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The New Revenue
Recognition Standard –
Implications for Internal Audit
1
Agenda
 Introductions
 Overview of New Revenue Recognition Standard
 5 Step Standard Summary
 Timing
 Implications for Internal Audit
 Next Steps
 Q&A?
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Introduction
Nimi Yogaratnam – QLogic Corporation, Senior Director,
Internal Audit
 CPA, CISA
 Experience: 20 years
Scott Jones, Managing Director Protiviti (Orange County)
 CPA, Attorney
 Experience: 32 Years
– Peat Marwick Mitchell (now KPMG)
– InterFirst Bank
– First Interstate Bank
– Arthur Andersen
– Protiviti (effective May 2002)
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Overview - Protiviti
Clients include
more than:
 6th Largest
Business
Consulting
Firm
 3,500+
professionals
 1,000+ clients
 35% of all
Fortune 100
Companies
 25% of all
Fortune 500
Companies
 20% of all
Fortune 1000
Companies
 60+ offices
 24 countries
in Americas,
Europe and
Asia-Pacific
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Protiviti is one of
the fastest
growing
consulting firms
worldwide. Our
2013 revenues
$530 million.
Introduction – Quote: The World Is
Evolving Too Fast – Part I
"The world is too big for us. Too much is going on. Too many crimes. Too
much excitement. Try as you will, you get behind in the race in spite of
yourself. It's a constant strain to keep pace --- and still, you lose ground.
Science empties its discoveries on you so fast that you stagger beneath
them in hopeless bewilderment. The political world now changes so rapidly
you’re out of breath trying to keep pace with who’s in and who’s out.
Everything is high pressure. Human nature can’t endure much more!”
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Introduction – Quote: The World Is Evolving
Too Fast – Part II
"The world is too big for us. Too much is going on. Too many crimes. Too
much excitement. Try as you will, you get behind in the race in spite of
yourself. It's a constant strain to keep pace --- and still, you lose ground.
Science empties its discoveries on you so fast that you stagger beneath
them in hopeless bewilderment. The political world now changes so rapidly
you’re out of breath trying to keep pace with who’s in and who’s out.
Everything is high pressure. Human nature can’t endure much more!”
Atlantic Journal -- June 16, 1833
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Revenue Recognition Joint Project
Objective of project:
– Develop a standard based on a single model to deal
with all types of contracts and business sectors.
– ASC Topic 606 was introduced via ASU 2014-09
Some interesting facts:
ASU 2014-09 is 700 pages long
At 522 paragraphs, the Basis for Conclusions alone is
longer than any U.S. GAAP standard ever written,
except FAS 133
Prior to its release, the FASB held more than 650
meetings with users, preparers, etc. across many
jurisdictions
• Final Standard Released May 28, 2014.
• Effective for annual reporting periods beginning after
December 15, 2016
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Revenue Recognition Humor
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High Level Application of Revenue Model
Recognize revenue when:
Control over promised goods or services are transferred to customers
In an amount that reflects the consideration a company expects to be entitled to in
exchange for those goods and services
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1
Identify the contract with a customer
2
Identify the separate performance obligations in the contract
3
Determine the transaction price
4
Allocate the transaction price to the separate performance
obligations
5
Recognize revenue when (or as) the vendor satisfies a
performance obligation
Step 1 – Identify the contract with a customer
Contracts can be written, oral or implied.
A contract exists if:
•
The contract has commercial substance (that is, the risk, timing, or amount of the
entity’s future cash flows is expected to change as a result of the contract).
• The parties to the contract have approved the contract.
• The entity can identify each parties rights and payment terms.
• It is probable that the entity will collect the consideration to which it will be entitled in
exchange for the goods or services.
Permissible to apply guidance to a portfolio of contracts if no material differences would result
vs. applying to individual contracts.
Combine contracts if the contracts are entered into at or near the same time.
Contract modifications accounted for separately if the modification results only in the addition
of a distinct good/service at a price that is commensurate with that additional good/service.
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Scenario 1 – Identify the contract with a customer
• A Manufacturer enter into a contract on March 1, 2014 to
supply 1,000 widgets a month for $50 a unit. The contract ends
in December 31, 2014. There are no automatic renewal
provisions in the contract.
• During January and February 2015 the customer continues to
buy 1,000 widgets each month.
• On March 1, 2015 the Manufacturer enters into a new contract
to supply 2,000 widgets a month for $45 a unit.
• How should the manufacturer account for the widgets supplied
in January and February 2015?
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Step 2 – Identify the separate performance obligations in
the contract
A performance obligation is a promise in a contract with a customer to transfer a good or
service to that customer.
A good or service is distinct (Capable of being distinct and distinct within the context of the
contract) if either of the following criteria is met:
•
•
The entity regularly sells the good or service separately.
The customer can benefit from the good or service either on its own or together with other
resources that are readily available to the customer.
Notwithstanding the above criteria, a good or service in a bundle of promised goods or
services is not distinct and, therefore, the entity would account for the bundle as a single
performance obligation, if both of the following criteria are met:
•
•
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The goods or services in the bundle are highly interrelated and transferring them to the
customer requires that the entity also provide a significant service of integrating the goods
or services into the combined item(s) for which the customer has contracted.
The bundle of goods or services is significantly modified or customized to fulfill the
contract.
Scenario 2 – Identify the separate performance
obligations in the contract
• A software company enters into a contract to supply a perpetual
license, installation service and two years of post contract
support.
• Post contract support includes telephone support and
unspecified upgrades.
• How many performance obligations are in the contract?
• How will your answer change if the software requires significant
customization as part of installation?
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Step 3 – Determine the transaction price
The transaction price is the amount of consideration an entity expects to receive in exchange
for transferring promised goods or services to a customer, excluding any amounts collected
on behalf of third parties (for example, sales taxes). When determining the transaction price,
an entity would consider the effects of all of the following:
• Variable consideration
•
•
•
•
•
Discounts
Rebates
Refunds/Price Protection
Return rights
Concessions
• The time value of money
• Noncash consideration
• Consideration payable to the customer
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•
•
•
•
•
Penalties
Royalties
Performance bonuses
Milestones
Profit sharing
Scenario 3 – Determine the transaction price
• A manufacturer sells toys through a retail network for $75.
• Each unit sold contains a rebate coupon for $10.
• The manufacturer estimates that 50% of eligible rebates
will be redeemed.
• What is the manufacturer’s transaction price?
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Step 4 – Allocate the transaction price to the
separate performance obligations
Allocate to each separate performance obligation the amount of consideration the entity
expects to receive in exchange for satisfying that performance obligation.
Allocate transaction price based on relative stand alone selling prices.
Best evidence of a standalone selling price is the observable price of a good or service
when the entity sells that good or service separately in similar circumstances and to similar
customers.
If a standalone selling price is not directly observable, an entity shall estimate the
standalone selling price.
VSOE/TPE/BESP hierarchy no longer expressly required. However, entity is supposed
to “maximize observable inputs.
Allocate a discount proportionately to all performance obligations in the contract, unless the
entire discount relates to only one or more, but not all, performance obligations in a contract
If highly variable, consider a residual technique by reference to the total transaction price less
the standalone selling price of other goods or services in the contract.
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Scenario 4 – Allocate the transaction price to
the separate performance obligations
• A manufacturer sells product A and B for $4,000.
• The manufacturer regularly sells product A for $3,000 and
product B for 2,000.
• How should the manufacturer allocate the transaction price to
the product?
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Step 5 – Recognize revenue when (or as) the vendor
satisfies a performance obligation
Revenue is recognized when control over a good or service is transferred to the customer.
Need to determine whether the entity satisfies the performance obligation over time by
transferring control of a good or service over time. If the entity does not satisfy a performance
obligation over time, the performance obligation is satisfied at a point in time.
To determine the point in time when a customer obtains control of a promised asset and an
entity satisfies a performance obligation, the entity would consider indicators of the transfer of
control such as……..
•
•
•
•
•
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The entity has a present right to payment for the asset.
The customer has legal title to the asset.
The entity has transferred physical possession of the asset.
The customer has the significant risks and rewards of ownership of the asset.
The customer has accepted the asset.
Scenario 5 – Recognize revenue when (or as) the
vendor satisfies a performance obligation
• A contractor enters into a contract with a customer to build an
apartment building.
• The goods and services are not distinct in the contract, so the
arrangement is accounted for as a single performance
obligation.
• The customer makes monthly progress payments and can
terminate the contract at any time.
• When should the contractor recognize revenue?
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Transition & Effective Date
Transition Method
Full Retrospective
Retrospective Using
One or More Practical
Expedients
Cumulative Effect at
the Date of Adoption
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2015/2016
Restate for all contracts
2017
Date of Cumulative Effect
Adjustment
Apply new revenue standard
to all contracts
January 1, 2015
Restate for all contracts under
Apply new revenue standard
the new revenue standard except to all contracts
for contracts covered by the
practical expedients elected by
the preparer
January 1, 2015
These periods not restated for
any contracts
January 1, 2017
Apply new revenue standard
to new and existing
contracts; disclose effect of
applying new standard
New Revenue Model – Implications for Internal Audit
Contract Terms
Performance
Obligations
Key Metrics and
Performance
Indicators
Variable
Consideration
•
Processes and controls surrounding review of contract terms. Legal enforceability depends
on the interpretation of the law and could vary across legal jurisdictions..
•
Identifying and documenting performance obligations. Remember inconsequential or
perfunctory obligations are not excluded. The evaluation must include how or when the
obligations are performed.
•
Many key metrics and performance indicators are based on reported revenue. Organizations
may want to consider changes to key metrics and performance indicators.
•
Entities need to develop a process to estimate all forms of variable consideration in
determining the initial transaction price.
•
The transaction price should reflect the time value of money when the contract includes a
significant financing component. A practical expedient allows entities to disregard the time
value of money for short-term contracts. Assumptions involved in determining discount rates
need to be documented.
•
Certain contract acquisition costs would need to be capitalized. Processes and controls need
to be established to identify and record such costs.
Time Value
of Money
Contract Cost
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New Revenue Model – Implications for Internal Audit
Commissions
Systems
Industry specific
impact
Income Tax
Disclosures
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•
ASC 606 may pull forward revenue recognition in many cases. Companies may have to evaluate if
they really want to pay sales commissions earlier?
•
Various system implications through the order to cash process depending on adoption approach. .
•
Software and construction type arrangements may see a greater impact upon adoption. VSOE of
the FV of the undelivered items would no longer be required to separately account for elements in
a software arrangement. This may warrant a re examination of certain business practices.
•
The acceleration of revenue for book purposes may accelerate revenue for tax purposes.
Book/Tax basis differences, transfer pricing implications.
•
New rules will require substantial disclosures – both annually and quarterly. Disaggregation of
revenues, Contract balances, Performance obligations and Significant judgments employed in
recognizing revenues.
High Level Implementation Timeline
Analyze
Design
Implement
May 28th, 2014 - Issuance of
revenue recognition standard
2014
Optional retrospective
Reporting period
2015
2016
Potential Scenarios:
Low impact
Moderate impact
High impact
Retrospective
adopter
Key:
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Analyze
Design
Sustain
Implement
Sustain
Effective date of
revenue recognition
standard
1/1/17
“Steady
State”
Next Steps
Take time to Learn, Diagnose & Assess now…..
1. Education: Review final standard and implementation guidance Monitor Transition Resource
Group deliberations.
2. Analyze current revenue policy vs. the proposed standard to identify expected changes:
3. Depending on significance of accounting policy gaps, consider extent of Legal (or Tax)
involvement that may be required.
4. Perform a high level analysis of data gaps:
– Will required information be available from your existing processes?
– Will system changes be required?
5. Develop high level approach regarding transition method:
– Retrospective versus cumulative effect.
– Consider complexity of performing the transition and whether specific tools/systems may be
required.
6. Identify and assess additional resource needs; internal / external; temporary or permanent.
7. Educate senior management team, key stakeholders and Board of Directors.
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Q&A