2015 Deloitte Foundation/Federation of Schools of Accountancy Faculty Consortium Principles Under the New Revenue Recognition Standard May 2015

2015 Deloitte Foundation/Federation of Schools of Accountancy Faculty Consortium

Principles Under the New Revenue Recognition Standard

May 2015

Copyright © 2015 Deloitte Development LLC. All rights reserved.2

Dear Participants,

We look forward to discussing with you the principles under FASB’s new ASU (ASU 2014-09) on revenue recognition (also, known as ASC 606 in the Accounting Standards Codification).

As part of this discussion, we will use case studies to illustrate certain principles. In order to make the most efficient use of our time, this guide contains the cases we will discuss and relevant references within ASC 606. You can also find relevant guidance in Deloitte’s Roadmap on Revenue at:

http://www.iasplus.com/en-us/publications/us/roadmap-series/revenue

Please review the cases and relevant Codification cites prior to the conference. You should be prepared to discuss your views on application of the principles to the particular fact patterns.

We hope you find this conference and discussion of these cases interesting and helpful.

Participant GuidePrinciples Under the New Revenue Recognition Standard



Course Introduction


Agenda

Course flow

New Revenue Recognition Standard Review

Case Studies & Discussion

Session I: Step 1: Identification of a contract with a customer & Step 2: Identifying the performance obligations

Session II: Step 3: Determining the transaction price & Step 4: Allocating the transaction price

Session III: Step 5: Recognizing revenue & other issues

New Revenue Recognition Standard Review


The five steps revenue recognition process

Identify the contract

with a customer

(Step 1)

Identify the performance obligations

in the contract

(Step 2)

Determine the

transaction price

(Step 3)

Allocate the transaction

price to performance obligations

(Step 4)

Recognize revenue when

(or as) the entity satisfies a performance

obligation

(Step 5)

Core principle: Recognize revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration the entity expects to be entitled in

exchange for those goods or services

This revenue recognition model is based on a control approach which differs from the risks and rewards

approach applied under current U.S. GAAP.

Case Studies

Session I

Step 1: Identifying the Contract


Case facts

• Entity A enters into 1000 homogenous contracts with different customers for fixed consideration of $1,000 each.

• Before entering into a contract with a customer, Entity A performs procedures designed to determine whether it is probable that the customer will pay the amount owed under the contract (e.g., a credit check) and only enters into the contract if the entity concludes that it is probable that customer will pay.

• During the previous three years, Entity A has collected 98% of the amounts it has billed to customers.

• Based on an analysis of industry and historical collection data, Entity A has concluded that the collection rate from the past three years is the probable outcome for future contracts.

• Entity A intends to enforce its rights to the consideration to which it is entitled (i.e., it will not offer any concessions to its customers).o Accordingly, the only variability in the contract is due to customer credit risk.

Case study: Assessing collectability of contracts

QuestionHow should Entity A assess identification of contracts for revenue recognition? • View A: Each of the 1,000 contracts qualify; resulting in $1,000,000 in revenue and

$20,000 in bad debt expense upon satisfaction of the performance obligation.• View B: Only 98% of the portfolio of contracts is probable of collection; thus revenue

should be $980,000 when the performance obligation is satisfied.

?


Relevant resources

Relevant Guidance in ASC 606• ASC 606-10-25-1 • ASC 606-10-25-5 through 25-8• ASC 606-10-10-4

Case study: Assessing collectability of contracts

Step 2: Identifying the Performance Obligations


• Entity T, a TV manufacturer, enters into contract to ship 100 TVs from San Francisco to a customer in London for fixed consideration. The shipment from SF to London, by a 3rd party carrier, will take approximately 3 weeks.

• Terms are FOB shipping point. Legal title of the TVs transfers to the customer upon delivery to carrier. Entity T arranges shipping and charges customer for shipping.

• TVs were delivered to carrier 9 days before year end. Payment is due 30 days after receipt of goods.

• Entity T is not obligated to but has a history of replacing (or crediting customer’s account for) any TVs damaged during shipment. Entity T historically pursue claims against the carrier/insurance provider.

• Entity T has not elected the (proposed) practical expedient for shipping.

Case study: Synthetic FOB destination

Question

Is shipping a separate performance obligation?

Bonus for Session III – when does control of TVs transfer?

Case Facts

?


Relevant resources

Relevant Guidance in ASC 606• ASC 606-10- 25-14 through 26

Case study: Synthetic FOB destination


• Entity M, a parts supplier, enters into contract with an OEM (i.e., M’s customer) for fixed consideration of $30 million to (1) construct equipment for the customer that M will use to make parts for the customer and (2) supply 30 million parts to the customer.

• Legal title of the equipment transfers to the customer upon completion of the construction of the equipment (i.e., prior to M beginning production of the parts).

• M is one of many companies that have the ability to both construct the equipment and subsequently produce the parts.

Case study: Identifying performance obligations for a manufacturer

Question

Does the contract have one or more than one performance obligation?

Case Facts

?


Relevant resources

Relevant Guidance in ASC 606• 606-10-25-20 • 606-10-25-21

Case study: Identifying performance obligations for a manufacturer


• An entity enters into monthly contract with its customer to provide a service (e.g., fitness center) and charges monthly service fees. It also charges a one-time $50 nonrefundable upfront fee (equal to one-half of one month’s service fee of $100) payable at contract signing.

• Customers are under no obligation to continue to purchase the monthly service after the first month. And the entity has not committed to any pricing levels for the service in future months.

• The activity of signing up a customer does not result in a transfer of a good or service to the customer, as such, it does not represent a separate performance obligation. The upfront fee should therefore be deferred and recognized as the future service is provided.

• Historical data indicates that the average customer life is two years.

Case study: Material right (Nonrefundable upfront fees)

Questions

Case Facts

1. Does the renewal option create a material right (gives rise to a performance obligation) for a customer to renew the monthly service?

2. How should the entity account for the upfront fee based on your answer to the first question?

?


Relevant resources

Relevant Guidance in ASC 606• ASC 606-10-55-50 through 55-53 • ASC 606-10-55-41 through 55-45

Case study: Material right (Nonrefundable upfront fees)

Session II

Step 3: Determining the Transaction Price


• How much revenue should the entity recognize upon transferring control of the equipment to the customer? What should Entity P record on 1/2/20X1?

Case facts

• On 1/2/20X1, Entity P, a manufacturer, sells a large piece of equipment to a customer for consideration equal to five percent of the customer’s future net sales for the next five years.

• The entity has determined that the transaction meets the criterion in Step 1 to be accounted for as a contract with a customer.

• Control of the equipment transfers to the customer on the date of sale (1/2/20X1).• The consideration is payable after the customer issues its audited financial

statements for each year (and after Entity P issues financial statements each year).• Entity P has determined after careful analysis that there is not a significant financing

component in the transaction.• Based on the customer’s audited financial statements, the customer’s sales for the

last ten years have fluctuated from $1.4 million to $2.2 million with the probability weighted average amount being $2.0 million.

• Entity P is highly confident that the customer’s sales will not be less than $1.6 million in any of the next five years.

Case study: Accounting for contingent revenue

Question?


Relevant resources

Relevant Guidance in ASC 606• 606-10-32-5 through 32-9• 606-10-32-11 through 32-13 • 606-10-32-15 through 32-20 • 606-10-45-1 through 45-5

Case study: Accounting for contingent revenue


• Should the constraint on variable consideration be applied at the contract level ($10.01 million) or the performance obligation level ($10,000)?

Case factsAn entity enters into a contract with a customer to provide the customer with equipment and a consulting service. The contractual price for the equipment is fixed at $10 million. The contract does not include a fixed price for the consulting service, but if the customer’s manufacturing costs decrease by 5% over a one-year period, the entity will receive $10,000 for the consulting service. Also assume the following:• The equipment and the consulting service are separate performance

obligations.• The standalone selling prices of the equipment and consulting service are

determined to be $10 million and $10,000, respectively.• The entity concludes $10,000 is the consideration amount for the consulting

service using the most likely amount method under ASC 606-10-32-8. • The entity allocates the performance-based fee of $10,000 entirely to the

consulting service in accordance with ASC 606-10-32-40.

Case study: Insignificant variable consideration at contract level

Question?


• How should the entity measure the transaction?

Case factsOn September 1, Entity W enters into a contract with a Customer C to provide the customer with 100 widgets on December 15. In return, Customer C promises to transfer to Entity W, upon inspection and acceptance of the widgets, but no later than December 28, 10 shares of C stock. Customer C is a private company. The transaction occurs as contracted and stock is delivered on December 28. Assume these additional facts:• On September 1 the selling price of a widget is $10. On November 1, Entity W

institutes a price increase of $0.55 per widget.• The estimated fair value of a share of Customer C stock, based on limited

private transactions, is as follows:• September 1 = $100• November 1 = $95• December 15 = $102• December 28 = $105

Case study: Widgets for Stock

Question?

Step 4: Allocating the Transaction Price


Case study: Allocating a discount

Case facts

Entity W sells three items A, B, and C, respectively. The standalone selling prices of A, B, and C are as shown to the right:

Product Standalone Selling Price

Item A $30

Item B $70

Item C $50Consider the following scenarios:

SCENARIO 1

On January 1, 20X1, the entity enters into a contract with a customer to provide the customer with one of each item for consideration of $135 (a $15 discount) based on the schedule to the right:

Date Deliverable

03/31/X1 Item A

06/30/X1 Item B

09/30/X1 Item C

The following bundles are also regularly sold at the following combined prices:

Bundle Price Combined Standalone Selling Price Discount in BundleA + B $85 $30 + $70 = $100 $15A + C $65 $30 + $50 = $80 $15B + C $105 $70 + $50 = $120 $15

QuestionFor Scenario 1, how would the entity allocate the discount in the contract?

?


Relevant resources

Relevant Guidance in ASC 606• 606-10-32-28 through 32-30• 606-10-32-31 through 32-35• 606-10-32-36 through 32-38• 606-10-32-39 through 32-41




Case facts

SCENARIO 2

On January 1, 20X1, the entity enters into a contract with a customer to provide the customer with one of each item for consideration of $135 (a $15 discount) based on the schedule to the right:

Date Deliverable

03/31/X1 Item A

06/30/X1 Item B

09/30/X1 Item C

The following bundles are also regularly sold at the following combined prices:

Bundle Price Combined Standalone Selling Price Discount in BundleA + B $85 $30 + $70 = $100 $15A + C $65 $30 + $50 = $80 $15B + C $120 $70 + $50 = $120 $0

Question

For Scenario 2, how would the entity allocate the discount in the contract?

?

As a reminder, the standalone selling prices of A, B, and C are as shown to the right:

Product Standalone Selling Price

Item A $30

Item B $70

Item C $50

Session III

Step 5: Recognizing Revenue


Case study: Right to payment (Over time vs. point-in-time)

Case facts

January 1, 20X1, Entity X enters into two contracts with customers that are similar except for termination provisions. Each is for the sale of 10,000 customized parts at $100 per part. The parts have no alternative use to Entity X (ASC 606-10-25-28). On March 31, 20X1, Entity X produced and held a total of 4,000 parts of finished goods and an additional 100 parts in WIP with costs-to-date of $5,000. The total cost to produce each part is $90.

Contract A

Contract A states that if the contract is terminated, the customer is required to pay the full price for all finished goods on hand. For parts in process, the customer is required to pay Entity X its cost plus 10% which is the expected margin on the finished goods (and therefore a reasonable margin). As such, if the contract is terminated on March 31, 20X1, Entity X would be entitled to $405,500 ($100 for the 4,000 finished goods and cost of $5,000 plus 10% for the 100 parts in WIP).

Contract B

Contract B states that if the contract is terminated, the customer is required to pay the full price for all finished goods on hand and only Entity’s X’s cost for any parts in process. As such, if the contract is terminated on March 31, 20X1, Entity X would be entitled to $405,000 ($100 for the 4,000 finished goods and cost of $5,000 for the 100 parts in WIP).

QuestionHow should Entity X recognize revenue for contract A and B – i.e., over time or at a point-in-time?

?


Relevant resources

Relevant Guidance in ASC 606• ASC 606-10-25-27(c) • ASC 606-10-25-29• ASC 606-10-55-11 through 55-15

Case study: Right to payment (Over time vs. point-in-time)


Case study: Nature of a license

Case facts

Scenario 1: A film distribution entity licenses a new hit film to a movie theater for showing over a 3 month period (December through February) for fixed consideration of $50,000. Historically, the entity has marketed the film (e.g., via television, radio, print advertising, and billboards) in all regions in which it licenses the film.

Scenario 2: An entity licenses to licensee for fixed consideration of $50,000 the right to use the trademark of a professional sports team that no longer exists.

Question

How should licensor recognize revenue– i.e., over time or at a point-in-time?

?


Relevant resources

Relevant Guidance in ASC 606• 606-10-55-54 through 58

Case study: Nature of a license

Gross versus Net Presentation


• Should ABC Company report as revenue the gross amounts received from Customers for vacation rentals? Would net revenue presentation be more appropriate?

• What information do you think is relevant / needed for the analysis?

ABC Company (the “Company”) provides a vacation rental program to individuals (“Customers”) seeking to rent vacation homes and utilize the amenities (e.g., golf courses, tennis courts, etc.) through the Company’s club and resort facilities. The Company does not own the properties that it rents but rather enters into agreements with the homeowners that allow the Company to rent their homes as part of a vacation package. Homeowners received a percentage of the net rental income collected by the Company.

The Company does not market or promote a specific house/unit but rather markets/promotes a vacation experience, manages all interactions with Customers and is the only entity with an agreement with Customers. The Company has full discretion in determining the rental fee and is primarily responsible for the entire customer experience (including housekeeping services, concierge services, amenities, etc.). If a Customer is not satisfied with the house/unit, the Company is responsible for finding a suitable replacement.

Case study: Gross versus Net Presentation

Case facts

Questions?


Relevant resources

Relevant Guidance in ASC 606• 606-10-55-36 through 40

Case study: Gross versus Net Presentation

Contract Costs


• Question 1: What amount(s) should Entity G capitalize upon initial signing of the contract and upon contract renewal?

• Question 2: What is the amortization period for both the initial commission and the renewal commission?

Case study: Costs to obtain a contract

Case facts

• Entity G, a janitorial services provider, enters into a contract with a customer to provide cleaning services for a two year period.

• Upon the initial signing of the contract, Entity G pays a salesperson a $200 commission for obtaining the new customer contract. An additional commission of $120 is paid each time the customer renews the contract for an additional two years.

• The $120 renewal commission is not commensurate with the $200 initial commission (i.e., a portion of the $200 initial commission relates to future anticipated contract renewals)

• Based on its historical experience, 98% of customers renew their contract for at least two more years or four years total (i.e., the contract renewal represents a specific anticipated contract).

• The average customer relationship is four years.

Questions?


Relevant resources

Relevant Guidance in ASC 606• 340-40-25-1 through 25-4 • 340-40-35-1 through 35-2

Case study: Costs to obtain a contract


Things are changing. Read publications to keep up to date on latest information.

Stay tuned!

• FASB, IASB, TRG, SEC, AICPA, and accounting firms are still in the process of interpreting the guidance in the standard.

• Practice may evolve out of industry interpretations.• Newest developments at FASB may result in the ASU being revised

before it comes effective.

Stay Tuned!

USGAAPplus.com contains the latest news in financial reporting

Documents

2015 Deloitte Foundation/Federation of Schools of Accountancy Faculty Consortium Principles Under the New Revenue Recognition Standard May 2015