The time to implement the new revenue recognition guidance is fast approaching. The standard outlined in the Financial Accounting Standards Board (FASB)'s Accounting Standards Update (ASU) 2014-09, Revenue from Contracts with Customers (Topic 606) takes effect for calendar year public business entities in the year ending December 31, 2018. For all other calendar year entities, it takes effect for the December 31, 2019 year ends. At its core, the new revenue recognition guidance requires an entity to recognize revenue that relates to the transfer of promised goods or services to customers in amount that reflects the consideration the entity expects to receive in exchange for those goods or services. Manufacturers may have already been weighing how revenue recognition methods such as over-time recognition, point-in-time recognition and the sell-through method may change with the new guidance. While these procedures will be changing, there are other elements that should be considered pre-adoption. Bill-and-hold arrangements, accounting for costs for long-term contracts, warranties and variable consideration may all be impacted by the new guidance.

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August 2016
Changes to Warranties, Returns and Other Ways Manufacturers Can Prepare
for Revenue Recognition
The time to implement the new revenue recognition
guidance is fast approaching. The standard outlined
in the Financial Accounting Standards Board (FASB)’s
Accounting Standards Update (ASU) 2014-09,
Revenue from Contracts with Customers (Topic 606)
takes effect for calendar year public business entities
in the year ending December 31, 2018. For all other
calendar year entities, it takes effect for the December
31, 2019 year ends.
At its core, the new revenue recognition guidance
requires an entity to recognize revenue that relates
to the transfer of promised goods or services to
customers in amount that reflects the consideration
the entity expects to receive in exchange for those
goods or services. Manufacturers may have already
been weighing how revenue recognition methods such
as over-time recognition, point-in-time recognition and
the sell-through method may change with the new
guidance. While these procedures will be changing,
there are other elements that should be considered
pre-adoption. Bill-and-hold arrangements, accounting
for costs for long-term contracts, warranties and
variable consideration may all be impacted by the
new guidance.
Bill-and-Hold Arrangements
A bill-and-hold arrangement arises when an entity
bills customers for goods that are ready for delivery,
but the entity does not immediately ship the goods to
the customer.
Existing U.S. generally accepted accounting
principles (GAAP) do not specify when an entity
recognizes revenue from such an arrangement. Many
private companies follow the guidance required for
public company registrants, which consists of seven
criteria issued by the staff of the Securities and
Exchange Commission (SEC). Those criteria include
a sometimes challenging requirement for a fixed
delivery schedule. The SEC has not yet commented
on whether the seven criteria specified by its staff will
continue under the new revenue recognition standard.
In the new guidance, a bill-and-hold arrangement
must meet four criteria before the entity can recognize
the revenue from the arrangement. If the following
are met, control can have been transferred to the
customer even if the goods are not physically in the
customer’s possession:
1. The reason for the bill-and-hold arrangement
must be substantive, such as the customer
requesting the arrangement;
2. The product must be identified separately as
belonging to the customer;
3. The product currently must be ready for the
physical transfer to the customer; and

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4. The entity cannot have the ability to use the
product or direct it to another customer.
An arrangement that includes substitution of the goods
in the arrangement for other orders will not meet the
criteria for a bill-and-hold arrangement because the
goods are not controlled by the customer. In this
instance, the entity would not recognize revenue from
the order until the goods are physically transferred to
the customer. Take the following example.
A toy manufacturer enters into an arrangement
with a retailer to supply action figures. The retailer
has limited shelf space for the action figures, so it
specifies within the contract when the action figures
should be delivered. Action figures for the retailer
are stored with the manufacturer’s other action figure
toys. The delivery date extends past year end, so the
toy manufacturer has to decide if it should recognize
revenue from the action figures under contract with
the retailer. Because the toys are not stored separately
from its other inventory, the toy manufacturer cannot
recognize revenue from its contract with the retailer
until either the toys are delivered or the arrangement
meets the bill-and-hold criteria.
Long-Term Contracts
Several issues may arise with long-term contracts,
perhaps the most significant is whether the revenues
under the contract should be recognized over-time
or at a point in time. Another challenging issue is
evaluating whether a long-term contract contains
a significant financing component that requires the
recognition of interest income or expense. Entities
must carefully consider whether financing plays a
significant component to their contract by evaluating
both:
1. The difference, if any, between the amount of
promised considerations and the cash selling
price of the promised goods or services, and
2. The combined effect of the expected length
of time between when the entity transfer the
promised goods or services to the customer
and when the customer pays for those goods or
services and the prevailing interest rates in the
relevant market.
A contract does not have a significant financing
component if:
• The customer paid for the goods or services in
advance and the timing of the transfer of those
goods or services is at the discretion of the
customer. For example, billings in excess of cost
(i.e., overbillings) that will be resolved within one
year generally would not need to be evaluated
under the significant financing component
guidance.
• A substantial amount of consideration promised
by the customer is variable, and the amount of
timing of that consideration varies on the basis
of the occurrence or nonoccurrence of a future
event that is not substantially within the control of
the customer or the entity, such as sales-based
royalty.
• The difference between the promised
consideration and the cash selling price of the
good or service occurs because of reasons other
than a financing component, and the difference
between the amounts is proportional to the reason
for the difference. For example, the payment terms
might include a provision that protects either the
buyer or the seller in case the other party does
not fulfill its terms of the contract.

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Also important to note is that an entity may elect to
not account for a significant financing component for
contracts where the entity expects the timing between
the payment from the customer and transfer of control
of the good or service will be one year or less. For
example, billings in excess of costs (i.e., overbillings)
that will be resolved within one year generally would
not need to be evaluated under the significant
financing component guidance.
Another issue that arises in long-term contracts is how
to account for and recognize costs. Existing guidance
doesnotspecifyhowtoaccountforthecostofobtaining
a contract (commissions, legal costs, etc.), resulting in
some entities capitalizing costs and others expensing
them as incurred. Under the new guidance incremental
costs of obtaining a contract that are expected to be
recovered are capitalized and amortized. Incremental
direct costs of obtaining a contract are those costs
that are contingent upon signing the contract such
as direct commissions and contingent legal fees.
Another form of cost, fulfillment costs that are not tied
to a performance obligation, such as design, set-up
and tolling, can be capitalized and amortized. In some
cases, even pre-contract costs related to fulfilling an
expected contract may also be capitalized. In order to
be capitalized, fulfillment costs or pre-contract costs
that are not subject to other accounting guidance such
as for inventory, internal-use software, property plant
and equipment or software to be sold must meet the
following conditions:
• Relates directly to a contract/anticipated contract;
• Generates or enhances resources to satisfy
future performance obligations; and
• Expected to be recovered.
The following costs are expensed:
• General administrative costs unless explicitly
chargeable to the customer;
• Wasted materials, labor and resources not
reflected in the price of the contract;
• Expenses related to satisfying performance
obligations; and
• Expenses that cannot between distinguished
between satisfied and unsatisfied performance
obligations.
Warranties
Accounting for warranties under the new standard will
depend on the type of warranty involved. Assurance
type warranties, or provisions that offer protection
in case the product or service does not function as
agreed upon, will be accounted for under guidance
for guarantees. Service-type warranties, typically
sold separately, must be accounted for as separate
performance obligations. Take the following example.
A manufacturer sells forklifts for $10,000 with a one-
year warranty included. The one-year assurance-
type warranty, which is required by law, costs the
manufacturer$500. Afterthefirstyear,customershave
the option of buying five additional warranty years for
$5,000. A customer contracts with the manufacturer
for a new forklift with a five-year warranty for a total
of $14,000. The manufacturer would analyze the one-
year included warranty, and the five-year additional
warranty provided in the arrangement. In assessing
the warranties, the manufacturer considers that if the
answer is yes to either of the following two conditions
the warranty is a service type warranty:

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1. Does the customer have the option to purchase
the warranty separately? or
2. Does the warranty provide a service beyond
assurance that the product complies with
agreed-upon specifications? In assessing this
condition, evaluate and weight factors such as:
• Is the warranty required by law?
• What is the length of warranty coverage?
• What types of tasks are promised?
Based on the analysis assume the manufacturer
concludes that the on-year included warranty is
an assurance type warranty because it is required
by law and that the optional five-year warranty is a
service type warranty because the customer was
able to purchase it separately. The contract therefore
contains two performance obligations, a forklift and a
five-year warranty. The entity must now allocate the
total transaction price of $14,000 between the two
performance obligations:
Standalone
Selling Price
Relative
Price
Allocated
Revenue
Forklift $10,000 67% $9,333
Warranty $5,000 33% $4,667
Total $15,000 100% $14,000
When bookkeeping the transaction, the following
entries are recorded when control of the forklift is
transferred:
Debit
Account receivable $14,000
Revenue (9,333)
Contract liability (4,667)
To record sale of fork-lift and service-type warranty
Warranty expense 500
Accrued warranty (500)
To record liability for assurance-type warranty guaranty
Recognition of the contract liability (deferred service-
type warranty revenue), occurs in years two through
six. Expenses related to the service-type warranty
are expected to be recognized as incurred.
Variable Consideration
Coupons, rebates, volume discounts, price protection,
rights of return and price concessions are common
forms of variable consideration that manufacturers
may include as part of their contracts. Manufacturers
will recognize variable consideration using either the
most likely amount or expected value, so long as it is
probable that a significant reversal will not occur.
An important decision when deciding how to account
for a contract, or component of a contract, is whether
to use a contract or portfolio method. Although the
new guidance is written at a contract level, a portfolio
method is permitted as long as it is not expected to
result in a materially different outcome.
For rights of return, entities will consider the likelihood
that a customer will return the product as part of the
variable consideration calculation. Take the following
example.
A manufacturer sells a piece of medical equipment
worth $1,000 and estimates there is a 5 percent
chance that the good will be returned. The equipment
cost the manufacturer $800 to make, but it would not
have a significant restocking cost. The manufacturer
would account for the right of return as:

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The information in this MHM Messenger is a brief summary and may not include all the details relevant to your situation.
Please contact your MHM auditor to further discuss the impact on your audit or audit report.
Account Debit
Cash $1,000
Contract asset (Cost x likelihood of return) $40
Cost of sales $760
Revenue ($950)
Inventory ($800)
Contract liability (Transaction price x
likelihood of return)
(50)
The contract asset in the above entry represents the
cost of the equipment expected to be returned, net of
the cost of preparing the product for re-sale, while the
contract liability is the right of return liability expected
to be repaid to the customer.
Get Prepared Early
Learn more about the revenue recognition changes
with our webinar, Top Issues in the New Revenue
Recognition Guidance Manufacturers Should
Consider. For more information on how revenue
recognition will affect manufacturers, please contact
Peter Gold or Mark Winiarski. Peter can be reached
at pgold@cbiztofias.com or 617.761.0739. Mark can
be reached at mwiniarski@cbiz.com or 816.945.5614.