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New Revenue Recognition Standard & Tax Implications

business-861325_640On May 28, 2014 the Financial Accounting Standards Board (FASB), in conjunction with the International Accounting Standards Board (IASB), issued a new standard on revenue recognition. The goal of the new standard is to streamline financial information across industries by clarifying the principles for recognizing revenue and developing a common revenue standard for U.S. GAAP and International Financial Reporting Standards (IFRS). The core principle is that an entity should recognize revenue to depict the transfer of promised goods or services to customers in an amount that reflects the extent to which the entity expects to be entitled in exchange for those goods or services. This can be applied to all contracts with customers regardless of the industry or transaction. Therefore, it provides a comprehensive framework that reduces the number of requirements a company must consider when recognizing revenue.

WHO IS AFFECTED?

This affects any entity that either enters into contracts with customers to transfer goods or services, or enters into contracts for the transfer of non-financial assets – unless those contracts are within the scope of other standards (i.e. insurance contracts or lease contracts).

The new revenue recognition standard may affect the timing related to income for tax accounting for taxpayers who:

  • presently use the percentage of completion method,
  • derive income from the provision of services,
  • engage in bill and hold transaction for the sale of goods,
  • do accounting for sales and returns for goods, and
  • earn income from warranties.

WHAT DO YOU NEED TO DO UNDER THE NEW REVENUE STANDARD?

Since U.S. GAAP does not provide a general standard of revenue recognition, the new recognition standard will apply to revenue from customer contracts across all industries. In turn, this means that more detailed judgement should be used when it comes to decision-making and estimating related to recognizing revenue.

The new revenue standard will require you to identify the exchange between parties in the pattern of revenue recognition by following these FIVE STEPS:

  1. Identify the contract with the customer
  2. Identify the performance obligations in the contract
  3. Determine the transaction price
  4. Allocate the transaction price to the performance obligation in the contract, and
  5. Recognize revenue when (or as) the entity satisfies a performance obligation

Examples of the new standard implications in comparison to current standards:

New Revenue Recognition Standard

Current U.S. GAAP Standard:

  • Manufacturers producing goods to a customer’s specification may be required to recognize revenue as they produce the units
  • When they deliver the units
  • Goods and services can each be considered as a separate performance obligation
  • Treated as a single performance obligation, recognizing revenue once the last promised good or service is delivered
  • Transaction price will be the amount entitled to be recognized as revenue
  • Amount expected to be received
  • Variable consideration can be recognized if significant support can be provided to show that revenue will not be reversed
  • Revenue required to be fixed and determinable
  • Long term contracts will recognize revenue on when and how control of the asset is transferred
  • Revenue recognized by applying the percentage-of-completion method

 

WHEN WILL IT TAKE EFFECT?

The new standard is effective for annual reporting periods after:

  • December 15, 2017 (Public Companies)
  • December 15, 2018 (Private Companies)

Early application is permitted for annual periods after December 15, 2016, including interim periods within that reporting period.

WHAT ARE THE TAX IMPLICATIONS?

Adoption of the new revenue standard will result in creating or changing existing temporary differences in accounting for income taxes for financial reporting purposes. In some cases, the revenue recognition for tax purposes depends on revenue recognition for financial accounting purposes (i.e. when a taxpayer uses a deferred method to account for advance payments). In that case, the new revenue recognition standard will likely affect a company’s cash tax position. Additionally, adopting the new revenue recognition standard may require a change in the tax accounting method which requires IRS consent, since implementation of the new standard may reveal improper revenue recognition methods for tax purposes.

WHAT STEPS SHOULD YOU TAKE?

Even though the effective date is a few years out, this time should be utilized by your company to start the process of preparing for the adoption and evaluating the tax exposure due to the new revenue recognition standards.

The following are items to consider:

  • Analyze the impact the changes will have on your company
  • Decide on a plan for adopting the new standard
  • Assess your current systems and processes in order to determine changes to comply with the new standard
  • Inform management of the new rules in order to analyze existing contracts and determine what changes will be needed
  • Consider the impact of drafting new agreements

HOW FF&F CAN HELP

As is always the case, procedures, practices, and relevance of standards vary between and across industries, companies, and geographies. Taking this into account, FF&F can provide the necessary guidance and expertise to navigate through the challenges and implications that arise as a result of the new standard.

We have a team of experts who can assist you in evaluating your current processes and identifying any necessary changes that would have a significant impact on your company, including the impact the new revenue recognition standard will have on your current and deferred taxes. We can then propose a course of action to ensure you are in full compliance for all your tax matters.

For more information on the new revenue recognition standard or our services, please contact us at info@fffcpas.com or 212-245-5900.

 

2P0C0779-EditKimberly Roque, CPA, MST has 8 years of accounting experience, with 6 in private and 2 in public accounting. Her focus is consolidated corporate tax returns and income tax provisions.