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TECHNOLOGY COMPANIES AND ASC 606 HOW WILL IT IMPACT YOU?

Technology Companies and ASC 606. How will it Impact You? / 2

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Presenters

Todd Berry

[email protected]

617-239-4125

Hank Galligan

[email protected]

617-422-7521

Daniel Newton

[email protected]

617-239-7026

Lee Sentnor

[email protected]

617-239-4142

Michael Williams

[email protected]

617-239-4174

mailto:[email protected]






Learning Objectives:

Understand implementation timing and alternatives

Describe likely specific impacts of ASC 606 on technology companies

Identify the tax reporting challenges with adoption of ASC 606

Explain typical adoption project milestones and possible timeline for adoption

of ASC 606

Discussion Outline

UNDERSTAND IMPLEMENTATION TIMING AND ALTERNATIVES


ASU 2015-14 Effective dates (August 2015):

Public entities - 1st interim period within annual reporting periods

beginning after December 15, 2017

– Early adoption permitted only as of annual reporting periods

beginning after December 15, 2016

Nonpublic entities - Annual reporting periods beginning after December

15, 2018 and interim periods within annual periods beginning after

December 15, 2019:

– Early adoption permitted as of either:

– An annual reporting period beginning after December 15, 2016, including

interim periods within that year

– An annual reporting period beginning after December 15, 2016 and interim

periods within annual reporting periods beginning one year after adoption

Effective Dates and Transition


Introduction and Transition

ASC 606 is required to be applied retrospectively by one of the following methods:

i.

• Retrospective application to each reporting period presented in accordance with ASC 250-10-45-5 through 45-10 (i.e., full restatement of comparative figures).

ii.

• Modified retrospective with one or more practical expedients (i.e., completed contracts, use of hindsight for variable consideration, etc.)

iii. • Cumulative effect of change at adoption date

(disclose effect of applying new standard)


ASU 2013-12 Definition of a Public Business Entity states:

Public Business Entity A public business entity is a business entity meeting any one of the criteria below. Neither a

not-for-profit entity nor an employee benefit plan is a business entity.

a. It is required by the U.S. Securities and Exchange Commission (SEC) to file or furnish financial statements, or

does file or furnish financial statements (including voluntary filers), with the SEC (including other entities whose

financial statements or financial information are required to be or are included in a filing).

b. It is required by the Securities Exchange Act of 1934 (the Act), as amended, or rules or regulations promulgated

under the Act, to file or furnish financial statements with a regulatory agency other than the SEC.

c. It is required to file or furnish financial statements with a foreign or domestic regulatory agency in preparation

for the sale of or for purposes of issuing securities that are not subject to contractual restrictions on transfer.

d. It has issued, or is a conduit bond obligor for, securities that are traded, listed, or quoted on an exchange or an

over-the-counter market.

e. It has one or more securities that are not subject to contractual restrictions on transfer, and it is required by

law, contract, or regulation to prepare U.S. GAAP financial statements (including footnotes) and make them

publicly available on a periodic basis (for example, interim or annual periods). An entity must meet both of

these conditions to meet this criterion.

An entity may meet the definition of a public business entity solely because its financial statements or financial

information is included in another entity’s filing with the SEC. In that case, the entity is only a public business

entity for purposes of financial statements that are filed or furnished with the SEC.

Definition of a Public Enterprise

THE “FIVE STEP” MODEL AND LIKELY IMPACT ON TECHNOLOGY COMPANIES


The Five Step Model

Core principle:

The five steps to apply the core principle are:

Recognize revenue to depict the transfer of 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 or services


The Biggest Changes

Some of the items that will change:

Performance obligation vs elements/deliverables

Reliance on new estimates with continuous true ups

Focusing on transfer of control as the revenue trigger, as opposed to risks and

rewards of ownership

Sales and contracting processes may need to be changed

IT systems may need to be updated

Internal controls will need to be updated

Extensive new disclosures

On the Next few slides we will go through some specific changes that will likely

effect technology companies


Distinct Performance Obligations

Existing GAAP:

No accounting distinction between the various types of maintenance and support

activities that software companies provide to customers.

Things like phone support, bug fixes, and delivery of, when and if available,

(unspecified) updates and product enhancements are all lumped into a single

accounting unit known as PCS.

In general, the portion of the arrangement fee allocated to PCS is recognized

ratably over the period that services are being rendered.

ASC 606 accounting:

Requires companies to make a closer analysis of the various activities that comprise

maintenance and support.

It is possible that some of these activities might be considered distinct, and

therefore change the pattern in which revenue is recognized relative to today’s

accounting guidelines.


Vendor-Specific Objective Evidence (VSOE)

Existing GAAP:

Special accounting rules for companies that sell bundled software and/or

software-related deliverables.

ASC 606 accounting:

Eliminates these guidelines. In particular, companies will no longer be required

to have VSOE to separate elements (now distinct performance obligations) in a

bundled software arrangement, which will be a big change in practice.


Estimating Stand Alone Selling Prices

Existing GAAP:

Use VSOE or BESP.

In the software world you can default to residual value for delivered items.

ASC 606 accounting:

Must estimate stand alone selling price.

Use of residual method while still available should be very rare.


Extended Payment Terms

Existing GAAP:

Deferral of revenue recognition if payment terms extend more than 12 months

from the date of delivery of a software license.

ASC 606 accounting:

No longer a “bright-line” or prescriptive requirements like the 12-month

extended payment restrictions in current GAAP.


Specified Upgrades and Product Roadmaps

Existing GAAP:

Somewhat punitive rules when companies offer “specified upgrade rights” and

Roadmaps which hit to upgrades.

No VSOE for the specified features fully defer all revenues under the

arrangement until the upgraded software features are delivered to the

customer.

ASC 606 accounting:

Specified upgrades and roadmaps maybe viewed as distinct performance

obligations.

If they are distinct they will be separated using stand alone selling price


Accounting Method Implications – Book Vs. Tax

Example: Use of property, service, and advance payment

On January 1, 20X1, Company A, a calendar year taxpayer, enters into a three-

year agreement with Customer B to provide:

– Software License, which is distinct, for $6,000 (stand alone selling

price)

– Ongoing Software Maintenance Services, which are distinct, for

$3,000 (stand alone selling price)

Price is payable in equal installments of $3,000 on January 1, 20X1, 20X2, and

20X3



Recognize ratably over the three year period:

Recognize right to use software license at a point in time & Recognize transfer of

maintenance service over time:

* Tax would recognize as payments received. New Schedule M due to ASC 606 recognition of revenue

Current GAAP* 20X1 20X2 20X3

License $2,000 $2,000 $2,000

Maintenance $1,000 $1,000 $1,000

Total Revenue $3,000 $3,000 $3,000

ASC 606 20X1 20X2 20X3

License $6,000 $0 $0

Maintenance $1,000 $1,000 $1,000

Total Revenue $7,000 $1,000 $1,000



If advance payments are received, then recognize revenue under Rev. Proc. 2004-

34

* Taxable income is accelerated under Rev. Proc. 2004-34 due to ASC 606 acceleration of revenue

Tax (Under Current GAAP)

20X1 20X2 20X3

License $2,000 $4,000 $0

Maintenance $1,000 $2,000 $0

Total Revenue $3,000 $6,000 $0

Tax (Under ASC 606)

20X1 20X2 20X3

License* $6,000 $0 $0

Maintenance $1,000 $2,000 $0

Total Revenue $7,000 $2,000 $0


Cumulative Effect Adjustment:

The new standard can be adopted either retrospectively or as a cumulative

effect adjustment to retained earnings at the date of adoption.

In either case, the adjustment required to adopt the new standard can affect

the cumulative temporary differences at the date of adoption.

As a result, the Cumulative Effect Adjustment to reflect the adoption of the

new standard will need to include the related tax effects on the transition

adjustment

Tax Implications Initial Adoption


Term/Perpetual Licenses

Existing GAAP:

Revenues from term/perpetual software licenses may be recognized upon

delivery, provided the license can be unbundled from other deliverables in the

arrangement, such as PCS.

Many term licenses with PCS bundled are recognized ratably over the term of

the arrangement.

ASC 606 Accounting:

Contain a different approach to determining whether revenues from any

license agreement – term or perpetual – should be recognized over time or at a

point in time.

Focuses on distinct performance obligations. If they are distinct they will likely

be accounted for separately.


Variable Revenue

Existing GAAP:

Price must be fixed and determinable in order for revenue to be recognized

Variable revenue is generally not recognized until the uncertainty is resolved

ASC 606 Accounting:

The fair value of consideration received or receivable is measured and included

in the transaction price

Trade discounts, volume rebates and other incentives are taken into account in

determining fair value

Will either be based upon “most likely amount” or the “expected value”


Consulting Services

Existing GAAP:

Typically recognized on a proportional performance basis and many times use

labor effort as the performance measure

ASC 606 Accounting:

The determination will be whether the services and the product are distinct,

including in context of the arrangement

Over time recognition may not be as clear

Milestones/Delivery of reports may indicate point in time

Question will be when does the customer obtain control of the underlying asset


Sales to Resellers and Distributors

Existing GAAP:

For various reasons including generous product return rights and price

protection many companies are on the so-called “sell through method”

Revenue under this method is not recognized until the product has been sold

through to the end user.

ASC 606 Accounting:

Fixed and determinable fee no longer required.

Cornerstone of the new rules is to recognize revenue when control has

transferred.

The amount of revenue recognized will consider the risk that the seller may

grant price concessions, accept returns or grant other concessions


Rights of Returns

Existing GAAP:

Either recognize revenue upon delivery, net of an allowance for returns, if

reliable estimate can be made and other GAAP requirements are met or

Defer revenue until right of return expires..

ASC 606 Accounting:

Revenue recognized when control is transferred to a customer

The rights of return may not effect when control transfers and therefore not

preclude revenue

The right of return results in variable revenue for which an estimate needs to

be made


Cost of Contracts/Amounts Billed to Customers

Existing GAAP:

No very specific GAAP

Decision left to company policy.

ASC 606 Accounting:

Specific guidelines and rules provided.

Incremental costs of obtaining a contract should be deferred and amortized on

a systematic basis consistent with the pattern in which revenue related to the

contract is being recognized. As a practical expedient, an entity may recognize

the incremental costs of obtaining a contract as a period expense if the

amortization period would have been one year or less.

Costs incurred in fulfilling a contract should be accounted for similarly, except

there is no practical expedient to immediately expense these costs, even if the

related contract will conclude in one year or less.


Initial Adoption:

If the adoption of the new standard results in accelerated income and the

entity files a Form 3115 accounting method change, an unfavorable tax

adjustment may be required.

That adjustment (i.e., the income inclusion catch-up adjustment that is the

difference between the tax accounting on the old method and new method as

of the beginning of the year of change) would generally be spread over four

years for tax purposes to the extent the adjustment is unfavorable.

Additional temporary differences will arise for the portion of the effect of the

tax accounting method change that has not yet been recognized for tax

purposes.

Tax Implications Initial Adoption


Common tax method: “Just follow books”

More efficient, avoids book/tax differences

May be correct, may not – tax requirements frequently differ from GAAP

If “tax follows books” and then books changes course, the options are:

Tax stays put (no change);

Tax shifts to follow the new book treatment; or

Tax shifts to something completely different

Options depend on

Was the former “book method” consistent with tax law?

Is the new “book method” consistent with tax law?

Is there a more optimal method (different from old/new book) that is

appropriate?

Tax Implications After Adoption


Costs of Obtaining a Contract:

Incremental costs that an entity incurs only as a result of obtaining a contract (e.g., sales

commissions) will be capitalized for financial reporting purposes under the new standard

if the entity expects to recover these costs.

As a practical expedient, an entity is not required to capitalize the incremental costs of

obtaining a contract if the amortization period would be one year or less.

Once capitalized, the costs are amortized over the period of future benefit, which

includes anticipated renewals of the contract.

For both cash-basis and accrual basis taxpayers, the default U.S. federal income tax

treatment is to capitalize and amortize the costs of obtaining a contract over the

contractual term, but there are several exceptions that may permit a current deduction

(e.g., sales commissions to employees would generally fall within one of these

exceptions).

As a result, deferred tax accounting will be impacted by the existence and scale of

differences in the basis for financial reporting and tax amounts of capitalized contract

acquisition costs.

Tax Implications After Adoption

PROJECT PLAN AND TIMELINE


5. MONITORING AND MAINTENANCE

4. DETERMINATION OF HISTORICAL IMPACT AND IMPLEMENTATION

3. IDENTIFY NECESSARY PROCESS CHANGES TO COMPLY WITH ASC 606

2. ASC 605 VS. 606 GAAP ANALYSIS

1. GET STARTED

Project Plan and Timeline



ESTIMATED

LEVEL OF

EFFORT

Q1 Q2 Q3 Q4

JAN FEB MAR APR MAY JUN JUL AUG SEP OCT NOV DEC

GET STARTED WIDE

VARIETY

GAAP ANALYSIS 1-2 WEEKS

PROCESS CHANGES

2-12 WEEKS

IMPLEMENTATION

& CALCULATION 2-12 WEEKS

MONITOR &

MAINTENANCE ONGOING

YEAREND & 10K

QUARTERS

CONTROLS

TESTING

AUDITOR REVIEW

& PRELIM



PHASE 2 - ASC 605 VS. 606 GAAP ANALYSIS

DETAILS ESTIMATED TIME

Identify ASC 606 vs. 605 differences for each revenue stream

Consider disclosure requirements

Identify potential accounting/business policy alternatives

Consider tax implications

Meet with Audit Committee

Auditor Review and Agreement

PHASE 1 – GET STARTED


Becoming familiar with the New Standard

Identify revenue streams

Initial estimate of level of effort

Initial project plan/ presentation to management



PHASE 3 - IDENTIFY NECESSARY PROCESS CHANGES TO COMPLY WITH ASC 606


Detailed analysis of impact on revenue, if implemented

Identify data capture requirements

Agree detailed analysis and data needs with auditor

Identify changes for business policies and processes

Identify potential changes to IT systems

Discuss process owners

Vendor selection for new IT system



PHASE 4 – DETERMINATION OF HISTORICAL IMPACT AND IMPLEMENTATION


Capture key data field to implement new ASC 606

Contract review and estimating variable consideration

Documentation business policy/ process implementation

Consider inventor relation implications and the effects of adopting ASC 606

Generate pro form numbers/disclosures

Testing accounting systems for proper recognition based on ASC 606 adoption

Audit of restated and/or cumulative adjustment

Auditor assessment and testing of new control environment

Train other departments like sales and order entry

PHASE 5 – MONITORING AND MAINTENANCE


Monitor compliance with business processes and internal controls

Identify and resolve issues arising from new transaction or sales models


QUESTIONS

APPENDIX


Standard Examples and Implementation Guidance

This implementation guidance is organized into the following categories:

a. Performance obligations satisfied over time (paragraphs 606-10-55-4 through 55-15)

b. Methods for measuring progress toward complete satisfaction of a performance obligation (paragraphs 606-

10-55-16 through 55-21)

c. Sale with a right of return (paragraphs 606-10-55-22 through 55-29)

d. Warranties (paragraphs 606-10-55-30 through 55-35)

e. Principal versus agent considerations (paragraphs 606-10-55-36 through 55-40)

f. Customer options for additional goods or services (paragraphs 606-1055-41 through 55-45)

g. Customers’ unexercised rights (paragraphs 606-10-55-46 through 5549)

h. Nonrefundable upfront fees (and some related costs) (paragraphs 60610-55-50 through 55-53)

i. Licensing (paragraphs 606-10-55-54 through 55-65)

j. Repurchase agreements (paragraphs 606-10-55-66 through 55-78)

k. Consignment arrangements (paragraphs 606-10-55-79 through 55-80)

l. Bill-and-hold arrangements (paragraphs 606-10-55-81 through 55-84)

m. Customer acceptance (paragraphs 606-10-55-85 through 55-88)

n. Disclosure of disaggregated revenue (paragraphs 606-10-55-89 through 55-91).



The examples are organized as follows:

Identifying the Contract

a. Example 1—Collectability of the Consideration

b. Example 2—Consideration Is Not the Stated Price—Implicit Price Concession

c. Example 3—Implicit Price Concession

d. Example 4—Reassessing the Criteria for Identifying a Contract

Contract Modifications

a. Example 5—Modification of a Contract for Goods

b. Example 6—Change in the Transaction Price after a Contract Modification

c. Example 7—Modification of a Services Contract

d. Example 8—Modification Resulting in a Cumulative Catch-Up Adjustment to Revenue

e. Example 9—Unapproved Change in Scope and Price




Identifying Performance Obligations

a. Example 10—Goods and Services Are Not Distinct

b. Example 11—Determining Whether Goods or Services Are Distinct

c. Example 12—Explicit and Implicit Promises in a Contract

Performance Obligations Satisfied Over Time

a. Example 13—Customer Simultaneously Receives and Consumes the Benefits

b. Example 14—Assessing Alternative Use and Right to Payment

c. Example 15—Asset Has No Alternative Use to the Entity

d. Example 16—Enforceable Right to Payment for Performance Completed to Date

e. Example 17—Assessing Whether a Performance Obligation Is Satisfied at a Point in Time

or Over Time




Measuring Progress toward Complete Satisfaction of a Performance Obligation

a. Example 18—Measuring Progress When Making Goods or Services Available

b. Example 19—Uninstalled Materials

Variable Consideration

a. Example 20—Penalty Gives Rise to Variable Consideration

b. Example 21—Estimating Variable Consideration

Constraining Estimates of Variable Consideration

a. Example 22—Right of Return

b. Example 23—Price Concessions

c. Example 24—Volume Discount Incentive

d. Example 25—Management Fees Subject to the Constraint




The Existence of a Significant Financing Component in the Contract

a. Example 26—Significant Financing Component and Right of Return

b. Example 27—Withheld Payments on a Long-Term Contract

c. Example 28—Determining the Discount Rate

d. Example 29—Advance Payment and Assessment of the Discount Rate

e. Example 30—Advance Payment i. Noncash Consideration

f. Example 31—Entitlement to Noncash Consideration

Consideration Payable to a Customer

a. Example 32—Consideration Payable to a Customer




Allocating the Transaction Price to Performance Obligations

a. Example 33—Allocation Methodology

b. Example 34—Allocating a Discount

c. Example 35—Allocation of Variable Consideration

Contract Costs

a. Example 36—Incremental Costs of Obtaining a Contract

b. Example 37—Costs That Give Rise to an Asset

Presentation

a. Example 38—Contract Liability and Receivable

b. Example 39—Contract Asset Recognized for the Entity’s Performance

c. Example 40—Receivable Recognized for the Entity’s Performance




Disclosure

a. Example 41—Disaggregation of Revenue Quantitative Disclosure

b. Example 42—Disclosure of the Transaction Price Allocated to the Remaining Performance

Obligations

c. Example 43—Disclosure of the Transaction Price Allocated to the Remaining Performance

Obligations—Qualitative

Warranties

a. Example 44—Warranties p. Principal versus Agent Considerations

b. Example 45—Arranging for the Provision of Goods or Services (Entity Is an Agent)

c. Example 46—Promise to Provide Goods or Services (Entity Is a Principal)

d. Example 47—Promise to Provide Goods or Services (Entity Is a Principal)

e. Example 48—Arranging for the Provision of Goods or Services (Entity Is an Agent)




Customer Options for Additional Goods or Services

a. Example 49—Option That Provides the Customer with a Material Right (Discount

Voucher)

b. Example 50—Option That Does Not Provide the Customer with a Material Right

(Additional Goods or Services)

c. Example 51—Option That Provides the Customer with a Material Right (Renewal Option)

d. Example 52—Customer Loyalty Program

Nonrefundable Upfront Fees

a. Example 53—Nonrefundable Upfront Fee




Licensing

a. Example 54—Right to Use Intellectual Property

b. Example 55—License of Intellectual Property

c. Example 56—Identifying a Distinct License

d. Example 57—Franchise Rights

e. Example 58—Access to Intellectual Property

f. Example 59—Right to Use Intellectual Property

g. Example 60—Access to Intellectual Property

h. Example 61—Access to Intellectual Property

Repurchase Agreements

a. Example 62—Repurchase Agreements

b. Example 63—Bill-and-Hold Arrangements


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