In 2014 the Financial Accounting Standards Board (FASB) and the International Accounting Standards Board released their highly anticipated standard on revenue recognition. The standard was issued as part of a convergence of efforts to more closely align accounting principles generally accepted in the United States of America with international accounting standards.
Issued by FASB as Accounting Standards Update (ASU) 2014-09 – Revenue from Contracts with Customers, the standard outlines a single, comprehensive, principal-based model for entities to use in recognizing revenue arising from customer contracts and replaces current revenue recognition standards. The overall goals of the standard are to streamline and remove inconsistencies in revenue recognition; improve comparability; provide a more robust framework for addressing revenue issues; and increase the usefulness of the financial statement disclosures. While the standard was issued in 2014, its implementation has been delayed several times and most entities have not paid much attention to it.
However, as discussed below, implementation is now drawing near and entities need to begin thinking about the potential impacts.
Under the new revenue recognition standards, entities, including dealerships, must perform the following five steps in recognizing revenue:
In order to comply with the new revenue recognition standards, entities must reassess their current revenue accounting and determine whether changes are necessary. While guidance suggests that original equipment manufacturers (OEMs) and automotive parts suppliers will likely be impacted more significantly than dealerships, several examples of areas where dealerships’ revenue accounting may be impacted when applying the standards include:
In addition to reassessing current revenue accounting, financial statement disclosures will need to be expanded to include information about the amount, timing and uncertainty of revenue and cash flows; the judgement, and changes in judgement, exercised in applying the revenue recognition model; and any assets recognized from costs to obtain or fulfill a contract.
Many dealerships offer their customers free services such as maintenance, tires and car washes as a means to incentivize them to purchase a vehicle. Most dealerships deem these deliverables to be inconsequential obligations or “marketing” deliverables and currently do not defer a portion of revenue from the sale of a vehicle in order to fulfill the obligation. Under the new standard, however, they may be considered separate performance obligations, requiring that a portion of the revenue from the sale of the vehicle be deferred and recognized over the term that the free services are provided.
The dealership will need to determine the portion of the transaction price that is attributable to the free services. While recent guidance on the standard from FASB has indicated that an entity is not required to assess whether promised goods or services are performance obligations if they are immaterial in the context of the contract with the customer, dealerships will need to review their free service offerings and determine if they are in fact immaterial. This will likely be determined based on the amount of free services 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 10 free oil changes, such services may be considered material.
Short-term and extended warranty contracts that are sold and held by a dealership or provided with the sale of a vehicle (e.g., 90-day warranty on used vehicles) may also be considered separate performance obligations under the ASU. Similar to the free service(s) example, the portion of the total transaction price attributable to the vehicle would be recognized upon delivery, but the portion attributable to the warranty would be required to be deemed deferred revenue recognized over the coverage period. If a dealership transfers the warranty to a third party warranty or reinsurance company by purchasing coverage from those parties, it has satisfied its performance obligation and would recognize the full amount of revenue at the time of transfer (likely concurrent with the sale of the vehicle).
Under the new standard, variable consideration would be estimated by taking into account available information (e.g., past history or projected sales) and would be included in the transaction price only to the extent that it is probable that its inclusion would not result in a significant future revenue reversal. Dealerships may have sales contracts that include variable elements (e.g., incentive bonuses). Consideration payable to the customer (e.g., cash rebates, credits, or discounts) may also be variable. While accounting for variable consideration under the new standard may ultimately be consistent with current accounting (as often times incentives, rebates, etc., provided by the OEMs are easily determinable), dealerships will need to evaluate their contracts under the ASU to assess whether their current accounting remains appropriate.
For public entities, the standard is effective for annual reporting periods beginning after December 15, 2017 (calendar year 2018). For non-public entities, the standard is effective for annual reporting periods beginning after December 15, 2018 (calendar 2019). Both public and non-public entities are permitted to adopt the guidance early, for periods beginning after December 15, 2016 (calendar 2017).
This article covers only a few areas where a dealership may be impacted by the new revenue recognition standard and is not intended to be all encompassing. While there are still a few years before it will become effective, dealerships need to begin a process of reviewing the new standard, considering their current revenue accounting and determining what adjustments may be required to comply.