FASB is changing revenue recognition rules - how will your bank be impacted?
Michael Meserve, Audit Manager
On May 28, 2014, the Financial Accounting Standards Board (FASB) issued Accounting Standards Update (ASU) 2014-09, Revenue from Contracts with Customers, which will be codified as Accounting Standards Codification (ASC) 606 (Topic 606). The standard will eliminate recognition guidance under current U.S. Generally Accepted Accounting Principles, and replace it with a principles-based approach for determining revenue recognition. Since issuance of the ASU, FASB continues its revisions and interpretations.
In a previous white paper, we addressed general principles, likely implementation issues and the implementation dates of ASU 2014-09. This article addresses certain issues specific to the Depository and Lending Institutions industry.
The good news for Depository and Lending Institutions is that due to the scope exceptions in Topic 606, the major source of revenue, interest income recognition and measurement on loans and investments, will not be impacted by the new guidance.
The American Institute of Certified Public Accountants (AICPA) has formed sixteen industry task forces to develop a guide that will provide direction and illustrative examples when applying ASU 2014-09. Below is a list of potential revenue recognition implementation issues identified by the FASB and/or the Depository and Lending Institutions Industry Task Force as of the date of this article. The list contains the status of each implementation issue, and will be updated as the issues make their way through the due diligence process. This process includes a thorough review by the AICPA’s Revenue Recognition Working Group (RRWG) and Financial Reporting Executive Committee (FinREC), as well as FASB’s Transition Resource Group (TRG), where applicable.
|Issue #||Description of Implementation Issue||Status|
|1||Scope Issues This implementation issue contains the FASB IASB TRG conclusions related to scope issues for depository institutions including: credit cards, deposit services charges, and servicing/subservicing||Out for exposure until October 2, 2017|
|1a||Question on revenues scoped out of ASC 606|
|4||Sale of Non-Operating Assets (Other Real Estate Owned) This implementation issue provides considerations for depository institutions in applying the guidance in ASC 606 to sales of other real estate owned.||Finalized and included in the AICPA Guide Revenue Recognition|
At this juncture, certain topics pertaining to the implementation of ASU 2014-09 with respect to Depository and Lending Institutions are unresolved; however, based on comments of the FASB staff, we have some preliminary indications as to where some of the scope issues may wind up. The scope issues at this time are not resolved in an authoritative manner, but do provide some insights for future outcomes.
Under the current standards, ASC 310-20 discusses credit cards, available lines of credit, debit cards and similar types of instruments as “loan commitments” and any related revenues associated with such instruments are deemed to be “loan commitment fees.” These commitment fees are recognized over the entirety of the commitment period. When a fee is compensating the institution for services provided during the commitment period, fees are generally seen as falling within the scope of ASC 310-20. In these scenarios the fees are viewed as an extension of the commitment period and cannot be separated and reliably measured under Topic 606. Since credit card fees are generally viewed as falling within Topic 310-20 and not the current revenue topic (Topic 605), they should continue to be viewed through the current lens; however, because the nature of the arrangement must be that of a credit card lending arrangement in order to be within the scope of ASC 310-20, institutions should not presume the arrangement falls entirely outside the scope of Topic 606 and will need to continue to evaluate the overall nature of such arrangements.
Although nothing authoritative has been promulgated at this time, deposit-related fees (i.e. fees collected with respect to customer related deposits) appear to be trending towards inclusion under Topic 606 at this time. The reason for their inclusion is primarily due to two considerations: 1) deficiencies in the current standards under Topic 405 and 2) the board views customer deposits as short-term contracts between the financial institution and the customer. That contract is eligible to be terminated at any time by either party without compensation owed to the other party (in other words, no termination penalty). More information on this is expected in the near future; however it is expected that in most cases, implementation of Topic 606 will result in the same revenue recognition as current practice.
For servicing and sub servicing income, conflicting viewpoints on the application of Topic 606 exist. Current guidance under Topic 860 requires financial institutions to record a servicing asset or liability dependent on expected future servicing cash flows compared to the fair value of such services (i.e. adequate compensation). Expected amounts exceeding the fair value result in a servicing asset (and vice versa). The disagreements revolve around whether the portion of servicing income at or below adequate compensation (in other words, when a servicing liability is recorded) would be within the scope of Topic 606. Given the difficulty of applying this logic in practice (due to fluctuations from period to period for myriad reasons), it appears that the board will continue to acknowledge all servicing income under the scope of Topic 860 and thus not subject servicing income to the new revenue recognition standard.
Sale of Non-Operating Assets (Other Real Estate Owned)
Currently, the FASB views a financial institution’s “Non-Operating Assets” (OREO) as assets in which the financial institution is not in the business of investing. As a result, FinREC believes that a loan generated from the sale of the non-operating asset (i.e. seller-financing) is not considered to fall within the financial institution’s ordinary scope of business and therefore would fall within the scope of new guidance in ASC 610-20, Other Income-Gains and Losses from the Derecognition of Nonfinancial Assets (Topic 610-20). Authoritative guidance requires Topic 610-20 to apply certain provisions of Topic 606 to determine whether a contract exists. Those provisions include the following, all of which need to be met for a contract to exist:
- The buyer and the financial institution have approved the contract and are committed to perform as agreed.
- The financial institution can identify each party’s rights regarding the goods or services to be transferred.
- The financial institution can identify the payment terms for the goods or services to be transferred.
- The contract has commercial substance (that is, the risk, timing, or amount of the financial institution’s future cash flows is expected to change as a result of the contract).
- It is probable that the financial institution will collect substantially all of the consideration to which it will be entitled in exchange for the goods or services that will be transferred to the buyer. In evaluating whether collectibility of an amount of consideration is probable, a financial institution shall consider only the buyer’s ability and intention to pay that amount of consideration when it is due. The amount of consideration to which the financial institution will be entitled may be less than the price stated in the contract if the consideration is variable because the financial institution may offer the buyer a price concession.
Commitment of the buyer to perform its obligations is a matter of judgment and can be supported by factors such as the loan-to-value ratio of the property or the intended use of the property. Collectibility is also considered to be a matter of judgment and should be evaluated on the amount of consideration to which the institution expects to be entitled in exchange for goods or services that will be transferred to the buyer and not the stated contract price. For example, price concessions should be considered up front in evaluating consideration transferred and incorporated as needed. After proper evaluation, if a financial institution still determines that it’s not probable to collect substantially all consideration, a contract does not exist.
When a contract with a customer does not meet the criteria in Topic 606 and the financial institution received consideration, the financial institution should only recognize revenue when:
- The financial institution has no remaining obligations to the buyer, and all, or substantially all, of the consideration promised by the buyer has been received by the financial institution and is nonrefundable.
- The contract has been terminated, and the consideration received from the buyer is nonrefundable.
- The financial institution has transferred control of the property (which comes with its own set of criteria and judgments), the financial institution has stopped transferring goods or services to the buyer (if applicable) and has no obligation under the contract to transfer additional goods or services, and the consideration received from the buyer is nonrefundable.
If one or more of the items above is met, revenue should be recognized. Otherwise, the consideration shall be recorded as a liability until one of those criteria is met.
Identifying different revenue streams that are impacted by the implementation of ASU 2014-09 is only the beginning of an organization’s challenges with addressing Topic 606. Financial institutions should consider necessary changes to their existing data systems and software needed (if any) in order to implement ASU 2014-09. Further, financial institutions might need to make adjustments to their current controls in order to ensure the information is properly captured and recorded. Finally, retrospective adoption is required when applying the standard, so appropriate data should be collected as soon as feasible. Practical expedients are available depending on the nature of the transaction.
More to Come
There are still a number of issues being worked on by the Depository and Lending Institutions Industry Task Force, including finalization of some of the above topics, and it is likely that additional issues will be added to the Task Force agenda as they are identified. We will continue to provide updates as other issues are identified and/or resolved by the Task Force. In the meantime, more information regarding revenue recognition implementation issues, for each of the sixteen industries focused on, is posted regularly on the AICPA Revenue Recognition Resource Center.
For questions on this article, or other technical issues impacting depository and lending institutions, contact Michael Meserve or your BNN advisor at 1.800.244.7444.
Disclaimer of Liability: This publication is intended to provide general information to our clients and friends. It does not constitute accounting, tax, or legal advice; nor is it intended to convey a thorough treatment of the subject matter.