1. Break-out Session 2A: Revenue recognition
Break-out Session 2A: Revenue recognition
Ann Kruse, Partner, St. Louis
Latina Fauconier, Advisory Director, Detroit Mark Wilmot, Director, Detroit

2. Agenda Overview of the New Standard
Revenue Recognition Activities and Implementation Issues
Common Findings
Tax Considerations

3. Overview of the new standard1

4. Overview of new revenue standard
Executive summary
Converged standard on revenue recognition issued by FASB and IASB in May 2014
Principles-based standard replaces nearly all existing industry-specific or transaction-specific guidance for both US GAAP and IFRS
Still certain differences between GAAP and IFRS (e.g., notion of probability, changes made by FASB and not IASB like licensing)
Also includes guidance for certain costs to obtain or fulfill a contract with a customer (e.g., incremental costs of obtaining a contract).
Achieve a single, comprehensive revenue recognition model
Core principle is that revenue recognition depicts transfer of control to customer in an amount that reflects consideration to which an entity expects to be entitled

5. Overview of new revenue standard (continued)
Scope set to improve consistency and comparability within industries, across industries, and across capital markets
Scope of the standard
Specifically excluded
Applies to all contracts with customers to transfer goods, services, or nonfinancial assets
Applicable to all entities and industries with only certain transactions excluded
Sectors most heavily impacted:
EMC, Technology, Aerospace
& Defense, Automotive,
Pharmaceutical & Life Sciences
Lease contracts
Insurance contracts
Financial instruments
Guarantees (other than product warranties)
Certain nonmonetary exchanges
Contracts with other than customers (e.g., collaborations)

6. When is it effective U.S. GAAP Public U.S. GAAP Non-public IFRS
Effective Date
Beginning after December 15, 2017
2018 calendar year
Beginning after December 15, 2018
2019 calendar year
Beginning on January 1, 2018
Early adoption permitted?
Yes
No earlier than the original effective date for public entities
2017 calendar year
No earlier than the original effective date for public entities
Method of adoption
Retrospective (with certain practical expedients allowed) or modified retrospective

7. Transition and related disclosure for public companies
Year 1
(2016)
Year 2
(2017)
Year 3
(2018)
Retrospective:
Legacy GAAP
New standard
Cumulative effect at Jan 1, 2016
Modified retrospective: **
Retrospective
Entity may use one or more practical expedients
Parallel reporting in Year 1 and Year 2
Reporting under new standard only in Year 3
Apply to all existing contracts as of the effective date and to all future contracts
Recognize cumulative effect to existing contracts in opening retained earnings on effective date
Disclose impact on all affected financial statement line items in the period the standard is adopted
Begin phasing in new systems and processes prior to effective date
Practical expedients on completed contracts
Modified retrospective
Cumulative effect at Jan 1, 2018
Assumed adoption date = January 1, 2018
**Practical consideration to begin phasing in new systems and processes (reporting required Year 3 only)

8. Revenue recognition activities and implementation issues2

9. Revenue recognition activities
New Revenue Standard
Transition
resource group
Other industry working
groups and committees
AICPA task forces
SEC
Preparers and audit firms
FASB and IASB

10. How does it work Five step model
Identify the contract(s) with a customer
Identify the performance obligations in the contract
Determine the transaction price
Allocate the transaction price to the performance obligations in the contract
Recognize revenue when (or as) the entity satisfies a performance obligation

11. Where are the issues?

12. Comparison to existing guidance – Other
Other aspects of the standard
Existing guidance
Diversity in recognition of revenue related to licenses
Little guidance on accounting for costs outside of contract accounting
Required disclosures set forth in ASC 605
New guidance
Guidance provided to assess whether license recognized at a point in time or over time
Incremental costs to obtain and fulfill a contract are capitalized if recoverable
More extensive quantitative and qualitative disclosures required

13. Potential areas of difference
“Cash cap” guidance
Allocation of discounts
Bill and hold arrangements
Certain POC methods
Certain Subscriptions
Combining contracts
Consignment arrangements
Contingent revenue
Collectability
Contract modifications
Customer loyalty programs
Customization implementation
Discounted goods or services
Distributor revenue
Elimination of industry guidance
Extended payment terms
Extended Warranties
Funded R&D arrangements
In-transit loss coverage
Learning Curve
Licenses
Other contract costs
Performance fees
Sales commission
Sell through
Service level agreements
Time value of money
Units of delivery method
Vendor protection clauses
Volume Discounts
Disclosures

14. Impact on the process, systems and data
The new Revenue Recognition standard impacts the allocation methodologies, triggers for, and timing when revenue is recognized for products and services delivered to customers. This change impacts the order-to-cash and close-to-report cycles as shown below.
Revenue recognition systems
Transaction Systems
(order, quoting, contract processes)
Invoicing, Billing and Collections Systems
Revenue Models & Triggers
Revenue Calculation Systems
General Ledger
Reporting
Platforms
Accounting guidance has changed, requiring new judgments and estimates to be made, new data capture, new calculations and new reporting to meet guidance requirements
“If I change $1 of revenue, what are we going to have to change?”
New data may be needed from:
Ordering systems
Quoting systems
Contracting systems
Billing and invoicing systems
Cash and treasury processes
Licensing operations
CRM
New requirements may be needed in the following organizations or processes:
Revenue calculation systems
Close and accrual processes
General ledger and reporting systems
Forecasting and budgeting processes
Incentive compensation
Investor relations
Tax
Channel partner incentive programs

15. Common findings 3

16. Identification of performance obligations
-1 Tax
Potential material separate performance obligations
Warranties
Discounted or free samples, products, tools, equipment
Cooperative advertising
Employee demonstrators
Implementation services
Licenses
Research and development services
Customer premises equipment
Customer options
Tooling

17. Determination of transaction price
-1 Tax
Variable consideration is recognized under the new standard to the extent probable, which serves to reduce transaction price
Performance bonuses
Volume discounts
Tiered/promotional pricing
Coupons
Loyalty programs
Price protection
Early payment discounts
Advertising allowances/marketing funds
Residual value guarantees
Repurchase obligations

18. Determination of transaction price (continued)
-1 Tax
Contingent revenue
Milestones
Service level guarantees
Customers with credit risk
Pay for performance
Risk share contracts

19. Allocation of transaction price and recognition of revenue
-1 Tax
Under the new standard, for financial reporting purposes, the transaction price will be allocated to performance obligations based upon relative stand alone selling prices versus stated contract prices
Deviation from contractual pricing and cash payment patterns
Certain accrued liabilities will be recast as deferred revenue obligations
Potential implications for unbilled accounts receivable
Potential implications for advance payment liabilities
Revenue is recognized at either a point in time or over time
Sell-through arrangements generally recognized when control of goods transferred to distributor
Licenses may be recognized upfront versus over time
Customized goods may be subject to over time recognition versus point in time recognition

20. Tax considerations 4

21. Tax revenue recognition rules
The tax law contains specific revenue recognition rules, under which revenue generally is recognized the earlier of when it is due, paid or earned
Amounts due or paid in advance of being earned (advance payments) may be eligible for tax deferral under specific provisions (Rev. Proc or Section 451 regulations), but tax deferral generally cannot exceed the book deferral
Revenue generally earned for:
Goods, when benefits and burdens of ownership of good transfers
Services, when services (or divisible services) are complete
Licenses, over the period the licensee has the right to use the property
Long-term contracts, as costs are incurred

22. Tax revenue recognition principles
The form of the contract generally is respected such that
Generally required to account for each separate deliverable in a contract based on the stated contract prices
Contract modifications generally do not create separate contracts
Contract inducement costs generally capitalizable only to the extent
External costs,
Contract term exceeds 12 months,
Contract is not terminable at will, and
Amount is not de minimis ($5,000 or less)
Consider where book-tax differences are mapped in compliance software
Pursuant to the financial accounting change in accounting principle, consider how retained earnings adjustments will be tracked and reflected in tax returns (disaggregation of cash flows from revenue and expense recognition)

23. Summary of tax considerations
Accounting for income taxes
International taxes
Transfer pricing
State income taxes
Effective tax rate considerations
Other
Adjustments to deferred tax balances
Changes in current/non-current deferred classification
Impacts on any valuation allowances
Impacts on uncertain tax positions
Effect on intra- period allocations
Impact on financial statement disclosures
Effect of any book and/or tax method changes on E&P
Impact on the determination of foreign source income
Effects to controlled foreign corporation debt netting calculation
Impacts to allocation of interest expense under fair market value apportionment method
Impact on benchmarking analyses (e.g., timing of impact on comparables)
Impact on intercompany invoice amounts
Need to allow additional lead in case for year-end transfer pricing adjustments
Necessary changes to documentation and additional clarifications in policies
Potential sales and use tax implications
Income and net worth implications, including potential impact on tax base and apportionment
Section 199 deduction computation
Calculation of credits (e.g., R&E)
Calculation of charitable contribution limitations
State tax rate
Establishment and/or change to internal controls
Evaluation of compliance and provision systems for availability, integrity, and retention of data to enable the performance of accurate tax calculations and reliance on automation/ technology
Modeling of tax impacts and forward looking projections

24. Tax accounting methods
Financial accounting changes will impact cash taxes in certain instances:
Recognition of advance payments deferred to extent of book deferral
Treatment of additional items as deferred revenue as opposed to as accrued liabilities (e.g., customer loyalty programs)
Identification of impermissible tax method
Changes could impact book-tax differences and deferred taxes, including:
Recognition of sale of goods, services, long-term contracts, licensing revenue
Contingent consideration
Time value of money adjustments
Changes also may require tax accounting method changes
IRS Notice requests comments on technical and procedural aspects of this new guidance

25. Practical illustration
Background: Company X sells an automobile with a one year scheduled maintenance service included, on November 1, 20X4 for $1,000. Under the existing (current) revenue recognition guidance, the first performance obligation (sale of car) is allocated $1,000 of revenue, while the second performance obligation (scheduled maintenance) is allocated $0 of revenue. Upon recognition of the first performance obligation, there is no deferred revenue for book or tax purposes. Under the new standard, performance obligation 1 (sale of car) will be allocated $900 of revenue and performance obligation 2 (scheduled maintenance) will be allocated $100 of revenue. Upon recognition of the first performance obligation, deferred revenue of $100 will exist in the financial statements. Company X utilizes the deferral method of accounting as prescribed in Rev. Proc For federal income tax purposes, under the current standard, X will recognize $1,000 of revenue upon sale of the car in 20X4. Under the new standard, X will recognize $900 of revenue in taxable income and defer the $100 to the extent it is deferred for financial reporting purposes in 20X4. In 20X5, X will recognize the remaining amount of $100 of revenue in taxable income.

26. Practical illustration (continued)
IRC Section 199 implications for Company X:
$100 of income deferred from 20X4 to 20X5 under the new standard
Assume costs associated with DPGR remain constant
Current standard
New standard
Difference
QPAI $
1,000
900
(100)
Associated costs
(200) -
Subtotal
(800)
(700)
100
Limitation 9%
Deduction
(72.0)
(63.0)
9.0
Unfavorable ETR impact in 20X4
Favorable cash tax benefit: $3.2M ($9M * 35%) in 20X4

27. Practical illustration (continued)
State and local tax implications for Company X:
$100 of income deferred from 20X4 to 20X5 under the new standard
Assume filing in 3 states (A, B, C) with single factor sales apportionment
Income deferral relates to State A sales
Impact to state apportionment:
Current standard
Sales
Apportionment
State A
1.000
57%
State B
500
29%
State C
250
14%
1,750
New standard
Sales
Apportionment
900
55%
500
30%
250
15%
1,650

28. Practical illustration (continued)
Impact to blended state tax rate:
Current standard
Rate
Apportionment
Blended rate
State A
10.00%
57%
5.71%
State B
5.00%
29%
1.43%
State C
3.00%
14%
0.43%
7.57%
New standard
Rate
Apportionment
Blended rate
10.00%
55%
5.45%
5.00%
30%
1.52%
3.00%
15%
0.45%
7.42%
Impact to overall state tax expense:
State taxable income
1,650
State ETR change
-0.15%
Impact to state expense
(2.43)
Cash tax favorable

29. Thank you Ann Kruse, Federal Partner St. Louis, MO
(314)
Latina Fauconier, Advisory Director
Detroit, Michigan
(313)
Mark Wilmot, Federal Director
(313)
This document is for general information purposes only, and should not be used as a substitute for consultation with professional advisors.
This document was not intended or written to be used, and it cannot be used, for the purpose of avoiding US federal, state or local tax penalties.
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