Seven Common Questions about the Tax Implications of the New Revenue Recognition Standard
By Thomas Scott, senior manager
In May 2014, the Financial Accounting Standards Board (FASB) issued Accounting Standards Update 2014-09 Revenue from Contracts with Customers, which replaces a host of existing rules-based, industry-specific guidance with a single, principles-based standard. To help you get prepared for the new standard, we answered seven common questions you may be asking yourself.
When is it effective?
Currently, the standard is not effective until annual reporting periods beginning after Dec. 15, 2016 for public companies and annual reporting periods beginning after Dec. 15, 2017 for private companies. It will require retrospective application. On April 29, 2015, the FASB issued for public comment a proposed Accounting Standards Update that would delay the effective date by one year.
What is “in scope”?
The new guidance will apply to all entities that enter into contracts with customers and excludes insurance contracts, leases and financial instruments. By and large, no industries are exempt.
What are the advantages of the new standard?
- Eliminating industry-specific guidance
- Greater likelihood of acceleration of revenue
- Eliminating fixed and determinable requirement
- Must recognize variable consideration
- Costs to obtain a contract must be deferred
Companies will need to examine their revenue recognition policies and sustain parallel records under existing and new standards for a smooth transition.
What is the five-step model?
The new standard establishes a five-step model for recognizing revenue.
- Identify contract with customer. A contract is defined as any agreement that creates enforceable rights and obligations.
- Identify separate performance obligations. Are you promising to transfer a good or service to the customer? Is the good or service separately identifiable, and can the customer benefit from the good or service? The responses to these questions will determine whether there are multiple performance obligations or promises.
- Determine transaction price. Transaction price is the consideration the vendor expects, including variable consideration; therefore, this can be an estimate. The fixed and determinable requirement in the current standard has been eliminated. Examples of variable consideration include discounts, rebates, refunds, credits, price concessions, incentives, performance bonuses, penalties and other similar items.
- Allocate transaction price. Once determined, the transaction price is allocated to the separate performance obligations in the contract based on relative standalone selling prices. If the standalone selling price is not observable, an entity can (must) eliminate it.
- Recognize revenue when performance obligation is satisfied. Revenue is recognized when (or as) the performance obligation is satisfied. The revenue standard provides guidance to help determine if a performance obligation is satisfied at a point in time or over time.
Adoption of the new guidance will be subject to expanded disclosure requirements.
When is revenue generally recognized for tax purposes?
Generally, a taxpayer recognizes revenue for tax purposes when the requirements of “all events” have been satisfied:
- The taxpayer has a fixed right to receive the revenue (which generally occurs the earlier of when it is due, paid or earned); and
- The amount can be determined with reasonable accuracy.
Typically, cash basis taxpayers include in gross income all amounts they actually or constructively receive during the year. Accrual basis taxpayers include revenue in gross income for the tax year in which they have the right to receive payment for services or goods when it is due, received or earned.
Revenue from the sale of goods is generally recognized when the risks and rewards of ownership of the goods pass to the customer, which typically occurs upon shipment, delivery, acceptance or title passage. Service revenue is generally earned when the performance of the service contracted or required is complete.
Under limited conditions, the Internal Revenue Code permits the deferral of income on certain advance payments, provided the deferred income is not being recognized later for tax purposes other than for financial reporting purposes. Revenue Procedure 2004-34 permits eligible taxpayers a limited one-year deferral of advance payments (amounts that are due or paid before they are earned) for goods, services, use of certain intellectual property and other eligible payments in the year of receipt provided the revenue is deferred for financial reporting purposes.
What are some key income tax consequences of the new standard?
Changes in financial reporting with the implementation of the new revenue recognition standard could have the following tax impacts:
- Acceleration of taxable income – With the financial reporting impact, we expect there will be acceleration of revenue. This change will have an immediate impact on cash flow and should be monitored closely.
- Financial statement presentation for taxes not based on income – A major change with the new revenue standard which impacts taxpayers’ financial statement presentation is the reporting of taxes not based on income on a gross or net basis. The guidance requires the company to assess whether it acts as a principal in a transaction or as an agent acting on behalf of others. Production taxes are generally levied on the company and should be presented as an expense. Sales and use taxes which are collected by the company as an agent are presented on a net basis for financial statement reporting. Companies should evaluate each tax differently for all jurisdictions because a tax could be a sales tax in one jurisdiction and production in another.
- Change in tax accounting method – As a result of the new guidance and due to the potential acceleration of revenue, companies may be required to request a tax accounting method change. If so, a potential unfavorable tax adjustment may be required. However, this adjustment would qualify for spreading the additional income over four years for tax purposes.
- Impact on accounting for income taxes – With the retrospective adoption of the new standard, there may be changes to the accounting for income taxes. The change could give rise to temporary differences and therefore impact related deferred income taxes.
What should taxpayers be doing now to prepare?
Companies should start preparing now. When implementing the new standards, companies should not overlook the requirements for tax purposes. This may include keeping track of new schedule M adjustments, if required. Taxpayers should also put procedures and policies in place to ensure that all new tax documentation is captured accurately and timely.
Have more questions about how the new revenue recognition standard may affect your company’s taxes? Contact Thomas Scott at [email protected] or 770-353-3035.