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New Revenue Recognition Standard’s Impact on Dealerships

New Revenue Recognition Standard’s Impact on Dealerships

Nov 17, 2017

The Financial Accounting Standards Board (FASB) has issued a new accounting standard for revenue recognition, “ASC 606: Revenue from Contracts with Customers.” This new standard outlines a single, comprehensive, principles-based model and replaces the current revenue recognition guidance under accounting principles generally accepted in the United States (GAAP). The standard will take effect for public entities with fiscal years beginning after December 15, 2017, including interim periods within those years, and for nonpublic entities in years beginning after December 15, 2018. 

The new standard requires entities, including dealerships, to apply a five-step revenue recognition process:

  1. Identify contracts with customers.
  2. Identify performance obligations in the contracts.
  3. Determine the transaction price.
  4. Allocate the transaction price to the performance obligations.
  5. Recognize revenue when or as performance obligations are satisfied.

How will the new standard impact dealerships?
In order to comply with the new standard, dealerships will need to assess the potential impacts on their existing revenue recognition practices and determine whether changes are required. 

While we believe the new standard will have substantially less impact on dealerships than some other industries, there are still several areas in which dealerships could be impacted. Examples include the following:

  • Warranties
  • Free services
  • Manufacturer incentives
  • Expanded disclosure requirements

Warranties
Step two of the five-step revenue recognition process is to identify performance obligations in contracts with customers. Warranties, under certain circumstances, will be considered separate performance obligations from the sale of the new or used vehicles. Standard warranties that are included in the sale price of a vehicle generally will not be considered separate performance obligations and will be accounted for in accordance with current rules on product warranties. However, extended warranties that are purchased at the option of the buyer and held for fulfillment by the dealership generally will be considered separate performance obligations, necessitating an allocation of the transaction price between the warranty and the sale of the vehicle. The portion of the transaction price allocated to the warranty will be deferred and recognized over time. The nature of warranties can vary significantly and will require separate assessment as dealerships review their contracts under the new revenue recognition guidance.

Free Services
As added incentives, dealerships have routinely been offering free services such as oil changes, state inspections, car washes, or discounted parts sales to purchasers of new and used vehicles.  Under the new standard, dealerships will need to determine the portion of the transaction price allocable to these services under step four of the five-step process. In most situations, the free services may be deemed an immaterial portion of the total transaction price and can be grouped with the vehicle sale performance obligation and recognized when the vehicle sale is recognized. However, dealerships will need to review their contracts and offerings of free services and make the assessment that the free services are indeed immaterial. Proper implementation of the new guidance requires analysis and documentation that all aspects of contracts have been considered.

Manufacturer Incentives
Step three of the five-step process is to determine the transaction price, including any variable consideration. For dealerships, this involves an analysis of transaction price components that may be variable, such as manufacturer incentives, customer rebates, and discounts. Once again, recognition under the new standard may not differ greatly from current practice if these components are known at the time of sale. However, an assessment of these factors, proper analysis, and documentation of a dealership’s conclusions need to occur.  

Expanded Disclosure Requirements
The objective of the new standard as it relates to disclosure requirements is to enable users of financial statements to understand the nature, amount, timing, and uncertainty of a company’s revenue and cash flows as a result of contracts with customers. To meet that objective, additional disclosures will be required, including the following, as some of the more significant disclosures a dealership should include:

Contracts With Customers
Under the current standard, dealerships typically disclose the nature of their contracts with customers. The new standard also requires disclosure of the disaggregation of revenue among the significant types of revenue. Dealerships that are not currently doing so will need to disclose their breakout of revenue by major type. This disclosure is optional for nonpublic companies. However, private companies will need to disaggregate revenues, at a minimum, by timing—those recognized over a period of time and those recognized at a point in time—as well as qualitative information about how economic factors such as type of customer, type of contract, and a customer’s geographical location affect the nature, amount, timing, and uncertainty of revenue and cash flows.

Performance Obligations
Dealerships will need to disclose certain information about their performance obligations in contracts with customers. These disclosures include when a dealership typically satisfies its performance obligations; significant payment terms (when payment is due, whether there is a significant financing component, and information about any variable consideration); nature of the goods or services the dealership has promised to transfer, indicating any that it arranges with another party to deliver (agent considerations); obligations for returns and refunds; and types of warranties and related obligations. Additional disclosures are required for public entities.

Significant Judgments or Changes in Applying the Guidance
Dealerships may already be meeting this requirement under the current standard; however, the new standard does require all companies to disclose the significant judgments and changes in judgments made in applying the new guidance that significantly affect the determination of the amount and timing of revenue. Additional disclosures are required for public entities.

Put Expertise on Your Side
Other potential issues that may affect certain dealerships include fleet sales, financing, and customized vehicle sales. If you have questions or concerns about the new reporting standard and how it impacts your particular dealership, please contact your Wipfli relationship executive or a member of the dealership practice. 

Author(s)

Steve Hewitt
Steve Hewitt, CPA
Dealerships Practice Leader
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