2. Recent Accounting Developments

Accounting Standards Updates Implemented

ASU 2018-05 was issued in March 2018 to clarify the income taxes disclosure requirements as they pertain to SAB 118, including the requirement to disclose a reasonable estimate, if determinable, of the tax effects of the TCJA in the reporting period in which the TCJA was enacted, as well as additional disclosures required in the following interim reporting periods if the measurement period approach is used. In accordance with ASU 2018-05, we disclosed a reasonable estimate of the income tax effects of the TCJA on our consolidated financial statements in our 2017 Form 10-K. We completed our analysis of the tax effects of the TCJA in the third quarter of 2018 with no material change to the amounts disclosed at December 31, 2017. See Note 14 (“Income Taxes”) for further details.

On January 1, 2018, we adopted ASU 2018-02 which allows for a reclassification from accumulated other comprehensive income to retained earnings for stranded tax effects resulting from the TCJA. As a result of the TCJA’s corporate rate reduction, we had $0.3 million of stranded tax effects in accumulated other comprehensive income related to our derivative instruments and terminated interest rate swaps, which we elected to reclassify to accumulated deficit.

On January 1, 2018, we adopted ASU 2017-12 using the modified retrospective approach to existing cash flow hedge relationships as of January 1, 2018. ASU 2017-12 expands and refines hedge accounting for both financial and nonfinancial risk components, aligns the recognition and presentation of the effects of the hedging instrument and hedged item in the financial statements and eliminates the requirement to separately measure and report hedge ineffectiveness. As a result of the adoption of ASU 2017-12, we recognized a net gain of $0.4 million as a cumulative-effect adjustment to opening retained earnings and a corresponding adjustment to other comprehensive income (loss) to reverse the cumulative ineffectiveness previously recognized in interest expense.

On January 1, 2018, we adopted ASU 2016-15 on a retrospective basis. ASU 2016-15 addresses diversity in practice and simplifies several elements of cash flow classification including how certain cash receipts and cash payments are classified in the statement of cash flows. ASU 2016-15 did not have an impact on our condensed consolidated statement of cash flow for the nine months ended September 30, 2017.

Revenue Recognition Update

On January 1, 2018, we adopted the Revenue Recognition Update using the modified retrospective method applied to those contracts which were not completed as of January 1, 2018. We recognized the cumulative effect of initially applying the Revenue Recognition Update as an adjustment to the opening balance of retained earnings. For contracts that were modified before the effective date, we identified performance obligations on the basis of the current version of the contract, which included any contract modifications since inception. The application of the practical expedient for contract modifications did not have a material effect on the adjustment to retained earnings. The comparative information has not been restated and continues to be reported under the accounting standards in effect for those periods.

Under previous guidance, contract operations revenue was recognized when earned, which generally occurs monthly when the service is provided under our customer contracts. Under the Revenue Recognition Update the timing of revenue recognition is impacted by contractual provisions for service availability guarantees of our compressor assets and re-billable costs associated with moving our compressor assets to a customer site. These changes are further discussed below and did not result in a material difference from previous practice for contract operations.

The Revenue Recognition Update resulted in a significant change related to our aftermarket services operations, maintenance, overhaul and reconfiguration services. Under previous guidance, revenue was recognized on a completed contract basis as products were delivered and title was transferred or services were performed for the customer. Under the Revenue Recognition Update, these services are recognized as revenue over time, using output or input methods to measure the progress toward complete satisfaction of the performance obligation based on the nature of the goods or services being provided. The adoption did not result in a material difference in the amount or timing of revenues for aftermarket services parts and components sales.

The Revenue Recognition Update provides guidance on contract costs that should be recognized as assets and amortized over the period that the related goods or services transfer to the customer. Certain costs that were previously expensed as incurred, such as sales commissions and freight charges to transport compressor assets, are deferred and amortized.

The following table summarizes the cumulative impact of the adoption of the Revenue Recognition Update on the opening balance sheet (in thousands):



	December 31, 2017			Adjustments Due to the Revenue Recognition Update			January 1, 2018
Assets
Accounts receivable, trade	$	113,416		$	7,883		$	121,299
Inventory	90,691			(6,917		)	83,774
Contract costs	—			21,524			21,524

Liabilities
Accrued liabilities	$	71,116		$	209		$	71,325
Deferred revenue	4,858			3,188			8,046
Deferred income taxes	97,943			4,427			102,370

Equity
Accumulated deficit	$	(2,241,243	)	$	14,666		$	(2,226,577	)

The following tables summarize the impact of the application of the Revenue Recognition Update on our condensed consolidated balance sheet and condensed consolidated statements of operations (in thousands):



	September 30, 2018
Balance Sheet	As Reported			Balance Excluding the Impact of the Revenue Recognition Update			Effect of Change
Assets
Accounts receivable, trade	$	141,781		$	123,079		$	18,702
Inventory	77,497			94,528			(17,031		)
Contract costs	36,482			—			36,482

Liabilities
Accounts payable, trade	$	70,950		$	70,875		$	75
Accrued liabilities	74,879			74,619			260
Deferred revenue	12,909			8,865			4,044
Deferred income taxes	2,845			2,570			275
Other long-term liabilities	19,612			19,595			17

Equity
Additional paid-in capital ⁽¹⁾	$	3,154,058		$	3,144,217		$	9,841
Accumulated deficit	(2,259,489		)	(2,283,130		)	23,641

——————


⁽¹⁾	Represents the impact of the Revenue Recognition Update on net income attributable to noncontrolling interest which was reclassed to additional paid-in capital pursuant to the Merger.



	Three Months Ended September 30, 2018
Statement of Operations	As Reported		Balance Excluding the Impact of the Revenue Recognition Update		Effect of Change
Revenue:
Contract operations	$	169,509	$	170,981	$	(1,472	)
Aftermarket services	62,863		59,623		3,240
Total revenue	232,372		230,604		1,768
Cost of sales (excluding depreciation and amortization):
Contract operations	69,056		73,673		(4,617		)
Aftermarket services	50,043		47,973		2,070
Total cost of sales (excluding depreciation and amortization)	119,099		121,646		(2,547		)
Selling, general and administrative	26,298		26,924		(626		)
Provision for income taxes	3,126		2,617		509
Net income attributable to Archrock stockholders	9,974		5,542		4,432



	Nine Months Ended September 30, 2018
Statement of Operations	As Reported			Balance Excluding the Impact of the Revenue Recognition Update			Effect of Change
Revenue:
Contract operations	$	496,156		$	500,306		$	(4,150	)
Aftermarket services	175,126			161,065			14,061
Total revenue	671,282			661,371			9,911
Cost of sales (excluding depreciation and amortization):
Contract operations	201,460			214,823			(13,363		)
Aftermarket services	143,173			132,984			10,189
Total cost of sales (excluding depreciation and amortization)	344,633			347,807			(3,174		)
Selling, general and administrative	80,455			82,051			(1,596		)
Provision for income taxes	1,913			(1,837		)	3,750
Less: Net income attributable to the noncontrolling interest	(8,097		)	(6,141		)	(1,956		)
Net income (loss) attributable to Archrock stockholders	8,095			(880		)	8,975

Accounting Standards Updates Not Yet Implemented

In August 2018, the FASB issued ASU 2018-15 which aligns the requirements for capitalizing implementation costs incurred in a hosting arrangement that is a service contract with the requirements for capitalizing implementation costs incurred to develop or obtain internal-use software (and hosting arrangements that include an internal-use software license). For public entities, ASU 2018-15 is effective for fiscal years beginning after December 15, 2019, including interim periods within those fiscal years. Early adoption is permitted. We are currently evaluating the impact of ASU 2018-15 on our consolidated financial statements and footnote disclosures and anticipate adopting this guidance on a prospective basis in the fourth quarter of 2018.

In August 2018, the FASB issued ASU 2018-13 which amends the required fair value measurements disclosures related to valuation techniques and inputs used, uncertainty in measurement, and changes in measurements applied. These amendments are effective for all entities for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2019. Early adoption is permitted. We are currently evaluating the impact of ASU 2018-13 on our consolidated financial statements and footnote disclosures.

In June 2016, the FASB issued ASU 2016-13 that changes the impairment model for most financial assets and certain other instruments, including trade and other receivables, held-to-maturity debt securities and loans, and requires entities to use a new forward-looking expected loss model that will result in the earlier recognition of allowance for losses. For public entities that meet the definition of an SEC filer, ASU 2016-13 is effective for fiscal years beginning after December 15, 2019 and early adoption is permitted. Entities will apply ASU 2016-13 provisions as a cumulative-effect adjustment to retained earnings as of the beginning of the first reporting period in which the guidance is adopted. We are currently evaluating the impact of ASU 2016-13 on our consolidated financial statements and footnote disclosures.

Leases

ASC Topic 842 Leases establishes a ROU model that requires a lessee to record a ROU asset and a lease liability on the balance sheet for all leases with terms longer than 12 months. Leases will be classified as either finance or operating, with classification affecting the pattern of expense recognition in the income statement. Under the new guidance, lessor accounting is largely unchanged. ASC Topic 842 Leases is effective for fiscal years beginning after December 15, 2018, including interim periods within those fiscal years. A modified retrospective transition approach that involves recasting the comparative periods in the year of initial application is required for leases existing at, or entered into after, the beginning of the earliest comparative period presented in the financial statements, with certain transition practical expedients available. In July 2018 the FASB provided an optional transition method that would allow adoption of the standard as of the effective date without restating prior periods. We intend to adopt ASC Topic 842 Leases on January 1, 2019 using the optional transition method and are currently assessing the transition practical expedients. Upon adoption, we will recognize the cumulative effect of adoption as an adjustment to the opening balance of our retained earnings. Comparative information will continue to be reported under the accounting standards in effect for those periods.

Additionally, the July 2018 amendment provided lessors with a practical expedient to not separate nonlease components from the associated lease component and, instead, to account for those components as a single component if the nonlease components otherwise would be accounted for under the Revenue Recognition Update and certain conditions are met. The amendment also provided clarification on whether ASC Topic 842 or the Revenue Recognition Update is applicable to the combined component based on determination of the predominant component. An entity that elects the lessor practical expedient also should provide certain disclosures. We are evaluating the impact of the July 2018 amendment on our contract operations services agreements and have tentatively concluded that the services nonlease component is predominant, which would result in the ongoing recognition following the Revenue Recognition Update guidance.

Our evaluation of the impact of adopting ASC Topic 842 Leases is ongoing. We have established a cross-functional implementation team to identify our lease population and are assessing changes to our internal control structure, business processes, systems and accounting policies that are necessary to implement the standard. We do not believe the standard will materially affect our consolidated statements of operations or cash flows. At September 30, 2018, adoption of ASC Topic 842 Leases would have resulted in recognition of a ROU asset of less than $25 million and a lease liability of a similar amount in our consolidated balance sheet. The amount of the ROU asset and the lease liability we ultimately recognize will depend on our lease portfolio as of the adoption date.