New Revenue Recognition Standard Poised to Affect Financial Services Companies
Aug. 29, 2017
By Tyler P. Johnson, CPA, and Thomas J. Tyler, CPA
In May 2014, the Financial Accounting Standards Board (FASB) issued Accounting Standards Update (ASU) No. 2014-09, “Revenue From Contracts With Customers (Topic 606),” which specifies a standardized approach for revenue recognition across industries and transactions. The standard becomes effective for annual reporting periods beginning after Dec. 15, 2017, for financial services companies that are public business entities (PBEs) and for annual reporting periods beginning after Dec. 15, 2018, for institutions that are not PBEs. Early adoption is allowed for reporting periods beginning after Dec. 15, 2016.
As financial institutions begin to prepare for the new standard, they also need to be aware of tax considerations as a result of adopting ASU 2014-09.
Tax Considerations in a Nutshell
When they adopt Topic 606, financial services companies will apply the topic’s five-step revenue recognition process to revenue streams that are within its scope and will change their current method of accounting for those revenue streams to comply with the requirements of the standard. For tax purposes, financial institutions recognize revenue under the principles of Internal Revenue Code (IRC) Section 451, which provides rules for determining the taxable year of inclusion for items of gross income. The all-events test under Treasury Regulation Section 1.451-1(a) states that under an accrual method of accounting, income is includible in gross income when all the events that fix the right to receive the income have occurred and the amount thereof can be determined with reasonable accuracy. All events that fix the right to receive income occur when 1) the required performance takes place, 2) payment is due, or 3) payment is made, whichever happens first.
As such, adopting Topic 606 may create or increase differences between financial accounting and tax rules, resulting in possible changes to existing cumulative temporary differences or in the establishment of new differences. Both changes could affect deferred taxes and current taxes payable. A financial institution must determine if its adoption of the new standard has caused a change in accounting method for tax purposes, therefore requiring it to file Form 3115, “Application for Change in Accounting Method.” Advance consent changes require filing Form 3115 during the year of change and paying a user fee. Automatic consent changes require that Form 3115 be attached to the originally filed federal tax return for the year the change is to be effective and do not require payment of a user fee.
An accounting method has been established for tax purposes if a material item has been consistently treated in two or more consecutive tax years. Section 1.446(1)(e)(2)(ii)(a) provides that a material item is any item that involves the proper time for including the item in income or the taking of a deduction. Revenue procedures have explained that a material item concerns timing and therefore is considered a method of accounting if the method does not permanently affect the lifetime income of a taxpayer but does or could change the taxable year in which income is reported.
Concerned with whether the new standards under Topic 606 are permissible methods of accounting for federal income tax purposes, the IRS issued Notice 2015-40 in June 2015. The notice sought comments on issues of conformity between the new standard and the IRC. The IRS requested comments on issues such as to what extent Topic 606 deviates from IRC Section 451, what types of changes in methods taxpayers anticipate requesting, and whether taxpayers should be required to use the automatic consent accounting method change procedures or the advance consent procedures to request permission to change a method of accounting under Topic 606. The IRS received very few comments in response to their request.
In March 2017, the IRS issued Notice 2017-17 to request comments on a proposed revenue procedure that will provide guidance on requesting consent to a qualifying same-year accounting method change. A qualifying same-year method change is a change of accounting method for recognizing income when the change is made for the same tax year for which the taxpayer adopts Topic 606 and the change is made as a result of, or directly related to, the adoption of Topic 606.
The proposed revenue procedure provides that a same-year accounting method change made under existing automatic change guidance described in the list of automatic changes in Revenue Procedure 2016-29 or any successor qualifies as an automatic change. Such a change must be implemented by applying the automatic change procedures of Section 6 of Revenue Procedure 2015-13 or any successor. Therefore, no user fee will be required.
Qualifying same-year method changes not listed in other automatic method change guidance would be implemented under the final revenue procedure issued by the government as long as the proposed method complies with IRC Section 451 or other revenue recognition guidance. Taxpayers making this type of change will be required to indicate that the change is being made under this revenue procedure – once it's final – as well as the applicable IRC section or other guidance that supports the new method.
Good News in Small Packages
Notice 2017-17 is welcome news for taxpayers. The IRS recognized the need to simplify the compliance burden related to accounting method changes caused by Topic 606 and appears to be doing so with the draft language of the proposed revenue procedure.
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