Annual Accounting and Auditing Update 11 December 2015
Disclaimer The views expressed by panelists are not necessarily those of Ernst & Young LLP. These slides are for educational purposes only and are not intended, and should not be relied upon, as accounting advice. Page 2 11 November 2015 Implementing the new revenue recognition standard
Agenda ASC 606 New Revenue Recognition Standard FASB Developments - Leases Restatement Themes Page 3 11 November 2015 Implementing the new revenue recognition standard
Introduction to today s speakers Drew Nagus EY - Financial Accounting Advisory Services Matt Schuler Raytheon Page 4 11 November 2015 Implementing the new revenue recognition standard
Where are we now? The new standard was issued on 28 May 2014, and a number of questions have arisen in transition. The Financial Accounting Standards Board (FASB)/International Accounting Standards Board (IASB) Joint Transition Resource Group for Revenue Recognition (TRG) and American Institute of Certified Public Accountants (AICPA) industry task forces are actively discussing issues submitted to them. Some of the issues discussed by the TRG have resulted in FASB and IASB activity: May 2015 FASB issued an Exposure Draft (ED) on licenses and performance obligations August 2015 FASB issued an ED covering principal versus agent assessments September 2015 FASB issued an ED covering certain transition issues, noncash consideration, sales taxes, and collectibility The IASB issued a single ED covering its proposed amendments The complexity of implementing the new standard should not be underestimated. Many companies are appropriately accelerating implementation efforts. Page 5 11 November 2015 Implementing the new revenue recognition standard
Effective date deferral The FASB issued Accounting Standards Update (ASU) 2015-14 on 13 August 2015, which finalized the one-year deferral for the new revenue standard: It will be effective in 2018 for calendar-year public companies. Early adoption will be allowed using original effective dates (annual periods beginning after 15 December 2016). The IASB has approved a one-year deferral for IFRS 15: Companies will be required to adopt it in 2018. Early adoption will continue to be allowed. Page 6 11 November 2015 Implementing the new revenue recognition standard
After adoption Which will you choose? After adoption Before adoption Journey to implement the new standard You have a choice in transition methods 2015 and prior 2016 2017 2018 (year of adoption) 2019 and beyond Reporting 10-K, 10-Q Legacy GAAP Legacy GAAP Legacy GAAP Footnotes Full retrospective Reporting 10-K, 10-Q SAB 74 disclosures (including transition method and impact) Joint Transition Resource Group and industry groups Presented in 2018 financial statements New GAAP New GAAP New GAAP New GAAP Footnotes ASC 250 Expanded Expanded Cumulative catch-up adjustment at January 1, 2016 Modified retrospective Presented in 2018 financial statements Reporting 10-K, 10-Q Legacy GAAP Legacy GAAP New GAAP New GAAP Footnotes Legacy GAAP Expanded Expanded Cumulative catch-up adjustment at January 1, 2018 Page 7 11 November 2015 Implementing the new revenue recognition standard
Revenue recognition Summary of the model Core principle: Recognize 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 those goods or services. Step 1: Identify the contract(s) with a customer Step 2: Identify the performance obligations in the contract Step 3: Determine the transaction price Step 4: Allocate the transaction price to the performance obligations Step 5: Recognize revenue when (or as) each performance obligation is satisfied Page 8 11 November 2015 Implementing the new revenue recognition standard
What makes this complex? Contracts Performance obligations Transaction price Allocation Recognition timing Strict criteria to be a contract Identifying promised goods and services May not equal contractual price Estimating standalone selling prices Transfer of control: point in time or over time Identifying the customer Contract modifications Identify explicit and implicit contract terms Established business practices Determining performance obligations (i.e., distinct goods and services) Options granting a material right Service-type and assurance-type warranties Variable consideration, incl. bonuses, returns, concessions, discounts Constraint on variable consideration Significant financing component Noncash consideration Exceptions for allocating variable consideration and discounts Measuring progress over time Consignment arrangements Customer acceptance Repurchase provisions Assessing collectibility Principal versus agent Payments to customers Licenses Combining contracts Subsequent changes in transaction price Page 9 11 November 2015 Implementing the new revenue recognition standard
Revenue recognition Step 1: Identify the contract(s) with a customer Contract defined as an agreement between two or more parties that creates enforceable rights and obligations Can be written, oral or implied Does not exist if both parties have not performed and can cancel without penalty Arrangement must meet these criteria to be within scope of standard: Parties have approved the contract and are committed to perform Each party s rights and payment terms can be identified Contract has commercial substance Collection is probable Contracts entered into at the same time with the same customer should be combined if certain criteria are met Page 10 11 November 2015 Implementing the new revenue recognition standard
Revenue recognition Step 2: Identify the performance obligations A performance obligation is a promise (explicit or implicit) to transfer to a customer either: A distinct good or service A series of distinct goods or services that are substantially the same and have the same pattern of transfer Performance obligations are identified at contract inception and determined based on contractual terms, customary business practice Proposed new guidance will allow entity to disregard promises that are deemed to be immaterial to a contract Proposed new guidance on shipping and handling Page 11 11 November 2015 Implementing the new revenue recognition standard
Revenue recognition Step 2: Identify the performance obligations (cont.) A good or service is distinct if the following criteria are met: It is capable of being distinct It is distinct within the context of the contract Principal vs. agent considerations Incidental obligations or marketing incentives may be performance obligations (e.g., free maintenance provided by auto manufacturers) Does not include activities to satisfy an obligation (e.g., setup activities) unless a good or service is transferred Page 12 11 November 2015 Implementing the new revenue recognition standard
Revenue recognition Step 3: Determine the transaction price Transaction price is defined as the amount of consideration to which an entity expects to be entitled in exchange for transferring promised goods or services to a customer Transaction price includes the effects of the following: Variable consideration (including application of the constraint) Significant financing component Consideration paid or payable to a customer TRG discussions regarding interaction of variable consideration and later of guidance Noncash consideration Page 13 11 November 2015 Implementing the new revenue recognition standard
Revenue recognition Step 3: Determine the transaction price (cont.) Variable consideration is estimated using an expected value or a most likely amount approach An entity is required to evaluate whether to constrain amounts of variable consideration included in the transaction price Amounts are included in the transaction price only if it is probable a significant revenue reversal will not occur when uncertainties are resolved Page 14 11 November 2015 Implementing the new revenue recognition standard
Revenue recognition Step 4: Allocate the transaction price Transaction price is generally allocated to each separate performance obligation on a relative standalone selling price basis Model provides two possible exceptions relating to the allocation of variable consideration and discounts, if certain criteria are met When a standalone selling price is not observable, an entity is required to estimate it Maximize the use of observable inputs Apply estimation methods consistently in similar circumstances Standard describes three estimation methods, but others are permitted (and a combination of estimation methods is allowed) Standalone selling prices used to perform the initial allocation should not be updated after contract inception Page 15 11 November 2015 Implementing the new revenue recognition standard
Revenue recognition Step 5: Recognize revenue Revenue recognized upon satisfaction of a performance obligation by transferring control of a good or service to a customer Control transfers over time if one of three criteria is met, otherwise control transfers at a point in time Customer simultaneously receives and consumes the benefits as the entity performs Entity s performance creates or enhances an asset that the customer controls as the asset is created or enhanced Entity s performance doesn t create an asset with an alternative use to the entity, and the entity has an enforceable right to payment for performance to date The following indicators should be considered when determining the point in time that control transfers: The entity has a present right to payment for the asset The customer has legal title to the asset The customer has physical possession of the asset The customer has the risk and rewards of ownership of the asset The entity has evidence of the customer s acceptance of the asset Page 16 11 November 2015 Implementing the new revenue recognition standard
Other aspects of the model Incremental costs of obtaining a contract Incremental costs of obtaining a contract would be capitalized if they are expected to be recovered Incremental costs are costs that would not have been incurred if the contract had not been obtained Practical expedient to allow immediate expense recognition, if the asset s amortization period is one year or less Assets are amortized over the period in which the related goods or services are transferred and subject to impairment If costs are determined to relate to more than one contract (e.g., expected contract renewals), amortization should consider both current and anticipated contracts What s changing? Current US GAAP allows an option to either immediately expense or capitalize costs of obtaining a contract Page 17 11 November 2015 Implementing the new revenue recognition standard
Other aspects of the model Costs to fulfill a contract Other applicable literature is considered first Costs of fulfilling a contract that cannot be capitalized under another standard would be capitalized if they meet all of the following criteria: Relate directly to a contract Generate or enhance resources that will be used to satisfy performance obligations in the future Are expected to be recovered Costs of fulfilling a contract that are capitalized would be amortized consistent with the pattern of transfer of the related good or service and would be subject to impairment Abnormal costs not considered in the price of the contract would be expensed as incurred Page 18 11 November 2015 Implementing the new revenue recognition standard
Revenue recognition Disclosure (cont.) Excerpt from Accounting Standards Codification Example 41 Disaggregation of Revenue Quantitative Disclosure Segments Primary Geographical Markets Consumer Products Transportation Energy Total North America $ 990 $ 2,250 $ 5,250 $ 8,490 Europe 300 750 1,000 2,050 Asia 700 260 960 $ 1,990 $ 3,260 $ 6,250 $ 11,500 Major Goods/ Service Lines Office Supplies $ 600 600 Appliances 990 990 Clothing 400 400 Motorcycles 500 500 Automobiles 2,760 2,760 Solar panels 1,000 1,000 Power plant 5,250 5,250 $ 1,990 $ 3,260 $ 6,250 $ 11,500 Timing of Revenue Recognition Goods transferred at a point in time $ 1,990 $ 3,260 $ 1,000 $ 6,250 Services transferred over time 5,250 5,250 $ 1,990 $ 3,260 $ 6,250 $ 11,500 Page 19 11 November 2015 Implementing the new revenue recognition standard
Revenue recognition Disclosure (cont.) Excerpt from Accounting Standards Codification Example 42 Disclosure of the Transaction Price Allocated to the Remaining Performance Obligations 20X8 20X9 Total Revenue expected to be recognized on this contract as of December 31, 20X7 $1,575 (a) $788 (b) $2,363 (a) Transaction price = $3,150 ($100 x 24 months + $750 variable consideration) recognized evenly over 24 months at $1,575 per year (b) $1,575 2 = $788 (that is, for 6 months of the year) On June 30, 20X7, an entity enters into two-year noncancellable contract. The customer pays fixed consideration of $100 per month and a onetime variable consideration payment ranging from $0 - $1,000 (that is, a performance bonus). The entity estimates that it will be entitled to $750 of the variable consideration. Page 20 11 November 2015 Implementing the new revenue recognition standard
What are we learning? Key observations and lessons learned from diagnostics Understanding the standard s complexity is necessary for adequate planning Leveraging a top down strategic scoping approach may reduce the number of detailed contract reviews required The process of identifying revenue streams should include consideration of multiple different categories to disaggregate a company s business Surveying can be challenging and time consuming, but may save time in the long run Working closely with local management, operations and legal when reviewing contracts is essential for a comprehensive understanding of the revenue streams Templates for gap analysis and contract reviews should include information beyond the technical accounting details Extrapolating the impacts of changes in revenue recognition patterns of one or more individual contracts across a larger revenue stream population can be time consuming and may require significant estimates and data inputs Page 21 11 November 2015 Implementing the new revenue recognition standard
Other Tax Business processes, control environment and data capture Accounting and reporting Transition and disclosures Accounting policy PMO governance and change management Program overview Business processes and system enablement critical path 2015 2016 2017 2018 2019 and beyond Diagnostic Solution development Implementation Sustain Governance objective and plan Program governance structure, ongoing management, budget and resource management, dependency analysis, risk management Revenue stream identification and scoping Communication structure, approach, routine work sessions with stakeholders Awareness, education and change management Individual contract selection and review Preliminary accounting policy decision Expanded contract review to support changes and lack thereof Training and implement new policy Accounting and disclosure gap analysis Transition method evaluation Finalize new policy Transition method selection Analyze accounting differences and potential financial impacts Evaluate enhanced disclosure requirements and data to support Follow TRG, FASB and IASB activities, AICPA and peer group implementation developments Understand and assess current transaction processing by revenue stream Develop systems and business processes requirements Design systems and processes enhancements Design and implement I/C changes Implement systems and processes enhancements Test and remediate I/C changes Go live in future state environment Sustain I/C environment Full retrospective -- interim processing environment, including cumulative adjustment and look-back transaction processing Transition contract and data approach, consideration and capture until future state environment is live Modified retrospective -- interim processing environment, including cumulative adjustment Maintain legacy processing environment for modified retrospective disclosures Identify new or different temporary differences Document, train and execute new tax policies and procedures Identify tax method changes and finalize new policy File method changes and adjust transfer pricing Other considerations I/C prices, transfer pricing and indirect taxes Assess and implement changes to customer contracting process, legal terms or business practices, finance planning and analysis, and investor relations Timely discussion of key implementation considerations with external audit team Page 22 11 November 2015 Implementing the new revenue recognition standard * Dates assume early adoption not elected
Critical path Sample full vs. modified retrospective timelines Full retrospective sample timeline 2015 2016 2017 J F M A M J J A S O N D J F M A M J J A S O N D J F M A M J J A S O N D Go-live 2018* Dual reporting for 2016 and 2017 Accounting Diagnostic (3 months) System enablement evaluation (1 month) Design** (3 months) Implementation (6 months) Testing (6 months) Data conversion cumulative catch-up and reprocessing transaction activity from January 2016 to April 2017 (5 months) Parallel accounting and audit (6 months) Turn off old GAAP Start year-end close Record cumulative effect adjustment Modified retrospective sample timeline 2015 2016 2017 J F M A M J J A S O N D J F M A M J J A S O N D J F M A M J J A S O N D 2018* Dual reporting for footnote disclosure Go-live Accounting Diagnostic (3 months) System enablement evaluation Design** (3 months) Implementation (6 months) Testing (6 months) Data conversion and cumulative Start yearend (1 month) catch-up (5 months) close Record cumulative effect adjustment *Timelines assume a January 2018 effective date **Includes solution approach for revenue forecasting Phase timeline Typical system blackout dates Page 23 11 November 2015 Implementing the new revenue recognition standard
FASB developments - Leases Page 24 11 November 2015 Implementing the new revenue recognition standard 2015 Year-end Corporate
Leases Overview Q3 2010 Exposure draft (ED) The FASB and the IASB have substantially completed redeliberations on the new leases standards Key remaining item effective date Key changes to today s US GAAP guidance include: 2011 2013 Redeliberations and second ED 2014 Q2 2015 Redeliberations on second ED Lessees would recognize assets and liabilities for most leases New presentation and disclosure requirements for lessees Real estate-specific guidance would be eliminated Q4 2015 Final standard Leases would be classified using a principle similar to IAS 17, Leases Only costs that would not have been incurred if a lease had not been executed would qualify as initial direct costs Final standards are not likely to be effective before 1 January 2018 Page 25 11 November 2015 Implementing the new revenue recognition standard 2015 Year-end Corporate
Leases Definition of a lease A contract is a lease if it both: Depends on the use of an identified asset (explicitly or implicitly) No identified asset if the supplier has a substantive substitution right Conveys the right to control the use of an identified asset that is, the customer has the right to (both): Direct the use of the identified asset Obtain substantially all of the potential economic benefits from directing the use Non-lease components of a contract would be accounted for separately under other applicable GAAP Subject to practical expedient for lessees Page 26 11 November 2015 Implementing the new revenue recognition standard 2015 Year-end Corporate
Leases Lease classification Lessees and lessors would classify leases using a classification principle similar to IAS 17, Leases Similar to US GAAP but without bright lines Today s real estate-specific guidance would be eliminated Today s additional lessor classification criteria would be changed Lessees would classify most leases as either: Type A similar to today s capital leases Type B similar to today s operating leases Optional exemption for short-term leases Lessors would classify all leases as either: Type A similar to today s sales-type or direct financing leases Type B similar to today s operating leases Page 27 11 November 2015 Implementing the new revenue recognition standard 2015 Year-end Corporate
Leases Lessee accounting. Initial recognition and measurement Subsequent measurement lease liability Type A lease Type B lease Initially measure the right-of-use (ROU) asset and lease liability at present value of lease payments. Initial measurement of the ROU asset also includes the lessee s initial direct costs and prepayments made to the lessor less lease incentives received from the lessor. Accrete the lease liability based on the interest method using discount rate determined at lease commencement * and reduce the lease liability by the payments made Measure the lease liability at the present value of remaining lease payments using discount rate determined at lease commencement Subsequent measurement ROU asset Income statement effect Amortize the ROU asset, generally on a straight-line basis over shorter of lease term or useful life of ROU asset Generally front-loaded expense Separate interest and amortization Measure ROU asset at amount of lease liability and adjust for cumulative prepaid or accrued rents (i.e., non-straight-line rent payments), any lease incentives received and lessee initial direct costs Generally straight-line expense Single line of lease or rent expense * As long as a reassessment and a change in the discount rate has not been triggered. Page 28 11 November 2015 Implementing the new revenue recognition standard 2015 Year-end Corporate
Leases Lessor accounting Many aspects of today s lessor accounting would remain the same Type A leases similar to today s sales-type or direct financing leases Selling profit (if any) would be deferred if lease does not transfer control of underlying asset to lessee (and collection of lease payments is probable) Lessors can recognize profit for Type A leases that meet all of the following: Selling profit is included (fair value is greater than carrying value) Control of the underlying asset is transferred to the lessee Collectibility of lease payments is probable If collectibilty is not probable: defer income recognition (similar to ASC 606) Type B leases similar to today s operating leases Page 29 11 November 2015 Implementing the new revenue recognition standard 2015 Year-end Corporate
Restatement themes Page 30 11 November 2015 Implementing the new revenue recognition standard 2015 Year-end Corporate
Learning objectives Determine whether the accounting topics that most commonly gave rise to restatements in recent years could require action on your part Page 31 11 November 2015 Implementing the new revenue recognition standard 2015 Year-end Corporate
Restatement themes Top three topics 2014 % Top three topics 2013 % Income taxes 17 Income taxes 15 Revenue recognition 13 Revenue recognition 10 Statement of cash flows 6 Statement of cash flows 10 Accounting for income taxes, revenue recognition and statement of cash flows continue to be leading causes of annual restatements Correct identified errors as soon as practicable to avoid restatement due to an accumulation of individually immaterial errors Page 32 11 November 2015 Implementing the new revenue recognition standard 2015 Year-end Corporate
Restatement themes General observations Restatements in 2014 not concentrated by issue General observations Identify and account for key contractual terms Focus on changes in business and effects on estimates on a timely basis Track tax basis of assets and liabilities beyond rollforward of basis differences Consider implications on internal controls Page 33 11 November 2015 Implementing the new revenue recognition standard 2015 Year-end Corporate
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