There have been sweeping changes made to the guidance for revenue accounting within ASC Topic 606 by the Financial Accounting Standards Board (FASB) as part of a convergence project with the International Accounting Standards Board (IASB). Those changes come into effect January 1, 2019 for all non-public companies including homeowners associations, condominiums and cooperatives. Because the revenue recognition standard will eliminate the transaction- and industry-specific revenue recognition guidance included in current GAAP and replace it with a principle-based approach, it is important for management companies to gain an understanding of the standard and how it may impact the entity’s revenue recognition.
Under the new guidance of Topic 606, revenue is recognized when the buyer receives the benefits of the product and/or service. Revenue is being determined based on contracts using a five step process.
Step 1: Identify the Contract
To determine if an agreement is a “contract” under Topic 606, one must answer the following questions:
If the answer to any of these questions is “No,” then there may not be a contract under the new revenue guidance. If there is no contract, then revenue should not be recorded.
Step 2: Identify performance obligations
For a service or good to earn revenue, it must be a performance obligation. A performance obligation has utility or value to the customer on its own or with available resources. A performance obligation also is separable from other promises from in the contract. The distinction on whether an item has value and is separable will require a significant amount of judgement. If it is determined a good or service is not separable or has value on its own, it would be linked or bundled with other goods or services until one performance obligation is identified.
For example, an Association’s main performance obligation is to manage common areas for the well-being of the owners which may include general repairs and maintenance, trash services, management fees, legal fees, etc. As such, all these services can be bundled as one performance obligation. Another example is the Association leasing its roof space to antenna companies. This performance obligation is separate from managing common areas and therefore need to be analyzed separately to determine how to recognize such revenue under Topic 606.
Step 3: Determine the transaction price
The transaction price for Associations is usually set through the approved budget. Owners are being charged based on the percentage interest as stated in the governing documents. There is rarely any ambiguity for this step.
Step 4: Allocation of price to performance obligations
A selling price needs to be allocated to all performance obligations. As indicated in Step 2, the main performance obligation for an Association is to manage common areas. The Association levies operating assessments to fund such performance obligations. As such, all of the operating assessments can be allocated to such performance obligation.
Step 5: Recognize revenue over time or at a point in time
Revenue will be recognized over time if the answer to any of the questions below is “yes”:
If the standards noted above are not met, recognition at a point in time is used.
UNIQUE CHALLENGES FOR THE CIRA INDUSTRY
What if an owner is delinquent and collection for work performed is not probable?
Under the new guidance, revenue can only be recognized if a contract exists. For a contract to exist, collectability must be at least probable. That means, for owners that have been delinquent on a continuous basis, the revenue test fails at Step 1. Therefore, revenue should not be recorded until payments are being received and the account is no longer considered delinquent (cash basis of accounting). However, that would skew with the assessment income as it no longer matches the approved budget.
To forgo this dilemma, we recommend the Association establish a contra-revenue and contra-receivable account. Operating assessments would continue to be recorded on a monthly basis based on the approved budget. However, the Association would offset the revenue by those owners that are considered not probable to be collectable through contra-revenue and -asset accounts. This provides the advantage that receivables can be traced back to the delinquency report and assessments can be tied back to the budget to assert completeness of revenue. (See Figure 1)
How to recognize reserve assessments?
There are two different thought processes on how to recognize reserve assessments:
There is currently no uniform answer on how to treat reserve assessments. However, a task force has been put in place and we hope more guidance is being provided before the end of 2019. In the meantime, we recommend management reviews both options and determines which best suits their understanding of reserve assessments. We also recommend that operating assessments and reserve assessments are being charged and recorded to separate accounts in case reserve assessments are going to be considered revenue and must follow the new revenue standards. It should help facilitate implementing the 5-step process keeping the operating and reserve assessments separate.
To make the switch to Topic 606, there are two approaches, the full retrospective approach and the modified retrospective approach.
Full retrospective adoption – Entities that elect full retrospective adoption will apply the standard to each period presented in the financial statements. This means entities will apply the standard as if it had been in effect since the beginning of all its contracts with customers presented in the financial statements and will recast revenue and expenses for all prior periods presented in the year of adoption. An entity may use one or more of the following practical expedients with full retrospective adoption.
Modified retrospective adoption – Entities that elect the modified retrospective method will apply the new standard to only the most current period presented in the financial statements. In addition, the entity will have to recognize the cumulative effect of applying the standard as an opening balance at the date of initial application.
CONSIDERATIONS DURING TRANSITIONS
While preparing to transition, companies should consider creating a transition timeline and plan of action to determine if a full or modified approach will be used. All accounting and finance staff will need to be educated on the standard to provide and understanding of the new revenue accounting guidance. We will be available for questions about the new standard and its impact on financial statement reporting.
For additional information, please contact Stephanie Thiere at 410 423 4833 or email@example.com or feel free to contact your local UHY Advisors professional.
Wednesday, April 24, 2019 | 7:30 AM – 9:30 AM EDT | The Hartford Club