Revenue Recognition

Five Steps to Revenue Recognition Tax Woes

FASB’s new revenue recognition standard could spawn costly changes in corporate tax compliance.
David KatzJune 11, 2015

Already so complex that the Financial Accounting Standards Board has proposed extending the compliance deadline for its new revenue recognition regime by a year, the updated standard could trigger another burdensome source of complexity for corporate taxpayers, the Internal Revenue Service says.

IRS_SignThe source? Discrepancies the standard would open up between financial reporting and tax filing. At issue is whether the five-step process for booking revenue mandated by the new FASB standard will diverge significantly from the way companies must recognize revenue in their tax returns. (Currently set to be launched for public companies with annual reporting periods beginning after December 15, 2016 and for non-public companies after December 15, 2017, those implementation dates would be put off for a year under a FASB proposal by the board.)

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If major discrepancies crop up between how companies report sales under generally accepted accounting principles — commonly called “book” reporting — and how they report revenue in their IRS filings, it could cost corporate taxpayers mightily in time and money to make adjustments to their systems and processes, according to Eric Lucas, a principal in the income tax and accounting group of KPMG’s Washington National Tax practice.

“Assuming that there’s no additional relief from a compliance standpoint, preparing returns and tracking these book-tax differences is going to be difficult for a lot of companies,” Lucas says.

Divergence of the Twain
Under the U.S. Internal Revenue Code, “taxable income is computed under the method of accounting the taxpayer regularly uses to compute income in keeping the taxpayer’s books,” according a June 1 notice issued by the IRS asking for public comment on the issue. (The proposed new standard and the related tax issues concern the accrual method of accounting used by most larger companies, rather than the cash method.)

Currently, a corporate taxpayer, following GAAP, “accrues income when the right to receive income is fixed and the amount can be determined with reasonable accuracy” by means of what’s called the “all events test,” according to the IRS notice. (Under the test, a seller of goods or services can claim to have booked revenue during a reporting period as of the earliest date when payment is received, due, or earned.)

But the new revenue recognition standard,  “Revenue from Contracts with Customers,” announced by FASB and the International Accounting Standards Board in May 2014, threatens to upset the tax applecart.

The crux of the standard is a five-step process that will demand far deeper analyses than most companies are used to, experts say. To recognize revenue, a seller operating under a written, oral, or implied contract to provide goods or services to a customer will be required to (1) identify the contract with a customer, (2) identify the separate performance obligations in the contract, (3) determine the transaction price, (4) allocate the transaction price to the separate performance obligations in the contract, and (5) recognize revenue when or as it satisfies a performance obligation.

The use of the new standards “may create or increase differences between financial accounting and tax accounting rules,” the IRS said in its notice, and the service and the Treasury Department are thinking about issuing guidance on the standards. (Comments should be submitted in writing to the IRS on or before September 16, 2015.)

Among the tax issues raised by the new accounting rules are “whether the new standards are permissible methods of accounting for federal income tax purposes, the types of accounting method change requests that will result from adopting the new standards, and whether the current procedures for obtaining IRS consent to change a method of accounting are adequate to accommodate those requests,” according to the notice.

Because the tax-filing rules are governed under federal law, changing them to accommodate the new financial reporting standards would require Congress and the President to enact a law changing the federal tax code accordingly.

If such a law isn’t enacted, however, there are things federal tax officials could do to bring the tax filing standards more in line with the new FASB standard. “Within the parameters of [current] statutory provisions, they could issue relief,” says Lucas.

“I think they’re going to want to focus on how we can make these [tax-filing rules] easier for companies that are implementing these new standards,” he adds. “How can we allow tax to follow book so there aren’t so many book-tax differences going forward?”

To align tax compliance with adherence to the new accounting rule, Lucas recommends that CFOs and others involved with financial reporting have their tax staffs on hand when finance and accounting staffs decide how to implement the new revenue recognition rules.

“From a tax perspective, what is key is to have the tax department and tax advisers involved with the book changes,” he says.