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views F E April 2017 Impact of the New Revenue Recognition Standard on Dealerships Jon Hansen, Partner | DHG Assurance The Financial Accounting Standards Board (FASB) has issued a new accounting standard for revenue recognition, “ASC 606: Revenue from Contracts with Customers”, replacing nearly all existing revenue guidance under US Generally Accepted Accounting Principles (GAAP). The new standard uses a 5-step process to analyze revenue recognition. This memo will analyze the new standard at a high level to assess the GAAP impact on dealerships. Effective dates Sales of vehicles (new and used) • Public entities: fiscal years beginning after December 15, 2017 • Non-public entities: December 15, 2018 fiscal years beginning after Analysis of impact on dealerships: Below, the key portions of the 5-step revenue process under the new revenue standard are assessed for each of a dealership’s typical key business areas: Assurance | Tax | Advisory | dhgllp.com 5-Step process under the new standard: Step 1: Identify the contract with the customer • Contract is for the sale of a vehicle and the transaction has an associated written contract (Buyer’s Order). Step 2: Identify the performance obligations of the contract • The primary performance obligation is the delivery of the vehicle. Other obligations (customization, etc.) are typically fulfilled before the delivery of the vehicle. views Step 3: Determine the transaction price Step 5: Recognize revenue when (or as) the entity satisfies a performance obligation. • The transaction price is clearly stated in the buyer’s order. The majority of the price is for the vehicle itself. Within the contract, other items can be listed (primarily for extended warranty and similar policies). See analysis of this component of the transaction price in the extended warranties section below. • For the sale of the parts, the performance obligation is satisfied upon delivery of the parts. Comparison to current practice: Dealerships reporting under GAAP are typically recognizing the revenue on the sale of parts upon delivery of the parts. The new standard would typically not significantly change this current practice. Step 4: Allocate the transaction price to the performance obligations in the contract • The transaction price components are primarily split between the delivery of the vehicle and the sale of extended warranty and related products, if applicable. Servicing of vehicles 5-Step process under the new standard: Step 1: Identify the contract with the customer Step 5: Recognize revenue when (or as) the entity satisfies a performance obligation. • Contract is for the providing of repair of and/or maintenance to the vehicle and the transaction has an associated written contract (invoice). • For the sale of the vehicle, the performance obligation is satisfied upon delivery of the unit and completion / signing of the contract. Step 2: Identify the performance obligations of the contract Comparison to current practice: • The performance obligation is the performance of the specified service(s). Dealerships reporting under GAAP are typically recognizing the revenue on the sale of new and used vehicles upon delivery of the unit and completion / signing of the associated contract, and are recording the amount of revenue identified in the contract as the sales price of the vehicle. The new standard would typically not significantly change this current practice. Step 3: Determine the transaction price • The transaction price is clearly stated on the final invoice. Step 4: Allocate the transaction price to the performance obligations in the contract • Although multiple repair services can be performed as part of one repair order, the services are typically completed within a relatively short timeframe and are all related to repair and/or maintenance of the vehicle. Sales of parts 5-Step process under the new standard: Step 1: Identify the contract with the customer Step 5: Recognize revenue when (or as) the entity satisfies a performance obligation • Contract is for the sale of parts and the transaction has an associated written contract (parts purchase order / invoice typically in one document) • For the sale of repair and maintenance services, the performance obligation is satisfied upon completion of the service(s) and return of the vehicle to the customer. Step 2: Identify the performance obligations of the contract • The performance obligation is the delivery of the parts. Comparison to current practice: Step 3: Determine the transaction price Dealerships reporting under GAAP are typically recognizing the revenue on repair services upon completion of the service and return of the vehicle to the customer. The new standard would typically not significantly change this current practice. • The transaction price is stated on the parts invoice. Step 4: Allocate the transaction price to the performance obligations in the contract • The only performance obligation is the delivery of the parts. Assurance | Tax | Advisory | dhgllp.com 2 views Leasing of vehicles Disclosure considerations Lease contracts are specifically excluded from the scope of the new revenue recognition standard. The FASB has issued a new standard on leases, which will be effective in 2019 for public entities and in 2020 for non-public entities. However, this new leasing standard does not significantly change lessor accounting from current practice. Specific wording from ASC 606 below outlines the major required disclosures under the new standard. Next to each item, potential impact on current disclosure is noted. ASC 606-10-50-1 The objective of the disclosure requirements in this Topic is for an entity to disclose sufficient information to enable users of financial statements to understand the nature, amount, timing, and uncertainty of revenue and cash flows arising from contracts with customers. To achieve that objective, an entity shall disclose qualitative and quantitative information about all of the following: Sales of extended warranties Updated guidance under the new revenue recognition standard: The key consideration for sales of extended warranty products under the new revenue recognition standard (ASC 606) is the principal vs. agent consideration. In general terms, a principal serves as the primary obligor for a performance obligation, while an agent arranges for another party to provide for goods or services a. Its contracts with customers: Dealerships typically disclose the nature of its contracts with customers. However, the new standard does require disclosure of the disaggregation of revenue among the significant types of revenue. Therefore those that are not currently doing so will need to disclose its breakout of revenue by major type, beginning upon adoption of the standard. Comparison to current practice: Dealerships that sell products on behalf of outside warranty companies typically recognize the revenue on the sale of extended warranty products upon delivery of the warranty contract to the customer, as the dealership serves as an agent, not the principal or primary obligor. This practice will not change under the new standard. b. The significant judgments, and changes in the judgments, made in applying the guidance in this Topic to those contracts: Dealerships’ disclosures may already cover this requirement, but dealerships should assess whether any new judgments were made as part of adopting the new standard and should disclose these judgment items in the financial statement footnotes. Dealership groups that have an extended warranty company included within their financial statements are already required under GAAP to defer and recognize the contract revenue over the life of the associated contracts. This would remain the same under the new standard. c. Any assets recognized from the costs to obtain or fulfill a contract with a customer: Not anticipated to be applicable for dealerships. Jon Hansen Partner, DHG Assurance 704.367.5864 [email protected] Assurance | Tax | Advisory | dhgllp.com 3