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ASC 606:  Are there “Get Out of Jail Free” cards?

Posted by Graham Hulme on Mar 1, 2018 8:00:00 AM

 Anyone who has played Monopoly knows that every player wants that "Get Out of Jail Free" card...In real life, though, there are no "Get Out of Jail Free" cards for those adopting ASC 606. 

Go Directly to Jail Image.pngHowever, there has been enough real-world feedback on ASC 606 to provide a potential safe passage past that dreaded “Go Directly to Jail” card.  Specifically, this blog piece focuses on direct feedback provided by the SEC to companies regarding their ASC 606 adoption practices.  SOFTRAX reviewed filings for the 1/1/17 through 12/31/17 timeframe for those companies that adopted ASC 606.  The details of this review are broken down in alignment with ASC 606’s 5 step model to offer illustrative samples as you traverse the game board of ASC 606.

 

SOFTRAX Observations:

  • The SEC’s questions led to answers that required a combination of art (qualitative) and science (quantitative) in the supplied narratives.
  • It is imperative companies go beyond just answering the “what” in their filings. Thus, providing “why”, “how”, “when”, and “who” information in responses becomes a necessity for filings under ASC 606.
  • While much of the SEC’s questions focused on the 5 core steps of ASC 606, there was a fair amount of digging the SEC did in its questions below the surface of these 5 steps. Areas such as “Incremental costs of obtaining a contract”, “Costs to fulfill a contract”, and “Significant financing component” were areas referenced.  These have been and will continue to be tackled in upcoming SOFTRAX articles and blogs.
  • Companies’ responses reference both ASC 605 and ASC 606 guidance in applicable cases.
  • SEC questions delved into yet-to-be-started and in-process areas of ASC 606 for companies. In such cases, companies responded accordingly and committed to greater disclosures on those areas in future filings.
  • The SEC did not have a heavy focus on ASC 606’s Step #4 “Allocate the transaction price to the performance obligations in the contract” as compared to the other four steps in the 5-step model. As a result, the below detail section does not present any information for Step #4.

 

Step #1 - Identify the contract(s) with a customer

“With a view towards future disclosures, please help us better understand the general nature of your contract modifications and whether modifications typically add distinct goods or services. Reference is made to ASC 605-10-25-10 and ASC 606-10-50-12(c).”

  • Company’s Response:

“Contract modifications are routine in the performance of our contracts, particularly in our defense groups. Contracts are often modified to account for changes in the contract specifications or requirements. Pursuant to ASC 606-10-25-10, we consider contract modifications to exist when the parties to the contract approve a modification that either creates new enforceable rights or changes existing enforceable rights and obligations.

In accordance with the guidance of ASC 606-10-25-12, we evaluate whether contract modifications should be accounted for as separate contracts. In most instances, contract modifications are for goods or services that are not distinct from the existing contract due to the significant integration services we perform. The modifications are, therefore, accounted for as if they were part of the existing contract.

 We propose to add the following disclosure in the performance obligations sub-section of the note discussing revenue recognition in our future Form 10-Q and Form 10-K filings:

 ‘Contract modifications are routine in the performance of our contracts. Contracts are often modified to account for changes in the contract specifications or requirements. In most instances, contract modifications are for goods or services that are not distinct, and, therefore, are accounted for as part of the existing contract.’”

 

Step #2:  Identify the performance obligations in the contract

“We note some of your contracts have multiple performance obligations. Please tell us and revise to disclose the nature of these performance obligations pursuant to ASC 606-10-50-12(c). For maintenance, support, and warranty services, please provide us with your analysis as to why these services were not separately identifiable in accordance with the guidance of ASC 606-10-25-21, as applicable.”

  • Company’s Response:

“Our contracts with multiple performance obligations are generally in our defense businesses. For production programs in these businesses, the product lifecycle generally spans from development to production to post-delivery maintenance and support. In most instances, these services are not contained in the same contract, as it is typical to have separate contracts for various phases of the product lifecycle. However, one or more phases of the product lifecycle are sometimes contained in a single contract. For these contracts, the discrete phases are often assessed as separate performance obligations.

We provide warranties to our customers associated with certain product sales in our defense and Aerospace groups. These warranty services are typically not priced or negotiated separately (there is no option to separately purchase the warranty) or the warranty does not provide customers with a service in addition to the assurance that the product complies with agreed-upon specifications. As we do not account for the warranty services as a separate performance obligation in accordance with ASC 606-10-55-31 and ASC 606-10-55-34, no further disclosure of the warranty services is necessary.

To better assist investors in understanding the performance obligations in our contracts, we propose to augment our future filings to include the following disclosures (additional language in italics):

‘A performance obligation is a promise in a contract to transfer a distinct good or service to the customer, and is the unit of account in ASC Topic 606. A contract’s transaction price is allocated to each distinct performance obligation and recognized as revenue when, or as, the performance obligation is satisfied. The majority of our contracts have a single performance obligation as the promise to transfer the individual goods or services is not separately identifiable from other promises in the contracts and, therefore, not distinct. Some of our contracts have multiple performance obligations, most commonly due to the contract covering multiple phases of the product lifecycle (development, production, maintenance and support). For contracts with multiple performance obligations, we allocate the contract’s transaction price to each performance obligation using our best estimate of the standalone selling price of each distinct good or service in the contract. The primary method used to estimate standalone selling price is the expected cost plus a margin approach, under which we forecast our expected costs of satisfying a performance obligation and then add an appropriate margin for that distinct good or service.’”       

     

Step #3:  Determine the Transaction Price

Example 1

“Please explain to us how you determined that rebates paid to customers in accordance with published fee schedules should not be accounted for as a reduction of the transaction price.  Refer to ASC 606-10-32-25 to 32-27.”

  • Company’s Response:

“In applying ASC 606-10-32-25, we identified two types of rebates paid to customers. The first type are tiered discounts offered to customers based on the amount of trades that are executed on our exchanges.  As these are volume driven, they reduce the transaction price and are recorded net in transaction fees on the consolidated statements of income. The second type of rebates paid to customers are liquidity payments, which we consider a distinct transaction and record as a cost of revenue in liquidity payments on the consolidated statements of income. We believe that providing (or removing) liquidity is a distinct service that is provided by customers, as we benefit from having an enhanced liquidity pool available on our markets, and that it is separately identifiable given its separation on the published fee schedules. We believe the enhanced liquidity pool attracts order flow and promotes order execution on our trading platforms. Through enhanced order flow, and therefore higher market share, we also earn additional market data revenue from the Securities Information Processor (SIP) plans and the Options Price Reporting Authority (OPRA), and our own proprietary market data becomes more valuable as more trades are included. Also as our market share grows, so does the need for our customers to become connected to markets, which results in higher connectivity revenue. Therefore, we account for the purchase of this service from our customers as an expense, just as we would account for the purchase of services acquired from any other vendor, in accordance with ASC 606-10-32-26.

For clarity, in future filings, we propose amending the paragraph below found on page 6 by removing the italicized phrase as follows:

‘In 2017, the Company changed the presentation of liquidity payments, or rebates paid to customers in accordance with published fee schedules, to be a cost of revenues, which historically had been netted against transaction fees. The Company also changed the presentation of royalty fees to be a cost of revenues. The presentation of routing fees and costs were also changed. Routing fees were presented in transaction fees in total revenues and routing and clearing costs in total cost of revenues. These fees were previously presented as a net operating expense. These changes were made to conform to current presentation and the changes have been reflected in all periods presented.’

Example 2

“We note your disclosure that your solar power system sales include performance guarantees that represent a form of variable consideration and are recognized as adjustments to revenue. Please help us better understand your accounting for these potential bonus payments and/or liquidated damages. In this regard, based on your disclosure, it is unclear to us whether these amounts are included as part of your estimate of your transaction price at the outset of the arrangement and then reassessed at the end of each reporting period. Refer to ASC 606-10-32-5 through 32-10 and ASC 606-10-32-14.”

  • Company’s Response:

“We respectfully advise the Staff that estimates of net contract revenues (i.e., transaction prices) for sales of solar power systems and EPC services may include several forms of variable consideration, such as performance incentives, liquidated damages, and other payments to customers. Potential bonuses or liquidated damages arising from system performance guarantees are estimated at contract inception at their ‘most likely amount’ in accordance with ASC 606-10-32-8 and then updated at the end of each reporting period as additional performance data becomes available and only to the extent that it is probable that a significant reversal of any incremental revenue will not occur.”

 

Step #4:  Allocate the transaction price to the performance obligations in the contract

  • No details for this article; will monitor SEC input in the coming months and provide details in future articles.

 

Step #5:  Recognize revenue when (or as) the entity satisfies a performance obligation

Example 1

“You disclose you recognize revenue over time using an input measure (e.g., costs incurred to date relative to total estimated costs at completion). Revise to disclose why this method is a faithful depiction of the transfer of goods or services pursuant to ASC 606-10-50-18(b).”

  • Company’s Response:

“Because of the continuous transfer of control to our customers in our defense groups, we primarily recognize revenue over time. Revenue that is recognized over time is typically recognized using an input measure (e.g., costs incurred to date relative to total estimated costs at completion). This method is a faithful depiction of the transfer of goods or services pursuant to ASC 606-10-50-18(b) because it results in the recognition of revenue on the basis of our to-date efforts in the satisfaction of a performance obligation relative to the total expected efforts in the satisfaction of that performance obligation. We believe that the use of an input measure best depicts the transfer of control to the customer, which occurs as we incur costs on our contracts.

To assist in a better understanding of our use of the input measure, we propose to augment our future filings to include the following disclosures (additional language in italics):

‘Substantially all of our revenue in the defense groups is recognized over time because control is transferred continuously to our customers. Typically, revenue is recognized over time using costs incurred to date relative to total estimated costs at completion to measure progress toward satisfying our performance obligations. Incurred cost represents work performed, which corresponds with, and thereby best depicts, the transfer of control to the customer. Contract costs include labor, material, overhead and, when appropriate, G&A expenses.’

 

Example 2

“We note that you recognize revenue at a point in time for the manufacture of business-jet aircraft in your Aerospace group, which is generally when the customer accepts the fully outfitted aircraft. Please tell us, and revise to disclose, what significant judgments were evaluated in determining that this was the appropriate point to recognize revenue. Refer to ASC 606-10-25-30 and 606-10-50-19. In addition, please provide us with your analysis regarding whether revenue for your business-jet aircraft should be recognized over time in accordance with ASC 606-10-25-2 through 29. In this regard, please specifically address your consideration of customer deposits and customer specific specifications.”

  • Company’s Response:

“We do not recognize revenue over time for our business-jet aircraft because none of the criteria outlined in ASC 606-10-25-27 are met:

  • We have a present right to payment for the asset.
  • The customer has legal title to the asset.
  • We have transferred physical possession of the asset.
  • The customer has significant risks and rewards of ownership of the asset.
  • The customer has accepted the asset.

 The customer controls the asset when the customer accepts the asset. We have determined that this is the appropriate point in time to recognize revenue because the customer acknowledges that the aircraft meets the contractual specifications and is acceptable to the customer through the execution of a memorandum of delivery. This acceptance generally occurs at the final delivery of the fully outfitted aircraft, which is also typically the date when legal title of the asset is transferred to the customer and the customer obtains physical possession of the asset.

 To clarify the timing of revenue recognition in our Aerospace group, we propose to enhance our future filings to include the following disclosures (additional language in italics):

 ‘The majority of our revenue recognized at a point in time is for the manufacture of business-jet aircraft in our Aerospace group. Revenue on these contracts is recognized when the customer obtains control of the asset, which is generally upon delivery and acceptance by the customer of the fully outfitted aircraft.’

 

Example 3

“We note your disclosure that you recognize revenue for certain services over time.  Please tell us how you considered the requirements in ASC 606-10-50-13 to 50-15 to disclose information about remaining performance obligation or application of optional exemptions.”

  • Company’s Response:

“In our analysis of ASC 606, we considered certain revenue streams as services transferred over time.  Primarily, these revenue streams are recorded in access fees, exchanges services and other fees, and market data fees on our consolidated statements of income. The nature of the services provided in these streams are subscription-based where the customer is billed monthly for its subscription to our market data or its monthly connectivity to our markets. While the services are provided over time, the revenue amounts are known and recognized monthly.  Therefore there are no remaining performance obligations related to these services transferred over time at the end of the reporting period.

 The balance of contract liabilities at the end of the reporting period that required disclosure under ASC 606-10-50-13 primarily consisted of prepayments of transaction fees and certain access and market data fees, both of which have been categorized in the respective point-in-time or over-time categories as determined by the nature of the revenue stream.  Based on the amount of total deferred revenue disclosed in the table on page 10, we determined that any remaining performance obligations that would require disclosure under ASC 606-10-50-13 were immaterial to our financial statements, and as such, we omitted the disclosure.”

 

Final Comments

Advance to Go Monopoly image.pngHow can you safely pass go and collect your $200? Using information such as the above, documented guidance exists to help prepare, implement, and adopt ASC 606.  It’s likely there’s no “one size fits all” approach, but using information from the first wave of adopters can be a critical piece of your company’s plan.  Additionally, as the above shows, addressing ASC 606 is multi-layered, highly complex, and ripe for process improvement and automation as evidenced by a company’s response to an SEC ASC 606 question as follows:

“As disclosed in the Form 10-K filed February 22, 2017, the Company is currently in the process of finalizing our assessment of the impact of Accounting Standards Update No. 2014-09, Revenue from Contracts with Customers (Topic 606) on the Company’s financial statements and the related disclosures.  We acknowledge that the Update will require the Company to disaggregate revenue from contracts with customers into categories and disclose them depending on the facts and circumstances that pertain to the entity’s contracts with customers. Examples of different categories that may be appropriate, but are not required, to use for this disclosure as provided in ASC 606-10-55-91 include type of goods or services.  As a result, we are currently assessing the need to implement improvements in the GL Software and / or FA Software to be in compliance with the new disclosure requirements. We are still assessing and have not yet concluded which categories will be used by the company for disclosures."

Pass GO and collect Monopoly Image.png

SOFTRAX offers superior experience, knowledge, products, and services to address your company’s ASC 606 needs.  We encourage you to visit http://www.softrax.com/about/contact-us to learn more about SOFTRAX and the value we can provide for your company’s ASC 606 adoption.

Topics: ASC 606, SEC Comments, GAAP, Blog, Accounting, FASB, Revenue Management, Revenue Recognition, Rev Rec

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