The New Revenue Recognition Standard – Implications for Internal Audit 1
Agenda Introductions Overview of New Revenue Recognition Standard 5 Step Standard Summary Timing Implications for Internal Audit Next Steps Q&A? 2
Introduction Nimi Yogaratnam – QLogic Corporation, Senior Director, Internal Audit CPA, CISA Experience: 20 years Scott Jones, Managing Director Protiviti (Orange County) CPA, Attorney Experience: 32 Years – Peat Marwick Mitchell (now KPMG) – InterFirst Bank – First Interstate Bank – Arthur Andersen – Protiviti (effective May 2002) 3
Overview - Protiviti Clients include more than: 35% of all 6 th Largest Fortune 100 Business Companies Consulting Firm 25% of all Fortune 500 3,500+ Companies professionals 20% of all Fortune 1000 1,000+ clients Companies 60+ offices Protiviti is one of 24 countries the fastest in Americas, growing consulting firms Europe and worldwide. Our Asia-Pacific 2013 revenues $530 million. 4
Introduction – Quote: The World Is Evolving Too Fast – Part I "The world is too big for us. Too much is going on. Too many crimes. Too much excitement. Try as you will, you get behind in the race in spite of yourself. It's a constant strain to keep pace --- and still, you lose ground. Science empties its discoveries on you so fast that you stagger beneath them in hopeless bewilderment. The political world now changes so rapidly you’re out of breath trying to keep pace with who’s in and who’s out. Everything is high pressure. Human nature can’t endure much more!” 5
Introduction – Quote: The World Is Evolving Too Fast – Part II "The world is too big for us. Too much is going on. Too many crimes. Too much excitement. Try as you will, you get behind in the race in spite of yourself. It's a constant strain to keep pace --- and still, you lose ground. Science empties its discoveries on you so fast that you stagger beneath them in hopeless bewilderment. The political world now changes so rapidly you’re out of breath trying to keep pace with who’s in and who’s out. Everything is high pressure. Human nature can’t endure much more!” Atlantic Journal -- June 16, 1833 6
Revenue Recognition Joint Project Objective of project: – Develop a standard based on a single model to deal with all types of contracts and business sectors. – ASC Topic 606 was introduced via ASU 2014-09 Some interesting facts: ASU 2014-09 is 700 pages long At 522 paragraphs , the Basis for Conclusions alone is longer than any U.S. GAAP standard ever written, except FAS 133 Prior to its release, the FASB held more than 650 meetings with users, preparers, etc. across many jurisdictions • Final Standard Released May 28, 2014 . • Effective for annual reporting periods beginning after December 15, 2016 7
Revenue Recognition Humor 8
High Level Application of Revenue Model Recognize revenue when: Control over promised goods or services are transferred to customers In an amount that reflects the consideration a company expects to be entitled to in exchange for those goods and services 1 Identify the contract with a customer 2 Identify the separate performance obligations in the contract Determine the transaction price 3 Allocate the transaction price to the separate performance 4 obligations Recognize revenue when (or as) the vendor satisfies a 5 performance obligation 9
Step 1 – Identify the contract with a customer Contracts can be written, oral or implied. A contract exists if: • The contract has commercial substance (that is, the risk, timing, or amount of the entity’s future cash flows is expected to change as a result of the contract). • The parties to the contract have approved the contract. • The entity can identify each parties rights and payment terms. • It is probable that the entity will collect the consideration to which it will be entitled in exchange for the goods or services. Permissible to apply guidance to a portfolio of contracts if no material differences would result vs. applying to individual contracts. Combine contracts if the contracts are entered into at or near the same time. Contract modifications accounted for separately if the modification results only in the addition of a distinct good/service at a price that is commensurate with that additional good/service. 10
Scenario 1 – Identify the contract with a customer • A Manufacturer enter into a contract on March 1, 2014 to supply 1,000 widgets a month for $50 a unit. The contract ends in December 31, 2014. There are no automatic renewal provisions in the contract. • During January and February 2015 the customer continues to buy 1,000 widgets each month. • On March 1, 2015 the Manufacturer enters into a new contract to supply 2,000 widgets a month for $45 a unit. • How should the manufacturer account for the widgets supplied in January and February 2015? 11
Step 2 – Identify the separate performance obligations in the contract A performance obligation is a promise in a contract with a customer to transfer a good or service to that customer. A good or service is distinct (Capable of being distinct and distinct within the context of the contract) if either of the following criteria is met: • The entity regularly sells the good or service separately. • The customer can benefit from the good or service either on its own or together with other resources that are readily available to the customer. Notwithstanding the above criteria, a good or service in a bundle of promised goods or services is not distinct and, therefore, the entity would account for the bundle as a single performance obligation, if both of the following criteria are met: • The goods or services in the bundle are highly interrelated and transferring them to the customer requires that the entity also provide a significant service of integrating the goods or services into the combined item(s) for which the customer has contracted. • The bundle of goods or services is significantly modified or customized to fulfill the contract. 12
Scenario 2 – Identify the separate performance obligations in the contract • A software company enters into a contract to supply a perpetual license, installation service and two years of post contract support. • Post contract support includes telephone support and unspecified upgrades. • How many performance obligations are in the contract? • How will your answer change if the software requires significant customization as part of installation? 13
Step 3 – Determine the transaction price The transaction price is the amount of consideration an entity expects to receive in exchange for transferring promised goods or services to a customer, excluding any amounts collected on behalf of third parties (for example, sales taxes). When determining the transaction price, an entity would consider the effects of all of the following: • Variable consideration • • Discounts Penalties • • Rebates Royalties • Refunds/Price Protection • Performance bonuses • Return rights • Milestones • • Concessions Profit sharing • The time value of money • Noncash consideration • Consideration payable to the customer 14
Scenario 3 – Determine the transaction price • A manufacturer sells toys through a retail network for $75. • Each unit sold contains a rebate coupon for $10. • The manufacturer estimates that 50% of eligible rebates will be redeemed. • What is the manufacturer’s transaction price? 15
Step 4 – Allocate the transaction price to the separate performance obligations Allocate to each separate performance obligation the amount of consideration the entity expects to receive in exchange for satisfying that performance obligation. Allocate transaction price based on relative stand alone selling prices. Best evidence of a standalone selling price is the observable price of a good or service when the entity sells that good or service separately in similar circumstances and to similar customers. If a standalone selling price is not directly observable, an entity shall estimate the standalone selling price. VSOE/TPE/BESP hierarchy no longer expressly required. However, entity is supposed to “maximize observable inputs. Allocate a discount proportionately to all performance obligations in the contract, unless the entire discount relates to only one or more, but not all, performance obligations in a contract If highly variable, consider a residual technique by reference to the total transaction price less the standalone selling price of other goods or services in the contract. 16
Scenario 4 – Allocate the transaction price to the separate performance obligations • A manufacturer sells product A and B for $4,000. • The manufacturer regularly sells product A for $3,000 and product B for 2,000. • How should the manufacturer allocate the transaction price to the product? 17
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