Current Developments in Revenue Recognition

Report
Current Developments
Developed and presented by Samuel A. Monastra, CPA

SAMUEL A. MONASTRA, CPA
Mr. Monastra is a Director with McGladrey, LLP. He has extensive
experience with publicly held companies and large privately held
companies. Industry focus: manufacturing, life sciences &
technology, financial services, and public sector.
Mr. Monastra served in executive roles with National CPA firms,
and as a member of the Editorial Board of the Pennsylvania CPA
Journal. He has also been a frequent speaker for numerous State
CPA Societies, the Institute of Internal Auditors, and the Institute
of Management Accountants on financial reporting topics.
Mr. Monastra has a focus on financial reporting with a particular
emphasis on Revenue Recognition, IASB/FASB Convergence, IFRS,
Business Combinations, Asset Impairments, and Fair Value.

Revenue is usually one of the largest items on a
company’s financial statements. Accordingly,
both in substance and form, it may be one of the
most important components to present fairly, in
all material respects, in accordance with the
applicable financial reporting framework. The
Financial Accounting Standards Board (FASB) and
the International Accounting Standards Board
(IASB) are continuing to jointly define revenue
recognition for what is truly becoming a
worldwide economy
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FASB - rules based
IASB – principles based
The FASB based the rules for revenue recognition
on a document housed within the SEC reporting
guidelines: SEC Staff Accounting Bulletin No. 104
(SAB 104)
Additional guidance is based upon SFAS No. 48
“Revenue Recognition When the Right of Return
Exists” and AICPA Statement of Position No.97-2
“Software Revenue Recognition”
Today,
Revenue Recognition Codification 605
Sub-section
 10
Overall
 15
Products
 20
Services
 25
Multiple Element Arrangements
 28
Milestone Method
 30
Rights to Use
 35
Construction & Production Contracts
 40
Gains & Losses
 45
Principal Agent Considerations
 50
Customer Payments & Incentives
Here are the basics:
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Revenue must be earned or realized before
financial statement recognition
EARNED when an entity has substantially
performed what is necessary to be entitled to
the benefits of the revenue
REALIZED when assets received or receivable
are readily convertible into known amounts of
cash
Recognize revenue when the transaction is
consummated (revenue is both earned and
realized)
The four “bedrock” principles:
persuasive evidence of an arrangement
price is fixed or determinable
ability to pay
delivery or performance has occurred
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Also consider:
Right of return/ refund policy
Parties must be independent of each other
Must be an arms length transaction
Seller has no further obligations
Not a consignment
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Areas of concern include:
“bill and hold” transactions
Channel stuffing
Early/ delayed shipments
Segregation of goods
Ignore customer acceptance provisions
Side agreements
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Areas of concern include:
Related party transactions
Sales cut-offs
Unusual terms – not typical for the company
or industry
Fraud
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Areas of concern include with rights of
return:
Allowed to return unsold items
Inability to estimate or significant increase in
inventory in distribution channel
New products and newness of products
Shift in product demand or technology
Long return periods
 Goods become obsolete, used up, fulfill original
purpose, break, etc.
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Present authoritative sources:
Accounting Standards Codification
Topic 600 -- Revenues
Topic 985 -- Software
Industries with specific revenue recognition revenue
recognition rules and exceptions include:
Section
Industry
 905
Agriculture
 908
Airlines
 910
Contractors- Construction
 912
Contractors- Federal Government
 915
Development Stage Companies
 920
Entertainment- Broadcasters
 922
Entertainment- Cable TV
 924
Entertainment- Casinos
 926
Entertainment- Film
 928
Entertainment- Music
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Revenue recognition – sale of breeding
livestock
The gain or loss on the sale of breeding
livestock, regardless of whether purchased or
raised, is included in gross revenue. This
treatment recognizes the fact that the sale of
breeding livestock, either as cull animals or
as seed stock, is a normal, planned, and
ongoing part of the business.
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Theatres:
Recognize revenue at the time of exhibition unless
nonrefundable guarantees are paid by the exhibitor
(which may happen with a“hot” film when the
exhibitor bears little risk), in which case revenue is
recognized upon execution of the license agreement,
provided all of the following criteria are met.
The license fee is known and collected or the cost can
be reasonably determined and collected.
The licensee has accepted the film in accordance with
the license agreement.
The film is available for its first showing.
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Casinos:
Casino revenue is reported on the accrual basis. Revenue
recognized and reported by a casino is generally
defined as a win from gaming activities, that is, the
difference between gaming wins and losses, not the
total amount wagered.
Base jackpots shall be charged to revenue ratably over the
period of play expected to precede payout; however, if
immaterial, they shall be charged to revenue when
established. Any portion of the base jackpot not
charged to revenue when the jackpot is paid shall be
charged to revenue at that time.
Industries with specific revenue recognition revenue
recognition rules and exceptions include:
Section
Industry
 932
Extractive Industries- Oil & Gas
 940
Financial Services- Brokers & Dealers
 942
Financial Services- Depository & Lending
 944
Financial Services- Insurance
 946
Financial Services- Investment Companies
 948
Financial Services- Mortgage Banking
 952
Franchisors
 954
Health Care Entities
 958
Not-for-Profit Entities
 970
Real Estate- General
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Franchise Revenue
Revenues include retail sales at Company restaurants and franchise and
property revenues. Franchise revenues include royalties, and initial and
renewal franchise fees. Property revenues include rental income from
operating lease rentals and earned income on direct financing leases on
property leased or subleased to franchisees. Retail sales at Company
restaurants are recognized at the point of sale and royalties from
franchisees are based on a percentage of retail sales reported by
franchisees. Royalties are recognized when collectibility is reasonably
assured. Initial franchise fees are recognized as revenue when the
related restaurant begins operations. A franchisee may pay a renewal
franchise fee and renew its franchise for an additional term. Renewal
franchise fees are recognized as revenue upon receipt of the nonrefundable fee and execution of a new franchise agreement. In
accordance with SFAS No. 45, “Accounting for Franchise Fee Revenue,”
the cost recovery accounting method is used to recognize revenues for
franchisees for whom collectibility is not reasonably assured. Rental
income on operating lease rentals and earned income on direct financing
leases are recognized when collectibility is reasonably assured.
Industries with specific revenue recognition revenue
recognition rules and exceptions include:
Section
Industry
 972
Real Estate-Common Interest
Realty Associations
 974
Real Estate-REIT’s
 976
Real Estate-Retail Land
 978
Real Estate-Time Sharing
 980
Regulated Operations
 985
Software
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Software Industry
Nuances
Sales cycle
Development costs
Multiple deliverables
Mode of delivery
The Financial Accounting Standards Board (FASB) and the International Accounting
Standards Board (IASB) initiated a joint project 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.
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Provide a more robust framework for addressing revenue issues.
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Improve comparability of revenue recognition practices across entities, industries,
jurisdictions, and capital markets.
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Provide more useful information to users of financial statements through
improved disclosure requirements.
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Simplify the preparation of financial statements by reducing the number of
requirements to which an entity must refer.
To meet those objectives, the FASB and the IASB are proposing amendments to the
FASB Accounting Standards Codification® and to IFRSs, respectively.
FASB vs. IASB
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FASB - rules based
IASB – principles based
What does it mean to have a rules based system?
What Does it mean to have a principles based
system?
FASB vs. IASB
Why the different systems?
Culture
Geography
Legal system
FASB vs. IASB
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What Does “International Convergence of Accounting Standards”
Mean?
The phrase international convergence of accounting standards
refers to both a goal and the path taken to reach it.
The FASB believes that the ultimate goal of convergence is a
single set of high-quality, international accounting standards
that companies worldwide would use for both domestic and
cross-border financial reporting.
Today, the path toward that goal is the collaborative efforts of
the FASB and the International Accounting Standards Board (IASB)
to both improve U.S. generally accepted accounting principles
(U. S. GAAP) and International Financial Reporting Standards
(IFRS) and eliminate the differences between them.
FASB vs. IASB
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The FASB believes that there is demand for international
convergence, driven by investors’ desire for high-quality,
internationally comparable financial information that is
useful for decision-making in our increasingly global
capital markets.
The FASB and the IASB have been working together toward
convergence since 2002. The two Boards have described
what convergence means and their tactics to achieve it in
two different documents—the Norwalk Agreement issued
in 2002 and the Memorandum of Understanding (MOU)
between the IASB and the FASB, originally issued in 2006
and updated in 2008.
FASB vs. IASB
The main way the FASB and IASB collaborate
is through joint projects to develop common
standards. The FASB issues those standards
as U.S. GAAP and the IASB issues them as
IFRS; over time, the two sets of standards are
expected to both improve in quality and
become increasingly similar if not the same.
FASB vs. IASB
Over 140 countries use IFRS
Argentina, Australia, Austria, Belgium, Brazil,
Canada, Chile, China, Cuba, Czech Republic,
Denmark, Egypt, Finland, France, Germany,
Greece, Hong Kong, India, Ireland, Israel,
Italy, Japan, Mexico, Russia, Spain,
Switzerland, Taiwan, United Kingdom, to
name a few.
FASB vs. IASB
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The future path of IFRS in the U.S.
remains unclear. While over 170 foreign
companies whose stocks trade in the U.S. are
able to file their financial statements in IFRS
with the SEC without reconciling them with
U.S. GAAP, thanks to a rule change in 2007, it
is unlikely at this point that the SEC will agree
to allow U.S. companies to do the same this
year.
FASB vs. IASB
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The long, arduous process of harmonizing IFRS and
U.S. GAAP is continuing for now, but other countries
are pushing the IASB to adopt a more multilateral
approach, with greater involvement by Asian
countries like China and India. U.S presence on the
Monitoring Board may even be diminished, as another
regulator from the Americas could take the place of
the SEC. The priorities of the IASB are likely to shift
toward other countries’ wish lists for standards in
areas such as foreign currency exchange and
agriculture, and those priorities are not likely to
match up with U.S. demands.
FASB vs. IASB
Simplification
Transparency
Consistency
FASB vs. IASB
Overview
 Preliminary views document issued in
December 2008
 Exposure draft issued in June 2010
 Revised exposure draft issued in November
2011 with comments due March 13, 2012
 Final standard expected in late 2012 / early
2013
FASB vs. IASB
Scope
 Applicable to all industries and entities
 Specific contracts with customers outside of
scope: financial instruments, guaranties (other
than warranties), insurance, leases, certain nonmonetary transactions
 Contracts with performance obligations in
multiple standards
 Recognition and measurement principles also
applicable to sales of non-financial assets that
are not classified as revenue
FASB vs. IASB
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
FASB vs. IASB
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FASB and IASB Convergence Project- Revenue
Recognition
Revised proposed revenue model
Five Steps
Identify contract with the customer
Identify separate performance obligations
Determine the price
Allocate the price to the performance obligations
Recognize revenue as performance obligations
are satisfied
FASB vs. IASB
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FASB and IASB Convergence Project- Revenue Recognition
Five Steps
1) Identify contract with the customer
 Enforceable agreement between parties
 Can be written, oral or implied
 Combination: required for contracts entered into at or near
the same time if certain criteria are met
 Modifications are treated separately if separate
performance obligation is added and the consideration is
consistent with the standalone price. Otherwise combine
with remaining goods and services
FASB vs. IASB
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FASB and IASB Convergence Project- Revenue Recognition
Five Steps
2) Identify separate performance obligations
 Promise in a contract to transfer a good or service
 Account for separately if distinct because either of the following criteria
are met:
good or service is regularly sold separately or
customer can benefit from good or service on its own or together with
other readily available services
 However, bundle of promised goods or services accounted for as one
performance obligation if both of the following criteria are met:
highly interrelated and require significant integration service and
significantly modified or customized to fulfill contract
FASB vs. IASB
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FASB and IASB Convergence Project- Revenue Recognition
Five Steps
3) Determine the transaction price
 Amount of consideration to which an entity expects to be
entitled from a customer
 Variable consideration – estimate based on probabilityweighted or most likely amount.
 Time value of money
only affects transaction price if significant financing
component exists
can ignore if time between payment and transfer of
services is one year or less
FASB vs. IASB
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FASB and IASB Convergence Project- Revenue Recognition
Five Steps
3) Determine the transaction price
 Noncash consideration
measure at fair value or by reference to standalone selling price
of related goods or services
 Consideration payable to a customer
reduction of transaction price unless in exchange for a distinct
good or service
 Collectibility
not considered in transaction price
record uncollectible amounts adjacent to revenue
FASB vs. IASB
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FASB and IASB Convergence Project- Revenue Recognition
Five Steps
4) Allocate the transaction price
 Generally based on relative standalone selling prices of separate
performance obligations
 Standalone selling price
observable selling price when sold separately
otherwise, estimate based on cost plus margin, adjusted market
assessment, or residual technique if highly variable or uncertain
 Subsequent changes in the transaction price are allocated on a
relative standalone selling price unless certain criteria are met
FASB vs. IASB
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FASB and IASB Convergence Project- Revenue Recognition
Five Steps
5) Recognize revenue
 Recognize revenue as performance obligations are satisfied based on
transfer of control
 Determine if satisfied (and revenue recognized) over time, based on
whether an entity’s performance:
creates or enhances an asset the customer controls or
does not create an asset with an alternative use and one of the following
criteria is met: customer receives a benefit as entity performs, another
entity would not need to re-perform work completed to date, vendor has
right –to-payment for performance to date
select method of progress toward completion (output or input)
FASB vs. IASB
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FASB and IASB Convergence Project- Revenue Recognition
Five Steps
5) Recognize revenue
 If prior criteria not met, then satisfied at a point in time
 Recognize revenue when customer obtains control based on the
following indicators:
entity has right to payment
entity has transferred legal possession
customer has legal title and risks and rewards of ownership
customer has accepted goods or services
 Recognize amount allocated to performance obligation except for
certain variable consideration, which is limited to reasonably assured
amount based on: experience with similar performance obligations,
whether that experience is predictive of outcome
Other revenue issues
Onerous performance obligations
 Only applicable to performance obligations
satisfied over a period greater than one year
 Recognize liability if allocated transaction
price is less than lower of:
direct costs to satisfy performance obligation,
or
amount to be paid to exit the performance
obligation
Other revenue issues
Onerous performance obligations
 Direct costs include:
Direct labor and materials
Allocated costs directly related to contract
Costs explicitly charged to the customer
Other costs incurred only because contract
entered into
Other revenue issues
Contract Costs
 Capitalize direct costs of fulfilling a contract or
anticipated contract if those costs:
Generate or enhance a resource that will be used
to satisfy performance obligations in the future
(e.g. set-up costs) and
Are expected to be recovered
 Capitalize incremental costs to obtain contract if
expected to be recovered
 Practical expedient to expense costs as incurred
if amortization period would have been one year
or less
Other revenue issues
Warranties
 Customer option to purchase separately:
Separate performance obligation recognized over
time (warranty service)
 No customer option to purchase separately and
warranty does not provide an additional service:
Recognize revenue and accrue expected costs
Consider following in determination of whether
additional service is being provided: whether
warranty is required by law, length of warranty
period, nature of tasks to be performed
Other revenue issues
Other Issues
 Customer unexercised rights (breakage):
Relatively consistent with current US GAAP
 Licensing and rights to use:
Same guidance as other goods and services
Revenue recognized at point in time when
control transfers if separate performance
obligation
Other revenue issues
Disclosure / transition/ effective date
 Effective no earlier than 2015 for public
companies and 2016 for non-public
companies
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FASB and IASB Convergence Project
Five Steps
Identify contract with the customer
Identify separate performance obligations
Determine the price
Allocate the price to the performance
obligations
Recognize revenue as performance
obligations are satisfied
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FASB and IASB Convergence Project
Background and Development of the
Thought Process
The convergence project has been established
in order to ease the FASB transition to
International Financial Reporting Standards
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FASB and IASB Convergence Project
International Financial Reporting Standards (IFRS)
are based upon accounting principles as opposed
to the FASB rules based approach.
Accounting principles used in the development of
the revenue recognition model include:
substance over form, monetary unit assumption,
cost principle, full disclosure principle, matching,
materiality, conservatism. Also, the revenue
recognition principle indicates that revenue is
recognized upon sale or service performance

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