The new revenue recognition standard

1. The new revenue recognition standard 17 July 2014

2. Agenda • Overview and transition • The five-step model • Other aspects • Next steps The new revenue recognition standard

3. Overview • FASB and IASB issued a new global revenue recognition standard on 28 May 2014 • Standard replaces nearly all existing US GAAP and IFRS guidance on revenue recognition • Virtually every industry is affected • Standard requires entities to make more estimates and use more judgment than under current guidance • Its effect on financial statements, business processes and internal controls will likely be significant for some entities • FASB/IASB transition resource group and other implementation resource groups have been created The new revenue recognition standard

4. OverviewA converged standard? • The FASB and IASB each issued new standards • The standards are substantially the same except for five areas: • The Boards use the term “probable” for the level of confidence needed when assessing collectibility, which results in a lower threshold under IFRS (based on existing definitions of “probable”) • The FASB requires more interim disclosures than IASB • The IASB allows early adoption • The FASB does not allow an entity to reverse impairment losses on assets recognized • The FASB provides relief for nonpublic entities relating to specific disclosure requirements and the effective date The new revenue recognition standard

5. Overview and transition • Effective for annual periods beginning after 15 December 2016 (1 January 2017 for calendar year-end public entities and IFRS preparers) • Optional one-year deferral for nonpublic entities under US GAAP • Early adoption prohibited for US GAAP public entities, but nonpublic entities are permitted to adopt up to the public entity effective date • Early adoption permitted for IFRS preparers • Standard includes an expanded definition of a public entity • Entities can choose to adopt the standard using either a full retrospective approach or a modified retrospective approach The new revenue recognition standard

6. Overview and transitionAdoption methods available The new revenue recognition standard

7. Scope and exceptions What is in scope • Contracts with customers • Sale of some nonfinancial assets that are not an output of the company’s ordinary activities (e.g., property, plant and equipment, intangibles) What is not in scope • Leasing contracts • Insurance contracts • Financial instruments contracts • Certain nonmonetary exchanges • Certain put options on sale and repurchase agreements • Guarantees within the scope of ASC 460 The new revenue recognition standard

8. Agenda • Overview and transition • The five-step model • Other aspects • Next steps The new revenue recognition standard

9. Summary of the model • 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 entitledin exchange for those goods or services Step 1: Identify the contract(s) with a customer Step 2: • Identify the performance obligations in the contract Step 3: Determine the transaction price Step 4: Allocate the transaction price to the performance obligations Step 5: Recognize revenue when (or as) each performance obligation is satisfied The new revenue recognition standard

10. Step 1: Identify the contract(s) with a customer • Contract defined as an agreement between two or more parties that creates enforceable rights and obligations • Can be written, oral or implied • Does not exist if both parties have not performed and can cancel without penalty • Arrangement must meet these criteria to be within scope of standard: • Parties have agreed to terms and are committed to perform • Each parties’ rights and payment terms can be identified • Contract has commercial substance • Collection is probable • Contracts entered into at the same time with the same customer should be combined if certain criteria are met • Accounting for contracts that are not within the scope of the model The new revenue recognition standard

11. Step 2: Identify performance obligations • A performance obligation is a promise (explicit or implicit) to transfer a distinct good or service to a customer • Performance obligations are identified at contract inception and determined based on: • Contractual terms • Customary business practice • Incidental obligations or marketing incentives may be performance obligations (e.g., “free” maintenance provided by automotive manufacturers, loyalty points provided by a hotel) • Does not include activities to satisfy an obligation (e.g., set-up activities) unless a good or service is transferred The new revenue recognition standard

12. Step 2: Identify performance obligations (cont.) Two-step model to identify which goods or services are distinct Step 1 - Focus on whether the good or service is capable of being distinct Step 2 - Focus on whether the good or service is distinct in the context of the contract Customer can benefit from the individual good or service on its own • The good or service is not integrated with, highly dependent on, highly interrelated with, or significantly modifying or customizing other promised goods or services in the contract OR Customer can use good or service with other readily available resources The new revenue recognition standard

13. Example 1: Identify performance obligations • Entity enters into a contract to manufacture and install customized equipment and provide maintenance services for a five-year period • Installation services include the integration of multiple pieces of equipment at the customer’s facility in order for the equipment to operate as a single unit • Equipment cannot operate without installation • Entity sells equipment and installation services together, does not sell installation separately • Other vendors can provide the installation services • The maintenance services are sold separately The new revenue recognition standard

14. Example 1: Identify performance obligations (cont.) Step 1 – Capable of being distinct? Step 2 – Distinct in the context of the contract? Good cannot be used without installation, but customer can obtain installation from another source. Good is distinct. Move to Step 2. Equipment and installation are highly interrelated. Significant customization is required during installation. Good isn’t distinct on its own because it must be combined with installation. Equipment Installation Installation can be provided by multiple vendors, so service is distinct. Move to Step 2. See discussion above. Equipment and installation are not distinct from one another. Maintenance Services have a distinct function because they are sold separately. Move to Step 2. Services are not highly interrelated. No integration, modification or customization required. Services are distinct. • In this example, there would be two performance obligations: (1) the equipment and installation because they are not distinct; (2) maintenance services because they are distinct services in the contract.

15. Principal Agent • Provides goods or services itself • Arranges for another party to provide goods or services Step 2: Identify performance obligations Principal versus agent considerations • Determining whether an entity acts as a principal or an agent in a specific arrangement affects the amount of revenue recognized (gross versus net recognition) • Appropriately identifying the entity’s performance obligation is fundamental to the principal or agent determination • An entity is a principal if the entity controls a promised good or service before its transfers to a customer • An entity may not be a principal if it obtains legal title only momentarily before is transferred to a customer The new revenue recognition standard

16. Step 2: Identify performance obligations Principal versus agent considerations (cont.) Entity is not primarily responsible for fulfilling contract • An entity is an agent if the entity’s performance obligation is to arrange for the provision of goods or services by another party • Indicators that an entity is an agent include: Net Indicators: Entity does not have discretion in establishing prices Entity does not have inventory risk Entity’s consideration is in the form of a commission Entity is not exposed to credit risk The new revenue recognition standard

17. Step 3: Determine the transaction price • Transaction price is defined as the amount of consideration to which an entity expects to be entitled in exchange for transferring promised goods or services to a customer • Transaction price includes the effects of the following: • Variable consideration (including application of the constraint) • Significant financing component • Consideration paid to a customer • Noncash consideration The new revenue recognition standard

18. Step 3: Determine the transaction priceVariable consideration • Transaction price may vary because of variable consideration (e.g., bonuses, discounts, rebates, refunds, credits, price concessions, incentives) • The transaction price is estimated using the approach that better predicts the amount to which the entity is entitled based on its facts and circumstances (i.e., not a “free choice”) Expected value Most likely amount • Sum of the probability-weighted amounts in a range of possible outcomes • Most predictive when the transaction has a large number of possible outcomes • Can be based on a limited number of discrete outcomes and probabilities • The single most likely amount in a range of possible outcomes • May be appropriate when the transaction will produce only two outcomes The new revenue recognition standard

19. Step 3: Determine the transaction pricePrice concessions • Entering into a contract expecting to collect less than the full transaction price may indicate a price concession • Price concessions (including implied price concessions) cause consideration to be variable and should not be included in the estimated transaction price • If an entity determines it is not probable of collecting the estimated transaction price, a valid contract does not exist (as discussed in Step 1 of the model) • When assessing Step 1 (identify the contract), an entity also must consider Step 3 of the model (determine the transaction price) • Distinguishing between customer credit risk (i.e., bad debt) and implied price concessions (i.e., reductions of revenue) will require significant judgment The new revenue recognition standard

20. Step 3: Determine the transaction priceConstraint on variable consideration • Required to evaluate whether to “constrain” amounts of variable consideration included in the transaction price • Objective of the constraint – include variable consideration in the transaction price only to the extent it is “probable” that a significant revenue reversal will not occur when uncertainty is subsequently resolved • “Significant” is relative to cumulative revenue recognized • Estimates of the transaction price that includes variable consideration should be updated at each reporting date • Specific rule for licensed intellectual property • Sales- or usage-based royalties should not be included in the transaction price until the customer’s subsequent sales/usage of a good or service occurs or the performance obligation is satisfied The new revenue recognition standard

21. Example 2: Determine the transaction price Variable consideration • Entity enters into a contract and will receive $100,000 performance bonus if specified performance targets are met • Entityestimates 80% likelihood it will receive entire performance bonus and 20% likelihood it will receive none of the bonus • Due to the binary nature of the outcome, entitydetermines that the best predictor of the ultimate consideration it will receive is the “most likely amount” approach • Therefore, $100,000 is included in the transaction price • Constraint likely has no effect because entity concluded it was probable that bonus will be received The new revenue recognition standard

22. Entity enters into a contract and will receive a performance bonus up to $100,000 if it meets specified performance targets. It estimates the likelihood of achieving the targets as follows: Expected value approach is determined to be the best method – entity calculates $59,000 using this method However, entity must consider whether any of the $59,000 should be constrained Example 3: Determine the transaction price Variable consideration The new revenue recognition standard

23. Step 3: Determine the transaction price Significant financing component • The time value of money is considered when significant, and the primary purpose of the payment terms is to provide financing to counterparty • Evaluation not required if customer is expected to pay within one year of when control of the goods or services is transferred Noncash consideration • Measured at the fair value of the consideration received or promised Consideration payable to a customer • Determine whether such amounts are: • A reduction of the transaction price and revenue • A payment for distinct goods and services • A combination of the two The new revenue recognition standard

24. Step 4: Allocate the transaction price • Transaction price is generally allocated to each separate performance obligation on a relative standalone selling price basis • Model provides two possible exceptions relating to the allocation of variable consideration and discounts, if certain criteria are met • When a standalone selling price is not observable, an entity is required to estimate it • Maximize the use of observable inputs • Apply estimation methods consistently in similar circumstances • Standard describes three estimation methods but others are permitted (and a combination of estimation methods is allowed) • Standalone selling prices used to perform the initial allocation should not be updated after contract inception The new revenue recognition standard

25. Step 5: Recognize revenue as performance obligations are satisfied • Revenue recognized upon satisfaction of a performance obligation by transferring a good or service to a customer • A good or service is considered to be transferred when (or as) the customer obtains control • Performance obligations are either satisfied over time or at a point in time • The following are indicators of when control is transferred: • The entity has a present right to payment for the asset • The customer has legal title to the asset • The customer has physical possession of the asset • The customer has the risk and rewards of ownership of the asset • The entity has evidence of the customer’s acceptance of the asset The new revenue recognition standard

26. Step 5: Recognize revenue as performance obligations are satisfied over time • Control of goods and services is transferred over time if one of the following three criteria is met: • The entity creates or enhances an asset that the customer controls as it is created or enhanced • The entity’s performance does not create an asset with alternative use, and the entity has a right to payment for performance completed to date • The customer simultaneously receives and consumes the benefits of the entity’s performance as the entity performs “Pure service” contracts • (1) Disregard potential limitations that would prevent the transfer of a remaining PO to another entity • (2) Assume another entity fulfilling the remaining PO would not have the benefit of any asset the entity controls • Another entity would not have to re-perform work completed to date • If none of the criteria are met, control transfers at a point in time 3 July 2014 The new revenue recognition standard

27. Step 5: Recognize revenue as performance obligations are satisfied over time (cont.) • Revenue is recognized over time by measuring progress toward completion of performance obligations • The objective is to most faithfully depict the entity’s performance • Select a single method for each performance obligation based on facts and circumstances • Output methods • Input methods • Apply method consistently for all similar arrangements • If unable to reasonably estimate progress, revenue should not be recognized until progress can be estimated • However, if entity can determine that no loss will be incurred, it should recognize revenue up to costs incurred The new revenue recognition standard

28. Agenda • Overview and transition • The five-step model • Other aspects • Next steps The new revenue recognition standard

29. Other aspectsWarranties • Two types of warranties (i.e., assurance-type warranties and service-type warranties) • If the customer has the option to separately purchase the warranty, it represents a separate performance obligation • If the customer does not have the option to separately purchase the warranty, it would accrue for the expected warranty costs unless the services under the warranty are beyond “quality assurance” services • Factors to consider when determining whether a warranty promise provides more than “quality assurance” include: • Is the warranty required by law • Length of time covered by the warranty • The nature of the tasks to be performed under the warranty promise • Guidance is similar to current US GAAP The new revenue recognition standard

30. Other aspectsContract costs • Incremental costs of obtaining a contract are capitalized if expected to be recovered • Practical expedient to allow immediate expense recognition if the asset’s amortization period is one year or less • Costs of fulfilling a contract that cannot be capitalized under another standard are capitalized if they: • Relate directly to a contract or an anticipated contract • Generate or enhance resources that will be used to satisfy performance obligations in the future • Are expected to be recovered • Other applicable literature should be considered first • Assets are amortized over the period the goods or services are transferred and are subject to impairment test The new revenue recognition standard

31. Other aspectsLoss contracts • Guidance on onerous contracts included in previous drafts of the standard was removed • Boards elected to retain current guidance on loss contracts, including: • ASC 440 for firm purchase commitments for goods or inventory • ASC 605-20 for separately priced extended warranty and product maintenance contracts • ASC 605-35 for construction-type and production-type contracts  • ASC 815 for certain derivative contracts • ASC 840 and ASC 420 for operating leases that are subleased • ASC 944 for certain reinsurance contracts • ASC 985-605 for certain software arrangements The new revenue recognition standard

32. Other aspectsDisclosure • Key principle – to help financial statement users understand the nature, amount, timing and uncertainty of revenue and cash flows arising from contracts with customers • Entity must present qualitative and quantitative information about: • Contracts with customers • Significant judgments and changes in judgments made when applying the guidance to those contracts • Assets recognized from costs to obtain or fulfill a contract • Fewer disclosure requirements for nonpublic entities • For US GAAP entities, most disclosures are required for annual and interim periods The new revenue recognition standard

33. Agenda • Overview and transition • The five-step model • Other aspects • Next steps The new revenue recognition standard

34. Next stepsSAB Topic 11.M disclosures • Staff Accounting Bulletin (SAB) Topic 11.M requires disclosure of the effects of recently issued accounting standards • Includes disclosures of the required adoption date, the allowed and planned adoption method, effect on the financial statements and other significant matters resulting from adoption • An entity’s disclosures on the new standard will likely evolve as more information about the effect is known • The SEC staff has requested disclosure of the transition method as soon as it is known • Entities are required to consider these disclosure requirements in their next report filed with the SEC (e.g., quarterly filings) • Required to provide disclosures until the standard is adopted The new revenue recognition standard

35. Next steps – business considerationsWhat can you do now? • Understand the magnitude of the changes to your entity from both a financial statement and business perspective • Establish a project management plan for adoption of the standard • Determine training requirements for individuals responsible for key judgments and estimates • Identify common transactions and potential implementation issues • Establish a process for gathering appropriate data to comply with the new standard • Communicate your questions on the guidance through the planned implementation groups The new revenue recognition standard