The year 2018 may ultimately be remembered as the year of revenue recognition, significant changes to the recognition of revenue for book and tax transpired this year. US tax reform provided a new Section 451 statutory provision, which substantially modified long-standing revenue recognition rules. Similarly, ASC 606 and IFRS 15 significantly changed the way in which revenue is recognized on GAAP and IFRS financial statements. These changes, when considered collectively, could dramatically affect the way in which taxpayers compute their 2018 federal taxable income.

Changes to federal income tax revenue recognition

Tax reform provided taxpayers with new revenue recognition rules effective for tax years beginning after December 31, 2017:

• New Section 451(b) requires accrual-basis taxpayers to recognize income at the earlier of when recognized for tax purposes under the historic "all events test" or when taken into account in applicable financial statements. This effectively requires tax revenue recognition at the earliest of earned, due, received or recognized for financial statement purposes. This will be a fundamental change to long-standing tax revenue recognition principles and will not provide simple book conformity.
• New Section 451(c) codifies and modifies the deferral method for advance payments permitted under Revenue Procedure 2004-34. While IRS Notice 2018-35 permits a taxpayer to continue following the provisions of Revenue Procedure 2004-34, future guidance is expected to terminate or severely limit this ability. Furthermore, Treas. Reg. Section 1.451-5 was repealed, thus eliminating multiple year deferral to taxpayers receiving advance payments for certain goods and long-term contracts.

Because of the tax reform changes to revenue recognition, many taxpayers have filed or are currently preparing tax accounting method changes. While the fact patterns diverge based on a taxpayer's current methods, industry and ASC606 impact, the following illustrates common scenarios:

• Fact: Taxpayer is currently using Treas. Reg. Section 1.451-5 advance payment deferral.
• Action: Taxpayer must change to either: (i) the deferral method under Revenue Procedure 2004-34 (see Notice 2018-35), or (ii) a method under Section 451(b) or (c).
• Fact: Taxpayer is currently using the deferral method under Revenue Procedure 2004-34.
• Action: Taxpayer may continue relying on Revenue Procedure 2004-34 (see Notice 2018-35), but may need to file a method change to adopt Section 451(c) once guidance is published.
• Fact: Taxpayer is currently following Section 451 as drafted before tax reform.
• Action 1: Taxpayer must evaluate whether new Section 451(b) will result in an acceleration of revenue.
• Action 2: Taxpayer should also consider if the deferral provisions of Section 451(c) apply.
• Fact: Taxpayer has an adjustment to retained earnings as part of the book change from ASC 605 to ASC 606.
• Action 1: Taxpayer must evaluate the book adjustment to assess the impact to tax revenue recognition.
• Action 2: Taxpayer must properly account for the retained earnings adjustment when computing 2018 federal taxable income.
• Fact: Taxpayer has accelerated book revenue recognition due to ASC 606 changes.
• Action 1: Taxpayer must evaluate whether new Section 451(b) will require an acceleration of tax revenue.
• Fact: Taxpayer's book treatment relative to the timing of expense recognition changed for book purposes.
• Action 1: Taxpayer must evaluate current tax treatment under existing tax rules to assess permissibility and the requirement for any new book/tax adjustments.

As illustrated in these examples, taxpayers should evaluate their current facts and methods of accounting to properly assess and adopt the new tax revenue recognition provisions. Although this analysis is often complex, best practices exist that can assist in making the process more efficient.

Changes to financial statement revenue recognition

The Financial Accounting Standards Board and the International Accounting Standards Board have issued largely converged revenue recognition standards that supersede nearly all existing revenue recognition guidance under US GAAP (ASC 606) and IFRS (IFRS 15).

The standard's core principle is that a company must recognize revenue when (or as) it transfers control of performance obligations to customers at an amount that reflects the consideration to which the company expects to be entitled in exchange for those performance obligations. In doing so, companies will use more judgment and make more estimates than under former guidance.

ASC 606 was effective for public entities for fiscal years beginning after December 15, 2017, and for interim periods therein (e.g., calendar year-end public entities had to adopt ASC 606 in the quarter ended March 31, 2018). Nonpublic entities must adopt ASC 606 for fiscal years beginning after December 15, 2018, and interim periods within fiscal years beginning after December 15, 2019. That is, nonpublic entities are not required to apply ASC 606 in interim periods in the year of adoption.

IFRS 15 is effective for annual reporting periods beginning on or after January 1, 2018. IFRS 15 does not distinguish between public and nonpublic entities so adoption is not staggered for IFRS preparers.

Interaction of financial statement and federal taxation revenue recognition rules

As taxpayers focus on their 2018 tax compliance, many are trying to decipher the proper approach for integrating the new revenue recognition rules under tax reform and ASC 606. As an initial matter, taxpayers should determine their implementation profile to assess the amount of adoption effort required.

At one end of the spectrum, there are taxpayers that may experience a straightforward adoption of Section 451. Such taxpayers typically have no ASC 606 changes, no cumulative catch-up adjustment for financial statement purposes and no change in the timing of revenue recognition under new Section 451. On the other end of the spectrum, certain taxpayers may undergo an extremely complex adoption. These taxpayers generally have significant ASC 606 adjustments, intricate cumulative catch-up adjustments, one or more tax technical issues in need of resolution and the need to establish sophisticated processes to properly capture and process relevant data. Many taxpayers will fall somewhere in the middle of the spectrum and will need to expend a moderate level of effort to ensure compliance with new Section 451. The following graphic illustrates the continuum of complexity that a Section 451 adoption may require for a taxpayer.

To assist taxpayers in assessing the level of effort required to comply with new Section 451, attached is a decision tree entitled "Evaluating the Section 451/ASC 606 tax impact." This flowchart may prove useful in assessing a taxpayer's current state and budgeting resources required for adoption.

Developing an implementation process

Once an assessment is made regarding the anticipated level of effort required to comply with new Section 451, an implementation plan must be developed. However, taxpayers are often uncertain as to how to approach this task. For taxpayers falling outside of a basic adoption, there exists a general process of analysis, which is helpful when developing a detailed implementation plan. This process is attached and entitled "Section 451/ASC 606 process of analysis".

Taxpayers may consider the steps contained within this general structure and modify as appropriate when developing a customized adoption methodology. As taxpayers work through this process, they should be mindful that certain potential actions are time sensitive. For example, a non-automatic Form 3115 (if required) must be filed before their year-end. Furthermore, the filing of an automatic change under Revenue Procedures 2018-29 and 2018-49 (if eligible) must be made for the year of ASC 606 adoption.

Guidance — Existing and anticipated

A common taxpayer inquiry relates to the release date(s) of additional tax guidance. Although additional guidance is anticipated, several releases of informative and instructional guidance were provided to taxpayers during the past 12 months as illustrated below.

Taxpayers must evaluate their facts and circumstances, considering the guidance provided, as they assess their Section 451 implications. Given the potential complexities and time sensitivity surrounding this area, taxpayers should not delay their Section 451 assessment, implementation and adoption in the anticipation of additional, future guidance. Taxpayers should be actively engaged in this process and supplement their decisions and actions upon the release of additional guidance.

The following timeline illustrates the steps and timing necessary for a calendar-year taxpayer to effectively analyze and implement the new Section 451 provisions.

As indicated, taxpayers should currently be fully engaged in their assessment and implementation of new Section 451. To the extent taxpayers have not started a meaningful analysis or are in the infancy of such analysis, care should be taken to develop a proper and efficient implemetation strategy. That strategy should consider substantive and procedural matters surrounding adoption, as well as the timing of their identified implentation steps so that time sensitive tasks (e.g., Form 3115 filings, provision disclosures, etc.) are completed by or before their due dates.

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ATTACHMENT

Flow Charts for Section 451