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4-2019

ASC 606 AND TAXABLE REVENUE: The newrevenue recognition standard combined with taxcode changes introduced by the Tax Cuts and JobsAct will impact when taxable revenue is rRobert BloomJohn Carroll University, rbloom@jcu.edu

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Recommended CitationBloom, Robert, "ASC 606 AND TAXABLE REVENUE: The new revenue recognition standard combined with tax code changesintroduced by the Tax Cuts and Jobs Act will impact when taxable revenue is r" (2019). 2019 Faculty Bibliography. 22.https://collected.jcu.edu/fac_bib_2019/22

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went into effect in 2018 forpublicly listed companiesand in 2019 for privatecompanies.

Accounting income isaccrual-based, reflectingrevenue when the earningsprocess is complete. U.S.Generally AcceptedAccounting Principles(GAAP) are concernedwith measuring the rev-enue that’s highly probableof receipt in terms of cashinflows and reflectingincome by matching theexpenses incurred in thesame period to generatethose revenues. Taxableincome hasn’t had that ori-entation. Revenue in taxa-tion, assuming that taxprofessionals are usingaccrual accounting, isrequired to meet an “allevents test” to qualify for inclusion in taxable in come. This test is two-pronged: (1) The rightto receive is fixed, and (2) The amount can bedetermined with reason-able accuracy.

THE REVENUE RECOGNITION STANDARD

ASC 606 was issued in2014. The previous revenuestandard in the U.S. was ahodgepodge of many dif-ferent industry rules. Thecurrent formulation of thestandard has a decidedlylegalistic flavor in terms offocusing on probable con-tractual performance. Tra-ditionally under U.S. GAAP,“probable” has been con-sidered to mean a highprobability, often at least60%. On the other hand,under IFRS, “probable”refers to “more likely thannot,” connoting a probabil-ity of more than 50%.

The new standard lacksthe specificity typical of

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ASC 606 AND TAXABLE REVENUEThe new revenue recognition standard combined with taxcode changes introduced by the Tax Cuts and Jobs Act willimpact when taxable revenue is recognized. BY ROBERT BLOOM

CONGRESS PASSED the Tax Cuts and JobsAct (TCJA) in December 2017. It’snow a little more than a year later,and tax professionals are still onlybeginning to understand many ofits provisions. To comply with thenew law, tax professionals willneed to learn about the new

accounting revenue recognition standard, Revenue fromContracts with Customers, issued as a joint endeavor bythe Financial Accounting Standards Board (FASB) andthe International Accounting Standards Board (IASB).Known as Accounting Standards Codification (ASC)606 or International Financial Reporting Standard(IFRS) 15, the standard represents a major change inrevenue recognition. In the United States, ASC 606

U.S. accounting principles,and its application ishighly dependent onaccountants’ judgment.Applying ASC 606 consistsof five steps. Step 1 is todetermine if a contractexists and, if so, to delin-eate its specific character-istics. (A contract isdefined as an agreementbetween two or more par-ties creating enforceablerights and obligations.)

Step 2 is to analyze thecontract to pinpoint thepromises pertaining to thetransfers of goods or serv-ices that each party makesto the other. Revenue is tobe recognized when trans-fers occur. If those actionsare distinct, then they rep-resent performance obliga-tions that need to beaccounted for separately.Should the contractinclude significant financ-ing across more than oneyear, present value analysisis applied.

Step 3 is to identify thetransaction price reflectingthe amounts to be receivedfrom the transfers of goodsor services, which mayinvolve not just fixed con-sideration but also “vari-able consideration.” Theactual revenue reportedshould reflect variableconsideration from salesreturns and allowances,refunds, discounts, incen-tives, and bonuses. Thisconsideration is estimated

by using a “most likely”approach if there are lim-ited alternative outcomesor an “expected value”approach if there’s a rangeof outcomes. The consider-ation is included in therevenue, assuming that asignificant reversal in theamount recognized won’toccur.

Step 4 is to determinehow to allocate the trans-action price among thecontract performances byfinding stand-alone pricesfor each performance obligation.

Step 5 entails revenuemeasurement by allocatingit to the individual per-formance obligations thathave been satisfied. Theobligations may be fulfilledat a particular point intime, which is usually thecase with goods, or over aspecified time period withservices.

THE IMPACT OF ASC 606

Under ASC 606, revenuemay be reported soonerthan was previously thecase based on satisfyingperformance obligationsunder contracts. Unlikemost accounting standards,this standard is viewed asmore of a guiding principlethan a set of prescriptiverules to follow. It reliesheavily on the judgment of management and inde-pendent auditors to esti-

mate revenue. According tothe new IRC §451(b), addedby the TCJA (amending IRC §451 and applying totaxpayers having an appli-cable certified financialstatement), adherence toASC 606 may recognizetaxable revenue earlierthan under the traditional“all events test” in somesituations. Hence, the newtax law and new revenuestandard should producefewer book-tax differencesand higher taxable incomesooner than under the pre-vious standard.

In more concrete terms,under the new tax law,accounting revenue re -ported in Year 1 generallycan’t be considered taxrevenue in Year 2. Bothaccounting and tax rev-enue usually must bereported in the same year.For example, under ASC606, licensors are requiredto fully report revenuefrom licensing agreementsduring the first year of amultiyear contract, con-trary to previous account-ing practice, if the licensorshave performed their obli-gations fully. Therefore, taxrevenue would follow theaccounting revenue andreport such revenue in thefirst year.

ALIGNING TAXABLE ANDACCOUNTING REVENUE

What, conceivably, couldbe the rationale for thisattempt by the IRS to aligntaxable revenue withaccounting revenue? Pre-sumably, accounting rev-enue under ASC 606 willshow revenue earlier, anopportunity for the IRS toraise its revenue collec-tions sooner. This situationis reminiscent of whathappened under the TaxReform Act of 1986 (H.R.

3838). In a similar fashion,the IRS attempted to raiseadditional revenue by nolonger permitting compa-nies to follow the accrualaccounting method for baddebts whereby estimates ofuncollectible accounts aremade in each period ofsales and matched againstthose sales in the incomestatement. For tax report-ing since the 1986 Act,companies have had topostpone the bad debtsdeduction on the taxreturn to the period whenthe accounts are actuallydeemed to be uncollectibleand therefore written off.

Alignment of tax andaccounting revenue recog-nition would simplify IRSaudits since much of therevenue will be the samefor both tax and account-ing purposes. Convergingthese two revenue calcula-tions could impose arestraint on artificial earn-ings management. In anycase, it remains to be seenhow many companies willbe showing revenue earlierfor accounting than before,thereby reporting revenuein a less conservative man-ner. Finally, one must won-der whether the newreporting requirement will constitute a disincen-tive for companies to fol-low the new accountingrevenue recognition crite-ria since tax revenue willnow follow accountingrevenue. SF

Robert Bloom, Ph.D., is a pro-fessor and the Andersen Fellow in the School of Accountancy and Information Sciences in theBoler College of Business at JohnCarroll University in UniversityHeights, Ohio. He can be reachedat rbloom@jcu.edu.

© 2019 A.P. Curatola

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TO COMPLY WITH THE NEW LAW, TAX PROFESSIONALS WILL NEED TO LEARN ABOUT THE NEW ACCOUNTING REVENUERECOGNITION STANDARD.