The new revenue recognition standard is in effect so if you haven’t already, now is the time to address this potentially significant change in financial reporting with your CPA.
It has been over five years since the Financial Accounting Standards Board (FASB) and the International Accounting Standards Board (IASB) issued their final standard on revenue from contracts with customers in May of 2014. The standard, issued as ASU 2014-09 (as amended) by the FASB and as IFRS 15 (as amended) by the IASB, outlines guidance for entities to use in accounting for revenue arising from contracts with customers and supersedes most current revenue recognition guidance, including industry-specific guidance. The effective dates for privately owned entities are annual reporting periods beginning after December 15, 2018 (calendar 2019). Five years have passed quickly and all businesses, including dealerships, who report under Generally Accepted Accounting Principles should be implementing the standard now.
The new standard requires entities to recognize revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration the business expects to be entitled in exchange for those goods/services. This core principle of the standard is supported by the following five–step process for recognizing revenue:
The blumshapiro Dealers Services Group has reviewed this new standard and the five–step process closely as well as the financial statements of public dealership groups who were required to implement in 2018. We have also helped clients through implementation. Through those processes, we have identified several key areas where dealerships’ revenue recognition procedures may change under the new standard.
Currently, most dealerships recognize revenue in their service department and body shops when the services are completed. Under the new standard, the performance obligations associated with repair and maintenance services are considered to be satisfied over time, which results in the acceleration of revenue recognized. For example, if a vehicle is brought in for service on December 30, but the work is not completed until January 2, the dealership needs to consider the amount of revenues earned and expenses incurred on the work-in-process as of December 31 and potentially recognize such amounts in their financial statements. In short, dealerships will need to review their service department and body shop work-in-process at the end of a reporting period to determine if such amounts are significant enough to require recognition under the new standard.
Additionally, some dealerships receive retrospective commission from finance and insurance (F&I) product providers. Retrospective commission is a commission paid by the F&I provider on the annual performance of the portfolio of contracts sold. Those dealers who receive these funds generally recognize this revenue in the period they are notified of a forthcoming payment. Under the new standard, such revenues are considered to be part of the initial transaction price and must be estimated and recorded in the period the product is sold. If a dealership receives retrospective commission, this is a significant change that results in the acceleration of revenue recognition. In order to accommodate this change, dealers need to work with their F&I providers to determine projections for performance and expected retrospective commission. That process needs to start now, if it has not already.
Finally, many dealerships provide their customers with certain incentives upon the sale of the vehicles. For example, a dealership might offer free tires for life, or free oil change services for a certain period of time. They may also offer a loyalty program where the purchaser of a vehicle receives discounted goods and services for a period of time after the sale of the vehicle. While guidance on the standard from FASB has indicated that an entity is not required to assess whether promised goods or services are separate performance obligations if they are immaterial in the context of the contract with the customer, dealerships will need to review these offerings and determine if they are in fact immaterial. This will likely be determined based on the amount of incentives provided with the vehicle. For example, if the dealership includes one free oil change with the purchase of a vehicle, it is likely immaterial in the context of the contract with the customer. If the dealership includes free oil changes for life, such services may be considered material. If it is determined that such incentives are material, they will need to be considered separate performance obligations to which a portion of the overall transaction price must be allocated. The recognition of revenue related to these obligations will need to be over the time the services are provided.
The new revenue recognition standard is in effect so if you haven’t already, now is the time to address this potentially significant change in financial reporting with your CPA. While we’ve covered some of the key areas impacting dealerships, all dealership revenue streams must be reviewed in the context of the new standard and its five–step process outlined above to determine if any changes to current revenue recognition procedures are required. At blum, we know this is challenging, and are here to help guide you through it.