rev recog for class

7/27/2019 Rev Recog for Class

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To see what is

right and not todo it is want of

courage.

(Confucius)


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3

PerceivedNeed

Opportunity RationalizationFRAUD


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Recording revenue too soon Recording fictitious revenue Including one time gains in revenue Shifting expenses to a later period (capitalizing

an expense) Failing to recognize liabilities Cookie jar reserves Shifting revenue to a later period Accelerating discretionary expenses


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Starts with making the numbers

Then managing the numbers

Ends with making up the numbers

The jail

5


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The activity is within reasonable

ethical and legal limits (not reallyillegal or unethical)

Loyalty to the company

No one will ever know

Im helping the company


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Ethical

Unethical

IllegalLegal

Corporate

Decisions

Financial

Reporting Rules

Professional andFinancialDecisions

Quadrant IIEthical and IllegalQuadrant IEthical and Legal

Quadrant IVUnethical and IllegalQuadrant IIIUnethical and Legal


9/55

Revenue recognition Fictitious sales

Premature revenue recognition

Channel stuffing

Contingencies (not yet met)

Inventory and Cost of Goods Sold

Reserves

Foreign Corrupt Practices Act violations

Deloitte Dbrief 2008


10/55

Sales contingencies not disclosed toaccounting or management

Sales booked before delivery completed Significant rights of return existed Revenue recognized before underlying

services were performed False sales agreements and documentation Bill and hold sales not deferred Round trip transactions Refundable membership fees


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Bill and hold transactions Long associated with financial fraud

Difficult substance over form questions

Customer agrees to purchase goods, but the

seller remains in possession until the customerrequests shipment

Look at inventory to determine whether there aregoods that were billed to customers but not

shipped or physically separated


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Barter transactions Two companies swap the same commodity with

each company recognizing revenue from theexchange even though little of economic

substance has actually transpired Round trip transactions

Similar to barter except that one company sells aproduct for cash to another company, which inturn sells an equivalent product back to the initial

seller for a similar price, with each companyrecognizing revenue on its sale


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13

Revenue Recognition


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FASB Concept Statement #5Revenue is recognized when it is:

14

Realized or

Realizable

Earnedand


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Persuasive evidence of an arrangement exists Sales generally evidenced by a written contract and

a purchase order

Delivery has occurred or services have beenrendered

Title and risk of loss have passed

Customer acceptance criteria considered

Undelivered elements?

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SAB 101 Basis for RevenueRecognition


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Sellers fee is fixed or determinable Extended payment terms Rights of return Refund, cancellation or termination clause

Collectibility is reasonably assured History of concessions? Credit worthiness of customer Liquidated Damages and other penalties/rebates

Revenue should not be recognized until it isrealized or realizable and the revenue isearned.17


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Customer has taken title and assumed therisks and rewards of ownership of theproducts specified in the sales agreement

Product has been delivered to the customersplace of business or another site specified bythe customer

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If delivery has not occurred, the followingcriteria must be met: Risk of ownership passes to the buyer

Buyer has a fixed commitment to purchase

Fixed schedule for delivery

No further seller-specific performanceobligations

Segregated goods

Product must be complete and ready forshipment

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Characteristics of these arrangements are:

Involve the delivery or performance of multipleproducts and services

Delivery may take place over varied lengths of

time May result in a significant impact to the timing of

revenue recognition

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21

The following products or services are consideredelements for purposes of applying accountingguidance Services (i.e. NNSS, Software Release Service, etc.) Extended warranty (separately priced and

optional) Future upgrades/enhancements (specified and

unspecified) Hardware/software Significant Incremental Discounts on optional

products/services Engineering and installation Training credits Certain product credits Other non-cash incentives


22/55

Issued in October 2009 - ASU 2009-13 Eliminates requirement to establish Fair value of

all components

Requires use of VSOE or third party evidence, ifavailable Otherwise, use managements estimated selling price

(ESP)

Allocate based on estimated selling prices of all

deliverables No change to the standalone value criteria

Does not change previous rules (SOP 97-2ASC985-605) or apply to software transactions


23/55

Previously all items had to have stand alonefair market value to be separatedotherwiseno revenue was recognized until the bundledtransaction was complete

New rules permit more liberal revenuerecognition


24/55

Modified criteria now used to separate elements in a

multiple-element arrangement Replaces the term fair value with selling price Introduces the concept of best estimate of selling

price for determining the selling price of adeliverable

Establishes a hierarchy of evidence for determiningbest selling price of a deliverable

Requires the use of the relative selling price method

and prohibits the use of the residual method toallocate arrangement consideration among units ofaccounting

Expands the disclosure requirements for all entitieswith multiple-element arrangements


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Eliminates previous criterion that requiredobjective and reliable evidence of fair valuefor the undelivered item(s).

Under previous guidance, evidence of fair

value included either of the following: Vendor-specific objective evidence (VSOE), which

includes the price charged when the same elementis sold separately or, for an element not yet soldseparately, the price established by managementwith the relevant authority

Third-partyevidence (TPE), such as competitorssales prices for the same or largely interchangeableproducts or services to similar customers in stand-alone sales, if VSOE is not available


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An item has stand-alone value if either of thefollowing conditions is met: It is sold separately by any vendor.

The customer could resell the item on a stand-alonebasis.

Determining whether stand-alone value exists is

relatively straightforward when the item beingevaluated is sold separately by the entity.


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Company A is a manufacturer of office equipment. On February15, 20X0, Company A enters into an arrangement with CompanyB for the delivery and installation of a state-of-the-art colorcopier/printer and ongoing maintenance for three years. Theequipment is delivered and installed on February 28, 20X0.Currently no competitors offer comparable color copier/printers.However, there is an observable secondary market for these

color copier/printers. Company A has a history of entering intomaintenance agreements with secondary owners of its officeequipment.

Even though there are currently no competitors, Company Aconcludes that the color copier/printer has stand-alone valuebecause a secondary market exists. The fact that company Aprovides maintenance services to secondary owners of its

equipment supports the position that the copier/printer hasstand-alone value in this arrangement.


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The amended guidance replaces the termfair value with selling price to clarify thatrevenue is allocated based on entity-specificassumptions rather than on market

participant assumptions


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Arrangement consideration should be allocatedat the inception of an arrangement using relativeselling prices Subsequent changes in selling prices do not change

initial allocation

Exceptions and qualifications Only allocate revenue that is fixed and determinable Amount allocated to delivered items is limited to amount

that is not contingent on delivery of any undelivereditem or meeting specified performance criteria

Measurement of revenue per period must assumecustomer will not cancel arrangement

Revenue recognized cannot exceed non-cancelableamounts

Other GAAP requires deliverable to be recorded at Fair

Value


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1. VSOE

Vendor-specific objective evidence (VSOE), which includes the pricecharged when the same element is sold separately or, for an element notyet sold separately, the price established by management with therelevant authority

2. TPE in the absence of VSOEThird-partyevidence (TPE), such as competitors sales prices for the

same or largely interchangeable products or services to similarcustomers in stand-alone sales, if VSOE is not available

3. Best estimate of selling price only in the absence of both VSOE and TPEbest estimate of selling price, management should consider market

conditions in addition to entity-specific factors (This is the new addition)Now required for delivered and undelivered elements

- Allocate arrangement consideration on pro rata basis- Residual method no longer allowed


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VSOE = Price charged when same element issold separately

Minimal authoritative implementationguidance

Bell-curve approach Generally used inpractice Example - 80% of separate sales within +/- 15%

range


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Third-party evidence (TPE), suchas competitors sales prices forthe same or largely

interchangeable products orservices to similar customers instand-alone sales, if VSOE is not

available


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Consider marketconditionsinclude:

Overall economic conditions Customer demand for the deliverable(s)

Impact of competition for the deliverable(s)

Profit margins realized by entities in theindustry


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Pricing practices for the deliverables,

including discounts (i.e. volume discounts) Costs incurred by the entity to provide the

deliverables Profit objectives for the deliverables In a services arrangement, it may be

practicable for a customer to perform certain

services themselves potential costs savings by the customer would be

considered in determining its gross profit margins.


36/55

Entity A, with a December 31, 2009 year-end, sells equipment Y andZ, both with stand-alone value, to Entity B. Total arrangementconsideration is $150,000. There are no return rights for Y and norefund rights if Z is not delivered. Equipment Y is delivered on

December 15, 2009 and Z is delivered on April 15, 2010. Entity Ahas determined its best estimate of selling price for Y and Z is$100,000 and $50,000, respectively. Entity A has historically andcontinues to establish TPE of $110,000 for equipment Y.Under previous guidance in ASC 605-25, since Entity A lacks

objective and reliable evidence of fair value for the undeliveredelement (Z), the arrangement is a single unit of accounting. Revenue

of $150,000 isdeferred until Z is delivered in April 2010, assuming all otherrevenue recognition criteria are met.

Under the amended guidance, the hierarchy requires that VSOE andthen TPE, be considered first. Since TPE exists for equipment Y, thatamount will be used for allocation. The discount is allocated ratably

between equipment Y and Z under the relative selling price method.As such, $103,125 [($110,000/$160,000) x $150,000] isrecognized when Y is delivered in December 2009, and $46,875[($50,000/$160,000) x $150,000] is recognized when Z is deliveredin April 2010, assuming all other revenue recognition criteria aremet.


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ESP is not the same as fair value Level of support for estimated selling prices

Consider available evidence Develop a methodology and consistently apply Monitor for changes Changes could occur mid-period

or even daily! No requirement for ability to reasonably estimate

Estimated selling prices can vary by customerclass or geography

Ok to consider cost plus a standard profit margin

as support Some estimates likely to be quite subjective innature


38/55

On January 1, 20X0, Entity E, an equipment manufacturer,

enters into a multiple-element arrangement tomanufacture and deliver equipment A, B, and C on July 1,20X0, October 1, 20X0, and January 1, 20X1, respectively,for total consideration of $760,000. All of the deliverables

meet the separation criteria in ASC 605-25, and as aresult, Entity E would account for each element in thisarrangement as a separate unit of accounting. Entity E hasVSOE for equipment A and TPE for equipment B, but doesnot have VSOE or TPE for equipment C.

Because Entity E does not have VSOE or TPE for an element

that meets the other separation criteria in ASC 605-25,management must determine its best estimate of sellingprice for equipment C.


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On January 1, 20X0, Entity E, an equipment manufacturer,

enters into a multiple-element arrangement tomanufacture and deliver equipment A, B, and C on July 1,20X0, October 1, 20X0, and January 1, 20X1, respectively,for total consideration of $760,000. Stated contract prices

are $185,000 for equipment A, $265,000 for equipment B,and $310,000 for equipment C. The deliverables all meetthe separation criteria in ASC 605-25, and as such, EntityE would account for each element in this arrangement as aseparate unit of accounting. Because Entity E does nothave VSOE or TPE for any of these products, it mustestimate the selling price for each deliverable.

Entity E considered the following factors in determining itsbest estimate of selling price for equipment A, B, and C.


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Alternative 1 The arrangement consists ofone deliverable: the sale of future proprietaryinstrument systems under the license anddistribution agreement.

evaluated as a single arrangement becausethe two agreements were entered into by thesame parties at the same time and incontemplation of each other.

Does not represent a borrowing


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Proponents ofAlternative 1 believe that withoutthe license and distribution agreement, theresearch and development agreement is of novalue to Careway. Under the terms of theresearch and development agreement, Careway is

not entitled to any of the intellectual rights of theresearch and development activities or findings(even in the event of default) and thereforecannot use or sell those findings. Accordingly,the only way in which Careway derives anybenefit from the contractual arrangements withSolvGen is throughCarewaysfuture distributionof the proprietary instrument systems to third-party customers.


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Codification example 605-25-55-37


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The arrangement consists of two deliverables: (1)

research and development and(2) the sale of future proprietary instrumentsystems under the license and distributionagreement

rejected because SolvGen retains the right to all

the research and development findings in allinstances, nothing delivered to Careway isassociated with the research and developmentactivities, and the research and developmentagreement is of no value to Careway without thelicense and distribution agreement on astandalone basis. Therefore, in this case theresearch and development activities do notrepresent a deliverable.


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1 The milestone payments should be

recognized as revenue beginning with thecommercial launch (i.e., March 31, 2006) ofthe instrument system over the remainingterm of the license and distributionagreement on a pro rata basis as products aredistributed under the license and distributionagreement.

the milestone payments received to date bySolvGen are analogous to upfront paymentsand should be deferred and amortized asrevenue beginning with the date of thecommercial launch of the product


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Proponents ofAlternative 1 believe thatrecognizing revenue related to nonrefundablemilestone payments before the commercial

launch date of the product amounts torecognizing revenue before a deliverable beingprovided to the customer, Careway. Before thecommercial launch date, there is no product thatCareway can buy from SolvGen and sell to a thirdparty, and therefore Careway has received nobenefit under the agreements with SolvGen.Therefore, the commercial launch date is thepoint in time that Careway can begin to

recognize any benefits under the agreements bypurchasing the instrument systems from SolvGenand selling those instrument systems to thirdparties.


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Alternative 2The milestone paymentsshould be recognized as revenue on astraight-line basis beginning with the datesuch payment is made over the remaining

term of the license and distributionagreement


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Alternative 2 proponents also believe that theamortization of the up-front fees should beginonce each milestone payment has been received.

Proponents of Alternative 2 contend that thisapproach is consistent with the SEC guidancestated above and results in recognizing themilestone payments in a systematic, rationalmanner over the remaining term of the license

and distribution agreement. Proponents ofAlternative 2 also note that the milestonepayments are nonrefundable and that services(i.e., research and development activities) have

already been provided. Therefore, proponents ofAlternative 2 do not believe it is necessary to waituntil the commercial launch date of theinstrument system to begin recognizing revenuefor payments received


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Alternative 4The milestone paymentsshould be recognized as revenue on astraight-line basis beginning with thecommercial launch (i.e., March 31, 2006) of

the instrument system over the remainingterm of the license and distributionagreement.

Same as 1 only straight-line


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if the Company can demonstrate the ability to

reliably estimate sales of the proprietaryinstrument systems over the five-year licenseand distribution agreement period.

2 was rejected because while proponents of

Alternative 2 considered the milestonepayments to be analogous to up-frontpayments, they ignored the conclusion in thefirst question that there is only one

deliverable in the arrangement


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3 was rejected because at the time the paymentswere made, there was no exchange of significantvalue between the two parties

SolvGen has a continuing obligation tomanufacture and supply instrument systems toCareway. In signing the agreements and inmaking the milestone payments, the customer,Careway, is purchasing rights to sell the

instrument systems. SolvGen, in signing theagreement and receiving the milestonepayments, is obligated to supply futureinstrument systems to Careway. Therefore,SolvGen has an integrated package ofperformance obligations that are not discreteearning events and that ultimately relate toCareways ability to sell future products andSolvGens continuing obligation to provide thoseproducts.


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Although significant judgment must beapplied, it is unlikely that the case solutionunder Discussion 1 would change underIFRSs. The research and development

agreement and the license and distributionagreement should be evaluated as a singlearrangement because the two agreementswere entered into by the same parties at the

same time and in contemplation of each other

rev recog for class

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