P RESENTED BY L ANCE T RAMMELL, CPA L ANE G ORMAN T RUBITT, PLLC O CTOBER 16, 2014 R EVENUE R ECOGNITION C HANGE IS GOOD … RIGHT ?

I NTRODUCE T OPIC 606 N O : R EVENUE FROM C ONTRACTS WITH C USTOMERS I DENTIFY THE REASONS FOR THE C HANGE P ROVIDE OVERVIEW OF THE F IVE S TEP R ECOGNITION P ROCESS D EFINE KEY TERMS OF THE MODEL OBJECTIVES

In May 2014 FASB introduced the new standard on revenue recognition. The overall objective was to develop a standard that would provide a comprehensive model for accounting for revenue on contracts with customers which would help to provide consistency in recognition and presentation of revenue. Revenue from Contracts with Customers

W HAT WAS WRONG WITH THE EXISTING STANDARD ( S )? T OO MANY OF THEM B Y CREATING A COMPREHENSIVE STANDARD THE HOPE IS THAT WE WILL SEE :  B ETTER QUALITY IN REPORTING TIMELY ACTUAL RESULTS  STRENGTHEN REQUIREMENTS BY NOT HAVING SO MANY “ SPECIAL INSTANCES OR EXCEPTIONS ”  IMPROVE COMPARABILITY S O WHY THE CHANGE ?

 A reporting entity that either enters into contracts with customers to transfer goods or services  A reporting entity that enters into contracts for the transfer of nonfinancial assets unless those contracts are within the scope of other standards. W HO DOES THE NEW STANDARD APPLY TO ?

The guidance is based on the overall premise that an entity should recognize revenue in an amount that reflects the actual consideration that the entity expects to be entitled to. W HAT ’ S GOING TO CHANGE ?

S TEP 1: I DENTIFY THE CONTRACT WITH THE CUSTOMER S TEP 2: I DENTIFY THE PERFORMANCE OBLIGATIONS ( PROMISES ) IN THE CONTRACT S TEP 3: D ETERMINE THE TRANSACTION PRICE S TEP 4: A LLOCATE THE TRANSACTION PRICE TO THE PERFORMANCE OBLIGATION IN THE CONTRACT S TEP 5: R ECOGNIZE REVENUE WHEN / AS THE REPORTING ENTITY SATISFIES THE PERFORMANCE OBLIGATION T HE P ROCESS Identify the Contract with a Customer Identify the Performance Obligations (promises) in the contract Determine the Transaction Price Allocate the Transaction Price to the Performance Obligation in the Contract Recognize revenue when (or as) the Reporting Entity satisfies a Performance Obligation

S TEP 1: I DENTIFY THE C ONTRACT A C ONTRACT IS AN AGREEMENT BETWEEN TWO OR MORE PARTIES THAT CREATES ENFORCEABLE RIGHTS AND OBLIGATIONS  C AN BE WRITTEN, ORAL OR IMPLIED BY THE ENTITY ’ S CUSTOMARY BUSINESS PRACTICE  C AN BE INSTANTANEOUS OR LONG TERM  T HE KEY HERE IS CREATING ENFORCEABLE OBLIGATIONS T HE PROCESS Identify the Contract with a Customer Identify the Performance Obligations (promises) in the contract Determine the Transaction Price Allocate the Transaction Price to the Performance Obligation in the Contract Recognize revenue when (or as) the Reporting Entity satisfies a Performance Obligation

E LEMENTS OF A CONTRACT -  M UST CONTAIN AN APPROVAL AND COMMITMENT OF THE PARTIES  I DENTIFY THE RIGHTS OF THE PARTIES INVOLVED  I DENTIFY TERMS OF PAYMENT  E STABLISH COMMERCIAL SUBSTANCE  PROBABLE THAT THE ENTITY WILL COLLECT THE CONSIDERATION THAT IS DUE IN EXCHANGE FOR THE GOODS OR SERVICES S TEP 1: I DENTIFY THE C ONTRACT

C ONTRACTS CAN BE -  C OMBINED  M ULTIPLE CONTRACTS ARE NEGOTIATED WITH A SINGLE OBJECTIVE  T HE C ONSIDERATION IN ONE CONTRACT DEPENDS ON THE OTHER CONTRACT  G OODS / SERVICES ARE PROMISED ARE A SINGLE PERFORMANCE OBLIGATION  C AN BE MODIFIED DUE TO A CHANGE IN SCOPE OR PRICE  M UST BE MUTUALLY AGREED TO  C HANGE IN REVENUE IS PROSPECTIVELY IF THE MODIFICATION RELATES TO DISTINCT GOODS OR SERVICES TRANSFERRED AFTER MODIFICATION  C UMULATIVE CATCH - UP OF REVENUE IF MODIFICATION IS NOT RELATED TO A DISTINCT GOOD OR SERVICE S TEP 1: I DENTIFY THE C ONTRACT

S TEP 2: P ERFORMANCE O BLIGATIONS A PERFORMANCE OBLIGATION IS A PROMISE IN A CONTRACT WITH A CUSTOMER TO TRANSFER GOODS OR SERVICES  Obligations are goods or services that are distinct or a series of distinct goods or services that are substantially the same and same pattern of transfer  There can be more than one performance obligation within a contract  Required to identify how many promises are in the contract to properly determine the transaction price per obligation T HE PROCESS

A RE DETERMINED BASED ON WHETHER THE GOODS OR SERVICES ARE D ISTINCT.  The customer can benefit from the good/service on its own or with other resources that are readily available to the customer. AND  The entity’s promise to transfer the good/service to the customer is separately identifiable from other promises in the contract. S TEP 2: P ERFORMANCE O BLIGATIONS

E XAMPLE NON DISTINCT – C ONSTRUCTION C ONTRACTOR A mechanical contractor has entered into a contract to provide the installation of a new HVAC system. The contractor will perform the design configuration, purchase the equipment and provide the labor for installation. Do we have separate performance obligations? S TEP 2: P ERFORMANCE O BLIGATIONS

E XAMPLE DISTINCT – S OFTWARE A software developer enters into a contract with a customer to transfer software license, perform installation, and provide unspecified software updates and technical support for a two year period. In the normal course of business the developer sells these services separately. Each good or service will benefit the customer on their own. Therefore we have 4 separate performance obligations S TEP 2: P ERFORMANCE O BLIGATIONS

S TEP 3: T RANSACTION PRICE  T RANSACTION PRICE  IS THE AMOUNT OF CONSIDERATION THAT AN ENTITY EXPECTS TO RECEIVE IN EXCHANGE FOR TRANSFERRING PROMISED GOODS OR SERVICES TO A CUSTOMER.  C AN CONTAIN BOTH FIXED AND VARIABLE COSTS RELATED TO THE TRANSFER OF THE GOODS.  S ALES P RICE – V ARIABLE C ONSIDERATION = T RANSACTION P RICE  T RANSACTION PRICE IS WHAT IS REPORTED AS REVENUE AT THE TIME OF SALE T HE PROCESS Identify the Contract with a Customer Identify the Performance Obligations (promises) in the contract Determine the Transaction Price Allocate the Transaction Price to the Performance Obligation in the Contract Recognize revenue when (or as) the Reporting Entity satisfies a Performance Obligation

V ARIABLE C ONSIDERATION  F ACTORS THAT CAN INFLUENCE THE OVERALL TRANSACTION PRICE.  O NLY INCLUDED AS PART OF THE TRANSACTION PRICE TO THE EXTENT THAT IT IS PROBABLE THAT A SIGNIFICANT REVERSAL IN THE CUMULATIVE AMOUNT OF REVENUE RECOGNIZED WILL NOT OCCUR IN FUTURE PERIODS IF THE ESTIMATES OF VARIABLE CONSIDERATION CHANGE.  E XAMPLE - V OLUME DISCOUNT  O THER CONSIDERATIONS OF SALE TYPICALLY NOT REVIEWED UNTIL AFTER THE SALE IS COMPLETED ( SALES INCENTIVES, REBATES )  S IGNIFICANT FINANCING COMPONENT OF THE REVENUE TRANSACTION  E NTITY WILL ADJUST THE AMOUNT OF CONSIDERATION PROMISED TO REFLECT THE TIME VALUE OF MONEY.  I F PROMISED AND IT IS PROBABLE THAT IT WOULD GENERATE A SIGNIFICANT ADJUSTMENT TO REVENUE IF IT IS NOT CONSIDERED, THEN CONSIDER UPFRONT.  T HE PROMISE DOES NOT HAVE TO BE IN WRITING, IT CAN ALSO BE PART OF THE ENTITY ’ S NORMAL BUSINESS PRACTICE  V ARIABLE CONSIDERATION PUTS IT INTO A C ASH FLOW PERSPECTIVE, MEANING WE ARE RECORDING IN REVENUE WHAT WE ACTUALLY EXPECT TO RECEIVE. S TEP 3: T RANSACTION PRICE

V ARIABLE C ONSIDERATION – C ONTINUED  C ONSTRAINTS – F ACTORS THAT WOULD INCREASE THE LIKELIHOOD OF A SIGNIFICANT REVENUE REVERSAL.  F ACTORS OUTSIDE THE ENTITY ’ S INFLUENCE -3 RD PARTIES, OBSOLESCENCE  U NCERTAINTY ABOUT AMOUNT OF CONSIDERATION EXPECTED MAY NOT BE RESOLVED FOR AN EXTENDED PERIOD OF TIME  I N NORMAL BUSINESS PRACTICE, THE ENTITY MAY OFFER A BROAD RANGE OF PRICE CONCESSIONS OR CHANGE PAYMENT TERMS ON SIMILAR CONTRACTS ( I. E. INCONSISTENT )  C ONTRACT ITSELF HAS A LARGE NUMBER AND BROAD RANGE OF POSSIBLE CONSIDERATIONS. ( I. E. TOO MUCH TO PREDICT ) S TEP 3: T RANSACTION PRICE

S TEP 4: A LLOCATION OF PRICE TO PERFORMANCE O BJECTIVE – ALLOCATE THE TRANSACTION PRICE TO EACH PERFORMANCE OBLIGATION WITHIN THE CONTRACT  B ASE IT ON STANDALONE SELLING PRICE BASIS  P RICE THE ENTITY WOULD SELL A GOOD OR SERVICE SEPARATELY TO A CUSTOMER.  I F PRICE IS NOT DIRECTLY IDENTIFIABLE, THEN IT WOULD HAVE TO BE ESTIMATED  A DJUSTED M ARKET ASSESSMENT APPROACH  E XPECTED COST PLUS A MARGIN APPROACH  R ESIDUAL APPROACH T HE PROCESS Identify the Contract with a Customer Identify the Performance Obligations (promises) in the contract Determine the Transaction Price Allocate the Transaction Price to the Performance Obligation in the Contract Recognize revenue when (or as) the Reporting Entity satisfies a Performance Obligation

 M AKE SURE YOU UNDERSTAND THE COMPONENTS OF THE VARIABLE CONSIDERATION AND ONLY APPLY IT TO THE RELATED PERFORMANCE OBLIGATION IF THE CONTRACT CONTAINS MULTIPLE OBLIGATIONS.  C HANGES IN THE TRANSACTION PRICE  A PPLY TO THE RESPECTIVE OBLIGATIONS.  A LLOCATE THE CHANGE IN TRANSACTION PRICE TO THE PERFORMANCE OBLIGATIONS IDENTIFIED IN THE CONTRACT BEFORE THE MODIFICATION IF THE CHANGE IN TRANSACTION PRICE IS ATTRIBUTABLE TO AN AMOUNT OF VARIABLE CONSIDERATION PROMISED BEFORE THE MODIFICATION.  I F CHANGE CREATES A SEPARATE CONTRACT, THE ENTITY SHOULD ALLOCATE THE CHANGE IN THE TRANSACTION PRICE TO THE PERFORMANCE OBLIGATIONS OF THE MODIFIED CONTRACT THAT WERE NOT FULLY SATISFIED AFTER THE MODIFICATION. A LLOCATION OF PRICE

S TEP 5: R ECOGNIZE REVENUE R EVENUE IS RECOGNIZED WHEN THE ENTITY SATISFIES THE PERFORMANCE OBLIGATION. T HE PERFORMANCE OBLIGATION IS CONSIDERED TO BE SATISFIED WHEN THE CUSTOMER TAKES CONTROL OF THE ASSET. T HIS CAN OCCUR EITHER AT A POINT IN TIME OR OVER A PERIOD OF TIME. T HE PROCESS

C ONTROL - A BILITY TO DIRECT THE USE OF AND SUBSTANTIALLY ALL OF THE REMAINING BENEFITS OF THE ASSETS  C ONTROL OVER A PERIOD OF TIME ( ONE MUST BE MET ):  Customer simultaneously receives and consumes benefits provided by the entity’s performance 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 does not create an asset with alternative use to the entity, and the entity has an enforceable right to payment for performance completed to date. S TEP 5: RECOGNIZE REVENUE

 C ONTROL OVER A PERIOD OF TIME IS MEASURED BASED ON INPUT OR OUTPUT METHODS  I NPUT METHOD RECOGNIZES REVENUE BASED ON THE ENTITY INPUTS ( COSTS / EFFORTS ) PUT INTO SATISFYING THE PROJECT.  E XAMPLES – MATERIALS COSTS, LABOR HOURS, MACHINE HOURS  DISADVANTAGE OF INPUT METHOD IS THAT THERE MAY NOT BE A DIRECT RELATIONSHIP BETWEEN THE INPUTS AND THE CONTROL OF GOODS  O UTPUT METHOD RECOGNIZES REVENUE ON THE BASIS OF DIRECT MEASUREMENTS OF THE VALUE TO THE CUSTOMER  E XAMPLES – SURVEYS, APPRAISALS, MILESTONES, UNITS DELIVERED  D ISADVANTAGE OF OUTPUT METHOD IS THAT YOU HAVE TO MAKE SURE THAT YOUR METHOD IS A TRUE DEPICTION OF THE ENTITY ’ S PERFORMANCE TOWARDS COMPLETE SATISFACTION OF OBLIGATION. C ONTROL ( CONTINUED )

 C ONTROL AT A PERIOD IN TIME ( NOT LIMITED TO ):  Entity has a present right to payment of the asset  Customer has legal title to the asset  Entity has transferred physical possession of the asset  Customer has accepted the asset C ONTROL ( CONTINUED )

C ONTRACT A SSET - AN ENTITY ’ S RIGHT TO CONSIDERATION IN EXCHANGE FOR GOODS OR SERVICES THAT THE ENTITY HAS TRANSFERRED TO A CUSTOMER BEFORE PAYMENT IS DUE. C ONTRACT L IABILITY - AN ENTITY ’ S OBLIGATION TO TRANSFER GOODS OR SERVICES TO A CUSTOMER FOR WHICH THE ENTITY HAS RECEIVED CONSIDERATION N EW T ERMS

US GAAP Reporting periods after December 15, 2016 Including interim reporting periods therein Publicly Traded Companies Early application not allowed Reporting periods after December 15, 2017 Non-publicly Traded IFRS Reporting periods beginning January 1, 2017 Early application allowed IMPLEMENTATION

US GAAP - FASB – Financial Accounting Standards Board IFRS - IASB – International Accounting Standards Board TRG – Joint Transition Resource Group Potential implementation issues submission form to Public accounting firms S OURCES

?Q UESTIONS ?