In May 2014, the Financial Accounting Standards Board (FASB) issued Accounting Standards Update (ASU) 2014-09, Revenue from Contracts with Customers, later codified as Accounting Standards Codification (ASC) Topic 606. This major overhaul of revenue recognition (effective for fiscal years starting after December 15, 2017 for public companies) affects almost every industry, and the depository and lending industry is no exception. The complex arrangements between financial institutions and their clients pose some of the most difficult issues for the new standard.
The AICPA and the major accounting firms have assembled industry task forces to research the industry-specific accounting issues within ASC 606, and we will draw from the guides they have published as we provide a brief explanation of the key issues depository and lending institutions face when applying ASC 606. For more information on any of these issues, see:
- AICPA: Revenue Recognition: Audit and Accounting Guide
- EY: Technical Line: How the new revenue standard affects banks
- PwC: In Depth: Revenue: Transition Resource Group issues impacting the banking industry
We will also provide references to other RevenueHub articles for more detailed explanations of related ASC 606 topics. For general information on the basics of revenue recognition, see our RevenueHub article, The Five-Step Method.
The following are the issues that companies in the depository and lending industry commonly face:
1. ASC 606 Scope Issues: Credit Cards, Deposit Services Charges, and Servicing/Subservicing
This implementation issue has been submitted to the AICPA Revenue Recognition Working Group, but has not been finalized for inclusion in the AICPA revenue recognition guide as of this article’s publication date. Major accounting firms, however, have provided some guidance on the handling of the implementation issue, which is discussed below.
Credit cards – Interest, receivables, and fees on credit cards will continue to be accounted for using ASC 310, and will not be within the scope of ASC 606. The Transition Resource Group (TRG) and the Securities and Exchange Commission (SEC) Observer of the TRG meeting both agree that any annual fees that give cardholders access to additional services besides the use of a credit card are still within the scope of ASC 310, so long as the arrangement between the bank and the customer is a credit card lending arrangement. The TRG further agreed that if all of the fee revenue from a credit card rewards program is within the scope of ASC 310, the rewards program itself would not be within the scope of ASC 606.
Financial Guarantees – The fees received from providing a guarantee on a loan are generally outside of the scope of ASC 606, as they are within the scope of ASC 460 and ASC 815.
Servicing/Subservicing – Financial institutions sometimes service financial assets for their customers, providing benefits such as foreclosure executions, accounting monitoring, and collections. If the servicing or subservicing rights meet the required criteria, they will fall within the scope of ASC 860. The TRG agrees that income from these servicing and subservicing arrangements would not fall within the scope of ASC 606.
Deposit Service Charges – The TRG agrees that revenue acquired from customer deposit fees and charges will generally fall within the scope of ASC 606, as ASC 405 fails to provide any kind of revenue recognition model for these types of fees. Practitioners should not be confused by the scope exception for ASC 405 found within the new revenue standard, as ASC 405 only provides guidance on determining the correct liability accounting for customer deposits, and does not cover revenue recognition.
2. Revenue Scoped Out of ASC 606
This implementation issue has been submitted to the AICPA Revenue Recognition Working Group, but has not been finalized to be included in the AICPA revenue recognition guide as of this article’s publication date. Major accounting firms, however, have provided some guidance on the handling of the implementation issue.
Several types of contracts related to banking have been excluded from the scope of the new revenue standard, with financial instrument arrangements being a prime example. Because these contracts are scoped out of ASC 606, any related gains and losses will not be accounted for using the new standard. This will include gains and losses on derivatives, loans, and security investments. Furthermore, dividend and interest income earned by banks on their lending activities, reverse purchase agreements, or bank owned instruments will not be accounted for under ASC 606.
Some types of contracts fall within both the scope of ASC 606 and other topics in the codification, and the proper accounting treatment for such contracts is addressed within the new revenue standard. An entity should first apply the separation and measurement guidance found within the non-606 ASC topic(s), and then apply the separation and measurement guidance found in ASC 606 to those portions of the contract that are not accounted for using the other ASC topic(s).
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3. Sale of Non-Operating Assets (Other Real Estate Owned)
The challenges that banks are finding with ASC 606 as it relates to the sale of non-operating assets are contained in four main categories: scope, collectability, determining the amount of consideration, and the satisfaction of performance obligations. Each of these areas will be addressed below.
Bank transactions that involve the sale of non-financial assets will be within the scope of ASC 610 rather than ASC 606 in most circumstances. This treatment is appropriate because the sale of a non-financial asset is not considered to be part of the bank’s ordinary activities.
Although outside the scope of ASC 606, the sale of non-operating assets still requires the use of the new standard, because ASC 610-20-40-1(a) requires banks to apply the guidance found within ASC 606-10-25-1 through -8 in determining whether a contract exists. The five criteria found in ASC 606-10-25-1 must all be met for a contract to exist. In the sale of real estate by a bank, three out of the five criteria are normally met, but the remaining two commonly require additional analysis. The first of the two remaining criteria requires that the participating parties in the contract have given their approval of and comital to the contract and the obligations contained therein. It is important to consider all of the relevant facts surrounding the contract to determine the level of commitment from both parties, as this evaluation is a matter of judgement.
The fifth criterion requires entities to determine whether it is probable they will collect substantially all of the consideration they are owed. This will require banks to determine the likelihood that their buyers will perform under the contract. Banks should look at every aspect of the contract and arrangement to determine whether collectability is likely. It is important to note that when determining collectability as part of the test for contract existence, banks should consider any price concessions or constraints on variable consideration that would affect the transaction price. This adjusted transaction price should be used in place of the full contract value under the ASC 606 revenue model.
Determining Amount of Consideration
ASC 610 further refers to ASC 606 for aid in measuring the consideration to be included in the calculation of the gain or loss recognized upon derecognition of a non-financial asset. ASC 606 is to be used for measuring the transaction price and accounting for changes in that price. One of the unique challenges for banks in determining the transaction price is the presence of a significant financing component in the sale of real estate. When the financing terms of a seller-financed arrangement are not aligned with the market because no financing component is considered, the consideration will need to be discounted to determine the correct transaction price.
Additionally, banks need to determine if price concessions are present in their contracts that will result in a reduction of the estimated transaction price. Determining if price concessions are present can be complicated by the presence of credit risks and the judgment involved in quantifying those credit risks and expected concessions.
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Satisfaction of Performance Obligations
Because the sale of a nonfinancial asset is determined by the transfer of control, ASC 610 refers to ASC 606-10-25-30 to determine when an entity satisfies its performance obligation at a point in time (i.e., through the transfer of control).
ASC 606-10-25-30 provides five indicators to determine whether control of an asset has been transferred. FinREC believes that generally, the first three indicators and the fifth indicator are met with the close of the sale, though the third and fourth indicators may require some further analysis. In determining whether the transfer of physical possession has occurred (third indicator), and if the customer holds significant risks and rewards of ownership (fourth indicator), FinREC reminds banks to refer to ASC 606-10-55-68 for help. This guidance states that control has not been transferred if the seller has the right or obligation to repurchase the asset in the future.
FinREC feels that banks should be careful in considering all the specific circumstances surrounding their sales of nonfinancial assets, as laws and regulations may result in banks retaining the risks and benefits of property ownership, thus preventing full transfer of ownership.
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It is likely that many other issues and questions will arise for depository & lending institutions as entities adopt ASC 606. This article serves as a base reference point for your research into some of the focal issues anticipated by industry experts. Similar industry-specific issues, discussions, and resources are available on the RevenueHub site for major industries identified by the AICPA. Click on the following link for a list of these articles: Industry-Specific Issues.