2015-Issue 38—In May 2014, in an effort to align standards, the FASB (Financial Accounting Standards Board) and IASB (International Accounting Standards Board) issued final standards on revenue recognition. These final standards were the product of an FASB/IASB joint project that spanned several years.
ASU (Accounting Standards Update) 2014-09, “Revenue from Contracts with Customers” (Topic 606), was promulgated as follows:
- Section A — Summary and Amendments That Create Revenue from Contracts with Customers and Other Assets and Deferred Costs — Contracts with Customers
- Section B — Conforming Amendments to Other Topics and Subtopics in the Codification and Status Tables
- Section C — Background Information and Basis for Conclusions
The hope of the FASB and IASB was to co-develop clear standards that would remove inconsistencies and weaknesses in the existing standards, provide a more robust framework, improve comparability of financial statements across industries and jurisdictions and provide more useful information to users while simplifying the preparation of financial statements by reducing the number of requirements to which preparers must refer. The new guidance affects any entity that either enters into contracts with customers to transfer goods or services or enters into contracts for the transfer of nonfinancial assets, unless those contracts are within the scope of other standards (for example, insurance contracts or lease contracts).
However, given the widespread nature of its application, concerns about the implementation of ASU 2014-09 arose and the FASB decided to delay the effective date of the ASU. The FASB received feedback from preparers, practitioners and readers of financial statements that deferring the implementation of ASU 2014-09 was extremely desirable. Respondents noted concerns about aligning information technology solutions with the implementation and reporting related to the new revenue recognition standards. Initially, for public business entities, certain not-for-profit entities and certain employee benefit plans, the effective date of the new standard was set for annual reporting periods beginning after December 15, 2016, including interim periods within that reporting period. The effective date for all other entities was determined to be for annual reporting periods beginning after December 15, 2017 and interim periods within annual periods after December 15, 2018. In August 2015, the FASB issued ASU 2015-14, “Deferral of the Effective Date,” which defers the application of ASU 2014-09 for all entities by one year.
The new guidance in ASU 2014-09 will affect how companies analyze recognition of revenue and related costs, as reflected in the FASB’s ASC 606, “Revenue from Contracts with Customers,” and ASC 340-40, “Other Assets and Deferred Costs — Contracts with Customers.” It should be noted that companies in certain industries may be affected more than companies in other industry groups. Regarding presentation and disclosure, ASC 606 will require a significant increase in the level of revenue-related disclosures, particularly for SEC registrants.
The scope of ASC 606, “Revenue from Contracts with Customers,” covers most contracts, with the following exceptions:
- Lease contracts;
- Certain non-monetary exchanges;
- Guarantees other than warranties;
- Various contractual rights or obligations related to financial instruments; and
- Insurance contracts.
Other ASC guidance applies to the types of contracts listed above.
Thus far, we have discussed the changing landscape with respect to the GAAP accounting treatment related to revenue recognition. A thorough analysis of customer contracts and revenue recognition would not be complete without an analysis of the tax implications. Revenue Procedure 2004-34 provides guidance on the tax treatment for the deferral of advance payments. In general, Rev. Proc. 2004-34 “allows taxpayers a limited deferral beyond the taxable year of receipt for certain advance payments. Qualifying taxpayers generally may defer to the next succeeding taxable year the inclusion in gross income for federal income tax purposes of advance payments to the extent the advance payments are not recognized in revenues in the taxable year of receipt.”
For the purposes of Rev. Proc. 2004-34, a payment received by a taxpayer is considered to be an “advance payment” if:
- Including the payment in gross income for the taxable year of receipt is a permissible method of accounting for federal income tax purposes;
- The payment is recognized by the taxpayer in revenue in its applicable financial statements for a subsequent taxable year; and
- The payment is for:
- The sale of goods;
- The use of intellectual property;
- The occupancy or use of property if the occupancy or use is ancillary to the provision of services;
- The sale, lease or license of computer software;
- Guaranty or warranty contracts;
- Memberships in an organization; or
- Any combination of the items listed above.
Conversely, for Rev. Proc. 2004-34 purposes, the term “advance payment” does not include:
- Rent (with certain exceptions);
- Insurance premiums (generally);
- Payments with respect to financial instruments, including prepayments of interest;
- Payments with respect to warranty and guaranty contracts under which a third party is the primary obligor;
- Certain payments of taxes; or
- Payments in property to which IRC Section 83 applies (stock-based compensation).
Under Rev. Proc. 2004-34, permissible methods of accounting include the “full inclusion method” and the “deferral method.” With the full inclusion method, the taxpayer includes the full amount of advance payments in gross income for federal income tax purposes, regardless of whether the taxpayer recognizes the full amount of advance payments in revenues for that taxable year for financial reporting purposes, and regardless of whether the taxpayer earns the full amount of advance payments in that taxable year. Under the deferral method, taxpayers include an amount of the advance payment in gross income to the extent recognized in revenues in their applicable financial statement for that taxable year, and include the remaining amount of the advance payment in gross income for the succeeding taxable year.
Thus, the interplay between the new GAAP accounting rules related to revenue recognition and the tax rules around the inclusion of advance payments is complex. Careful analysis is required to understand the amounts recognized for financial statement purposes, tax purposes, quantification of book/tax differences and the resulting deferred tax balance at the end of the fiscal year.
Alvarez & Marsal Taxand Says:
The FASB and IASB’s joint project involving revenue recognition is poised to create greater comparability of financial statements for users. Companies should use the implementation deferral period to ensure that information technology systems are adequate and prepared to handle the new reporting and disclosure requirements created by ASU 2014-09. Also, a detailed review of a company’s “cascade” or “waterfall” schedules related to deferred revenue and advance payments is advisable in order to analyze contracts on a comprehensive level. Additionally, a review should result in understanding the amounts recognized for financial statement and tax purposes, as well as the differences that will result upon adoption of ASU 2014-09.
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Branden Wilson, Associate, contributed to this article.
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The information contained herein is of a general nature and based on authorities that are subject to change. Readers are reminded that they should not consider this publication to be a recommendation to undertake any tax position, nor consider the information contained herein to be complete. Before any item or treatment is reported or excluded from reporting on tax returns, financial statements or any other document, for any reason, readers should thoroughly evaluate their specific facts and circumstances, and obtain the advice and assistance of qualified tax advisors. The information reported in this publication may not continue to apply to a reader's situation as a result of changing laws and associated authoritative literature, and readers are reminded to consult with their tax or other professional advisors before determining if any information contained herein remains applicable to their facts and circumstances.
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