Revenue recognition for Aerospace and Defense companies

44 Pages·2012·2.41 MB·English

New on the
Horizon:
Revenue recognition for
Aerospace and
Defense companies
March 2012
kpmg.com
kpmginstitutes.com
Contents
One model. Two approaches. Five steps.
One more chance to comment. 1
1. Are the revised proposals good news for A&D
companies? 2
2. Key impacts 4
3. Scope 6
3.1 In scope 6
3.2 Partially in scope 6
4. Step-by-step 8
4.1 Step 1: Identify the contract with the customer 8
4.2 Step 2: Identify the separate performance
obligations 10
4.3 Step 3: Determine the transaction price 13
4.4 Step 4: Allocate the transaction price to the
separate performance obligations 17
4.5 Step 5: Recognize revenue 20
4.6 Contract costs 26
4.7 Onerous performance obligations 28
5. Application issues 30
5.1 Product warranties 30
5.2 Customer incentives 31
6. Presentation 33
7. Disclosures 34
8. Effective date and transition 37
About this publication 39
KPMG’s Global Aerospace and Defense practice 41
Contact us 41
New on the Horizon: Revenue recognition for Aerospace and Defense companies | 1
One model. Two approaches.
Five steps. One more chance to
comment.
A wide range of accounting changes under both US GAAP and IFRS is expected to impact the Aerospace and Defense (A&D)
industry. The IASB’s and the FASB’s joint projects range from an overhaul of revenue recognition, a new model for leasing
arrangements, and new standards on fair value measurement and fnancial instruments, among others. We expect the volume and
scope of the projects being undertaken by the Boards to result in companies being tasked with implementation of multiple new
accounting standards in the coming years, many of which will have impacts beyond accounting.
This publication focuses on the joint revenue recognition project. We welcome the revised proposals on revenue recognition
published by the IASB and FASB in November 2011. It is good news that the Boards listened to much of the feedback on the earlier
version of the proposals published in 2010. The revised proposals retain a single model with two ways to recognize revenue: over
time or at a point in time. The model continues to require a fve-step analysis of contracts, focusing on transfer of control.
All companies, under the proposals, would apply the single model. This means a greater degree of judgment would be required,
heightening the challenge of consistent interpretation. A&D companies should therefore consider whether the proposals have
suffcient clarity to be successfully applied.
The proposals may ultimately represent business as usual for some A&D companies, but it is likely that some would experience
some degree of change. A number of revisions to the revenue proposals refected in the 2011 ED, including a broader scope for the
percentage of completion accounting and new criteria for bundling performance obligations, are likely to come as a relief to A&D
companies. However, some proposals may be a challenge to apply in the A&D industry and companies should take a keen interest
in further developments on the project.
The A&D industry has one more chance to infuence a new standard on revenue. We hope that this publication will assist you in
gaining a greater understanding of the revenue project and its potential impact on your business. We encourage you to contact us
to further discuss the issues raised within and any additional questions you may have on the upcoming standard. The deadline for
comment letters is March 13, 2012.
Marty Phillips Brian Heckler Dr. Gerhard Dauner
Global and National Aerospace and Accounting Advisory Services Diversifed Industrials
Defense Leader Lead Partner European Leader
KPMG in the US KPMG in the US KPMG in Germany
© 2012 KPMG IFRG Limited, a UK company, limited by guarantee. All rights reserved.
2 | New on the Horizon: Revenue recognition for Aerospace and Defense companies
1. Are the revised proposals
good news for A&D
companies?
IASB’s and the FASB’s joint revenue project continues to draw attention of A&D companies, although the views on the
developments may vary between IFRS and US GAAP issuers. A&D companies actively participated in the consultation on the
revenue model proposed in June 2010 (the 2010 ED) and expressed a number of concerns arguing that the 2010 revenue model
did not ft the underlying economics of their long-term contracts. The revised proposals were issued in November 2011 (the 2011
ED) and many A&D companies are now analyzing whether their concerns were adequately addressed.
This publication looks at the potential impact of the revised proposals on A&D companies, discusses whether their previous
concerns have been adequately addressed, and highlights application issues relevant to both IFRS and US GAAP issuers.
Good news compared to the 2010 ED Remaining challenges
●● Percentage of completion method. A broader range of ●● Unit of account. The unit of account needs to be considered
contracts may qualify for the percentage of completion carefully on a contract-by-contract basis, and there may be
accounting, including a number of arrangements in the A&D changes from current accounting.
industry.
●● New criteria for bundling performance obligations. ●● Contract modifcations. The number and nature of
Bundling is required if certain criteria are met, and a number modifcations (including unapproved or unpriced change
of A&D arrangements are likely to meet the revised criteria. orders) may create implementation challenges and may defer
the recognition of related revenue.
●● Input method for measuring progress. The input method ●● Time value of money. The pattern of payments may not
is allowed under the 2011 ED provided that it refects the necessarily be intended to include a fnancing arrangement
performance under the contract. if governments and budgets are involved. The requirements
could be challenging to apply in practice.
●● Onerous performance obligations. Applying the ‘onerous
test’ at a performance obligation level may result in
recognition of an upfront loss at the beginning of an overall
proftable contract.
●● Accounting for costs. The 2011 ED does not include
comprehensive guidance on cost accounting.
●● Disclosure. Increased qualitative and quantitative disclosure
requirements may require new internal processes and
systems for collecting underlying data.
●● Transition. The volume, complexity, and long-term nature
of contracts may lead to challenges with retrospective
application.
© 2012 KPMG IFRG Limited, a UK company, limited by guarantee. All rights reserved.
New on the Horizon: Revenue recognition for Aerospace and Defense companies | 3
Although the overall developments on the revenue project may come as good news for many A&D companies, there may be
some uncertainty as to whether the proposals are suffciently clear to be interpreted and applied consistently across the industry.
Additionally, some fear that the disclosure proposals will require signifcant investment in order to track and report additional
information.
This publication focuses on the challenges facing A&D companies reporting either under US GAAP or IFRS. For a full discussion
of the revised proposals, you may want to read our cross-sector publications New on the Horizon: Revenue from contracts with
customers; Defning Issues: Boards Release Revised Revenue Recognition Exposure Draft; Issues In-Depth: Boards Revise Joint
Revenue Recognition Exposure Draft.
© 2012 KPMG IFRG Limited, a UK company, limited by guarantee. All rights reserved.
4 | New on the Horizon: Revenue recognition for Aerospace and Defense companies
2. Key impacts
The new standard is expected to have impacts beyond accounting, tax and reporting,
and will impact an entity’s business and fnancial viewpoint, its systems and processes
and its people. Below are the key implementation issues that we envisage A&D
companies will wish to consider when evaluating the impact of the proposed revenue
recognition model.
Accounting, Tax and Reporting Systems and Processes
●● Revenue recognition may be accelerated or deferred. ●● New accounting systems and processes may be required.
Under the 2011 ED, the timing of revenue recognition Existing accounting systems and processes may need to
may change for some A&D companies as compared to be reviewed to determine if they have capability to analyze
current reporting. Some arrangements, for which revenue contracts in accordance with the fve steps in the proposed
is currently recognized at a point in time, may meet the revenue model (see Section 4). Areas of specifc challenge
criteria for recognizing revenue over time and in such cases for A&D companies may be identifying separate performance
revenue recognition may be accelerated. Conversely, obligations, applying the contract modifcation guidance for
some arrangements that are currently accounted for using potentially hundreds of change orders, applying the ‘onerous
the percentage of completion method may not meet the test’ at a performance obligation level, and calculating a
criteria for recognizing revenue over time, and therefore the fnancing element for each contract if payments do not match
recognition of revenue may be delayed. the performance progress and the lag extends over one year.
●● Changes to revenue recognition pattern may need to be ●● Evaluate systems capabilities to account for contract
communicated in advance of adoption. Retrospective modifcation. New systems and processes may be required
application may impact previously reported fnancial to track and evaluate these modifcations, and to remeasure
results. Communication may be required to stakeholders the transaction price and progress toward completion. If the
in advance of adoption. A&D companies may consider modifcation results in a new contract, then it will need to be
developing additional ‘non-GAAP’ disclosures in the recorded separately in the accounting system and accounted
management commentary to bridge historical performance for within the model.
and analysis. ●●
Constraining variable revenue may require new
●● Contract modifcations may lead to revenue volatility. processes to track and report progress. Under the
Contract modifcations may require remeasurement of proposals, variable revenue is constrained to the amount that
performance obligations for changes to the transaction an entity is reasonably assured to be entitled to. Companies
price and updated assessments of the progress toward using the inputs method for measuring progress and
completion. These changes may result in cumulative catch-up recognizing revenue will need to track total inputs to ensure
adjustments to revenue recorded in the current period. that the related revenue does not exceed the ‘ceiling’. This
●● Proposal includes changes to reporting and disclosure task may require new processes.
requirements. The new reporting and disclosure proposals ●● New disclosure requirements may require changes to
in the 2011 ED may require companies to change existing existing accounting systems and processes. Preparing
reporting packages, which will need to be rolled out to all the proposed new disclosures could be time-consuming
legal entities/locations globally. and may require system changes/upgrades to capture the
●● Dividends and taxation. Changes to revenue recognition required information. Processes will need to be reconsidered
to ensure that management judgment is exercised at key
may affect the timing of tax payments and the ability to pay
points as fnancial information is prepared.
dividends in some jurisdictions.
●● Retrospective application required. Applying the proposals
retrospectively could require the early introduction of new
systems and processes, and a period of parallel running for
some entities.
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New on the Horizon: Revenue recognition for Aerospace and Defense companies | 5
Business People and Change
●● All contracts will need to be analyzed based on each step ●● Training staff to apply the new revenue model. The new
in the proposed model. Conclusions reached will need to revenue model will require training of accounting and fnance
be appropriately documented to develop suffcient evidence staff, as well as sales and contracting staff, on the accounting
regarding positions reached. application of the standard to new and existing contracts.
Also, staff may require training on documenting conclusions
●● New accounting model may impact internal and external
reached upon implementation of the standard to current
reporting metrics. The impact on fnancial results, the
contracts.
resulting trends and comparability to historical results should
be assessed. Communication with external users about ●● Training staff on new systems, processes and
the expected timing of changes and volatility in revenue documentation requirements. The application of the new
and earnings, and also with the Board of Directors about standard, if approved in the form of the 2011 ED, will likely
impacts on internal metrics, should be considered. Updates require changes to existing systems and processes, and staff
to internal metrics may be required, including those linked to will need to be trained on these changes.
performance and compensation.
●● Changes to internal reporting metrics will require
●● Changes to contract terms and business practices. educating teams on the implications. Changes to internal
A&D companies should consider whether changes to reporting metrics need to be communicated effectively
standard contract terms and business practices are required throughout the organization to ensure that teams understand
to achieve or maintain a particular revenue profle. They the changes and implications, especially for changes to
also should analyze the impact on contracts currently metrics linked to compensation.
being negotiated and consider the proposed model when
structuring and negotiating new contracts.
●● New estimates and judgments required. The proposals
introduce new estimates and judgmental thresholds that
may affect the amount or timing of revenue recognition.
© 2012 KPMG IFRG Limited, a UK company, limited by guarantee. All rights reserved.
6 | New on the Horizon: Revenue recognition for Aerospace and Defense companies
3. Scope
3.1 In scope
ED 1, App A, BC30 Revenue is income arising in the course of an entity’s ordinary activities. Income is defned as increases
in economic benefts during the accounting period in the form of enhancements of assets or decreases
of liabilities that result in increases in equity, other than those relating to contributions from equity
participants, and that arise in the course of an entity’s ordinary activities.
The proposals in the 2011 ED apply only to one category of revenue: revenue from contracts with
customers. Other forms of revenue, for example, interest and dividends, will be dealt with under
other IFRSs and US GAAP ASC Topics.
KPMG Observations
The new single revenue standard is intended to replace the following guidance:
●● IFRS – IAS 11 Construction Contracts, IAS 18 Revenue, IFRIC 13 Customer Loyalty Programmes,
IFRIC 15 Agreements for the Construction of Real Estate, IFRIC 18 Transfers of Assets from
Customers and SIC-31 Revenue – Barter transactions Involving Advertising Services.
●● US GAAP – most of the revenue recognition requirements in ASC Topic 605 Revenue Recognition and
industry-specifc revenue recognition guidance included therein; additionally, the existing requirements
for the recognition of a gain or loss on the transfer of some non-fnancial assets (e.g. real estate sales
within the scope of ASC Subtopic 360-20 Property, Plant, and Equipment – Real Estate Sales) would be
amended or superseded to be consistent with the proposed recognition and measurement guidance.
It remains to be seen whether A&D companies feel that the new proposals are clear enough to be
applied consistently across the industry.
3.2 Partially in scope
ED 11, BC44–BC46 A contract could be partially in the scope of the 2011 ED and partially in the scope of other IFRSs, for
example a contract to lease an asset to a customer (within the scope of IAS 17 Leases or ASC Topic 840
Leases) and to deliver maintenance services on the leased asset (within the scope of the 2011 ED).
In such a case, the entity considers whether the other IFRS or US GAAP ASC Topic includes specifc
guidance on the separation and initial measurement of components of contracts, namely:
●● if the other IFRS or US GAAP ASC Topic includes guidance on separation and/or measurement, then the
entity frst applies that guidance; or
●● if the other IFRS or US GAAP ASC Topic does not include guidance on separation and/or measurement,
then the entity applies the guidance in the 2011 ED.
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New on the Horizon: Revenue recognition for Aerospace and Defense companies | 7
KPMG Observations
One practical consequence of the proposed approach is that if a contract is partially within the scope of
the 2011 ED and partially within the scope of another standard, then the measurement of revenue may
depend on the requirements of the other standard. For example, a contract may include a lease of an
aircraft and other services.
It is diffcult to assess the signifcance of this proposal at present for A&D companies, given that the
Boards have an active project on lease accounting. For example, in the period since publication of the
2010 ED, the Boards have taken tentative decisions that could change when and how consideration
is allocated between the lease and service elements of a contract, which is of particular interest to
commercial aerospace companies.
Another practical consequence is that it may be necessary to apply more than one methodology to
allocate consideration within a single contract. For example, it may be necessary frst to allocate the
consideration between the revenue and non-revenue elements (i.e. the lease element) using the
guidance in another standard, and second to allocate the revenue element between the different
performance obligations using the guidance in the 2011 ED (see 4.4). This would require A&D companies
to exercise judgment and could be complex to apply.
© 2012 KPMG IFRG Limited, a UK company, limited by guarantee. All rights reserved.
8 | New on the Horizon: Revenue recognition for Aerospace and Defense companies
4. Step-by-step
ED 4 The 2011 ED describes a fve-step model for revenue recognition.
Step 1: Step 3:
cIodnetnraticfyt wthieth Contraccotn (torra cotsm) bined Transactciontprariccte for the trDaentsearcmtioinne ptrhicee
the customer
Step 2: Transaction Transaction Step 4:
Id
seenptaifrya tehe Poerbfloigrmataionnce Poerbfloigrmataionnce allopcaritceed to allopcaritceed to transaAcltlioocna tper icthee to the
performance 1 2 performance performance separate performance
obligations in obligation obligation obligations in the
the contract 1 2 contract
Step 5:
Recognize revenue
Recognize Recognize when (or as) the
revenue revenue entity satisfies a
performance
obligation

These fve steps are discussed in 4.1 to 4.5. The 2011 ED also specifes the accounting for some costs, as
described in 4.6. Additional guidance on onerous performance obligations is discussed in  4.7.
4.1 Step 1: Identify the contract with the customer
4.1.1 When to apply the model to a contract
ED 13 A contract is an agreement between two or more parties that creates legally enforceable rights and
obligations. A contract need not be written but may be oral or implied by the entity’s customary business
practices to the extent that they create legally enforceable rights and obligations.
ED 13 An entity considers the practices and processes for establishing contracts with customers to determine if
a contract exists. These practices and processes may vary across jurisdictions and industries, and may be
different for different classes of customers or goods or services.
ED 14 A contract exists only if:
●● the contract has commercial substance;
●● the parties have approved it and are committed to perform;
●● the entity can identify each party’s rights regarding the goods or services to be transferred; and
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