Revenue Recognition

U.S. GAAP vs. IFRS

Adoption vs. Convergence

• The Securities and Exchange Commission had previously voiced optimism that adoption was the future for U.S. public companies.

• Convergence has become the reality over the last decade as the momentum for adoption has slowed to a standstill.

Status of Convergence Work

• Business combinations Completed• Consolidated financial

Statements Completed• Fair value measurement Completed• Post-employment benefits Completed• Financial statement

Presentation – OCI Completed

Status of Convergence Work

• Share-based payments Completed• Segment reporting Completed• Inventory accounting Completed• Fair value option Completed• Borrowing costs Completed• Research and development Completed• Non-controlling interests Completed

The Latest Projects

• Revenue recognition Completed

• Leases In Process

• Financial instruments In Process

Leases

• The objective of this project is to improve financial reporting by ensuring that all assets and liabilities arising from lease contracts are recognized in the statement of financial position.

Financial Instruments

• The efforts to improve our requirements (FASB) and to reach a common solution have been complicated by differing imperatives that pushed the respective development timetables out of alignment.

• IASB has been replacing its financial instrument requirements in a phased approach whereas FASB developed a single proposal.

U.S. GAAP vs. IFRS

• Rules-Based Standards – Perceived to be the dominant approach of FASB, attempts to anticipate all or most of the application issues, U.S. GAAP is approximately 17,000 pages.

• Principles-Based Standards – Stated as the dominant approach of IASB, rely on broad statements of objectives and principles to be followed, IFRS is approximately 2,500 pages.

Measurement

• U.S. GAAP emphasizes measurement of items on the income statement, the matching principle, revenues and expenses are recorded as earned or incurred and the balance sheet effects are the result of these recognitions.

• IFRS emphasizes the measurement of assets and liabilities on the balance sheet at fair value.

Revenue Recognition

U.S. GAAP – Industry Practice

• Persuasive evidence of an arrangement exists

• Product is delivered or service performed

• Seller’s price to the buyer is fixed or determinable

• Collectability is reasonably assured

• 16 standards, 24 interpretations, and other documents, over 200 different authoritative pronouncements

IFRS - Judgment• There are probable future

economic benefits• Revenue can be measured

reliably• Costs can be measured reliably• Significant risk and rewards of

ownership are transferred• Managerial involvement is not

retained as to ownership or control

• 2 standards and 3 interpretations

Industry Specific Guidance

• Real Estate• Construction• Agriculture• Airlines• Contractors –

Government• Broadcasters• Films• Music

• Oil and Gas• Brokers and Dealers• Depository and Lending• Mortgage Banking• Franchisors• Health Care Entities• Software• Not-for-Profits

Announcement

May 28, 2014

FASB and IASB jointly announce the new revenue recognition standard and its effective dates

• U.S.GAAP Pub

The Objective of the New Guidance

• To clarify the principles for recognizing revenue and to develop a common revenue standard for U.S. GAAP and IFRSs that would:

– Remove inconsistencies and weaknesses in existing revenue requirements

– Provide a more robust framework for addressing revenue issues

– Improve comparability of revenue recognition practices across entities, industries, jurisdictions, and capital markets

– Provide more useful information to users of financial statements through improved disclosure requirements

– Simplify the preparation of financial statements by reducing the number of requirements to which an entity must refer

The 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.

Summary of Key Differences

• Collectibility Threshold– One of the criteria that contracts must meet

before an entity applies the revenue standard is that collectibility is probable. Probable is defined in U.S. GAAP as “likely to occur,” which is generally considered a 75%-80% threshold. IFRS defines probable as “more likely than not,” which is greater than 50%.

Summary of Key Differences

• Interim Disclosure Requirements– The IASB amended its interim disclosure standard

to require interim disaggregated revenue disclosures. The FASB amended its interim disclosure standard to require disaggregated revenue information, and added interim disclosure requirements relating to contract balances and remaining performance obligations (for public companies only).

Summary of Key Differences

• Early Adoption– Entities reporting under U.S. GAAP are not

permitted to adopt the revenue standard earlier than annual reporting periods beginning after December 15, 2016. IFRS allows early adoption.

Summary of Key Differences

• Impairment Loss Reversal– U.S. GAAP does not permit entities to reverse

impairment losses recognized on contract costs (that is, capitalized costs to acquire or fulfill a contract). IFRS requires impairment losses to be reversed in certain circumstances similar to its existing standard on impairment of assets.

Summary of Key Differences

• Relief for Nonpublic Entities– U.S. GAAP gives nonpublic entities relief relating

to certain disclosures and effective date. IFRS applies to all IFRS reporters, public or nonpublic, except entities that apply IFRS for SMEs.

Key Provisions

• The revenue standard applies to all contracts with customers, except for:– Lease contracts– Insurance contracts– Financial instruments and certain contractual rights or

obligations within the scope of other standards– Nonmonetary exchanges between entities in the same

line of business to facilitate sales to customers; and– Certain guarantees within the scope of other

standards (other than product or service warranties).

Key Provisions

• Some contracts include components that are in the scope of the revenue standard and other components that are in the scope of other standards (for example, a contract that includes both a lease and maintenance services).

The Five-Step Approach

• Step 1: Identify the contract(s) with the customer

• Step 2: Identify the separate performance obligations in the contract

• Step 3: Determine the transaction price• Step 4: Allocate the transaction price to

separate performance obligations• Step 5: Recognize revenue when (or as) each

performance obligation is satisfied

Identify the Contract(s) With the Customer

• A contract is an agreement between parties that creates enforceable rights and obligations. It can be written, oral, or implied by an entity’s customary business practice.

• An entity will apply the revenue standard to each contract with a customer when all of the following criteria are met:– The parties have approved the contract and intend to

perform their respective obligations.– Each party’s rights regarding the goods or services to be

transferred can be identified.– The payment terms can be identified.– The risk, timing, or amount of the entity’s future cash flows

are expected to change.– It is probable that the entity will collect the consideration to

which it will be entitled in exchange for goods or services transferred.

Collectibility

• The collectibility assessment is based on the customer’s ability and intent to pay as amounts become due, after considering any price concessions the entity expects to provide.

• Credit losses arising from a contract that was probable of collection at inception will be recognized as an expense in the income statement.

• An entity will only reassess whether it is probable it will receive payment if there is an indication of a significant change in facts and circumstances, such as a significant deterioration in a customer’s ability to pay for the remaining goods and services.

• Probable is defined differently in U.S. GAAP and IFRS. Management will have to use judgment to assess whether the deterioration relates to performance obligations previously satisfied, performance obligations to be performed in the future, or both.

Identify the Separate Performance Obligations in the Contract

• A performance obligation is a promise to transfer a distinct good or service to a customer.

• The objective of identifying distinct performance obligations is to depict the transfer of goods or services to a customer.

• Explicit or implicit promises in a contract to provide goods or services, including promises to provide goods or services that a customer can resell or provide to its customer are performance obligations, even if they are satisfied by another party.

• Management will need to determine whether promises are distinct when there are multiple promises in a contract.

• A good or service is distinct only if:– The customer can benefit from the good or service

either on its own or together with other readily available resources

– The good or service is separately identifiable from other promises in the contract

• The revenue standard provides indicators rather than criteria to determine when a good or service is distinct:

– The entity does not provide a significant service of integrating the individual goods or services in the contract into a bundle that is the combined item the customer has contracted to receive.

– The good or service does not customize or significantly modify another contractually promised good or service.

– The good or service is not highly dependent on or highly interrelated with other goods or services in the contract.

Determine the Transaction Price

• The transaction price is the amount of consideration that an entity expects to be entitled to in exchange for transferring promised goods or services to a customer.

• Determining the transfer price is more complex if the arrangement involves variable consideration such as:– A significant financing component– Noncash consideration– Consideration payable to a customer

Variable Consideration

• Variable consideration may be contingent on the outcome of future events– Discounts– Refunds– Rebates– Credits– Incentives– Performance bonuses– Royalties

Variable Consideration

• An entity should recognize revenue as performance obligations are met only if it is probable (U.S. GAAP) or highly probable (IFRS) that a change in the estimate of the variable consideration would not result in a significant reversal of the cumulative revenue recognized.

• The following indicators suggest that including an estimate of variable consideration in the transaction price could result in a significant reversal of cumulative revenue:

– The amount of consideration is highly susceptible to factors outside the entity’s influence.

– Resolution of the uncertainty about the amount of consideration is not expected for a long period of time.

– The entity has limited experience with similar types of contracts.– The entity has a practice of offering a broad range of price

concessions or changing payment terms.– There is a large number and broad range of possible outcomes.

Allocate the Transaction Price to Separate Performance Obligations

• The transaction price is allocated to the separate performance obligations in a contract based on the relative standalone selling prices of the goods or services promised.

• This allocation is made at contract inception and not adjusted to reflect subsequent changes in the standalone selling prices of the goods or services.

Recognize Revenue When Each Performance Obligation is Satisfied

• An entity will recognize revenue when (or as ) a good or service is transferred to the customer and the customer obtains control of that good or service.

• Control of an asset refers to an entity’s ability to direct the use of and obtain substantially all of the remaining benefits from the asset.

• The standard requires management to determine when control of a good or service has transferred to the customer.

• The timing of revenue recognition could change for some transactions compared to current guidance, which is more focused on the transfer of risks and rewards.

An Example

• An entity that transfers control of a good to a customer but retains some economic risks might need to record revenue when the good transfers, while under existing guidance revenue recognition might be delayed until all of the economic risks have also transferred.

Performance Obligations Satisfied Over Time

• An entity will recognize revenue over time if any of the following criteria are met:– The customer concurrently receives and consumes

the benefits provided by the entity’s performance as the entity performs. As an example, a contract with a customer to provide daily cleaning services of an office building.

Performance Obligations Satisfied Over Time

– The entity’s performance creates or enhances a customer-controlled asset. As an example, it is common in transactions with a government that the government entity controls any work-in-process or other output of the contract.

Performance Obligations Satisfied Over Time

– The entity’s performance does not create an asset with an alternative use and the entity has a right to payment for performance completed to date.• The assessment of whether an asset has an alternative

use should be made at inception and not reassessed. • A right to payment exists if an entity is entitled to

payment for performance completed to date if the customer terminates the contract for reasons other than the entity’s non-performance.

Performance Obligations Satisfied at a Point in Time

• An entity will recognize revenue at a point in time for performance obligations that do not meet the criteria for recognition of revenue over time.

Performance Obligations Satisfied at a Point in Time

• To determine when a customer obtains control and an entity satisfies a performance obligation, the entity should consider the definition of transfer of control while considering the following indicators:– The entity has a present right to payment for the asset.– The entity transferred legal title to the asset.– The entity transferred physical possession of the asset.– The entity transferred the significant risk and rewards

of ownership to the customer.– The customer accepted the asset.

Thank You!