Just when you think you’ve got your financial reporting figured out, you hear about the impending new revenue recognition standards. At best, financial reporting under GAAP can be a convoluted task. Mix in the daunting tax implications of the new standards, and you’ve got a myriad of potential consequences affecting your tax liability.
While much of the focus on revenue recognition thus far has been on implementing the financial reporting changes, the new standards affect income tax planning as well and may result in the need to file an application(s) to change accounting methods for tax purposes.
We’ve highlighted a few changes under the new standards that may affect taxable income.
In order to recognize revenue there must be a probable chance of collection. The standards provide that in the event collection is not probable, an entity cannot default to cash basis recognition. Due to the narrow definition of doubtful collectability in the tax rules, revenue may fail to be probable under the new standards yet recognizable for tax purposes.
Businesses must allocate the sales price of a bundled contract among performance obligations based on the individual selling prices for the products. For tax purposes, the allocation of the contract price recognizes the prices of the separate products specified in the contract. This may result in book income being greater than taxable income, or vice versa.
Contracts with variable consideration are often based on expectations developed by using estimates. These estimates are used to quantify the amount of revenue to be recognized when it is probable that a reversal will not occur when the contingencies are resolved. Under the former financial reporting rules, revenue recognition was not permitted with the existence of contingencies, which concurred with tax rules. Under the new standards, although revenue from contingencies for financial statement purposes may be recognized, the seller may not have a fixed right to receive that revenue under tax rules. This causes an inconsistency between the new reporting standards and tax reporting rules.
The new standards specify that a given amount of revenue is recognized when the buyer takes control of the goods or services. The timing will depend on the nature of the seller’s performance obligation and whether control is conferred at a single point or over time. As a result, financial statement revenue recognition will often be faster for advanced payments dealing with variable consideration and bundled contracts, compared to the timing for tax which requires recognition in the year of receipt as governed by the all events test for tax purposes.
There is a widely used exception that authorizes tax conformity with financial reporting methodology and allows revenue to be deferred for tax purposes until it is recognized for financial reporting purposes. So, under this circumstance, an acceleration of revenue recognition involving advanced payments for financial reporting purposes will require an identical result for tax purposes.
How We Can Help
It is important to start asking questions about how these new revenue recognition standards could impact your business not only from a financial reporting perspective but also from a tax planning perspective. Our recent blog, Questions You Should Be Asking About Revenue Recognition, is a good starting point.
Many businesses will be impacted in some way by these new standards. Our team at HORNE is ready to strategize with you to implement a plan and help you along the way. We look forward to serving you.
For weekly insights into enterprise, please sign up here: