Accounting Update 2019 Part II

Accounting Update 2019 Part II
Presented by Anne Morris Chris Rouse

Accounting Update 2019 – Part II
The New Revenue Recognition Standard – Accounting Standards Update Eliminates all (??) industry and transaction guidance for revenues in current standards Largest impact on businesses with contracts satisfied over a period of time and businesses with contingent pricing Prior periods presented may be either restate prior years presented or adjust for cumulative effect in year of adoption The IFRS Statement is virtually the same as FASB’s Many amendments, modifications and clarifications have been subsequently issued #WBInsights18

REVENUE RECOGNITION Effective Dates (after ASU ) Public companies Annual reporting periods beginning after December 15, 2017 Early application is permitted for annual reporting periods beginning after December 15, 2016 (original effective date) Private companies Annual reporting periods beginning after December 15, 2018 Earlier application permitted but not before early date for public companies #WBInsights18

REVENUE RECOGNITION Overarching Principles in ASU 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 and services In effect, revenue is recognized as changes in assets and liabilities are recognized Sending a bill or collecting cash has nothing to do with revenue recognition #WBInsights18

REVENUE RECOGNITION Overarching Principles in ASU Five steps to achieve core principle Identify the contract with a customer Identify the separate performance obligations Determine the transaction price Allocate the transaction price to performance obligations Recognize revenue when the entity satisfies a performance obligation Compare to current Standard (1) persuasive evidence, (2) delivery, (3) fee fixed or determinable and (4) collectibility assured #WBInsights18

REVENUE RECOGNITION Identifying the Contract Definition of contract uses the phrase “enforceable rights” May be written or oral A contract has the following criteria Has commercial substance Parties to contract have approved it Each parties rights can be identified Payment terms can be identified Collection of consideration is probable Contract does not exist if each party has unilateral right to terminate a wholly unperformed contract without compensating the other party #WBInsights18

REVENUE RECOGNITION Identifying the Contract (continued) Combining contracts An entity will combine contracts if the contracts were entered into at or near the same time, and The contracts are negotiated as a package with a single commercial objective, or The amount of consideration in one contract depends on the price or performance of the other contract, or The goods or services are a single performance obligation #WBInsights18

REVENUE RECOGNITION Identifying the Contract (continued) Contract Modifications Separate performance obligations imply separate contract No separate performance obligation implies re-evaluation of both performance obligations and allocation of transaction price Accounting department action plan … Establish communication with sales to Obtain copies of contracts, web pages, advertising, oral representations and other elements of the contract Identify contracts as they are entered into Identify changes, additional contracts as they are entered into #WBInsights18

REVENUE RECOGNITION Identifying Performance Obligations A good or service, or a bundle of goods or services, is accounted for as a separate performance obligation only if it is distinct Customer can use the good or service on its own or in combination with resources readily obtainable and The vendor’s promise is separately identifiable from other promises in the contract #WBInsights18

REVENUE RECOGNITION Identifying Performance Obligations (continued) This is a key element in the new standard, and while it is similar to the current “multiple deliverables” Standard, there are important differences Entities not currently applying the multiple deliverable standard may have multiple performance obligations Entities currently applying the multiple deliverables standard may experience different performance obligations Accounting department action plan … Establish communication with sales, operations, etc to understand the performance obligations in the contracts #WBInsights18

REVENUE RECOGNITION Determining Transaction Price Transaction price is the amount of consideration expected to be received in exchange for the goods or service, considering … Variable consideration Time value of money Noncash consideration Consideration payable to customer Collectability Collectability does not consider customer’s credit risk #WBInsights18

REVENUE RECOGNITION Determining Transaction Price (continued) Transaction price is the amount of consideration expected to be received in exchange for the goods or service, considering … Variable consideration Time value of money Noncash consideration Consideration payable to customer Collectability Collectability does not consider customer’s credit risk #WBInsights18

REVENUE RECOGNITION Determining Transaction Price (continued) Variable Consideration Discounts Rebates Refunds Credits Incentives Bonuses/Penalties Price Concessions #WBInsights18

REVENUE RECOGNITION Determining Transaction Price (continued) Effect of Variable Consideration Two methods of estimating transaction price Expected Value Method Most Likely Method #WBInsights18

REVENUE RECOGNITION Determining Transaction Price (continued) Accounting department action plan Establish communications with sales department to understand the transaction price elements #WBInsights18

REVENUE RECOGNITION Allocating Transaction Price The accounting department allocates the transaction price based on info received from sales, operations, etc Allocate the transaction price to all separate performance obligations in proportion to the standalone selling price of the good or service underlying each of those performance obligations at contract inception Estimating the standalone selling price Adjusted Market Assessment Approach Expected Cost Plus a Margin Approach Residual Approach (limited use) #WBInsights18

REVENUE RECOGNITION Allocating Transaction Price (continued) Issues Allocation of a discount Allocation of variable consideration Changes in transaction price #WBInsights18

REVENUE RECOGNITION Recognizing Revenue Revenue is recognized when each separate performance obligation is satisfied. A performance obligation is satisfied when the promised good or service is transferred to the customer. A good or service is assumed to be transferred when the customer obtains control of that good or service. #WBInsights18

REVENUE RECOGNITION Recognizing Revenue (continued) Performance obligation satisfied over time The customer simultaneously receives and consumes the benefit as the entity performs the task The performance creates or enhances an asset that the customer controls as the asset is created or enhanced, or The entity’s performance does not create an asset with alternative use to the entity Enforceable right to payment for performance to date #WBInsights18

REVENUE RECOGNITION Recognizing Revenue (continued) Determining progress when satisfied over time Output method: direct measurement of value to customer Input method: efforts expended or resources consumed Accounting department action plan Establish communication with operations, shipping, and those in the entity that satisfy performance obligations to obtain performance info #WBInsights18

REVENUE RECOGNITION Some Special Issues Right of return Do not account for right of return as a separate performance obligation Adjust current revenue Product warranty Recognize separately if warranty provides customer with a service in addition to assurance that product or service complies with contract Customer option for additional goods Gives rise to a performance obligation only if option provides a material right to the customer that they would not have without entering into the contract #WBInsights18

REVENUE RECOGNITION Some Special Issues (continued) Right of return Do not account for right of return as a separate performance obligation Adjust current revenue Product warranty Recognize separately if warranty provides customer with a service in addition to assurance that product or service complies with contract Customer option for additional goods Gives rise to a performance obligation only if option provides a material right to the customer that they would not have without entering into the contract #WBInsights18

REVENUE RECOGNITION Some Special Issues (continued) Nonrefundable upfront fee Constitutes a performance obligation only if it actually transfers a good or service Otherwise, fee is an advance payment that is recognized as service is provided or goods are transferred #WBInsights18

REVENUE RECOGNITION Some Special Issues (continued) Licenses and rights of uses If license is not distinct performance obligation, combine with other goods or services If license is distinct, does value transfer At a point in time (access only to asset as it exists at a point in time) Over time (access to asset which is changing over time) #WBInsights18

REVENUE RECOGNITION Some Special Issues (continued) Principal vs Agent Principal – controls product or service prior to sale Agent – obligation is to arrange for the provision of a product or service by another entity #WBInsights18

REVENUE RECOGNITION Some Special Issues (continued) Consignments If the party receiving the product does not control the product, the arrangement is a consignment and revenue is not recognized until final delivery Controlled by vendor until specified event occurs or specified period occurs Vendor can require return of product or transfer to another third party The third party does not have obligation to pay for product #WBInsights18

REVENUE RECOGNITION Some Special Issues (continued) Bill and Hold Revenue recognized when customer obtains control Vendor may have a performance obligation for custodial activities (the “hold”) #WBInsights18

REVENUE RECOGNITION Disclosure “The objective of the disclosure requirements is to enable users of financial statements to understand the nature, amount, timing, and uncertainty of revenue and cash flows arising from contracts with customers.” #WBInsights18

REVENUE RECOGNITION Disclosure (continued) Categories of revenue based on economic factors effecting nature, amount, timing and uncertainty of revenues and cash flows eg, product line, geography, market or type customer, contract type or duration, sales channel, etc Non-publics can just disclose qualitative info on the above, but must disclose quantitative revenue info based on timing (ie, point of time vs. over time) #WBInsights18

REVENUE RECOGNITION Disclosure (continued) Publics must present in tabular form an analysis of contract assets and contract liabilities (illustration in Standard) Information about performance obligations, eg Goods or services involved When satisfied Payment terms Obligations for returns, warranties, etc Judgments, and changes in judgments, made in applying the Standard Other beans #WBInsights18

REVENUE RECOGNITION Steps to Implementation Form a Task Force of management, sales, operations and the accounting department Evaluate effect of changes on entity Decide how entity will adopt new standard Determine what changes need to be made to entity’s systems Determine what interim disclosures will be needed Develop a comprehensive project plan for implementation Educate key stakeholders #WBInsights18

REVENUE RECOGNITION Getting ready for the new standard Study the parts of the new standard that apply to you, especially the examples Review the implementation guidance on the FASB and AICPA websites Evaluate current contracts with customers Identify performance obligations and information systems Identify transaction prices Identify how performance obligations are satisfied #WBInsights18

REVENUE RECOGNITION Getting ready for the new standard (continued) Consider effect on compensation arrangements, income taxes, etc. May effect timing of compensation based on revenue or net income Some tax revenues are determined by GAAP Consider changes to information system to capture necessary info Much of the information necessary to implement the new standard does not exist in the accounting department #WBInsights18

REVENUE RECOGNITION Getting ready for the new standard (continued) Evaluate current revenue recognition practices and compare to requirements of new standard Communication of completion of performance obligations Consider necessary changes in contract to achieve desired revenue recognition timing Transfer of risks and rewards of ownership Point: This is a complicated standard – the first time – after that it’s a snap #WBInsights18

Lease Accounting A focused look at getting ready for one of most significant changes in accounting standards financial statement preparers have faced off with in many years #WBInsights18

New Lease Accounting Background Joint project of FASB and IASB begun in 2006 Discussion Paper, multiple Exposure Drafts, and public outreach FASB concluded that the current lease model does not meet the needs of users Initial exposure draft had a single lease model, but FASB revised to a two-lease model Operating leases and financing leases IASB stuck with a single lease model #WBInsights18

New Lease Accounting Effective Date and Transition Effective date is years beginning after 12/15/2018 for publics (and interims within), and 12/15/19 for non-publics (and interims after) Recognize and measure leases either … At beginning of earliest period presented, or As cumulative adjustment to opening retained earnings Lessees may use the modified retrospective method or a practical expedient Modified retrospective approach Existing capital leases will be “run off” Operating leases will present the lease liability and related asset that existed for each period presented #WBInsights18

New Lease Accounting Transition Requirements Lessor Same as lessees except no recognition of operating leases Transition of sale and leaseback Do not have to reassess prior sale and leaseback transactions Reassess previous failed sale leaseback transactions #WBInsights18

New Lease Accounting Key take-aways Bottom Line – the major effect on financial statements is the balance sheet capitalization of operating leases; everything else is beans Lessees will “capitalize” all leases, including all existing leases Lessees will separately display operating and financing leases EBIDAT will not change significantly Substantial new disclosure requirements for operating leases Not much change for lessors #WBInsights18

New Lease Accounting Determining Whether a Contract Contains a Lease Definition A contract, or part of a contract, that conveys the right to control the use of identified property, plant or equipment (an identified asset) for a period of time in exchange for consideration Compare to current “an agreement conveying the right to use property, plant or equipment, usually for a stated period of time” #WBInsights18

New Lease Accounting Determining Whether a Contract Contains a Lease (continued) 1. Is there an identified asset (ie, PP&E)? If Yes, go to 2 If No, it’s not a lease 2. Does the customer have the right to obtain substantially all of the economic benefits from use of the asset throughout the period of use? If Yes, go to 3 If the supplier has the benefits, it’s not a lease If Neither, go to 3 #WBInsights18

New Lease Accounting Determining Whether a Contract Contains a Lease (continued) 3. Does the customer have the right to direct how and for what purpose the identified asset is used? If yes, it’s a lease and 4 and 5 are not applicable If No, it’s not a lease If neither, go to 4 4. Does the customer have the right to operate the asset without the supplier having the right to change the operating instructions? If Yes, it’s a lease If No, go to 5 #WBInsights18

New Lease Accounting Determining Whether a Contract Contains a Lease (continued) 5. Did the customer design the asset in a way that predetermines how and for what purpose the asset will be used? If Yes, it’s a lease If No, it’s not a lease #WBInsights18

New Lease Accounting Determining Whether a Contract Contains a Lease (continued) Identified asset May be specific or implicit eg, a specific truck or a truck to be later identified Lessor substitution rights can negate lease accounting No identified asset if supplier has “substantive” substitution rights Substantive if supplier has practical ability to substitute and would benefit economically from substitution If lessee can’t determine if substantive, then presume it is not substantive #WBInsights18

New Lease Accounting Determining Whether a Contract Contains a Lease (continued) Right to control use of asset Lessee has the Power to direct the use of the asset Right to operate the asset without the supplier having change rights, or The customer designed the asset in a way that predetermines its use If customer specifies output and cannot change it, it is a supply or service contract and not a lease Lessee receives economic benefits of use #WBInsights18

New Lease Accounting Determining Whether a Contract Contains a Lease (continued) Illustrations from ASU Example 1, Rail Cars Example 2, Fiber Optic Cable Example 4, Retail Kiosk Example 6, Ship #WBInsights18

New Lease Accounting Lessee Accounting Finance leases meets any one of the following criteria Transfers ownership by the end of the lease term Grants lessee purchase option that lessee is “reasonably certain” to exercise Lease term is for the “major part” of the remaining economic life of the asset Present value of lease payments and any residual value guarantee by the lessee equals or exceeds “substantially all of the fair value of the asset” The asset is of such a specialized nature that it is expected to have no alternative use to the lessor at the end of the lease term All other leases are operating leases #WBInsights18

New Lease Accounting Lessee Accounting Finance lease criteria - Focus Grants lessee purchase option that lessee is “reasonably certain” to exercise Change from “bargain purchase option” in current Standard No guidance in FASB re “reasonably certain” More than “probable” Less than “certain” #WBInsights18

New Lease Accounting Lessee Accounting Finance lease criteria - Focus Lease term is for the “major part” of the remaining economic life of the asset Change from 75% in current Standard Implementation Guidance in Standard refers to 75% Expected that entities will quantify it in their accounting policies “lease term” includes options that are “reasonably certain” to be exercised #WBInsights18

New Lease Accounting Lessee Accounting Finance lease criteria - Focus Present value of lease payments and any residual value guarantee by the lessee equals or exceeds “substantially all of the fair value of the asset” Change from 90% in current Standard Implementation Guidance in Standard refers to 90% Expected that entities will quantify it in their accounting policies #WBInsights18

New Lease Accounting Lessee Accounting Short-term lease election Leases with a term of 12 months or less, no options that are “reasonably certain” to be exercised, and does not include a purchase option Requires an accounting policy election (ie, disclosure if adopted) Requires disclosures of amounts, etc #WBInsights18

New Lease Accounting Lessee Accounting Related party leases No special provisions for accounting for related party leases Standard refers to “legally enforceable” provisions #WBInsights18

New Lease Accounting Lessee Accounting Lease vs non-lease components Lease may have multiple components, eg building and machines Separate components if (1) lessee can benefit either separately on its own or if combined with other readily available resources, and (2) the right of use is neither highly dependent upon nor highly interrelated with the other assets in the lease Land is a separate component unless not significant to classification of lease or amount is insignificant #WBInsights18

New Lease Accounting Lessee Accounting Lease vs non-lease components (continued) Non-lease components are not capitalized Non-lease components are generally services, but not always Only plant, property and equipment is lease component; all other components would be non-lease components Lessee may use practical expedient and not separate non-lease components Allocate lease consideration based on relative standalone selling prices of each component Use observable info first, unobservable next and residual allocations last #WBInsights18

New Lease Accounting Lessee Accounting Lease payments include … Fixed payments less incentives to be paid to lessee Variable lease payments fixed by index at lease inception Exercise price of purchase option that is reasonably certain of being exercised Payments for termination penalties if lease term reflects exercise of option to terminate lease Amounts probable of being owed under residual value guarantee Lease payments specifically exclude ... Variable lease payments not fixed at inception Lessee guarantee of lessor debt Amounts allocated to non-lease components #WBInsights18

New Lease Accounting Lessee Accounting Initial measurement of lease obligation (continued) Lease term FASB changed from “most likely” period to … Non-cancelable period plus extension that lessee is “reasonably certain” to exercise, plus any extensions under the control of the lessor Reassess lease term if … Significant event or change under the control of lessee directly affects “reasonable certainty” An event covered by the contract occurs that requires lessee to exercise, or not exercise, options The lessee changes their mind re “reasonably certain” #WBInsights18

New Lease Accounting Lessee Accounting Initial measurement of lease obligation (continued) Measurement of right of use liability and asset Lease liability is present value of lease payments not paid, discounted using … Rate implicit in the lease if readily determinable, or if not then … The lessee’s incremental borrowing rate, or … Non-public entities may use risk-free interest rate Right of use asset is measured as … The lease liability Lease payments made before commencement, less any lease incentives received Initial direct costs #WBInsights18

New Lease Accounting Lessee Accounting Subsequent measurement Finance lease follows principles for property and debt Right of use asset is amortized on straight line basis from commencement over the lease term Lease liability is present value of remaining lease payments and interest is expensed Lease liability is not adjusted for changes in variable payments due to index #WBInsights18

New Lease Accounting Lessee Accounting Subsequent measurement (continued) Operating leases are different Lease liability is present value of remaining payments, excluding changes resulting from variable lease payments (eg, due to change in index) Right to use asset is lease liability adjusted for ... Prepaid or accrued rent due to uneven lease payments Unamortized lease incentives Unamortized initial direct costs Any impairment of assets Income statement recognizes a single lease cost as operating expense Impairment considerations included in consideration of all long-lived asset impairment #WBInsights18

New Lease Accounting Lease Modifications For both lessees and lessors, lease modification is a change in scope (the leased asset(s)) or term of lease Separate contract if (1) there is additional right of use and, (2) lease payments increase commensurate with standalone price for the additional right of use Change to existing lease for all other modifications results in remeasurement Modifications require reassessment of lease classification #WBInsights18

New Lease Accounting Lease Modifications (continued) Lessees required to remeasure when … Additional right of use granted Extends or reduces the lease term Changes consideration Fully or partially terminates the lease For terminations, adjust right of use proportionately and recognize gain or loss #WBInsights18

New Lease Accounting Lessor Accounting Lease classification Sales-type lease has same definition as financing lease for lessees Transfers ownership Option to purchase that lessee is reasonably certain to exercise Lease term is major part of remaining economic life Present value of lease payments plus lessee guaranteed residual value equals or exceeds substantially all of the fair value of the asset The asset is specialized and will have no alternative use to lessor at end of lease #WBInsights18

New Lease Accounting Lessor Accounting Lease classification (continued) Direct financing lease meets none of the requirements of sales type lease, but the … Present value of lease payments plus residual guarantee by a third party equals or exceeds substantially all of the fair value of the asset, and it is probable that lessor will collect lease payments and residual value guarantee All other leases are operating leases #WBInsights18

New Lease Accounting Lessor Accounting Lease vs non-lease components Same allocation as for lessees Consider revenue recognition guidance (a contract with a customer) May elect out of allocation #WBInsights18

New Lease Accounting Subleases Accounted for separately as lessee and lessor No netting of ee/or accounts #WBInsights18

New Lease Accounting Sale and Leaseback Transactions Several significant changes in sale and leaseback model Determining whether a sale occurs Apply standards in Revenues in contracts with customers Determine what the contract is Determine whether performance obligation has been satisfied ie, control has been transferred Control has not been transferred if leaseback is financing or sales type lease Control has not been transferred if there is option to purchase unless … Exercise price is fair value at option date, and … Substantially the same asset is readily available in the marketplace #WBInsights18

New Lease Accounting Presentation and Disclosure FASB views Separate display and/or disclosure of lease assets and liabilities is important to user understanding of financial position, results of operations and future cash flows #WBInsights18

New Lease Accounting Presentation and Disclosure Statement of financial position Lessee Present or disclose right to use assets and lease liabilities separately from other assets and liabilities Cannot present financing lease assets and liabilities and operating lease assets and liabilities in the same line item on the statement of financial position Lessor Present or disclose lease assets separately from other assets #WBInsights18

New Lease Accounting Presentation and Disclosure Statement of comprehensive income Lessee Operating leases in expenses as a single lease cost (ie, no interest breakout) Financing lease separately recognize amortization and interest elements Lessor Option to present or disclose based on business model Revenues, gains or financing income #WBInsights18

New Lease Accounting Presentation and Disclosure Statement of cash flow Lessee Aligns with income statement Operating leases in operations Financing leases in financing and interest expense Payments for leasehold improvements in investing Non-cash change is disclosed Lessor All cash receipts are operating #WBInsights18

New Lease Accounting Presentation and Disclosure Disclosures Overall – get a Great disclosure checklist Both lessees and lessors General description of leases Basis, terms and conditions of variable lease payments Existence, terms and conditions of options to extend or terminate leases Assumptions and judgments in determining whether contract contains a lease Assumptions and judgments in determining non-lease components Leases with related parties #WBInsights18

New Lease Accounting Presentation and Disclosure Lessee Qualitative disclosures Narrative regarding options recognized and not recognized Existence of residual value guarantees Restrictions or covenants Determination of discount rate Non-lease components Leases in progress #WBInsights18

New Lease Accounting Presentation and Disclosure Lessee (continued) Quantitative disclosures Finance least cost segregated by amortization and interest Operating lease cost Variable lease cost Short-term lease cost Sublease income Gain or loss on sale and leaseback #WBInsights18

New Lease Accounting Presentation and Disclosure Lessee (continued) Quantitative disclosures For each type lease … Cash paid for amounts included in lease liabilities Non-cash lease liabilities arising from obtaining right-to-use assets Weighted average remaining lease term Weighted average discount rate #WBInsights18

New Lease Accounting Getting Ready for the New Lease Standard Review the Illustrations in the new Standard Lessee advisors and Lessors are very aware of the new Standard, and are evaluating lease terms in light of the new Standard When evaluating new leases, consider Lease terms (“reasonably certain) Non-lease components Discount rates (rate implicit vs borrowing rate) Re-evaluate informal related party leases In conclusion … The devil is in the details … Study the new Standard and related Illustrations carefully #WBInsights18

In Conclusion ….. Bon Auditpetite! contact Anne Morris Chris Rouse Windham Brannon, PC #WBInsights18

New Lease Accounting #WBInsights18

Accounting Update 2019 Part II

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