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Back in 2014, the Financial Accounting Standards Board (FASB) issued ASU 2014-09, Revenue from Contracts with Customers, which created a new section in the FASB's Accounting Standards Codification: ASC Topic 606 (ASC 606). Prior to the establishment of ASC 606, the revenue recognition guidance in GAAP consisted of some broad revenue recognition concepts, along with numerous industry-specific and transaction-specific standards. As a result, it was often difficult to resolve issues about recognizing revenue, and following the guidance sometimes resulted in different accounting for economically similar transactions.
ASC 606 attempts to remediate this issue: it superseded all of the prior general revenue recognition requirements and most industry-specific guidance in the FASB Codification, and it replaced them with a common revenue standard (and a five-step model) that clarifies the principles for recognizing revenue. The core principle of ASC 606 is that "an entity should recognize revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services." For most Pacific Northwest banks, ASC 606 is already effective and should be reflected in their 2018 financial statements.
It was immediately clear that ASC 606 might have a significant effect on the manner in which revenue was recognized for particular industries, such as healthcare, construction, or software. However, ASC 606 specifically "scopes out" revenue related to financial instruments from items such as receivables, investments in debt and equity securities, MSRs, and leases. As a result, interest income is specifically excluded from the scope of ASC 606. This was welcome news for financial institutions, and at first glance, many institutions may have assumed that ASC 606 would generally not impact their accounting or financial reporting.
Of course, financial institutions typically have multiple revenue streams in the form of noninterest income. Asset management fees, trust fees, debit card and ATM fees, service charges on deposit accounts, and late charges are just a few examples. All of these are within the scope of ASC 606 and will require a separate evaluation using the new 5-step model.
In addition, sales of foreclosed assets – such as other real estate – are within the scope of ASC 606 and are subject to the 5-step model. In fact, ASC 606 removes prior GAAP guidance which prescribed certain minimum down-payments in order for bank-financed ORE dispositions to qualify for full recognition of any gain on sale. Under ASC 606, each individual ORE disposition needs to be separately evaluated under the 5-step model to determine the appropriate recognition for that transaction.
ASC 606 also requires significant additional disclosures regarding revenue. These include a disaggregation of revenue into categories that show how economic factors affect the nature, amount, timing, and uncertainty of revenue and cash flows. The guidance also calls for detailed disclosures about performance obligations, such as descriptive information about an entity's performance obligations, information about the transaction price allocated to remaining performance obligations, and when revenue will be recognized. There are many additional disclosures that may also be required, and the nature and extent of these disclosures will require significant judgment by management. In many cases, financial institutions will add a new, separate note to the financial statements in order to meet these new requirements.
It is our mission to share change that may affect our clients. At Delap LLP, we’re committed to bringing you superior service and guidance that may impact financial institutions. If you have any questions on the Revenue from Contracts with Customer rules, please contact our team today at (503) 697-4118.