New FASB, IASB Revenue Recognition Rules Could Have Significant U.S. Tax Implications

The Tax Management Transfer Pricing Report ™ provides news and analysis on U.S. and international governments’ tax policies regarding intercompany transfer pricing.

By Annette Smith, Christine Turgeon, George Manousos, Jennifer Kennedy, Dennis Tingey, Ross Margelefsky

PricewaterhouseCoopers LLP, Washington, D.C., New York, NY and Phoenix, AZ

In brief

The Financial Accounting Standards Board (FASB) and
International Accounting Standards Board (IASB) on May 28 published
their long-awaited joint revenue recognition standard titled
"Revenue from Contracts with Customers" (Topic 606 and IFRS

The largely principles-based standard (hereafter the new
standard) provides a framework to address revenue recognition
issues comprehensively for all contracts with customers regardless
of industry-specific or transaction-specific fact patterns for both
U.S. Generally Accepted Accounting Principles (GAAP) and
International Financial Reporting Standards (IFRS), with certain
limited exceptions.  The new standard, many observers believe,
will affect the financial reporting practices of almost every
company. Importantly, when a change in the recognition of revenue
is required, the change often will result in recognizing revenue
sooner, though certain cases could result in later recognition of
revenue compared to the current standard.

Although the U.S. tax law contains specific rules with respect
to the recognition of revenue for tax purposes, there are certain
instances in which revenue recognition for tax purposes depends on
revenue recognition for financial accounting purposes (e.g., for
advance payments). In these instances, the new standard could have
a significant impact on a company's cash tax position. In other
instances, financial accounting changes as a result of the new
standard could affect book-tax differences and deferred taxes
related to revenue recognition.

The new standard generally is effective for annual reporting
periods beginning after December 15, 2016 (public companies), and
December 15, 2017 (nonpublic companies). Companies must apply the
new standards either (1) retroactively to each prior reporting
period presented or (2) retroactively with the cumulative effect of
initially applying the standard recognized at the date of initial

Observation:  To understand the
possible effects of the new standard, it is important for each
company's tax department to be closely involved in the analysis of
the new standard, which could be a significant effort at many

In detail

Highlights of the new standard

To increase consistency in the recognition and presentation of
revenue, the new standard employs a single, principles-based model
for recognizing revenue that can be applied to all contracts with
customers to transfer goods, services, or nonfinancial assets,
except contracts within the scope of other standards (such as
leases, insurance contracts, certain financial instruments,
guarantees, and nonmonetary exchanges between entities in the same
line of business to facilitate sales to customers or potential
customers). The new standard supersedes the industry-specific
standards that currently exist under GAAP, including those for the
software and construction industries.

Under the new standard, companies recognize revenue to depict
the transfer of promised goods or services to customers in an
amount that reflects the consideration to which the company expects
to be entitled in exchange for those goods or services. To achieve
this core principle, a company must apply the following five

1. Identify the contracts with the customer,

2. Identify the performance obligations in the contract,

3. Determine the transaction price,

4. Allocate the transaction price to the performance obligations
in the contract, and

5. Recognize revenue when (or as) the entity satisfies a
performance obligation.

The new standard provides guidance as to how to apply each of
these five steps. For example, the standard explains that a
performance obligation is satisfied when (or as) the customer
obtains control of the good or the service. For each performance
obligation, the company must determine whether the obligation is
satisfied over time or at a point in time based on the criteria
provided. If performance occurs over time, revenue is recognized by
applying a method of measuring progress toward completion of the
performance obligation, such as `output methods' and `input
methods.' In contrast, if a performance obligation is satisfied at
a point in time, then revenue is recognized when control is
transferred to the customer based on the presence of certain

Overview of tax revenue recognition

Under general tax principles, a taxpayer must recognize revenue
when it has a fixed right to receive the revenue - which generally
occurs the earlier of when it is due, paid, or earned -
and the amount can be determined with reasonable accuracy. Revenue
generated from the sale of goods generally is earned when the
benefits and burdens of ownership of the good passes to the
customer, which could occur upon shipment, delivery, acceptance, or
title passage. Revenue generated from the provision of services
generally is earned when performance of the required services (or
divisible services) is complete.

Amounts that are due or paid before they are earned (known as
advance payments) may be eligible for deferred recognition for tax
purposes under specific provisions, such as the §451 regulations
for goods and integral services and Rev. Proc. 2004-34 for goods,
services, use of certain intellectual property, and other eligible
payments, both of which allow limited tax deferral that cannot
exceed the financial accounting deferral.

Impact on cash taxes

Because the tax law contains specific rules with respect to the
timing of the recognition of revenue, the new standard generally is
not expected to change the recognition of revenue for tax purposes
and thus generally will not affect cash taxes. However, in certain
circumstances, such as when a company receives advance payments, a
change in the recognition of revenue for financial accounting
purposes will affect tax recognition because the tax deferral for
advance payments cannot exceed the book deferral.

For example, the new standard is expected to accelerate the
recognition of revenue from certain software contracts.  Under
the current rules, software contracts containing multiple-element
deliverables must be treated as a single unit of account unless
there is vendor-specific objective evidence of the value of each
deliverable, which generally has the effect of deferring revenue
from such contracts.  Under the new standard, the transaction
price is allocated to each deliverable based on relative
stand-alone selling prices. To the extent the acceleration of
software revenue affects the recognition of advance payments, it
will result in an acceleration of any advance payments that are
deferred for tax purposes.

In addition, the new standard could accelerate the recognition
of revenue from the sale of goods in certain circumstances. 
Under current GAAP, revenue from the sale of goods is recognized
when risks and rewards of such goods are transferred to a
customer.  Under the new standard, revenue generally will be
recognized when control of the goods is transferred to the
customer, which is determined considering indicators, such as right
to payment, title, physical possession, risks and rewards of
ownership, and customer acceptance.  To the extent this
transfer of control standard accelerates the recognition of advance
payments for financial accounting purposes, it likewise will
accelerate recognition of advance payments for tax purposes.

Note that the IRS treats a change in the timing of the
recognition of advance payments as a change in method of

Impact on tax accounting

As outlined above, the tax law prescribes specific rules with
respect to the recognition of revenue for tax purposes. 
Consequently, most changes in the recognition of revenue for
financial accounting purposes that result from the new standard
likely will affect only the computation of a book-tax difference
and the related deferred taxes. Nonetheless, the new standard could
change the manner in which revenue is recognized for book purposes
and complicate the determination of book-tax differences.

For example, the tax law requires recognition of revenue from
the sale of goods when the `benefits and burdens of ownership' of
the property are transferred to the customer, which generally is
more consistent with the current GAAP `risks and rewards' model. As
a result, the new `transfer of control' model for goods could
result in new book-tax differences.

Similar complexities could arise if the transfer of control
model changes the timing of the recognition of services, long-term
contract, or licensing revenue for financial accounting purposes
but not tax purposes. To the extent the timing of an item of income
changes, companies would need the capability to track book-tax

In addition, under the new standard, an estimate of variable
consideration such as refund rights, incentives, performance
bonuses, or penalties must be included in the transaction price if
it is probable (GAAP) or highly probable (IFRS) that the amount
will not result in a significant revenue reversal when the
uncertainty is resolved. In contrast, under current rules, variable
consideration generally is not recognized as revenue until the
contingency is resolved, which is consistent with the tax
treatment. As a result, the new standard could create additional
book-tax differences with respect to variable consideration that
also must be tracked.

The takeaway

The new standard could affect the revenue recognition practices
of many companies that have contracts with customers to provide
goods, services, or non-financial assets, with a corresponding
impact on cash taxes (generally in situations involving advance
payments), book-tax differences, and deferred tax positions.

Implementation of the new standard also could potentially
require companies to request tax accounting method changes, such as
when the book recognition of advance payments is changing or when
implementation highlights use of an improper revenue recognition
method for tax purposes.

As companies prepare to implement the changes in the revenue
recognition model, it is important that companies do not overlook
any changes that are required for tax purposes, as well as any
changes to accounting procedures or systems that will be necessary
to ensure that they have the capability to track and report changes
required to comply with tax revenue recognition requirements.

For more information, in the Tax Management Portfolios, see
Connor, Kennedy, Manousos, and Tingey, 572 T.M.
, Accounting
Methods - Adoption and Changes.

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