New Accounting Guidance for Revenue Recognition (ASC 606)
On May 28, 2014, the Financial Accounting Standards Board issued Accounting Standards Update (“ASU”) No. 2014-09, Revenue from Contracts with Customers (Topic 606). The ASU and all subsequently issued clarifying ASUs supersedes the revenue recognition requirements and most industry-specific guidance in U.S. generally accepted accounting principles. This standard became effective for private organizations’ annual reporting periods beginning after December 15, 2018 (i.e., effective January 1, 2019 for calendar year-end organizations).
The core principle of the new guidance is that an entity recognizes 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. The new guidance also includes a cohesive set of disclosure requirements that will provide users of the financial statements with comprehensive information about the nature, amount, timing, and uncertainty of revenue and cash flows arising from the entity’s contracts with customers.
This new guidance affects each cooperative in different ways depending on the nature of its business, specific contract terms with its customers, and how revenues are generated. One area that is not obvious may impact certain cooperatives that have initial membership fees, sometimes called initiation or join fees. It appears that this is most common among purchasing cooperatives.
Change in Accounting for Membership Fees
Under the previous accounting guidance, non-refundable initial membership fees were recognized as revenue earned by the cooperative at the time the member had been issued its membership interest in the cooperative. Any annual fees charged were recognized over the year which the fee was applied. The new accounting guidance does not change the timing of when annual membership fees are recognized as revenue for most cooperatives, however, it changes how most cooperatives account for initial membership fees.
ASC 606 requires initial membership fees to be recognized over the membership period, as this is the period of time the cooperative has a performance obligation to the member. In cases where membership is not for a defined period of time, cooperatives should recognize revenue for initial membership fees over the estimated period of time the member is expected to be with the cooperative. Cooperatives should evaluate historical data to determine a reasonable average time period for its membership. The membership period will likely exceed one year for most cooperatives, so it will have deferred revenue for initial membership fees.
Cooperatives that prepare financial statements in accordance with U.S. GAAP should determine how this new guidance impacts its financial statements. Cooperatives that charge initial membership fees will more than likely be required to make a cumulative adjustment to record deferred revenue and adjust its retained earnings as of the beginning of the year of implementation (i.e., January 1, 2019 for calendar year ended December 31, 2019). The longer a cooperative’s average membership period is determined to be, the larger the adjustment will be.
Furthermore, for cooperatives subject to income taxes, the IRS does not allow revenues to be deferred for more than one year, so there will likely need to be a book-to-tax adjustment and deferred tax considerations for most cooperatives making this change. Revenues recorded on the tax return prior to being recognized in the financial statements create a deferred tax asset, which will decrease the net effect of the cumulative adjustment recorded for implementing the adoption of this new accounting guidance.
Please contact Wegner CPAs with any questions you have on this new accounting guidance and we can determine what the impact is for your cooperative, and assist you with the implementation.