Identifying the Federal Tax Consequences of Adopting ASC 606

| 1/23/2020
Identifying the Federal Tax Consequences of Adopting ASC 606

The new revenue recognition standards under Accounting Standards Codification (ASC) 606 and International Financial Reporting Standards (IFRS) 15, “Revenue From Contracts With Customers,” are applicable to nonpublic companies and organizations (including not-for-profits) for annual reporting periods beginning after Dec. 15, 2018 (early application was permissible if elected).

As auditors begin fieldwork for 2019 calendar year financial statements, it is important to consider the tax consequences of adopting the new revenue recognition standards and properly account for the tax impact in the income tax provision pursuant to ASC 740, “Income Taxes.” Careful attention should be given to how the revenue recognition rules under ASC 606 might affect the way revenue is recognized for federal income tax purposes given the changes in law under IRC Section 451(b), which was enacted by the Tax Cuts and Jobs Act of 2017

The core principle driving ASC 606 is that the recognition of revenue derived from the transfer of goods or services should reflect the amount of consideration the transferor expects to receive from the transfer. Based on this principle, revenue is recognized under ASC 606 in accordance with the following five-step process:

  1. Identify the contract with a customer.
  2. Identify the performance obligations in the contract.
  3. Determine the transaction price.
  4. Allocate the transaction price to the performance obligations.
  5. Recognize revenue as the entity satisfies a performance obligation.
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For some taxpayers, implementing this process will not change the timing of when revenue is recognized. For others, the timing might change from recognizing revenue from a point in time to recognizing it over time, or vice versa, creating the need to evaluate the change from a tax perspective.

If there is a change in revenue recognition due to implementing ASC 606, taxpayers might need to file Form 3115, “Application for Change in Accounting Method.” Revenue Procedure 2019-43 provides automatic accounting method change procedures related to making a change from a current tax method of accounting for the recognition of revenue to a method consistent with the new ASC 606 standard for:

  • Identifying performance obligations
  • Allocating transaction price to performance obligations
  • Considering performance obligations satisfied

Taxpayers should answer the following questions to help quantify the tax impact of adopting ASC 606 and to develop a plan to request and implement any necessary tax accounting method changes:

  • Is revenue recognition accelerating or decelerating?
  • How do the new standards align with the tax rules?
  • How will the changes affect the deferred tax provision calculations and the need for new book-to-tax differences?
  • What changes in revenue recognition result in a change for tax reporting, if any?
  • Will there be an adjustment to taxable income in implementing the changes?

The impact of adopting ASC 606 will vary based on industry and type of revenue transaction. Taxpayers should be proactive to determine how the new revenue recognition standards will affect their company. Depending on the facts, significant time might be required to understand the book adjustments, analyze the treatment for tax purposes, and determine if any method changes are required. Therefore, entities should work with their auditors and tax advisers now to determine whether there will be changes to revenue recognition for financial accounting purposes as a result of adopting ASC 606 and, if so, if those changes require a change in the entity’s accounting method for tax purposes.

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Andrew Eisinger
Washington National Tax
Brent Smith
Partner, Tax
David Strong
David Strong
Partner, Washington National Tax