee that the product was free of any defects. The cost of Widgets sold is $4,000,000. The term of the assurance warranty is two years, with an estimated cost of $30,000. In addition, A-1 sold extended warranties related to 400 Widgets for 3 years beyond the 2-year period for $12,000. Question: What are the journal entries that A-1 Company should make in 2019 related to the sale and the related warranties?

Warranties Question: What are the journal entries that A-1 Company should make in 2019 related to the sale and the related warranties? To record the revenue and liabilities related to the warranties: Cash ($6,000,000 + $12,000) 6,012,000 Warranty Expense 30,000 Warranty Liability 30,000 Unearned Warranty Revenue 12,000 Sales Revenue 6,000,000 Cost of Goods Sold 4,000,000 Inventory 4,000,000 To reduce inventory and recognize cost of goods sold:

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Revenue Recognition ASU No. 2014-09, ASC 606.

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Revenue Recognition ASU No. 2014-09, ASC 606.

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Presentation on theme: "Revenue Recognition ASU No. 2014-09, ASC 606."— Presentation transcript:

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About project

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