Robert Belcher and Ken Conner co-presented this PowerPoint at the 2012 RocketCity GovCon Conference hosted by Solvability in Huntsville, Ala. on Sept. 20, 2012.

1. FASB Proposals Affecting
Government Contractors
ROBERT BELCHER, CPA
KEN CONNER, CPA

2. Agenda
• Overview and scope of the exposure drafts
• Core principles and implementation guidance
• Recap of some key changes affecting government
contractors
• Preparing for the adoption of the new revenue
recognition and lease standards

3. FASB/IASB Projects and Target Date
FASB/IASB PROJECTS and TARGET DATES
Expected Date
2012/2013
2013
Project 3Q 4Q 1H
Investment Companies F
Accounting for Financial Instruments
Impairment E
Classification and Measurement E
Hedging
Insurance Contracts E
Leases E
Revenue Recognition F
Consolidation: Policy and Procedures F
F - Final document
E - Exposure draft

4. Revenue Recognition
Robert Belcher, CPA
Principal

5. Exposure draft overview
• In November 2011, the FASB and the IASB issued a revised exposure draft.
Revision of exposure draft issued June 2010 entitled “Revenue from Contracts
with Customers”
• Benefits:
– Remove the inconsistencies and weaknesses in the existing standard
– Provide a better framework for addressing revenue recognition issues
– Improves comparability across companies, industries and capital markets
– Simplifies the preparation of financial statements by reducing the number
of requirements
– Provide more useful information to investors through improved disclosure
requirements
• Overview – The revised proposal would replace virtually all the U.S. GAAP
guidance that currently exists on revenue recognition with a single model.
• Applies to any entity that enters into contracts with customers unless those
contracts are in the scope of other standards ( i.e. insurance or lease
contracts)

6. Exposure Draft Status
• Comment period November 14, 2011– March 13,
2012
• Effective date – not earlier than annual periods
beginning on or after January 1, 2015; early adoption
not permitted
• Roundtable discussions were held in April-May 2012.
The FASB will deliberate comments received as well
as consider feedback from the round discussions and
intend to issue a final standard by Q2 2013.

7. Five Distinct Revenue Recognition Steps
Core principle: Recognize revenue to depict the transfer of
goods or services in an amount that reflects the
consideration that an entity receives, or expects to
receive, in exchange for those goods or services.
Applying core principle:
Step #1 - Identify the contract(s) with the customer
Step #2 - Identify separate performance obligations “SPOs”
Step #3 - Determine the transaction price
Step #4 - Allocate transaction price to the SPOs
Step #5 - Recognize the allocated revenue when SPO
satisfied

8. Step #1 – Identify the contract(s) with the
customer
Key provision: An entity should apply the proposed
guidance to each contract identified.
Government contractors will need to consider:
• Contract existence i.e. right to receive
consideration and obligations to transfer
goods/services
• Combine two or more contracts if certain criteria
met
• Determine if contract modification results in SPO

9. Contract modifications i.e. change orders
• Contract modifications are any change in the scope
or price of a contract (or both).
• Treatment of contract modifications:
Account for as separate contract if modification
results in the addition of a SPO at a price that is
commensurate with that additional performance
obligation.
OR
Combine the modification with the contract and
reevaluate the performance obligation and
reallocate the transaction price to each SPO.

10. Step #2 – Identify SPOs
Key provision: Evaluate the terms of the contract and
your customary business practice to identify all
promised goods and services and determine whether
to account for each as a SPO.
• A performance obligation is a promise whether
explicit or implicit in a contract to transfer a good or
service to the customer. You will need to consider
your customary business practices.

11. Economic Units of Measure
• Previously the economic unit of measure was the
entire contract but now is the SPOs.
• Likely impact on government contractors is that more
economic units of measure will be identified (i.e.
design phase, construction phase, warranty).
• Identifying SPOs and allocating the transaction price
will require judgment and therefore experienced
personnel familiar with the new standard will be
needed.
• Revenue recognition is tied to satisfaction of SPOs
which may not be directly related to cost incurred;
cost capitalization rules will have an impact.

12. Separate vs. Bundle SPOs
• If more than one good or service is provided, you will
need to make a determination whether to bundle or
separate the performance obligation.
• Account for each promised good or service as a
separate performance obligation only if it is distinct.
• If not distinct, combine good or service with other
promised goods or services until you identify a bundle of
goods or services that is distinct.
• In some cases, that would result in accounting for all
the goods or services promised in the contract as a
single performance obligation.

13. Distinct Performance Obligations
Distinct if either:
1. You regularly sell the good or service separately, or
2. The customer can use the good or service either on
its own or together with resources that are readily
available to the customer.
Exception: If you transfer goods or services at the same
time, it is not necessary to apply the proposed
requirements to each performance obligation
separately if accounting for those obligations
together would result in the same amount and timing
of revenue recognition as if they were accounted for
separately.

14. Step #3 – Determine the transaction
price
Key provision: The transaction price is the amount of
consideration an entity expects to receive in exchange for
transferring goods or services to a customer.
To meet that objective, estimate the transaction price using
one of the following methods depending on which is most
predictive of the amount of entitled consideration:
– The probability-weighted amount; or
– The most likely amount.
This amount would then be allocated to the SPOs.

15. Step #4 – Allocate the transaction price
• Key provision: Allocate the transaction price to all
SPOs in proportion to the standalone selling price of
the good or service underlying each performance
obligation at contract inception.
• The best evidence of a standalone selling price
would be the observable price of a good or service
when you sell it separately.

16. Step #5 – Recognize revenue when
performance obligation satisfied
• Key provision: Recognize revenue when a
performance obligation is satisfied.
– In order to transfer a good or service, the
customer must obtain control.
• Indications the customer has taken control:
– Customer has unconditional obligation to pay
– Customer has legal title
– Customer has physical possession; exceptions
allowed for consignments and bill and holds.
– Design or function is customer specific
– Risk of ownership has passed to customer

17. Two Options for Revenue Recognition:
Point in Time or Over Time
– Identify each performance obligation within a
contract and determine if performance obligation is
satisfied:
At a point in time, or
• Recognize revenue when control of asset is transferred
to customer.
Over time i.e. continuous transfer.
• Recognize revenue as performance obligation is
satisfied.

18. Over Time i.e. Continuous Transfer
Recognize a performance obligation over time if:
• Your performance creates or enhances an asset that the
customer controls as the asset is being created, or
• Your performance does not create an asset with an
alternative use to you and at least one of the following:
• Customer receives a benefit as you perform each task;
• Another entity would not need to re-perform the tasks
performed to date if that other entity were to fulfill the
remaining obligation to the customer, or
• You have a right to payment for performance to date
even if the customer could cancel the contract for
convenience.

19. Over Time Revenue Recognition Methods
1. Output method – Recognize on basis of units produced
or delivered, contract milestones or surveys of goods or
services transferred to date relative to the total.
2. Input method – Recognize on basis of efforts expended
to date (cost of resources consumed, labor hours
expended, machine hours used) relative to total efforts
to be expended.

20. Recap of Key Concepts
• Fewer contracts may qualify for over time i.e.
continuous transfer revenue recognition. Need to
review contract terms closely.
• You need to meet over time i.e. continuous transfer
requirements to be able to recognize revenue on an
incomplete asset.
• Determine if you must account for change orders as
separate contracts or modifications to existing
contracts (and potentially new SPO).
• The total transaction price is allocated to SPOs
based on relative standalone selling prices.

21. Recap of Key Concepts
• Contract cost have been divorced/separated from
contract revenues therefore the new standard will
address accounting for cost capitalization.
• If cost capitalization rules were not added, many
government contractors might incur negative margins
in the early stages of contracts if performance
obligation not yet met.
• Changes to estimated future COST are not
recognized immediately unless you expect a loss on
the specific SPO.

22. Other Significant Items in Exposure Draft
• Warranties
– Account for a product warranty that related to
quality assurance by accruing warranty cost of the
time revenue is recognized rather than by
deferring revenue.
– A warranty is a SPO if:
• Customer has option to purchase the warranty
separately from the vendor, or
• Warranty provides a service to customer in
addition to assurance that the vendor‟s past
performance occurred as specified in the contract.

23. What You Need to Do
• Apply the proposed standard to your specific customer
contracts to determine the impact.
– It will be challenging to truly know the impact of this
proposed guidance without applying it directly to your
contracts and working through each of the principles.
• Are your current internal controls and operating systems
sufficient?
• Budget and plan for training for your staff
• Remember retroactive application
• Will the new standard impact debt covenants?
• Discuss with your tax preparer.

24. Resources
• FASB Revised Proposed Accounting Standards
Update – Revenue Recognition (Topic 605)
• FASB In Focus –short 2-page summary of proposal
• Accounting Research Manager – Short 17-page
summary of the revised exposure draft
• AICPA website – Interest Areas tab

25. Example – Long-term Contract
• An entity enters into a contract to construct a facility
or produce a product for a customer
• Requires engineering (design), procurement and
production activities
• Design is specific to the customer‟s requirements
and they are involved in specifying major elements
• The entity procures materials and equipment as they
are needed during production
• Customer obtains control of materials and equipment
as they are installed
• Production is expected to take 3 years

26. Example – Long-term Contract
How would the entity recognize revenue?
(Under current GAAP, combine all activities and apply
percentage of completion or completed contract.)

27. Example – Long-term contract
Design services:
Distinct? - Yes, contractor regularly sells design
services separately.
When do you recognize? - Over time as service is
performed - The vendor‟s performance does not
create an asset with an alternative use to the vendor
AND the vendor has a right to payment for
performance to date even if the customer could
cancel the contract for convenience.

28. Example – Long-term Contract
Procurement service:
Distinct? - No, construction company doesn‟t
regularly provide procurement services. Procurement
is an activity that is necessary for the entity to obtain
control of the promised materials and equipment.
When do you recognize? - N/A

29. Example – Long-term Contract
Construction:
Distinct? - Divide into separate performance
obligations if the pattern of transfer of the good or
service is different from the pattern of transfer of
other promised goods or services in the contract,
and the good or service has a distinct function.
When do you recognize? - Recognize revenue for each
performance obligation over time or with the passage of
time when it is satisfied.

30. Leases – The Winding Road
Ahead
A Review of Current and Proposed
Lease Treatment
Ken Conner, CPA
Principal

31. Objectives
• Review of current GAAP related to leases
• Case study on Capital versus Operating Leases
• Current Exposure Draft for Leases –
– What is the objective
– What are they proposing
– How will it work
• Examples of calculations

32. Leases – Current GAAP
• Capital leases meet one or more of the following criteria:
– 1) The lease conveys ownership to the lessee at the
end of the lease term.
– 2) The lessee has an option to purchase the asset at a
bargain price at the end of the lease term.
– 3) The term of the lease is 75% or more of the
economic life of the asset.
– 4) The present value of the rents, using the lessee's
implicit or incremental borrowing rate, is 90% or more
of the fair market value of the asset.
• Operating leases - All other leases

33. Leases – Current GAAP
• Lessee’s incremental borrowing rate - The rate that, at the
inception of the lease, the lessee would have incurred to borrow over
a similar term the funds necessary to purchase the leased asset.
• Interest rate implicit in the lease - The discount rate that,
when applied to (i) the minimum lease payments, excluding that
portion of the payments representing executory costs to be paid by
the lessor, together with any profit thereon, and (ii) the unguaranteed
residual value accruing to the benefit of the lessor, causes the
aggregate present value at the beginning of the lease term to be
equal to the fair value of the leased property to the lessor at the
inception of the lease, minus any investment tax credit retained by
the lessor and expected to be realized by him.

34. Why are FASB and IASB Looking at Lease
Accounting
• Leasing is an important source of finance.
• Provides users of financial statements with a complete
and understandable picture of an entity‟s leasing
activities.
• The models also lead to a lack of comparability and
undue complexity because of the sharp „bright-line‟
distinction between capital leases and operating leases.
• A new approach to lease accounting that would ensure
that assets and liabilities arising under leases are
recognized in the statement of financial position.
From FASB Exposure Draft Leases - August 17, 2010

35. Note from IASB and FASB
• NEWS RELEASE 07/21/11- IASB and FASB Announce Intention to
Re-Expose Leasing - July 21, 2011
Commenting on the decision, Hans Hoogervorst, Chairman of the IASB said:
“Although we have yet to conclude our deliberations on this project, the direction of travel indicates
that there are aspects of our revised proposals that would benefit from additional input from
interested parties.
Leslie F Seidman, Chairman of the FASB, said:
“During our discussions of the extensive comments we received on the exposure draft, the boards
have reaffirmed the major change to lease accounting, which is to report lease obligations and
the related right-to-use on the balance sheet. (emphasis added)
However, the boards decided to make many other changes to address the comments made by
stakeholders. The boards decided that, while we still have other matters to discuss, stakeholders
would appreciate the opportunity to comment on the revised package of conclusions.”
•

36. Capital or Operating – what is important?
– When does the reader of the financial statements
really care about lease obligations of any type?
What is material?
15 year building lease that qualifies as operating
Five year equipment lease that has a NPV of 75%,
80%, 89%
– How is a three year lease obligation different from
a three year note payable?

37. General Rules
• Accelerated Method (current effective interest rate
method) will be applicable for most equipment leases
• Straight-Line Method (current operating lease
accounting) will be applicable for most building/land
leases
– Exception – Accelerated method will be used for
building/land leases if the lease term is a
significant portion of the asset life

38. Determining the Line
• In determining whether the lease life is significant when
compared to the asset life the boards are presenting four
options
– (a) Determination based on the transfer of substantially all of the
risks and rewards of ownership (Capital lease criteria)
– (b) Determination based on whether the ROU asset represents
the acquisition of a more than insignificant portion of the
underlying asset.
– (c) Determination based on the nature of the underlying asset.
– (d) Determination based on the lessee‟s business purpose for
entering into the lease arrangement.
 Source IASB Agenda Paper 3D from June 13, 2012

39. Lessee Accounting - General
“A lessee would recognize an asset (the right-of-use
asset) representing its right to use an underlying
asset during the lease term, and a liability to make
lease payments. The lessee would amortize the
right-of-use asset over the expected lease term or
the useful life of the underlying asset if shorter. The
lessee would incur interest expense on the liability to
make lease payments.”
 SOURCE: Exposure Draft and FASB LEASE UPDATES APRIL 2011

40. Does Not Apply To -
• Short term leases – defined by FASB at its meeting of June 23,
2011 as, “A lease that, at the date of commencement of the
lease, has a maximum possible term, including any options to
renew, of 12 months or less.” (Emphasis added)
• An entity can elect to treat short term leases on a right-to-use
basis on a case-by-case basis
• “Leases” covered elsewhere in GAAP
– Leases with the right to explore for oil and minerals
– Leases for intangibles
– Leases for biological assets (i.e. timber or agricultural
products)
 SOURCE: Exposure Draft, minutes of June 23, 2011 FASB meeting

41. What Would It Do?
• (a) A lessee would recognize an asset representing its right to
use the leased („underlying‟) asset for the lease term (the
„right-of-use‟ asset) and a liability to make lease payments.
• (b) A lessor would recognize an asset representing its right to
receive lease payments and, depending on its exposure to
risks or benefits associated with the underlying asset, would
either:
– (i) recognize a lease liability while continuing to recognize
the underlying asset (a performance obligation approach);
or
– (ii) derecognize the rights in the underlying asset that it
transfers to the lessee and continue to recognize a residual
asset representing its rights to the underlying asset at the
end of the lease term (a derecognition approach).
 SOURCE: Exposure Draft and FASB Lease Updates April 2011

42. Key Components to Measurement
• Assets and liabilities recognized by lessees and
lessors would be measured on a basis that:
– (a) assumes the initial term of the lease and options to renew if
there is an economic incentive to extend the lease term
– (b) included fixed lease payments, variable payments that are
effectively fixed payment and variable payments tied to a rate or
index
– (c) is updated when changes in facts or circumstances indicate
that there would be a significant change in those assets or
liabilities since the previous reporting period.
 SOURCE: Exposure Draft and FASB LEASE UPDATES APRIL 2011

43. Key Components to Measurement
• Other measurement notes
– Don‟t change the interest rate on the original measurement
unless there has been a significant change
Election of option to renew
Renegotiation of key lease terms
• The lessee should allocate payments as follows:
– If the purchase price of each component is observable, the
lessee would allocate the payments on the basis of the
relative purchase prices of individual components;
– If the purchase price of one or more, but not all, of the
components is observable, the lessee would allocate the
payments on the basis of a residual method; or
– If there are no observable purchase prices, the lessee
would account for all the payments required by the contract
as a lease.

44. Example A
• Terms of the Lease –
– Five year triple net operating lease at $48,000 in
year one due on the first day of the month
– Lease payments escalate at 3% per year with no
contingent payments
– Incremental borrowing rate is 7%

45. Example A
• Record lease value –
– Lease Rights $218,042
Lease Obligation $218,042
• Entry to record payment in month two –
– Lease Obligation $2,752
– Interest Expense $1,248
Cash $4,000
• Entry to record „use‟ of lease property
– Lease Amortization - $3,634
Accumulated Amortization $3,634

46. Renewal Options
– Options to extend or terminate when there is a
significant economic incentive to extend, or not to
terminate the lease
– Reassess only when there is a significant change
in relevant factors
 SOURCE: FASB LEASE UPDATES APRIL 2011

47. Transition
• There is no grandfather clause.
• Speculation is that there will be a long lead time to
the effective date- (i.e. 2016).
• Interest rate determined at the date of application.
• Any prepaid or deferred rent at the date of
application included in the amortization of lease
rights.
• Capital leases with no economic incentives to renew
will use the carrying value established under capital
lease treatment.

48. Consequences
• How will lenders view the change in the short term?
In the long term?
• Raises EBITDA, by adding an interest component
previously imbedded in operating leases
• Raises „debt‟ obligation and debt to equity ratio
• If we know what the numbers are, do the bankers
and lawyers know what the documents say?
• Will it make as much sense to use debt as leases in
the future?
 http://ublog.naiglobal.com/blog/2010/09/15/proposed-fasb-lease-accounting-changes-
will-impact-sales-market/

49. Project Status
The Boards have decided to re-expose their proposed
standard
• The Boards released an exposure draft in the fourth
quarter of 2012
• Revised exposure draft expected in fourth quarter
2012
• Assuming a 2013 final standard, the earliest effective
date is likely 2016

50. Reference Sources
• Lease Update – Most current (August 1, 2012)
– http://www.fasb.org/cs/ContentServer?c=FASBContent
_C&pagename=FASB%2FFASBContent_C%2FProjec
tUpdatePage&cid=900000011123#summary
• Original Exposure Draft
– http://www.fasb.org/cs/BlobServer?blobcol=urldata&bl
obtable=MungoBlobs&blobkey=id&blobwhere=117582
1125393&blobheader=application%2Fpdf

51. Annual Tax Seminar
2012 Decosimo Tax Seminar
• October 30th
• Chattanooga Convention Center
• $99 | Eligible for up to 8 hours of CPE
• Register or learn more:
– www.decosimo.com/taxseminar2012

52. Connect with Me
H. Kennedy (Ken) Conner, CPA
Principal – North Alabama
Development
423.756.7100
kenconner@decosimo.com
On LinkedIn:
http://www.linkedin.com/in/kenconner
Disclaimer:
The contents of this presentation are for informational purposes only. The information is not intended to be a substitute for
professional accounting counsel. Always seek the advice of your accountant or other financial planner with any questions you
may have regarding your financial goals or specific situations.

53. Connect with Me
Robert Belcher, CPA
Assurance Principal
423.756.7100
robertbelcher@decosimo.com
On LinkedIn:
http://www.linkedin.com/pub/robert-
belcher/26/200/516
DISCLAIMER: The contents and opinions contained in this presentation are for informational purposes
only. The information is not intended to be a substitute for professional accounting counsel. Always seek
the advice of your accountant or other financial planner with any questions you may have regarding your
financial goals.