Revenue Recognition Issue 10 – Special Focus: Distribution
Companies that focus their efforts strictly in distribution may not think there is much change that could be required to their methods of revenue recognition. After all, they just take someone else’s product and ship it to their own customers, so revenues would just be recognized based on shipments made. Right?
Well, it is not that simple. You still need to look at the contractual relationships and understand the uniqueness of these relationships.
For example, let’s say you are a specialty product distributor and you have been contracted by one of your customers to deliver to their warehouse an extensive number of component parts that they will assemble and use in their machining operations, and that your contract with the customer provides that the contract is only fulfilled when all of the parts have been received and approved. If they don’t get all of the parts, the machine they are going to assemble is essentially worthless and not able to be used, and they have no alternative uses for the components. You have been able to gather and send them 95% of the required components, but one of the components is manufactured in Taiwan and the supplier is out of stock, so the parts have been backordered and will be directly shipped to your customer in 6-8 weeks, and this pushes the contract fulfillment from the end of December into mid-late January.
Under current accounting, you might have recognized the sales in December because substantially all of the parts have been shipped and accepted, and you might have even recognized the fulfillment obligation for the backordered parts as a liability. Under the new revenue recognition standard, you would need to evaluate and use your best judgment as to whether you can recognize revenue on these part sales prior to fulfillment of the entire contract. You would really need to consider the enforceability of the entire contract and whether the customer could just return all of the parts, whether they could just obtain the missing part from another source and bill you for the excessive costs, etc. It will no longer be sufficient to just look at when you can invoice product sales.
Please contact your BMF Advisor for additional information regarding the new standards.
Tax Accounting Method Considerations
The impact of this change hits more than just the financial statements – significant tax changes could also lie ahead. The new standard presents a unique opportunity for companies to revisit their tax methods for revenue recognition. Not only do they need to ensure compliance with the tax rules, but they can also take advantage of tax opportunities and planning around revenue recognition. Companies will need to determine whether the new book methods will be permissible for tax purposes.
In instances where the new methods are permissible, the company could file a Form 3115 to implement the new methods on its tax return. If the new methods are not permissible or if the company chooses to continue using their current tax methods, the new financial accounting changes could affect or create new book-tax differences and deferred taxes related to revenue recognition. Companies will need to consider the information needed to compute these book-tax differences, and whether the information will be available after the changes for financial statement purposes.
It is important to plan ahead to make sure that tax considerations are considered upfront and not an afterthought. Companies should thoroughly assess all their revenue streams and the proper tax methods for each to plan the appropriate actions for successful implementation.
James E. Merklin?>
CPA/CFF, CFE, CGMA, MAcc
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