| Revenue Recognition | Revenue Recognition We enter into contracts with customers typically having multiple commitments of goods and services including any combination of designing, developing, manufacturing, modifying, installing and commissioning of flow management equipment and providing services and parts related to the performance of such products. We evaluate the commitments in our contracts with customers to determine if the commitments are both capable of being distinct and distinct in the context of the contract in order to identify performance obligations. We recognize revenue when (or as) we satisfy a performance obligation by transferring control of the performance obligation to a customer. Control of a performance obligation may transfer to the customer either over time or at a point in time depending on an evaluation of the specific facts and circumstances for each contract, including the terms and conditions of the contract as agreed with the customer, as well as the nature of the products or services to be provided. Our larger contracts are typically completed within a one to three-year period, while many other contracts, such as “short cycle” contracts, have a shorter timeframe for revenue recognition. Control transfers over time when the customer is able to direct the use of and obtain substantially all of the benefits of our work as we perform. This typically occurs when products have no alternative use and we have a right to payment for performance completed to date, including a reasonable profit margin. Our contracts often include cancellation provisions that require the customer to reimburse us for costs incurred up to the date of cancellation, and some contracts also provide for reimbursement of profit upon cancellation in addition to costs incurred to date. Our primary method for recognizing revenue over time is the POC method. We measure progress towards completion by applying an input measure based on costs incurred to date relative to total estimated costs at completion (i.e., the cost-to-cost method). This method provides a reasonable depiction of the transfer of control of products and services to customers as it ensures our efforts towards satisfying a performance obligation, as reflected by costs incurred, are included in the measure of progress used for recognition of revenue. Costs generally include direct labor, direct material and manufacturing overhead. Costs that do not contribute towards control transfer are generally immaterial, but are excluded from the measure of progress in the event they are significant. Historically, revenue recognized under the POC method has been 5% to 10% of our consolidated sales. Under the New Revenue Standard, we have experienced an increase in the amount of revenue recognized over time. This increase is primarily due to the application of the new “transfer of control” model for revenue recognition. Under this model, revenue for performance obligations subject to contractual transfer of control during the manufacturing process must be recognized over time. This includes contracts with cancellation provisions that require reimbursement for costs incurred plus a reasonable margin and for which the performance obligation has no alternative use. Revenue from products and services transferred to customers over time accounted for approximately 23% and 3% of total revenue for the three month periods ended March 31, 2018 and 2017 , respectively. If control does not transfer over time, then control transfers at a point in time. We recognize revenue at a point in time at the level of each performance obligation based on the evaluation of certain indicators of control transfer, such as title transfer, risk of loss transfer, customer acceptance and physical possession. Revenue from products and services transferred to customers at a point in time accounted for approximately 77% and 97% of total revenue for the three month periods ended March 31, 2018 and 2017 , respectively. A contract modification, or “change order,” occurs when the existing enforceable rights and obligations of a contract change, such as a change in the scope, price or terms and conditions. We account for a change order as a new accounting contract when the change order is limited to adding new, distinct products and services that are priced in an amount consistent with standalone selling price. Other change orders are accounted for as a modification of the existing accounting contract. When a change order occurs for a contract having in-process over time performance obligations, the effect of the change order on the transaction price and the measure of progress for the performance obligations to which it relates is recognized as an adjustment to revenue (either as an increase in or a reduction of revenue) on a cumulative catch-up basis. Freight charges billed to customers are included in sales and the related shipping costs are included in cost of sales in our consolidated statements of income. If shipping activities are performed after a customer obtains control of a product, we apply a policy election to account for shipping as an activity to fulfill the promise to transfer the product to the customer. We apply a policy election to exclude transaction taxes collected from customers from sales when the tax is both imposed on and concurrent with a specific revenue-producing transaction. In certain instances, we provide guaranteed completion dates under the terms of our contracts. Failure to meet contractual delivery dates can result in late delivery penalties or liquidated damages. In the event that the transaction price of such a contract is probable of experiencing a significant reversal due to a penalty, we constrain a portion of the transaction price. This reduction to the transaction price could potentially cause estimated total contract costs to exceed the transaction price, in which case we record a provision for the estimated loss in the period the loss is first projected. In circumstances where the transaction price still exceeds total projected costs, the estimated penalty generally reduces profitability of the contract at the time of subsequent revenue recognition. Our incremental costs to obtain a contract are limited to sales commissions. We apply the practical expedient to expense commissions as incurred for contracts having a duration of one year or less. Sales commissions related to contracts with a duration of greater than one year are immaterial to our financial statements and are also expensed as incurred. We have not identified any material costs to fulfill a contract that qualify for capitalization under ASC 340-40. Performance Obligations 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 for recognition of revenue. Many of our contracts have multiple performance obligations as the promise to transfer the individual goods or services, or certain groups of goods and services, is separately identifiable from other promises in the contract. We allocate the transaction price of each contract to the performance obligations on the basis of standalone selling price and recognize revenue when, or as, control of each performance obligation transfers to the customer. For standard products, we identify the standalone selling price based on directly observable information. For customized or unique products and services, we apply the cost plus margin approach to estimate the standalone selling price. Under this method, we forecast our expected costs of satisfying a performance obligation and then add an appropriate standalone market margin for that distinct good or service. We have elected to use the practical expedient to not adjust the transaction price of a contract for the effects of a significant financing component if, at the inception of the contract, we expect that the period between when we transfer a promised good or service to a customer and when the customer pays for that good or service will be one year or less. A material product warranty exists when a customer has specifically requested or negotiated a warranty period that is significantly longer than our standard warranty period (i.e., a “service-type warranty”) and where the warranty obligation is material in the context of the contract. It is not common for our contracts to contain material product warranties. However, when such a warranty exists, we account for it as a separate performance obligation. We estimate the standalone selling price of the warranty obligation utilizing a cost plus margin approach and allocate a portion of the transaction price to the warranty performance obligation on the basis of estimated standalone selling price. We recognize revenue for warranty performance obligations over time on a straight line basis over the extended warranty period. A material right option is a benefit provided to a customer in a current contract, such as an option to receive future products or services for free or at a significant discount, that is incremental to benefits widely available to similar customers that do not enter into a specific contract. It is not common for our contracts to contain material right options. However, when a material right option exists, it is accounted for as a separate performance obligation and a portion of the transaction price is allocated to the performance obligation based on the estimated standalone selling price of the option. Revenue is recognized when (or as) the customer exercises the right to acquire future products and/or services. On March 31, 2018 , the aggregate transaction price allocated to unsatisfied (or partially unsatisfied) performance obligations was approximately $1,341 million . We estimate recognition of approximately $1,180 million of this amount as revenue in 2018 and an additional $161 million in 2019 and thereafter. During the first quarter of 2018, revenue recognized for performance obligations satisfied (or partially satisfied) in prior periods was not material. ASC 606 Adoption Impact We applied ASC 606 only to contracts that were not substantially complete as of January 1, 2018 and reflected the aggregate impact of all contract modifications (“change orders”) that occurred before the beginning of the earliest period presented when accounting for modified contracts at transition. The following table presents the cumulative effect of the changes made to our condensed consolidated balance sheet as of January 1, 2018 related to the adoption of the New Revenue Standard: December 31, Adjustments due to adoption of New Revenue Standard January 1, (Amounts in thousands) Accounts receivable, net of allowance for doubtful accounts(1) 856,711 (49,247 ) 807,464 Contract assets, net(2) — 219,496 219,496 Inventories, net(3) 884,273 (240,368 ) 643,905 Prepaid expenses and other 114,316 (4,457 ) 109,859 Total current assets 2,558,745 (74,576 ) 2,484,169 Deferred taxes 51,974 (2,706 ) 49,268 Other assets, net 199,722 2,005 201,727 Total assets 4,910,474 (75,277 ) 4,835,197 Accounts payable 443,113 10,165 453,278 Accrued liabilities(5) 724,196 (290,592 ) 433,604 Contract liabilities(4) — 178,235 178,235 Total current liabilities 1,242,908 (102,192 ) 1,140,716 Retirement obligations and other liabilities 496,954 6,568 503,522 Retained earnings(6) 3,503,947 20,015 3,523,962 Total equity 1,670,954 20,347 1,691,301 Total liabilities and equity 4,910,474 (75,277 ) 4,835,197 (1) Adjusted for contract assets accounted for under delivery based methods, previously reported in receivables, net. (2) Represents our right of payment in advance of our contractual right to bill the customer. (3) Adjusted for contract assets accounted under the over time method, previously reported in inventories, net. (4) Represents contractual billings in excess of revenue recognized at the contract level, previously reported in accrued liabilities. (5) Adjusted for deferred revenue previously reported in accrued liabilities and reclassified to contract assets and contract liabilities. (6) The cumulative impact to our retained earnings at January 1, 2018 was $20.0 million . The modified retrospective approach requires a dual reporting presentation to be disclosed in the year of adoption. The dual reporting requirement outlines the impact amount by which a financial statement line is affected in the current reporting period by the adoption of the New Revenue Standard as compared with the previous standard in effect before the adoption. The following tables present the dual reporting requirements: Three Months Ended March 31, 2018 (Amounts in thousands, except percentages) Balances without Adoption of New Revenue Standard Effect of Change As Reported Sales $ 849,229 $ 70,725 $ 919,954 Cost of sales (584,474 ) (64,047 ) (648,521 ) Gross profit 264,755 6,678 271,433 Gross profit margin 31.2 % 9.4 % 29.5 % Selling, general and administrative expense (229,237 ) 61 (229,176 ) Net earnings from affiliates 3,168 — 3,168 Operating income 38,686 6,739 45,425 Operating income as a percent of sales 4.6 % 9.5 % 4.9 % Interest expense (14,879 ) — (14,879 ) Interest income 1,639 — 1,639 Other expense, net (6,944 ) (211 ) (7,155 ) Earnings before income taxes 18,502 6,528 25,030 Provision for income taxes (6,546 ) (2,025 ) (8,571 ) Net earnings, including noncontrolling interests 11,956 4,503 16,459 Less: Net earnings attributable to noncontrolling interests (1,316 ) — (1,316 ) Net earnings attributable to Flowserve Corporation $ 10,640 $ 4,503 $ 15,143 March 31, 2018 (Amounts in thousands) Balances without Adoption of New Revenue Standard Effect of Change As Reported Accounts receivable, net 850,451 (75,207 ) 775,244 Contract assets, net — 286,190 286,190 Inventories, net 1,010,168 (308,321 ) 701,847 Prepaid expenses and other 120,509 (8,134 ) 112,375 Total current assets 2,516,785 (105,472 ) 2,411,313 Deferred taxes 50,451 (2,706 ) 47,745 Other assets, net 201,549 802 202,351 Total assets 4,877,692 (107,376 ) 4,770,316 Accounts payable 382,634 16,728 399,362 Accrued liabilities 735,167 (329,958 ) 405,209 Contract liabilities — 176,906 176,906 Total current liabilities 1,189,285 (136,324 ) 1,052,961 Retirement obligations and other liabilities 508,785 3,600 512,385 Retained earnings 3,489,748 24,548 3,514,296 Total equity 1,678,199 25,348 1,703,547 Total liabilities and equity 4,877,692 (107,376 ) 4,770,316 Disaggregated Revenue We conduct our operations through three business segments based on the type of product and how we manage the business: • Engineered Product Division ("EPD") for long lead time, custom and other highly-engineered pumps and pump systems, mechanical seals, auxiliary systems and replacement parts and related services; • Industrial Product Division ("IPD") for engineered and pre-configured industrial pumps and pump systems and related products and services; and • Flow Control Division ("FCD") for engineered and industrial valves, control valves, actuators and controls and related services. Our revenue sources are derived from our original equipment manufacturing and our aftermarket sales and services. Our original equipment revenues are generally related to originally designed, manufactured, distributed and installed equipment that can range from pre-configured, short-cycle products to more customized, highly-engineered equipment ("Original Equipment"). Our aftermarket sales and services are derived from sales of replacement equipment, as well as maintenance, advanced diagnostic, repair and retrofitting services ("Aftermarket"). Each of our three business segments generate Original Equipment and Aftermarket revenues. The following table presents our customer revenues disaggregated by revenue source: Three Months Ended March 31, 2018 (Amounts in thousands) EPD IPD FCD Total Original Equipment $ 139,628 $ 114,394 $ 210,534 $ 464,556 Aftermarket 317,160 72,858 65,380 455,398 $ 456,788 $ 187,252 $ 275,914 $ 919,954 Three Months Ended March 31, 2017(1) (Amounts in thousands) EPD IPD FCD Total Original Equipment $ 127,409 $ 107,853 $ 221,304 $ 456,566 Aftermarket 289,661 62,149 57,942 409,752 $ 417,070 $ 170,002 $ 279,246 $ 866,318 (1) Prior period is presented in accordance with Topic 605. Our customer sales are diversified geographically. The following table presents our revenues disaggregated by geography, based on the shipping addresses of our customers: Three Months Ended March 31, 2018 (Amounts in thousands) EPD IPD FCD Total North America(1) $ 183,036 $ 75,839 $ 124,408 $ 383,283 Latin America(1) 33,778 7,685 5,669 47,132 Middle East and Africa 61,690 15,144 33,049 109,883 Asia Pacific 108,082 20,020 56,222 184,324 Europe 70,202 68,564 56,566 195,332 $ 456,788 $ 187,252 $ 275,914 $ 919,954 Three Months Ended March 31, 2017(2) (Amounts in thousands) EPD IPD FCD Total North America(1) $ 159,228 $ 70,148 $ 113,162 $ 342,538 Latin America(1) 33,368 7,182 14,483 55,033 Middle East and Africa 72,779 13,735 28,895 115,409 Asia Pacific 80,576 22,439 44,580 147,595 Europe 71,119 56,498 78,126 205,743 $ 417,070 $ 170,002 $ 279,246 $ 866,318 (1) North America represents United States and Canada; Latin America includes Mexico. (2) Prior period is presented in accordance with Topic 605. Contract Balances We receive payment from customers based on a contractual billing schedule and specific performance requirements as established in our contracts. We record billings as accounts receivable when an unconditional right to consideration exists. A contract asset represents revenue recognized in advance of our right to receive payment under the terms of a contract. A contract liability represents our right to receive payment in advance of revenue recognized for a contract. The following table presents opening and closing balances of contract assets and contract liabilities, current and long-term, for the three months ended March 31, 2018 : ( Amounts in thousands) Contract Assets, net (Current) Long-term Contract Assets, net(1) Contract Liabilities (Current) Long-term Contract Liabilities(2) Beginning balance, January 1, 2018 $ 219,496 3,990 $ 178,235 $ 3,925 Revenue recognized that was included in contract liabilities at the beginning of the period — — (75,313 ) — Increase due to revenue recognized in the period in excess of billings 214,819 11 — — Increase due to billings arising during the period in excess of revenue recognized — — 74,659 — Amounts transferred from contract assets to receivables (147,921 ) — — — Other, net (204 ) 1,778 (675 ) (501 ) Ending balance, March 31, 2018 $ 286,190 $ 5,779 $ 176,906 $ 3,424 _____________________________________ (1) Included in other assets, net. (2) Included in retirement obligations and other liabilities. |
