Revenue

In May 2014, the FASB issued an amendment on revenue recognition. The amendment created Topic 606, Revenue from Contracts with Customers, and supersedes the revenue recognition requirements in ASC Topic 605, Revenue Recognition, including most industry-specific revenue recognition guidance throughout the Industry Topics of the Codification. In addition, the amendment supersedes the cost guidance in Subtopic 605-35, Revenue Recognition-Construction-Type and Production-Type Contracts, and created new Subtopic 340-40, Other Assets and Deferred Costs-Contracts with Customers. The core principle of ASC Topic 606 is that an entity recognizes revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services.

We adopted ASC Topic 606 Revenue from Contracts with Customers and all the related amendments ("new revenue standard") on January 1, 2018, using the modified retrospective method. The cumulative effect of the adoption was recognized as an increase to retained earnings (accumulated deficit) of $1 million and the changes made to our consolidated January 1, 2018 opening balance sheet for the adoption of ASC Topic 606 were as follows:



	Balance at December 31, 2017			Adjustments Due to ASU 2014-09			Adjustments Due to ASU 2016-16 (a)			Balance at January 1, 2018
	(Millions)
Balance Sheet
Assets
Inventory	$	869		$	(5	)	$	—		$	864
Prepayments and other (including contract assets)	291			6			—			297
Equity
Retained earnings (accumulated deficit)	(946		)	1			(2		)	(947		)

(a) Cumulative effect of adopting Accounting Standard Update 2016-16, Income Taxes - Intra Entity Transfers of Assets Other Than Inventory (Topic 740). See Note 12, New Accounting Pronouncements for further information.

Revenue from contracts with customers

We account for a contract when it has approval and commitment from both parties, the rights of the parties are identified, payment terms are identified, the contract has commercial substance and collectability of consideration is probable. While the majority of the contracts we enter into with original equipment (“OE”) and aftermarket customers are long-term supply arrangements, the performance obligations are established by the enforceable contract, which is generally considered to be the purchase order but in some cases could be the delivery release schedule. The purchase order, or related delivery release schedule, is of a duration less than one year. As such, the Company applies the practical expedient in ASC paragraph 606-10-50-14 and does not disclose information about remaining performance obligations that have original expected durations of one year or less, for which work has not yet been performed.

Certain taxes assessed by governmental authorities on revenue producing transactions, such as value added taxes, are excluded from revenue and recorded on a net basis.

Performance Obligations

The Company generates revenue through the design, manufacture, and sale of clean air and ride performance systems and products for light vehicle, commercial truck, off-highway and other applications. We recognize revenue for sales to our OE and aftermarket customers when transfer of control of the related good or service has occurred. Revenue from most of OE and aftermarket goods and services is transferred to customers occurs at a point in time. Contract terms with certain of our OE customers results in products and services being transferred over time due to the customized nature of some of our products together with contractual provisions in certain of our customer contracts that provide us with an enforceable right to payment for performance completed to date.

Under typical terms, we do not have the right to consideration until the time of shipment from our plants or distribution center or the time of delivery to our customers. The timing of revenue recognition from products transferred to customers over time may be slightly accelerated compared to our right to consideration at the time of shipment or delivery. We invoice the customer once transfer of control has occurred and we have a right to payment. Our typical payment terms vary based on the customer and the type of goods and services in the contract. The period of time between invoicing and when payment is due is not significant. Amounts billed and due from our customers are classified as receivables on the balance sheet. As our standard payment terms are less than one year, we have elected the practical expedient under ASC paragraph 606-10-32-18 to not assess whether a contract has a significant financing component.

Original Equipment

In a typical arrangement with an OE customer, purchase orders are issued for pre-production activities, which consist of engineering, design and development, tooling, and prototypes for the manufacture and delivery of component parts. We have concluded that these activities are not in the scope of ASC Topic 606 and for that reason, the Company has not made any changes to how it accounts for reimbursable pre-production costs, currently accounted for as a cost reduction. Generally, in connection with the sale of exhaust systems to certain OE manufacturers, we purchase catalytic converters and diesel particulate filters or components thereof including precious metals (“substrates”) on behalf of our customers which are used in the assembled system. These substrates are included in our inventory and are “passed through” to the customer at our cost, plus a small margin. Since we take title to the substrate inventory and have responsibility for both the delivery and quality of the finished product including the substrates, the revenues and related expenses are recorded gross. Revenues recognized for substrate sales were $621 million and $541 million for the three month periods ended June 30, 2018 and 2017, respectively, and $1,273 million and $1,088 million for the six month periods ended June 30, 2018 and 2017, respectively.

Due to the highly customized nature of certain finished components for our OE customers, revenue is recognized over time, consistent with the transfer of control of an asset with limited alternative use, and the Company having an enforceable right to payment for performance completed to date. We consider an input measure (e.g., costs incurred to date relative to total estimated costs at completion) as a fair measure of progress for the recognition of over time revenue associated with these customized parts. A cost measure best depicts the means of transfer of goods to the customer, which occurs as we incur costs to fulfill contracts. Total revenue recognized over time for such customized parts totaled less than $1 million and $2 million for the three and six month periods ended June 30, 2018, respectively.

Prices for our OE customer base are generally fixed on the purchase order and allocation of consideration between goods and services is rare as the highly customized parts are considered sold at their standalone selling price. If an occasion arose whereby a finished component was not deemed sold at its standalone selling price, consideration would be allocated among different performance obligations based on an estimate, most likely cost plus margin, of the standalone selling price of each distinct good or service in the contract.

Aftermarket

Our aftermarket customers take delivery of finished components, which are recognized as revenue at the time the customer takes possession, which is usually at the time of shipment. This determination is based on applicable shipping terms as well as the consideration of other indicators, including timing of when the Company has a present right to payment, when physical possession of products is transferred to customers, when the customer has the significant risks and rewards of ownership of the asset, and any provisions in contracts regarding customer acceptance. While unit prices are generally fixed, for certain of our aftermarket customers, we provide for variable consideration, typically in the form of promotional incentives and returns at the time of sale. Expected values are based upon the contractual terms of the incentives and historical experience with returns. In most cases, we are able to derive the expected value of variable consideration at a level to conclude it is probable that a significant revenue reversal will not occur in future periods. In cases where the high threshold for recognition is not established, such amounts will be constrained and recognized when the uncertainty underlying the constraint is resolved. Certain aftermarket contracts with customers include terms and conditions that provide for inventory adjustments that result in a customer right of return that should be accounted for on a gross basis. For these contracts we have recorded a refund liability and inventory return asset.

Contract Balances

Contract assets primarily relate to the Company’s rights to consideration for work completed but not billed at the reporting date on contracts with customers. The contract assets are transferred to the receivables when the rights become unconditional. Contract liabilities primarily relate to contracts where advance payments or deposits have been received, but performance obligations have not yet been met, and therefore, revenue has not been recognized.

The Company applies the practical expedient in ASC paragraph 606-10-50-14 and does not disclose information about the remaining performance obligations that have original expected durations of one year or less.

Disaggregation of revenue

Revenue from contracts with customers is disaggregated by product lines, as it depicts the nature and amount of the Company’s revenue that is aligned with the Company's key growth strategies. In the following table, revenue is disaggregated accordingly:



	Three Months Ended June 30, 2018
			Substrate		Value-add
	Total Revenues		Sales		Revenues
	(Millions)
Clean Air	$	1,694	$	621	$	1,073
Ride Performance	506		—		506
Aftermarket	337		—		337
Total Tenneco Inc.	$	2,537	$	621	$	1,916



	Six Months Ended June 30, 2018
			Substrate		Value-add
	Total Revenues		Sales		Revenues
	(Millions)
Clean Air	$	3,450	$	1,273	$	2,177
Ride Performance	1,019		—		1,019
Aftermarket	642		—		642
Total Tenneco Inc.	$	5,111	$	1,273	$	3,838

Changes to policies related to revenue recognition under ASC Topic 606

Upon the adoption of ASC Topic 606, there was a change in the pattern of revenue recognition for certain customized parts. Under ASC Topic 605, revenue was recognized for these customized parts when title and risk of loss passed to the customers under the terms of our arrangements with those customers, which was usually at the time of shipment from our plants or distribution centers. As a result of the adoption, the revenue from these contracts will now be recognized over time because the customized parts are considered to be assets with limited alternative use and the Company has an enforceable right to payment for work completed to date. The Company considers the costs incurred (input method) as a fair measure of progress for the over time recognition of revenue associated with these customized parts.

The following tables summarize the impacts of adopting ASC Topic 606 on the Company’s consolidated financial statements for the three and six month periods ended June 30, 2018:



	For the Three Months Ended June 30, 2018
	As Reported		Balances Without Adoption of ASC Topic 606		Effect of Change Higher/(Lower)
			(Millions)
Income Statement
Revenues
Net sales and operating revenues	$	2,537	$	2,537	$	—
Cost and expenses
Cost of sales (exclusive of depreciation and amortization)	2,159		2,159		—



	For the Six Months Ended June 30, 2018
	As Reported		Balances Without Adoption of ASC Topic 606		Effect of Change Higher/(Lower)
			(Millions)
Income Statement
Revenues
Net sales and operating revenues	$	5,111	$	5,109	$	2
Cost and expenses
Cost of sales (exclusive of depreciation and amortization)	4,357		4,355		2



	June 30, 2018
	As Reported			Balances Without Adoption of ASC Topic 606			Effect of Change Higher/(Lower)
				(Millions)
Balance Sheet
Assets
Inventory	$	898		$	906		$	(8	)
Prepayments and other (including contract assets)	348			328			20
Liabilities
Accrued Liabilities	326			315			11
Equity
Retained earnings (accumulated deficit)	(864		)	(865		)	1



	For the Three Months Ended June 30, 2018
	As Reported		Balances Without Adoption of ASC Topic 606		Effect of Change Higher/(Lower)
			(Millions)
Cash Flows
Operating Activities
Increase in inventories	$	19	$	27	$	(8	)
Increase in prepayments and other current assets	25		5		20
Increase in other current liabilities	33		22		11



	For the Six Months Ended June 30, 2018
	As Reported		Balances Without Adoption of ASC Topic 606		Effect of Change Higher/(Lower)
			(Millions)
Cash Flows
Operating Activities
Increase in inventories	$	53	$	61	$	(8	)
Increase in prepayments and other current assets	70		50		20
Increase in other current liabilities	30		19		11