Financial reporting and auditing experts are warning companies of more surprises they may encounter as they continue to work their way through 700 pages of new accounting rules on how to recognize revenue in their financial statements beginning in 2017.

“Disclosure, to me, is probably the biggest sleeper issue with this standard,” said Mark Barton, practice fellow at the Financial Accounting Standards Board who helped write the new rule that was issued in May. “Rightfully, there is a lot of concern with the timing of when revenue is going to be recognized, but the disclosures shouldn’t be overlooked.”

FASB and the International Accounting Standards Board, which worked jointly to develop a new approach for recognizing revenue under both U.S. GAAP and International Financial Reporting Standards, put a lot of thought into the disclosure requirements, said Barton, who explained the new standard at the recent Compliance Week West conference. “There are significant disclosure requirements that we don’t have under current GAAP,” he said.

The accounting standard update maps out a five-step process companies are required to follow to determine when and in what amounts to recognize revenue. “This is a control model,” explained Barton, meant to guide companies to recognize revenue when they transfer control of goods or services to customers. Under the model, companies must identify a contract with a customer, identify the performance obligations or promises contained within the contract, determine and allocate the transaction price for each performance obligation, and then recognize revenue as those performance obligations are satisfied.

As companies consider how to apply what sounds like a straightforward process to complex arrangements with customers, issues are arising, Barton said. Companies are working through, for example, how to identify distinct performance obligations, how to address arrangements where consideration or payment amounts might vary, and how to treat licensing agreements.

“This new accounting change could give rise to many more differences. For companies that want to minimize those differences, they might look to whether they can change their federal method to align with the new financial reporting, so they would have to determine if it’s a permissible method and file for a method change with the IRS.”
Joan Schumaker, Director of Tax Accounting, EY

The new standard requires disclosures that are meant to help users of financial statements understand the nature, timing, and amount of revenue and cash flows, as well as uncertainties. Companies will be required to break revenue into appropriate categories and explain contract balances, including the opening and closing balances of receivables, contract assets, and contract liabilities. Companies also must explain performance obligations, including when the company typically satisfies its performance obligations and the transaction price allocated to remaining performance obligations, not to mention significant judgments, changes in judgments, and quantitative or qualitative information about assets recognized from the costs to obtain or fulfill a contract.

A Taxing Discovery

Susan Yount, director of reporting practices at Workiva, said at the same conference that companies might also discover a sleeper in the implications of the new standard for tax reporting. “Your tax folks love changes and surprises just as much as you do,” she said. “Don’t spring this on them at the last minute.” Companies are likely to discover changes in their temporary differences between book and tax reporting as a result of the new revenue rules, she said, which is likely to require changes in policies and procedures and consideration of changing the tax reporting method with the Internal Revenue Service. “And you can’t just do that,” she warned. “You have to apply for permission, and they have to grant it.”


Below, KPMG outlines the significant tax implications of FASB’s new revenue recognition standard.
Key Facts:
Under the new revenue recognition standard entities may be required to change the timing or amount of revenue reported in financial statements for a variety of reasons, including the following.

The seller’s price is no longer required to be fixed or determinable.

Software companies are not required to have vendor-specific objective evidence (VSOE) of the fair value of undelivered items to separate the undelivered items from the delivered software license.

Revenue may be recognized over time or at a point in time depending on the circumstances and terms of the contract. In some cases, entities that currently recognize revenue upon delivery may recognize revenue over time while some entities currently recognizing revenue over time may recognize revenue at a point in time.

There are new requirements for capitalizing costs of obtaining or fulfilling a contract.

There is new gross versus net revenue guidance that may change the gross/net analysis for some entities.
Key Impacts
Changes in financial reporting for revenue may affect taxes by:

Accelerating taxable income because tax accounting methods change;

Creating or changing existing temporary differences in accounting for income taxes for financial reporting purposes;

Requiring revisions to transfer pricing strategies and documentation;

Requiring updated policies, systems, processes, and controls surrounding income tax accounting and financial accounting; and

Changing sales or excise taxes because revenue may be recharacterized between product and service revenue.
Other Considerations
In preparing to adopt the new revenue recognition standard, an entity should evaluate other impacts in addition to those discussed above. Management should consider:

Training and communication needs;

Contracting practices and potential changes that would affect financial reporting if an entity chooses to make revisions to contracts;

Potential changes to foreign tax accounting methods, particularly to the extent statutory reporting changes;

Specific contractual terms that may result in a difference between the allocation for tax and financial reporting purposes when accounting for contracts with multiple performance obligations;

Inconsistencies between financial and tax reporting that would require dual accounting records;

New data or information system requirements resulting from different tax and financial accounting methods;

Effects on income tax reporting, compliance, and planning (e.g., financial reporting for new tax-basis differences, the need to capitalize contract costs for financial reporting purposes, the effect of contract modifications, and the effect on an entity’s assessment of whether it is more likely than not that deferred tax assets will be realized for purposes of considering a valuation allowance because the available deferred tax liabilities are changed);

Potential effects on determining revenue-based apportionment factors used for calculating state income taxes and used for determining the applicable rate used to measure state deferred income taxes; and

Implications on net worth or capital-based taxes, if any.
Source: KPMG.

Joan Schumaker, director of tax accounting and risk advisory services for EY in the Americas, says she would agree she’s seeing companies identify tax issues in a number of areas as a result of the new rules for recognizing revenue. Accounting rules already differ from tax rules in terms of when companies should recognize revenue, so new rules for accounting will mean changes to temporary differences, she agreed. “This new accounting change could give rise to many more differences,” she says. “For companies that want to minimize those differences, they might look to whether they can change their federal method to align with the new financial reporting, so they would have to determine if it’s a permissible method and file for a method change with the IRS.”

Global companies will find added complexity, especially if they have foreign subsidiaries that are following statutory accounting requirements in other countries that change under the new IFRS standard. “Companies will have to evaluate how that new revenue recognition reporting is treated for income tax purposes,” Schumaker says. “That will be a country-by-country evaluation. What are the local tax rules for revenue recognition? Do they follow the change in statutory reporting, or do they have their own tax laws and rules for reporting of revenue? Does this create a current tax effect or a deferred tax effect with a new temporary difference?”

Transfer pricing, or the establishment of inter-company pricing to satisfy tax authorities, is another area of tax concern, said Yount. “If you have transfer pricing base on revenue or a profit-based method, that’s also going to change,” she said. “You want to start that early.”

Revenue Recognition Controls

Curtis Matthews, partner-in-charge of internal audit services outsourcing for Moss Adams, warned conference attendees to pay close attention to guidance to auditors as they adopt the new standard. The Public Company Accounting Oversight Board recently warned auditors to up their game in their audit of revenue under current standards, which is likely to affect how auditors will look at the controls companies establish over revenue even under the new standard, he said. And that all comes after auditors have already been warned by the PCAOB to toughen their audits of internal control broadly, leading to a “perfect storm,” he said. “An entity will need well-defined controls to recognize revenue.”

Peter Bible, a partner with audit firm Eisner Amper, says he agrees auditors will put heavy scrutiny on the controls companies establish under the new revenue recognition standard, especially given the significant use of judgment that will be involved. Critics like Sen. Carl Levin (D-Mich.) have already implored FASB to beef up the guidance around the use of judgment to assure it is not misused to create reserves. “Without the right amount of documentation, those judgments can all be viewed as cookie jars,” Bible says. “There will be a lot of focus there. Identifying performance obligations is one key area, he says. Companies will have a lot of latitude to determine for themselves what their performance obligations are and when they have been met. “You’re going to need a lot of documentation on that.”

Bible describes the new standard as “theoretically absolutely perfect,” but difficult to apply in practice. As an example, the former chief accounting officer for General Motors wonders how a major car company will deal with the accounting for the various performance obligations of selling a car, with the typical warranty coverage, plus possible roadside assistance or post-sale service. “If the market is 15 million vehicles, growing to 16 million, this is requiring you to track performance obligations by vehicle,” he says. “Just think of the IT requirements for something like that.”