The new revenue recognition standard — automotive
What you need to know
- The new revenue recognition standard is more principles-based than current revenue guidance and will require automotive entities to exercise more judgment.
- Original equipment manufacturers and automotive parts suppliers may identify more performance obligations than they do today.
- Automotive parts suppliers may be required to change the timing of revenue recognition for contracts to supply customized parts.
- The new standard is effective for public entities for fiscal years beginning after 15 December 2016, including interim periods within those years, and for nonpublic entities in years beginning after 15 December 2017.
Automotive entities may need to change certain revenue recognition practices as a result of the new revenue recognition standard jointly issued by the Financial Accounting Standards Board (FASB) and the International Accounting Standards Board (IASB) (collectively, the Boards). The new revenue recognition standard will supersede virtually all revenue recognition guidance in US GAAP and IFRS.
The new standard provides accounting guidance for all revenue arising from contracts with customers and affects all entities that enter into contracts to provide goods or services to their customers (unless the contracts are in the scope of other US GAAP requirements, such as the leasing literature). The guidance also provides a model for the measurement and recognition of gains and losses on the sale of certain nonfinancial assets, such as property and equipment, including real estate.
Automotive entities also may want to monitor the discussions of the Boards’ Joint Transition Resource Group for Revenue Recognition (TRG). The Boards created the TRG to help them determine whether more implementation guidance or education is needed.
The views we express in this publication are preliminary. We may identify additional issues as we analyze the standard and entities begin to interpret it, and our views may evolve during that process. As our understanding of the standard evolves, we will update our guidance.
To apply the new standard, original equipment manufacturers (OEMs) will need to change the way they evaluate incentives, and automotive parts suppliers (APSs) will need to change the way they evaluate long-term supply contracts. Both types of entities may identify separate performance obligations (i.e., unit of account) where today they do not. The accounting for contracts with repurchase options or residual value guarantees also may change.
OEMs frequently offer sales incentives in contracts to sell vehicles to dealers. These sales incentives can be in the form of a cash rebate bonus or other incentive to dealers and retail customers (who purchase the vehicle from the dealer). These incentives can also include free or heavily discounted goods or services provided to retail customers, such as free satellite radio or free maintenance for a specified period.
Under the new standard, cash incentives (or credits or other items that can be applied against amounts owed to the OEM) paid by the OEM to customers (dealers and retail customers) will generally be accounted for as a reduction in the transaction price, and therefore of revenue.
Long-term supply contracts
APSs commonly enter into long-term arrangements with OEMs to provide specific parts such as seat belts or steering wheels. An arrangement typically includes the construction of the equipment required to manufacture the part (referred to as tooling) to meet the OEM’s specifications. In many cases, the APS will construct and transfer the legal title of the tooling to the OEM after construction, even though they will retain physical possession of it to produce the parts.
Currently, some APSs account for tooling as a revenue element because they have concluded it is a deliverable in the arrangement. Those APSs will likely be able to reach the same conclusion under the new revenue standard because the Boards concluded that incidental goods and services are goods or services for which the customer pays and to which the entity should allocate consideration (i.e., identify as performance obligations) for purposes of revenue recognition.
Under their supply agreements, an APS may provide OEMs with a customized part (e.g., a car seat) that is designed and constructed to fit specifically within a particular make and model vehicle. In these types of arrangements, APSs will have to carefully consider whether each individual part is a separate performance obligation or whether all the parts supplied in the contract (or some combination of them) are considered a single performance obligation. After the performance obligations are identified, APSs will also need to evaluate whether the performance obligations meet the criteria for recognizing revenue over time (rather than at a point in time, such as when delivery occurs).
The Boards concluded that when an entity is creating something that is highly customized for a particular customer, which may be the case in an APS contract, it is less likely that the entity could use that asset for any other purpose. The standard states that an entity needs to consider the effects of contractual restrictions and practical limitations on the entity’s ability to readily direct that asset for another use, such as selling it to a different customer, when determining whether an asset has alternative use.
Repurchase options and residual value guarantees
OEMs may sell vehicles with a repurchase option or a residual value guarantee (e.g., when they sell fleets to rental car companies). Under today’s guidance, OEMs account for these vehicle sales as leases in accordance with Accounting Standards Codification (ASC) 840, Leases.
Under the new standard, arrangements repurchase features must be evaluated to determine whether they represent a sale, lease or financing, based on specified criteria. This evaluation includes considering factors such as the likelihood of a customer exercising a put option or the relationship between the repurchase price and the original selling price.
- Entities should perform a preliminary assessment on how they will be affected as soon as possible so they can determine how to prepare to implement the new standard. While the effect on entities will vary, some may face significant changes in revenue recognition. All entities will need to evaluate the requirements of the new standard and make sure they have processes and systems in place to collect the necessary information to implement the standard, even if their accounting results won’t change significantly or at all.
- Entities also may want to monitor the discussions of the Boards, the Securities and Exchange Commission (SEC) staff and the TRG.
- Public entities also should consider how they will communicate the changes with investors and other stakeholders, including their plan for disclosures about the effects of new accounting standards discussed in SEC Staff Accounting Bulletin (SAB) Topic 11.M. The SEC staff has indicated it expects an entity’s disclosures to evolve in each reporting period as more information about the effects of the new standard becomes available, and the entity should disclose its transition method once it selects it.