It’s the tax department’s turn to buzz over how to recognize revenue for tax purposes—and with good reason after getting some puzzling guidance from the Internal Revenue Service.
The IRS issued some accounting method guidance with respect to revenue recognition that has left tax experts scratching their heads. “It’s half guidance,” says David Hammond, a partner at BDO USA. “It’s really not the complete answer.”
For financial reporting purposes, the majority of public companies are already following new accounting rules, Accounting Standards Codification Topic 606, or ASC 606, on how to recognize revenue in financial statements. Calendar-year companies adopted the new, five-step method for when and in what amounts to recognize revenue beginning Jan. 1, 2018. Private companies have an extra year to comply.
For tax purposes, however, companies have to follow tax rules, not accounting rules, on recognizing revenue. Under those rules the IRS requires companies to get permission to change their accounting methods for recognizing revenue—even if companies are following new accounting rules as required under Generally Accepted Accounting Principles (GAAP).
Getting permission to change accounting methods is no small feat. The IRS has designated some changes to revenue accounting methods that it permits automatically, but the scope of accounting change that is occurring under GAAP far surpasses what the current rules permit automatically.
That means companies must appeal individually to the IRS for each accounting change it has made that is not permitted automatically by the current tax rules. Even the IRS acknowledged it didn’t want to deal with that level of administrative minutiae, and in 2015 it began exploring how to facilitate a transition. The IRS issued requests for taxpayers to provide input on what the IRS could or should do to reduce differences between book and tax rules.
“It’s half guidance. It’s really not the complete answer.”
David Hammond, Partner, BDO USA
The process got more complicated, however, as tax reform unfolded, says Christian Wood, a principal at audit firm RSM. “We had been expecting guidance for a while, but it was slowed down by the Tax Cuts and Jobs Act,” he says. “The Service has been getting some pressure that something needs to come out.”
Now the IRS has issued guidance, Revenue Procedure 2018-29, that permits some of the accounting changes companies have made to comply with GAAP as automatically permitted method changes for tax purposes. The guidance says companies can get automatic consent for some changes to their accounting that comply with the new standards, including identifying performance obligations, allocating the transaction price to those performance obligations, and considering when performance obligations are satisfied.
There’s still plenty the new guidance does not permit automatically, however, which is what now causes confusion and uncertainty for tax departments. “It’s a lot more narrow than we were hoping for,” says Wood. When considering the five-step method now required for accounting purposes, the new IRS guidance really only covers three of them, he says.
“In part, it’s because tax is struggling with some of the changes,” Wood says. In certain areas, the new accounting standard on revenue recognition requires companies to do some estimation. “Tax is uneasy or hasn’t quite figured out how to tackle that,” he says.
Consent will not be automatic, for example, where changes involve variable consideration in the transaction price, the IRS says, nor where a change is made in a year that is different from the year that the taxpayer adopts the new accounting standards. It also doesn’t apply to changes that do not comply with Internal Revenue Code Section 451 guidance, which changed considerably under the Tax Cuts and Jobs Act.
One of the most significant changes companies made in adopting the new revenue rules for accounting purposes was to factor in variable consideration, says Eric Lucas, a principal at KPMG. Variable consideration refers to any number of methods by which the price a customer pays for a product or service might vary, like the use of rebates, discounts, refunds, concessions, bonuses, or similar mechanisms or incentives.
“The shift from old GAAP to ASC 606 is in using more estimates and probabilities to determine revenue from variable consideration and either add it to or subtract it from the transaction price,” says Lucas. “That’s difficult on tax. On the tax side, typically estimates are not permitted. You have to wait until an amount is known.”
Having a different treatment for book versus tax purposes for variable consideration could produce a huge accounting burden all its own. “Most companies would have a difference between what they are doing for financial statement purposes and what they are doing for tax purposes,” says John Suttora, managing director at Grant Thornton. “So, companies might have a new book tax difference for that variable consideration element. That may result in having to track additional information.”
Based on the current state of guidance, says Suttora, companies would have to decide if they would want to track that difference so their tax accounting will comply with tax rules or request an accounting method change that would permit them to recognize variable consideration in accordance with accounting rules. But there’s a big risk involved in not tracking the difference and planning on an accounting method request. “It might not be granted,” he says.
In addition to offering limited guidance, the latest IRS notice indicates there will be more guidance to come, and it asks for comments to help shape that next round of guidance. With the timing unclear and the 2018 year-end deadline for filing consent requests rapidly approaching, that leaves companies with some decisions to make about how to proceed.
The timing is even more difficult for the handful of companies that adopted the new accounting standard before it was required, says Hammond. The new IRS notice specifically says it applies to companies that adopted the accounting rules in the year required. “This doesn’t provide any relief for early adopters at all,” says Hammond.
That means early adopters face the prospect of filing permission requests, for which the IRS charges a filing fee of $9,500 each, for any number of accounting method changes they’ve made to comply with ASC 606, says Hammond. For larger companies, the number of filings could approach 100 or more, he says.
Alison Jones, a principal at EY, says companies should make their views known to the IRS. “To me, all is not lost,” she says. “They asked for comments, and there have been very few companies and taxpayers that have stood up and commented. We absolutely need additional guidance.”
Companies should also consider the likelihood that they’ll probably have to file at least some permission requests, Jones says. “Maybe that’s something companies need to embrace a little bit,” she says. “Digging in to see what would be most helpful to them would be a good idea.”