Finishing strong in the ASC 606 marathon: An in-depth look at Step 5 and contract costs

Transcription

1 Finishing strong in the ASC 606 marathon: An in-depth look at Step 5 and contract costs Please disable popup blocking software before viewing this webcast Original Publication Date: May 23, 2017 CPE Credit is not available for viewing archived programs

2 CPE Reminders Use Q&A to ask questions during the webcast. To receive CPE, you must be active for the entire webcast and respond to at least 75% of the polls. CPE is not offered for audio-only attendees or replay viewing. Group participation will not receive CPE. You must be logged in individually to receive CPE credit. Upon conclusion of the program, please complete the final evaluation and your CPE certificate will be available if you have met the minimum CPE requirements. Turn off all pop-up blockers to download your CPE certificate. Grant Thornton LLP. All rights reserved. 2

3 For a Better Webcast Experience Use a wired internet connection from your local office and turn off your computer's Wi-Fi signal. For optimal viewing speed, close all other applications, including Outlook. Most technical issues (e.g., buffering, silenced audio) can be resolved by refreshing your feed using the F5 key. Technical help is available via the Q&A button, by calling or contacting GTWebcast@Level3.com Click the Resources button to download the presentation materials. Grant Thornton LLP. All rights reserved. 3

4 Speakers Lynne Triplett Partner Accounting Principles Doug Reynolds Partner Accounting Principles Carolyn Warger Experienced Manager Audit Grant Thornton LLP. All rights reserved. 4

5 Finishing strong in the ASC 606 marathon webcast series Part 1 An in-depth look at designing for success Link Part 2 Steps 1 and 2 of the new revenue model Link Part 3 Steps 3 and 4 of the new revenue model Link Part 4 - Step 5 and contract costs May 23, :30 p.m. CT 1.5 CPE hours Listen to the replay of prior events Register for one or all of the upcoming webcasts grantthornton.com > Events Part 5 - Licensing, modifications, and other potential hurdles June 13, :30 p.m. CT 1.5 CPE hours Grant Thornton LLP. All rights reserved. 5

6 Learning objectives Differentiate when to recognize revenue over time versus at a point in time Identify how entities that manufacture custom goods could be impacted by the new guidance Select an appropriate measure of progress when recognizing revenue over time Describe the proper accounting for contract costs Assess the impact of the new model on pre-production activities Grant Thornton LLP. All rights reserved. 6

7 Agenda Over time vs. point-in-time Measures of progress Contract costs Pre-production activities Grant Thornton LLP. All rights reserved. 7

8 Resources Joint Transition Resource Group for Revenue Recognition (TRG) FASB.org > Standards > Revenue Recognition Transition Resource Group AICPA Revenue Recognition Industry Task Forces AICPA.org > Interest Areas > FRC > Accounting & Financial Reporting > Revenue Recognition Grant Thornton LLP. All rights reserved. 8

9 Five-step model Identify the contract with a customer Identify the performance obligations Determine the transaction price Allocate the transaction price to the performance obligations Recognize revenue when or as an entity satisfies its performance obligations Grant Thornton LLP. All rights reserved. 9

10 Over time vs. point-in-time Grant Thornton LLP. All rights reserved. 10

11 Core principle An entity recognizes revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for the goods or services. Grant Thornton LLP. All rights reserved. 11

12 Core principle An entity should recognize revenue when (or as) it satisfies a performance obligation by transferring a promised good or service to a customer. A good or service is transferred when (or as) the customer obtains control of that good or service. A customer obtains control of a good or service when it can direct the use of and obtain substantially all of the remaining benefits from it. Grant Thornton LLP. All rights reserved. 12

13 Core principle Control transfers: over time or at a point in time Y Does control transfer over time? N Grant Thornton LLP. All rights reserved. 13

14 Over time or at a point in time Does customer receive and consume the benefits as the entity performs? Y N Control is transferred over time Does customer control the asset as it is created or enhanced? Y N Does asset have an alternative use to the entity? Y N Y Does entity have the enforceable right to receive payment for performance to date? N Control is transferred at a point in time Grant Thornton LLP. All rights reserved. 14

15 Customer simultaneously receives and consumes benefits Another entity would not need to substantially reperform the work Disregard contractual restrictions or practical limitations Assume another entity would not have the benefit of any asset that would remain controlled by the original entity if the obligation transferred MOVE CO. Grant Thornton LLP. All rights reserved. 15

16 Customer controls the asset as it is created or enhanced The customer controls the work-in-process arising from the entity's performance. This is common in the following types of contracts: Certain contracts for the U.S. government Work performed on a customer asset Construction on customer-owned land Software customization (at the customer location) Maintenance on customer equipment Grant Thornton LLP. All rights reserved. 16

17 No alternative use and right to payment Asset with no alternative use Assessment includes effects of contractual restrictions and practical limitations Contractual restriction: entity expects customer would enforce rights if entity tried to direct asset to another use; must be substantive Practical limitation: incur significant economic losses to direct asset to another use (cost to rework or only could sell at a significant loss) Right to payment for performance completed to date Must be enforceable Must be entitled to at least an amount that compensates for performance to date, including a reasonable profit margin Grant Thornton LLP. All rights reserved. 17

18 Example No alternative use? Contract to build customized equipment Customization begins when manufacturing is 75% complete Design specifications of the equipment are unique to the customer In-process asset could be redirected up until 75% complete Entity evaluates at contract inception whether there is any alternative use for the asset and considers the asset that will ultimately be transferred to the customer. Asset qualifies as an asset with no alternative use Grant Thornton LLP. All rights reserved. 18

19 Example Enforceable right to payment? In each of the last 5 years, customer has purchased 300 custom ice cream machines In anticipation of the customer s current year order, entity starts production The entity and the customer later enter into a contract for 300 units The entity has an enforceable right to payment when the contract is executed Cumulative catch-up at contract inception Grant Thornton LLP. All rights reserved. 19

20 Example Milestone payments? A contract to build a customized airplane Non-refundable payment schedule: - Payment at contract inception of 20% of the contract price - Regular payments throughout the construction period (50% of the contract price) - Final payment of 30% of the contract price after construction is completed and the airplane has passed the prescribed performance tests Entity does not have right to payment for performance complete to date Grant Thornton LLP. All rights reserved. 20

21 Indicators of transfer of control Present right to payment Customer acceptance Point in time Legal title to the asset Risks and rewards of ownership Physical possession Grant Thornton LLP. All rights reserved. 21

22 Customer acceptance Scenario 1 June 15, 2018 Sale of equipment June 30, 2018 Delivery of equipment July 6, 2018 Customer accepts equipment Acceptance based on specified size and weight Acceptance is objective and standard to all customers Recognize revenue when control transfers on June 30, when equipment is delivered Grant Thornton LLP. All rights reserved. 22

23 Customer acceptance Scenario 2 June 15, 2018 Sale of equipment June 30, 2018 Delivery of equipment July 6, 2018 Customer accepts equipment Acceptance based on customer's internal quality checklist to be completed within 30 days Acceptance is non-standard, specified by customer and relates to a highly complex device with limited history Recognize revenue when control transfers on July 6, upon formal acceptance Grant Thornton LLP. All rights reserved. 23

24 Accounting for unique revenue arrangements Consignment arrangements Indicators that control does not transfer to consignee: Product is controlled by the selling entity until a specified event Entity is able to require the return of the product or transfer the product to a third party Consignee does not have an unconditional obligation to pay for the product Bill-and-hold arrangements Criteria for control to transfer to the customer: Reason for bill-and-hold arrangement is substantive Product must be identified separately as belonging to the customer Product must be ready for physical transfer Entity cannot have the ability to use the product or direct it to another customer Distributors/ resellers No longer acceptable to wait until the product is sold to the end customer if the only uncertainty is the pricing Estimate the consideration to which an entity expects to be entitled and consider the constraint Grant Thornton LLP. All rights reserved. 24

25 Measures of progress Grant Thornton LLP. All rights reserved. 25

26 Measures of progress Select a single measure of progress for each performance obligation that best depicts the way the entity transfers control and apply it consistently Remeasure progress toward completion at the end of each reporting period Grant Thornton LLP. All rights reserved. 26

27 Measures of progress Method Description Examples Disadvantages Output method Recognize revenue by directly measuring the value of the goods and services transferred to date to the customer Surveys of performance completed to date, appraisals of results achieved, time elapsed, units produced, units delivered The outputs may not be directly observable and the information required to apply them may not be readily available Input method Recognize revenue based on the extent of efforts or inputs toward satisfying a performance obligation compared to the expected total efforts or inputs needed Resources consumed, labor hours expended, costs incurred, time elapsed, machine hours used There may not be a direct relationship between an entity s inputs and the transfer of control of the goods/services to the customer Grant Thornton LLP. All rights reserved. 27

28 Measures of progress Can control of a good or service underlying a performance obligation transfer at discrete points in time? When any of the three criteria to recognize revenue over time are met, control does not transfer at discrete points in time An appropriate measure of progress should not result in an entity recognizing a material asset that results from the entity s performance (such as work in process) Grant Thornton LLP. All rights reserved. 28

29 Practical expedient for measuring progress Does the entity have a right to consideration from a customer in an amount that corresponds directly with the value to the customer of the entity's performance completed to date? Y Recognize the amount to which the entity has the right to invoice Grant Thornton LLP. All rights reserved. 29

30 Example Practical expedient Power Seller and Power Buyer execute a contract for the purchase and sale of electricity over a 6-year term Power Buyer is obligated to purchase 10 megawatts of electricity per hour for each hour during the contract term at prices that contemplate the forward market price of electricity at contract inception Power Seller concludes that the promise to sell electricity represents one performance obligation that will be satisfied over time The contract prices are as follows: Years 1-2: $50/MWh Years 3-4: $55/MWh Years 5-6: $60/MWh Grant Thornton LLP. All rights reserved. 30

31 Measures of progress example Construction company agrees to install new elevators as part of a refurbishment service Elevators purchased in advance of beginning work and delivered directly to the construction site Cost of the elevators is 40% of the total expected costs Cost-to-cost input measure of progress Grant Thornton LLP. All rights reserved. 31

32 Measures of progress for multiple goods or services within one performance obligation Security company provides security solutions to its customers: Upfront installation services ($1,000) Monitoring services for two years ($100 per month) The monitoring period begins when the implementation is complete Installation services are typically performed over a 2-month period The customer cannot derive benefit from the installation or the monitoring service until the installation is complete Grant Thornton LLP. All rights reserved. 32

33 Measures of progress for multiple goods or services within one performance obligation Entity's overall promise is to provide the security services for one year No revenue would be recognized over the installation period because that activity does not transfer a service to a customer Select a method that depicts the performance of the security services to measure progress toward completion A time-based method beginning when monitoring service commences might be considered appropriate Grant Thornton LLP. All rights reserved. 33

34 Step 5 takeaways Customized goods may transfer over time Some costs may be excluded from a cost-tocost measure of progress A single measure of progress for each performance obligation An enforceable right to payment must include a reasonable margin Grant Thornton LLP. All rights reserved. 34

35 Contract costs Grant Thornton LLP. All rights reserved. 35

36 Costs to obtain a contract Are the costs incremental? Y N Capitalize the cost as an incremental cost of obtaining the contract Does the entity expect to recover the costs? Y Is the amortization period 1 year or less? Y Practical expedient: expense the related asset N Expense the cost as incurred Grant Thornton LLP. All rights reserved. 36

37 Example Costs to obtain a contract Cost Commission paid only upon successful signing of a contract Capitalize or expense Capitalize Travel expenses for sales persons pitching a new customer contract Expense Legal fees for drafting terms of arrangement for parties to approve and sign Expense Salaries for sales people working exclusively on obtaining new customers Expense Grant Thornton LLP. All rights reserved. 37

38 Example Commissions An entity has a commission program that increases the amount of commission a salesperson receives based on how many contracts the salesperson has obtained during an annual period. The breakdown is as follows: 0-9 contracts 0% commission contracts 2% of value of contracts contracts 5% of value of contracts Question: Which commissions are incremental costs of obtaining a contract? All commission costs are incremental costs of obtaining a contract and therefore should be capitalized Grant Thornton LLP. All rights reserved. 38

39 Timing of cost capitalization Apply other U.S. GAAP to determine when a liability should be recognized Recognize asset for costs to obtain a contract concurrently with recognition of the liability Grant Thornton LLP. All rights reserved. 39

40 Amortization of commissions Amortize incremental costs on a systematic basis, consistent with the transfer of goods/services to the customer. ASC How should we determine the appropriate amortization period? Can we default to average customer life? Estimating the amortization period for capitalized incremental costs is analogous to estimating the amortization/depreciation period for other intangible and tangible assets, which is subjective and requires judgment. Grant Thornton LLP. All rights reserved. 40

41 Amortization of commissions continued Amortizing capitalized commissions over a period longer than the initial contract would not be appropriate if an entity pays a commission on renewal that is commensurate with the commission paid when obtaining the initial contract. BC309 What does "commensurate with" mean qualitative, such as level of effort, or quantitative assessment only? Contract Quantitative assessment needs to be proportional Commission on initial contract Commission on renewal Commensurate 1 5% 5% Yes 2 5% 1% No Grant Thornton LLP. All rights reserved. 41

42 Costs to fulfill a contract Are the costs incurred covered under another ASC Topic? (for example ASC 330, Inventory) Y Account for the costs in accordance with ASC Topics Are all of the following conditions met: 1. The costs relate directly to a contract 2. The entity expects to recover the costs 3. The costs generate or enhance resources of the entity that will be used to satisfy performance obligations in the future N Y N Recognize an asset for such costs Expense costs as incurred Grant Thornton LLP. All rights reserved. 42

43 Example Costs to fulfill a contract An entity enters into a construction contract to build a high-rise apartment building. The entity incurs the following costs in order to fulfill the contract: Direct labor Direct materials Wasted materials not factored into the original contract price General and administrative costs of running the business Utility connection fee reimbursable by the customer Subcontractor hired to insulate the building Grant Thornton LLP. All rights reserved. 43

44 Amortization and impairment Amortize asset from contract acquisition or fulfillment costs consistent with the pattern of transfer of the related goods or services Assess for impairment Recognize an impairment loss if: Carrying Amount Amount entity expects to receive for goods/services to which the asset relates Cost of providing those goods or services Grant Thornton LLP. All rights reserved. 44

45 Pre-production activities Grant Thornton LLP. All rights reserved. 45

46 Pre-production activities Performance obligation or fulfillment activities? What is the nature of the promise? Is control transferred? Grant Thornton LLP. All rights reserved. 46

47 What is the nature of the promise? Promise to transfer a distinct additional good or service Necessary activities for the entity to fulfill a contract or transfer the promised good or service Performance obligation Fulfillment activities Grant Thornton LLP. All rights reserved. 47

48 Is control transferred? Engineering and development for a new product Is control transferred? Y N Performance obligation Fulfillment activity Would another entity need to reperform the work completed to date? Grant Thornton LLP. All rights reserved. 48

49 Contract cost and pre-production activity takeaways Consider whether commissions on renewals are commensurate Impairment analysis includes expected contract renewals and ignores constraint Consider whether pre-production activities are a performance obligation Grant Thornton LLP. All rights reserved. 49

50 Questions? Grant Thornton LLP. All rights reserved. 50

51 Speakers Lynne Triplett Partner Accounting Principles Doug Reynolds Partner Accounting Principles Carolyn Warger Experienced Manager Audit Grant Thornton LLP. All rights reserved. 51

52 Finishing strong in the ASC 606 marathon webcast series Part 1 An in-depth look at designing for success Part 2 Steps 1 and 2 of the new revenue model Part 3 Steps 3 and 4 of the new revenue model Part 4 Step 5 and contract costs Part 5 - Licensing, modifications, and other potential hurdles June 13, :30 p.m. CT 1.5 CPE hours Listen to the replay of prior events Register for the upcoming webcast grantthornton.com > Events Grant Thornton LLP. All rights reserved. 52

53 Disclaimer This Grant Thornton LLP presentation is not a comprehensive analysis of the subject matters covered and may include proposed guidance that is subject to change before it is issued in final form. All relevant facts and circumstances, including the pertinent authoritative literature, need to be considered to arrive at conclusions that comply with matters addressed in this presentation. The views and interpretations expressed in the presentation are those of the presenters and the presentation is not intended to provide accounting or other advice or guidance with respect to the matters covered. For additional information on matters covered in this presentation, contact your Grant Thornton, LLP adviser. Grant Thornton LLP. All rights reserved. 53

54 Thank you for attending To retrieve your CPE certificate Respond to online evaluation form. Please note you may need to disable pop-up blocking software to complete this evaluation. Print your CPE Certificate and retain for your records. Participants are responsible to maintain CPE completion records. Those receiving CPE will also receive the certificate at the address used to register for the webcast. We are unable to grant CPE credit in cases where technical difficulties preclude eligibility. CPE program sponsorship guidelines prohibit us from issuing credit to those not verified by the technology to have satisfied the minimum requirements in monitoring response and viewing time. If you experience any technical difficulties, please contact or Grant Thornton LLP. All rights reserved. 54

55 Thank you for attending Visit us online at: twitter.com/grantthorntonus linkd.in/grantthorntonus For questions regarding your CPE certificate, contact Grant Thornton LLP. All rights reserved. 55