Taxes and Revenue Recognition (ASC 606)
Tax laws can be complicated! Certain types of transactions are subject to rules that do not always match the U.S. GAAP accounting treatment. To the extent that tax accounting is similar to the rules used for financial reporting purposes, the taxpayers can employ the same methods. When considering ASC 606, Revenue from Contracts with Customers, changes in the amount and timing of revenue recognition for book purposes may also affect taxable income, as the timing may differ from the allowable recognition under federal income tax rules.
Under U.S. federal income tax principles, an accrual-based taxpayer reports taxable income in the year which:
- The right to receive revenue becomes fixed (Criteria #1), and
- The amount can be determined with reasonable accuracy (Criterion #2)
First of all, when does the “right to receive revenue become fixed?” An amount is considered fixed at the earliest of when:
- Payment is made,
- Payment is due, or
- Performance has occurred
These criteria are clearly different from the 5-step model found in ASC 606. If there is a timing difference between when revenue is recognized under ASC 606 and under the U.S. federal income tax principles, then a temporary difference will result.
Below we identify the potential differences between book at tax for each step:
Step 1: Identify the contract
Step 1 is to identify the contract with the customer. When determining if there is a contract, collectability must be considered. Under ASC 606, the collectability of the transaction price (the amount to which the entity expects to be entitled in exchange for the promised goods or services) must be probable or no revenue is recognized until certain criteria are met. Under the U.S. tax code, there is no requirement to meet a “probable” collectability threshold before recognizing revenue. Instead, the revenue must be fixed and determined with reasonable accuracy. There may be a contract for which collection is not “probable” for book purposes; therefore, no revenue would be recognized. In making the decision not to recognize revenue for tax purposes, it must prove that there is reasonable doubt and uncertainty regarding collectability. This “doubtful collectability exception” is likely different in application that the “probable” collectability threshold under U.S GAAP.
Step 2: Identify performance obligations
Performance obligations are promises to a customer under ASC 606. At contract inception, an entity should assess the goods or services promised – this is Step 2. To be categorized as a performance obligation, each promise to transfer to the customer must be: 1) a good or service that is distinct, or 2) a series of distinct goods or services that are substantially the same and that have the same pattern of transfer to the customer. On the other hand, tax laws generally place emphasis on the basis of the form of a contract. How performance obligations are bundled for book purposes under Step 2 may be different! If the wording in a contract and the Step 2 evaluations result in different conclusions, there could be timing differences in when and how much revenue is recognized.
Step 3: Determine the transaction price
Step 3 of ASC 606’s 5-step model requires entities to determine the transaction price of the contract. When determining the transaction price, entities must include variable consideration in their determination of the transaction price (subject, of course, to the revenue constraint). The transaction price is the amount the entity expects to be entitled in exchange for the transfer of goods or services to a customer. U.S. federal income tax principles do not recognize revenue until the amounts are fixed and determinable. The concept of variable or contingent revenue does not apply under tax law. Therefore, the amount of revenue recognized under each set of rules could differ.
Step 4: Allocate the transaction price
Again, tax law requires that the form of a contract be followed. Therefore, if a contract allocates the transaction price to various elements within the contract, that allocation would be followed. However, Step 4 of ASC 606 requires the transaction price to be allocated to each distinct performance obligation based on the relative stand-alone selling price. The timing and amounts included as revenue for tax purposes may not match revenues determined in step 4.
Step 5: Recognize revenue
Under ASC 606, revenue may be recognized for book purposes at a point in time or over a time period. Entities recognize revenue under ASC 606 when the customer obtains “control.” This would occur when the customer can either: 1) direct the use of, and obtain substantially all the benefits from, an asset, or 2) prevent other entities from directing the use of, and obtaining benefits from, an asset. Step 5 focuses on when control has been transferred. Tax law requires that income be reported in the year in which the revenue is fixed and determinable. In addition, there are special rules within the tax law for certain types of transactions (e.g. advanced payments, long-term construction contracts, installment sales, etc.), which may also cause differences.
Learn more
Need additional help? Check out our Revenue Recognition Topic Page or our Step-by-Step Guide to Revenue Recognition. Or, if you want to earn CPE while learning more, our ASC 606: Revenue from Contracts with Customers eLearning course collection!
Scared of accounting for income taxes? Don’t be! Our Income Taxes Topic Page is a great reference tool. Expand your knowledge with our ASC 740: Accounting for Income Taxes eLearning course collection.
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Disclaimer
This post is for informational purposes only and should not be relied upon as official accounting guidance. While we’ve ensured accuracy as of the publishing date, standards evolve. Please consult a professional for specific advice.
