Revenue Recognition Standard: What Will Change for Financial Institutions
In May 2014, the Financial Accounting Standards Board (FASB) issued Accounting Standards Update (ASU) 2014-09 – Revenue from Contracts with Customers, which created a new principle-based framework to determine when and how an entity recognizes revenue from its customer contracts (Accounting Standards Codification [ASC] 606).
Certain industries are expected to experience more significant impact to revenue recognition timing, such as construction, health care, technology, nonprofit, and some manufacturing organizations.
Since all financial institutions will be affected to some extent by the new revenue recognition guidance, management must evaluate how policies, procedures, and guidelines may need to change to support the accounting and reporting for the new criteria.
The effective date for the changes has been pushed back one year from the original date due to ongoing implementation discussions. Effective dates are currently set to begin after December 15, 2017, for annual and interim reporting periods of public entities, and after December 15, 2018, for annual periods of all other entities.
New framework based on core principle
FASB has established a core principle for recognizing revenue within the new rules, which states that revenue should only be recorded when services are provided or goods are transferred to customers at the agreed price.
FASB provides five steps for organizations to determine how to recognize revenue from customers:
- Identify the contract(s) with a customer
- Identify the separate performance obligations in the contract
- Determine the transaction price
- Allocate the transaction price to the separate performance obligations in the contract
- Recognize revenue when (or as) the entity satisfies a performance obligation
New guidance does not affect reporting for all revenue streams
Almost all existing revenue recognition guidance will be replaced by ASC 606, but the effects of the new revenue recognition guidance on financial statements are expected to be somewhat limited within the financial institutions industry.
The FASB Board acknowledged that some arrangements with customers have unique considerations that are specifically addressed in other areas of generally accepted accounting principles. FASB ASC 606 has specifically excluded financial instruments and other rights already within the scope of the following FASB ASC topics from the new revenue recognition guidance contracts with customers:
- Topic 310, Receivables
- Topic 320, Investments — Debt and Equity Securities
- Topic 323, Investments — Equity Method and Joint Ventures
- Topic 325, Investments — Other
- Topic 405, Liabilities
- Topic 460, Guarantees
- Topic 470, Debt
- Topic 815, Derivatives and Hedging
- Topic 825, Financial Instruments
- Topic 860, Transfers and Servicing
The following revenue streams are accounted for in the above topics, and therefore are not expected to be impacted by the new revenue recognition guidance:
- Loan interest income
- Investment interest income and dividends
- Loan servicing revenue and gains/losses
- Loan related fees (e.g., prepayment, late fees, commitment fees, and origination fees)
- Fees related to financial guarantees
Sources of revenue for financial institutions that are expected to fall under the new revenue recognition guidance include the following:
- Sales of foreclosed real estate property
- Certain asset management-related fee revenue
- Certain credit card related revenue, including interchange revenue rewards programs and annual fees
- Certain deposit account fees
Management should consider impact to business lending
Financial institution management who oversee business lending need to be aware of how the new revenue recognition standard will impact business borrower financial statements. Management should assess how revenue recognition changes might impact current and future financial covenants, and how borrower financial information is evaluated.
Groups developed to aid with guidance implementation
The American Institute of Certified Public Accountants (AICPA) has formed 16 industry task forces, including one focused on depository institutions, which are expected to develop guidance that will provide illustrative examples for how to apply the new revenue recognition standard.
Additionally, FASB, along with the International Accounting Standards Board (IASB), have created a joint transition resource group (TRG) to aid entities in the new revenue recognition standard. These groups continue to provide guidance for all entities, including financial institutions, for transitioning to the new revenue recognition standard. We encourage financial institutions to monitor developments from both the AICPA task force and the FASB TRG.
How we can help
FASB, AICPA, and several trade associations have begun studying these issues, but formal guidance is not expected soon. Because the effective date of these new rules has been deferred, many have taken a “wait and see” attitude, but the date for implementation will eventually arrive. Institutions should prepare to adopt the new requirements by inventorying their revenue streams and evaluating how they will be affected by the new rules. We can help you understand and adapt to these standards so that you can embrace the changes with confidence.