Spring 2015 issue of Horizons

FEATURE | The New Revenue Recognition Standard: Changes Ahead for Your Top & Bottom Line

5 Steps to Achieve the Core Principle The core principle of the new standard is that an entity should 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. To achieve that core principle, an entity should apply the following steps. Step 1: Identify the contract with a customer No revenue can be recognized until there is a contract as defined by U.S. GAAP. A contract is defined as an agreement between two or more parties that creates enforceable rights and obligations. In some instances, contracts should be combined and accounted for as one contract. ASU 2014-09 also provides guidance on how to account for contract modifications, which can result in estimated amounts recognized even when the amounts of the contract modifications are in dispute. For example, an entity enters into a contract to construct a building for a customer. Weather causes a delay which entitles the entity to additional compensation based on the underlying contractual terms, but the customer disagrees with the entity’s claim. The entity should recognize revenue to reflect the additional compensation resulting from the claim if it is probable that a significant reversal in the amount of cumulative revenue recognized will not occur in the future. Step 2: Identify the performance obligations in the contract A performance obligation is a promise in a contract to transfer goods or services. A promised good or service is accounted for separately if it is distinct. A good or service is distinct if the customer can benefit from the good or service on its own or together with other resources that are readily available and if the good or service is separately identifiable from other promises in the contract.

This may include implied obligations that are customary practices or are based on published policies. If a promise is not distinct, it should be bundled with other promises until the group of promises is distinct. Step 3: Determine the transaction price Transaction price is the amount of consideration to which an entity expects to be entitled in exchange for transferring promised goods or services to a customer. One of the most significant changes mandated by ASU 2014-09 is that variable consideration should be estimated and recognized if the obligation has been met. This includes variable consideration estimates related to contract price changes, discounts, rebates, refunds, credits, change orders, price concessions, incentives, performance bonuses, penalties, contingencies based on future events and other similar items. For example, if an entity enters into a contract to build an asset for $1 million and the terms of the contract include a penalty of $100,000 if the asset is not completed within a date specified in the contract, the $100,000 is deemed variable consideration for which an estimate regarding revenue recognition should be made. For a contract that has more than one performance obligation, an entity should allocate the transaction price to each performance obligation in an amount that depicts the amount of consideration to which the entity expects to be entitled in exchange for satisfying each performance obligation. Step 4: Allocate the transaction price to the performance obligations in the contract

This should be based on standalone selling prices at contract inception.

Any discounts in bundled items would be allocated proportionally unless certain criteria exist as discussed in ASU 2014-09.

page 24 | horizons Spring 2015