The document discusses establishing effective internal controls over revenue recognition for medical technology companies. Key points include communicating revenue recognition policies throughout the organization, establishing controls to ensure adherence to policies and prepare for audits, and focusing on areas of highest risk like estimates and accounting for multi-element arrangements. It provides an overview of the new revenue recognition standards and emphasizes the importance of training, documentation, and ongoing monitoring to implement the changes required.

1. Revenue Recognition for MedTech Companies Effectively Establish and Ensure Adherence to Internal Control Processes

2. Conference Marketing Document Revenue recognition impacts the entire organization, not just it’s financial executives. Communication is critical, especially to executive management (CEO, Sales, Operations) and ultimately to the board of directors. To effectively manage this process, internal accounting controls for interim and annual reporting must account for all points in the organization. In addition, these controls must support the preparation required for an audit.

3. Focus of this Session Establish effective internal accounting controls to ensure procedures are adhered to, Avoid the risk of last minute adjustments to revenue (and sales commissions), Avoid alienating members of the board of directors and other management team members because they do not understand the bean counters mentality, Coordinate with the independent accountants and prepare for an audit of revenue recognition, and Save your job as the champion of appropriate revenue recognition.

4. Revenue Recognition Most complex financial business process to manage. Area with the greatest risk of errors/inaccuracies. Largest single source of public company restatements. Errors may have material impact on financial statements. Required to be considered fraud risk under SAS # 99. Strong Internal Accounting Controls Need To Be In Place!

5. Comments Appreciated Comments on this presentation are welcomed. Please indicate the specific slide number that you are commenting on so the comment can be easily followed.

6. Incidences of Fraud The Deloitte Forensic Center analyzed and reported on hundreds of SEC Accounting and Auditing Enforcement Releases issued from January 2000 through December 2007. Revenue recognition fraud schemes were the most common type, at 38% of the total.

7. Catalysts For Change Initial implementation of formal revenue recognition standards by start-up companies. Convergence with International Accounting Standards Board revenue recognition requirements. Merged companies want to use exactly same policy for revenue recognition. If a problem is detected and revenue recognition controls are not adequate. New system implementations. “ Cultural change is difficult to implement and control.”

8. Evolving Standards US GAAP US GAAP & IFRS Discussion Paper Approach

9. Codification Of U.S. GAAP Effort to pull together standards in one place. 90 topics. Target date for approval = July 1, 2009 See www.asc.fasb.org . Includes a web based search tool. Separate section (605) on revenue recognition. -605 Revenue Recognition (topic) - 25 Multiple-Element Arrangements (subtopic) + 55 Implementation Guidance and Illustrations (section) ++Example 6-Biotech license, research and development and contract manufacturing agreement. (paragraph/example) ++Example 7-Sale of medical equipment with cartridges and installation. (paragraph/example) Codification Should Facilitate Searching of U.S. Standards and Convergence with IFRS!

10. Why Converge with IFRS? Single set of globally-accepted accounting standards. Common understanding by preparers, investors, auditors, standard setters and regulators. Facilitates comparability of financial information, eliminates dual reporting required for foreign locations, easier expansion into foreign markets, increases the mobility of finance professionals and provides easier access to capital markets.

11. US GAAP vs. Discussion Paper Overall Approach US GAAP Rules based approach. Numerous standards. Extensive accounting guidance. Discussion Paper (“DP”) Principles based. Only a few standards on revenue recognition.

12. Question About Risks Are risks more difficult to control in an environment that is rules based, has numerous standards and has extensive accounting guidance OR In an environment that is principles based and only has a few standards?

13. Objectives of New Principle Converge standards, enhance consistency and comparability of transactions. Simplify U.S. GAAP, from the 100 standards now in US GAAP. Provide guidance lacking in IFRS, such as revenue recognition with multiple deliverables.

14. Principle Contract with a customer includes rights to receive promised consideration and obligations to provide goods or perform services. Revenue is recognized on the basis of increases in a company’s net position in a contract with a customer. Contract rights are measured based upon the transaction price at the outset of the arrangement. Performance obligations are measured based on the estimated selling price and are recorded at an allocated amount based on the total customer consideration. As a company performs its obligations in a contract, where the rights exceed the obligations, the company has a net contract asset. Where the obligations exceed the rights, the company has a net contract liability. A company’s net position at contract inception is zero.

15. Proposed DP Changes In Standards That May Need To Be Controlled US GAAP and IFRS will have a converged model. A single revenue standard for all contracts. Revenue will be recognized when performance obligations are satisfied by transferring promised assets to customers. The transfer of control of assets will drive revenue recognition. Companies may no longer use the percentage of completion method as a separate revenue recognition model. Performance obligations must be identified and separated. The transaction price will be allocated to separate performance obligations such as a warranty or a right of return. Required to use estimates to reflect stand alone selling prices. May have to change allocation and estimation methods. Certain sales incentives may be treated as performance obligations. Performance obligations may need to be remeasured over the life of an arrangement. Certain contract costs may no longer be capitalized.

16. How Might The Proposed Model Work? Identify and separate performance obligations. Determine the transaction price, including the measurement of contract rights. Allocate the transaction price to the performance obligations on a relative stand-alone selling price basis-that is the company’s selling price of the goods and services underlying the performance obligations. Recognize revenue when performance obligations are satisfied as control of assets are transferred to the customer. Remeasure performance obligations when deemed onerous.

17. Areas That Need To Be Addressed Many open areas that need to be addressed-not in DP. Examples: Non-cash consideration. Changes in contracts terms and conditions. Gross vs. net presentation of revenue. Any transactions to be excluded (i.e. financial instruments). Disclosure required. Others-some not yet identified.

18. Questions On New Principle? Do you think the new principle will accomplish the objectives in your company: Consistency among transactions? Simplicity? Better guidance than IFRS? Will it be easy to educate nonfinancial management and have them understand these principles? Will the change in standards have a significant impact on your business operations? Will the change in standards have a significant impact on the amount of revenue your company recognizes?

19. Flip Flop on Positions When adopting DP you might now be required to adopt positions that are different from positions that you previously took! “ I voted for it before I voted against it.”

20. Example of Flip-Flop Previous standard Customer needs to be able to “use” the product before revenue can be recognized. Future standard Customer may not be required to be able to use the product before revenue is recognized.

21. Example of Flip-Flop Previous standard Percentage of completion accounting permitted. Future standard Percentage of completion accounting not permitted unless there is a continuous transfer of assets to the customer as the contract progresses.

22. Revenuerecognition.com Survey of 515 Companies (5/28/09) 54% agree or strongly agree that a contract-based approach to revenue recognition would clarify earnings process. Disagreement exists as contracts become more complex. 66% said there would be little or no difference in the timing of their revenue recognition. Industries where long-term, multiple phase projects make customer control very difficult to determine or achieve, the impact could be significant. More than 70% agreed with the Boards’ proposal to use stand alone pricing as the basis for allocating revenue. Management should be allowed to use estimated prices under some circumstances. Serious concerns expressed on the matter of estimated prices.

23. Overall Areas Of Risk Standards are not adequately understood People not educated Processes do not support standards Internal controls are inadequate Systems are inadequate Customer agreements/accounting are not consistent Measurement not broken-out Shipment/delivery issues Collection issues Prioritize These Risks In Your Organization!

24. Examples of Risks (GAAP Standard) CFO of a small cap publicly traded medical device company resigns on first day of the month following quarters end. Senior executive of a privately owned company has emotional outburst in the middle of a board meeting when he finds revenue will be adjusted on an interim basis. Privately owned medical imaging company discovered in due diligence that the companies software agreement did not correspond with the customer contracts, resulting in restatement of revenue and changes to the contracts for future revenue. VP of Sales and CFO internally provided different month to date “sales” amounts to CEO of privately owned company. Privately owned company recognized revenue 30 days after shipment due to “guarantee of money back refund for 30 days if not satisfied.”

25. How To Get Started Devise an overall strategy. Determine the impact on your company. Identify a project team and governance structure. Develop a detailed plan.

26. Start Early Not an issue to address at month end. Resolution when closing financial statements is way too late. Implementation will be time consuming. Contracts with customers might be involved. Business practices may need to be changed. IT systems issues might need to be addressed. Might impact world-wide operations. DP requirements ARE different and complex!

27. Timetable Discussion Comment Exposure New Effective Paper Period Ended Draft Standard Date Issued June 19, 2009 1 st ½ of 1 st ½ of 2012 or 12/19/2008 2010 2011 2013? Question-Is this Timeline Reasonable For Implementation and Compliance?

28. Intangible Benefits of Starting Early More effective process for implementation. More efficient revenue cycle processes. Overall lower costs. Credibility with those outside of finance group. Management team: More cooperation Less dissention Leadership implications

29. Devise An Overall Strategy Perform an initial assessment. Conduct a detailed gap analysis. Develop and communicate project deliverables, timelines and budgets.

30. Common Control Elements Understand Accounting standard Company environment Gather information Communicate Assess risk Coordinate Monitor and control activities Identify Key Controls! Monitor Coordinate Assess Risk Communication Information Understand Control

31. Who Needs to Understand Revenue Recognition Concepts Board of directors Audit committee All management Sales personnel Finance department Operating personnel Human resource personnel Information systems personnel Legal counsel Internal audit personnel Investor relations personnel This is not an issue for finance to manage in isolation!!

32. Revenue Recognition Committee Should serve one of the company’s primary internal controls. It should ensure that revenue recognition policies and procedures are accepted on a company wide basis. Intended to ensure compliance with the company’s revenue recognition policies and procedures. Conduct meetings at least quarterly to review and discuss significant transactions, how revenue can be recognized, requirements for revenue recognitions and ways to satisfy the requirements.

33. Revenue Recognition Committee Supervise other departments with a role in revenue recognition issues, such as contracts management. Train sales department personnel and others as to the proper conduct of business under the revenue recognition rules. Chaired by the CFO and include a member of the audit committee, legal counsel responsible for sales and service documents, contract management personnel, accounting department personnel responsible for revenue recognition issues and a vice president or manager of sales and other personnel involved in tracking and reporting sales.

34. Self Education Understand the details of the standard. Understand the drivers to your companies revenue cycle. Discuss situations with others outside the company. Read, read, read. Apply understanding to your company situation. Don’t fight the overall standard, the CFO and the independent accountants are there to enforce compliance with the standard. Can’t blame it on “them”.

35. Resources Available www.softrax.com www.revenuerecognition.com LinkedIn groups Independent accounts web sites: www.pwc.com www.ey.com www.kpmg.com www.deloitte.com

36. revenuerecognition.com http:// www.revenuerecognition.com/revrecchallenge/tellafriend

37. Communicate and Educate Others Everybody has an opinion. Opportunity for leadership by the finance staff. Some directors may not be up to date, relying on former business practices. Hypothetical examples will be important because it is common to ask “what if”. More formal seminars: Independent accountants. Executives of other companies.

38. Issues to Consider in Designing Controls What factors provide the best evidence of the transfer of control for your products? Is control based on legal control, time or physical control or a combination of these factors? Are existing contract templates adequate-should contracts forms be modified or amended? How will agreements that are not in writing be handled in your organization? Are systems and processes impacting revenue recognition adequate? What training is required for finance and nonfinance staff involved in revenue recognition and negotiating contracts?

39. Issues to Consider in Designing Controls Do compensation and incentive programs encourage or discourage compliance by the sales force? Does conformity impact tax issues-transfer pricing, state and local tax apportionment factors, franchise taxes or deferred taxes? What “education” is required for outside users of the financial statements-bankers, analysts, rating agencies? Does your organization recognize revenue for clinical trials or pay for performance agreements?

40. Issues to Consider in Designing Controls Is software a significant component of the product or is software sold separately? Are software updates, upgrades and other support services provided on the software component of the product? Does your company provide post-contract support? Are the costs to develop the software component of the product significant in relation to the costs of development of the product?

41. Contract Terms Pricing Discounts Delivery schedules Performance incentives Multiple elements

42. Coordinate and Work Together Cross functional approach. Include independent accountants. Common objectives. Identify touch points in the work flow process. Review hypothetical situations. Review contracts and other documents. Outline compliance requirements.

43. D&T Revenue Strategy

44. Example Touch Points Annual forecasting Sales planning Bonus/commission structure development Sales process Contracting/legal Order entry Manufacturing scheduling Warehousing/shipping Receiving (for returns) Invoicing Internal reporting Information systems Cost accounting General accounting External reporting Royalty calculations Tax reporting Customers/hospitals Distributors

45. Overall System Enhance revenue recognition functional in financial and other systems. Establish single source of “clean” revenue data. Implement business intelligence solution for analyzing revenue. Integrate sales, contract, service and support activities. Eliminate spreadsheets. Standardize revenue consolidation and reporting procedures. Reporting Compliance Accounting Recognition Allocation Scheduling Revenue System

46. Contracts Management Should be independent of the sales operation. Responsible for generating all sales contracts on approved forms. Ensures that all required signatures are obtained. Maintains files of all sales transactions, which should include all documents related to revenue recognition. Contradictory side letters should be prohibited. Contracts manager should apply the revenue recognition rules, policies and procedures to every transaction. For unusual transactions, an analysis should be prepared of its impact on revenue recognition, for further evaluation and review. Contract manager serves as the primary liaison with the auditors on all revenue issues.

47. Pricing Issues with Multi-Element Arrangements Historical pricing information must be collected to establish vendor specific objective evidence (VSOE). Rules use VSOE to determine the fair value of each item sold in a transaction. Sales department should understand VSOE in pricing strategies. Requires: A database of the current and past prices charged for each product and services sold A review of the pricing of all transactions to ensure consistency and flag exceptions.

48. Questions On Implementation? What additional investment in systems will be required? What incremental resources (people, training, contract specialists) will be required? Should a worldwide project manager for revenue recognition be appointed? Will moving to a global, single revenue recognition standard free up resources? Will establishment of a shared service center approach result in synergies and cost savings?

49. Formalize Results Develop compliance policies. Develop contract templates. Draft disclosures and footnotes. Develop internal accounting controls. Document controls. Update Sarbanes-Oxley documentation. Pull It All Together!

50. Policies & Procedures An outline of the organizations structure formed to implement the revenue recognition procedures. An explanation of the company’s business model and a description of each type of transaction. A sample of the revenue recognition rules and how they should be applied to transactions within the company’s business model. A description of the key revenue recognition issues which are in the company’s transactions, and ways of handling them. A comprehensive list of prohibited transactions. Procedures for archiving and cataloging pricing information, which is necessary for revenue recognition in multi-element transactions.

51. Implement and Monitor Budget vs. actual analyses of shipments and revenue. Finance meeting with sales personnel to review significant assumptions in accrued revenue recognition. Finance meeting with operating personnel to review significant assumptions in returns reserve calculations. Review detailed reports of product held by distributors. Compare usage data to the quantity of products on hand at distributors. Require formal documentation of a agreements related to revenue, with appropriate review by finance and legal (no “side agreements”). Create a mechanism for responding to questions, particularly from sales personnel.

52. Revenue Recognition Key Performance Indicator’s Revenue backlog Aged revenue-revenue that was to be recognized but was delayed Deferred revenue Consider applying on a product, segment, region or account basis to improve revenue performance.

53. Accounting Estimates/Reserves Components of multiple-element arrangements. Transfers to customers that result in revenue recognition. Consignment arrangements. Remeasurement when the cost to satisfy a performance obligation exceeds the initial measurement. FOB destination reserves. Product returns. Warranty and other post-delivery services.

54. Control and Enforcement Internal audit Traditional areas-channel stuffing, excess returns. New focus on areas of DP. Audit committee understanding of business. Independent accountants as partners. Clearly defined role of controller/CFO. Sarbanes-Oxley requirements. Most Effective Control “Tone from the Top”

55. Questions On Control? To what extent must your Sarbanes-Oxley documentation need to be revised to implement the new standard? How will your company address challenges of using more estimates in light of Sarbanes-Oxley?

56. Ethical Issues AICPA issued guide to comply with its Code of Professional Conduct, affecting members in public practice, business, academia and government. The guide provides an approach to help solve CPA’s ethical dilemmas. The approach involves identifying and evaluating ethical “threats” and if a threat is more than trivial, applying “safeguards” to eliminate or mitigate the threat. “ Safeguards” are actions or other measures that eliminate threats or reduce them to acceptable levels. Facing nontrivial threats or lacking effective safeguards??

57. AICPA Defined Threats Self-review threat. Advocacy threat. Adverse interest threat. Familiarity threat. Undue influence threat. Self-interest threat. Threats result in a loss of objectivity!!

58. Resolving Ethical Issues Recognize and consider all relevant facts and circumstances, Consider the ethical issues involved, Consider established internal procedures, Seek advice, Legal counsel Professional bodies Firm or employer personnel Formulate alternative courses of action.

59. Questions Any Questions?? Comments on this presentation are welcomed. Please email your suggestions for improvement to bob@dicksonconsulting.biz. Please indicate the specific slide number that you are commenting on so the comment can be easily followed.

60. Background On Bob Dickson Several years with an international public accounting firm. Many years as a CFO Member of board of trustees of mutual funds

61. www.dicksonconsulting.biz

62. Professional networking site Background Contacts Presentations References www.linkedin.com/in/dickson1