Companies are starting to awaken to yet another wrinkle in the new revenue recognition standard, as they learn it will affect how they account for sales of non-financial assets as well.
The intent of the revenue recognition standard is to change the way companies account for revenue they generate in the normal course of business—but the principles behind the new standard will also apply when companies shed assets they no longer need, like plant, property, equipment, or intangible assets, explains Dusty Stallings, a partner with PwC. “This is one of those areas where people were focused on revenue and not some of the other changes that came with the standard,” she says. “People just didn’t pay it any notice when it was first issued. Now they’re realizing this is going to be a big issue.”
Consider, for example, a manufacturer that outgrows a particular facility and invests in a new building and new equipment. The old building and equipment might well go into the resale market. How do you account for that? “The new standard says look to what the revenue standards say about how to measure the transaction price and when to recognize a sale,” Stallings says.
The logic adopted by the Financial Accounting Standards Board and the International Accounting Standards Board when they wrote the new standard, Stallings says, is that the accounting for one-off transactions such as equipment, real estate, and other intangible assets should follow the same pattern as the sale of goods and services to generate revenue.
Entities in the business of selling real estate, for example, are well aware of how the standard treats such sales, says Brad Hale, member of the professional standards group at audit firm Mayer Hoffman McCann. Current Generally Accepted Accounting Principles have some highly prescriptive guidance that will disappear under the new standard, he explains, so those companies will face significant change in how they account for sales of real estate.
Companies that are not in the real estate business, however, are starting to realize how their less frequent transactions will fall under the same guidance. “If you’re not in the real estate business, you don’t think of the sale of a building as falling under the revenue standard,” he says. “That has come as a surprise to folks.”
The Joint Transition Resource Group of FASB and IASB has not received any questions on how to apply the new guidance to non-financial assets, but that doesn’t mean there are no uncertainties around that aspect of the guidance, says Eloise Wagner, a partner at EY. “When companies are going through their assessment of how they are going to be impacted, they are not looking at one-off transactions,” she says. If companies are not airing those uncertainties openly yet, “I don’t think it’s because there are no issues in applying this portion of the standard. It’s that companies are not there yet.”
“If you’re not in the real estate business, you don’t think of the sale of a building as falling under the revenue standard. That has come as a surprise to folks.”
Brad Hale, Managing Director, CBIZ MHM
Many transactions of non-financial assets are basically the same as revenue transactions, says Tony Sondhi, president of financial advisory firm Sondhi & Associates. Companies don’t engage in those kinds of transactions often or routinely, so they may not have noticed that they will be swept into the new standard. “In economic terms, the end result is the same,” he says. “I have something I want to sell. It has a certain value to me and in a certain marketplace.”
Work the Steps
For non-financial asset sales, the new standard refers entities to the first and third steps in the new five-step revenue recognition model, Hale says. “Step one is identifying a contract with a customer,” he says. “Step three is how you calculate the transaction price. They’ve referenced those two steps in how you account for the sale of non-financial assets.” The common view, he says, is that all five steps of the model apply, although they may not be applicable to many transactions.
SALE OF NON-FINANCIAL ASSETS
Below, PwC explains how companies should apply FASB’s revenue recognition standard to the sale or transfer of non-financial assets.
Some principles of the revenue standard apply to the recognition of a gain or loss on the transfer of certain non-financial assets that are not an output of an entity’s ordinary activities (such as the sale or transfer of property, plant, and equipment). Although a gain or loss on this type of sale generally does not meet the definition of revenue, an entity should apply the guidance in the revenue standard related to the transfer of control (refer to RR 6) and measurement of the transaction price (refer to RR 4), including the constraint on variable consideration, to evaluate the timing and amount of the gain or loss recognized.
Entities that report under U.S. GAAP also apply the revenue standard to determine whether the parties are committed to perform under the contract and therefore whether a contract exists (refer to RR 2.6).
Applying the new model “has a lot of implications for when you actually qualify for a sale,” Hale says. That means companies will have to make judgments about when they have a contract, whether there are multiple obligations under the contract, and whether variable consideration is involved. That might arise if companies arrive at agreements that involve contingencies. “The new standard says you need to estimate what that variable consideration will be and that’s your day one transaction price,” he says. “That likely will result in earlier recognition of gains that may have been recognized later down the road under current guidance.”
The new standard introduces a concept that’s not fully defined under GAAP, says Brian Marshall, a partner with McGladrey, when it focuses the new principles on “in substance non-financial assets.” That could make difficult the determination of whether a particular transaction falls under the new revenue guidance as an asset sale or under consolidations guidance as the transfer of a business.
“If you’re selling a business, you’ll be in the consolidation model, but if you’re selling a business that’s in substance a non-financial asset, you’re going to be kicked into this revenue gain-or-loss model,” he says. “That’s going to be challenging.”
FASB is working its way through guidance meant to better define the difference between a business and “in substance non-financial assets,” partly to help with interpretation of the new revenue standard. An exposure draft with its proposed language is expected in the fourth quarter.
Another smaller surprise that is starting to catch companies’ attention is the guidance in the new revenue standard on how to recognize certain costs, especially incremental costs to obtain contracts and certain costs to fulfill them, Stallings says. The new standard says costs solely focused on obtaining contracts, such as sales commissions, must be capitalized and amortized over the life of the contract if they are expected to be recovered. Existing GAAP is not as explicit, so current practice is mixed.
As for fulfillment costs, existing GAAP doesn’t tell companies how to recognize costs they incur internally to prepare themselves to fulfill a contract, but are not directly tied to a contract (think of set-up or mobilization expenses here). The new standard says costs to fulfill a contract that are not addressed elsewhere in GAAP should be capitalized if they are expected to be recovered, Stallings says. Otherwise, companies would expense such costs as incurred.
FASB has delayed the effective date of the new standard into 2018. Hale, Sondhi and Wagner all say they have noticed a lull in implementation activity as a result. “We have seen a little bit of a slowdown,” Wagner says. After second-quarter earnings, activity has picked up steam again, she says.