Everyone has heard about it by now, the new Revenue Recognition standard that went into effect for annual reporting periods beginning after December 15, 2017. This new standard requires Broker-Dealers to go through several steps to recognize revenue. Those steps include:
- Identify the contract(s) with a customer
- Identify the performance obligations in the contract
- Determine the transaction price
- Allocate the transaction price to the performance obligations in the contract, and finally
- Recognize revenue when (or as) the entity satisfies a performance obligation.
Most of the above steps are easy to work through. The headache comes in for those Broker-Dealers working in the Merger and Acquisition space. Specifically, those broker-dealer agreements that typically contain upfront non-refundable retainers. Typically, those agreements don’t specify performance obligations associated with the non-refundable retainers. In the past, those non-refundable retainers were recognized as revenue when received as they were “non-refundable” according to the terms of the contract.
Under the new accounting standard, those “non-refundable” retainers may not be recognized as revenue when received, unless a performance obligation is associated with the retainer. So what is a performance obligation? Under the new standard, a broker-dealer shall assess the goods or services promised in a contract with a customer and identify, as performance obligations, each promise to transfer to the customer either:
- A good or service (or a bundle of goods and services) that is distinct, or
- A series of distinct goods and services that are substantially the same and that have the same pattern of transfer to the customer.
If a promised good or service is not distinct, a broker-dealer can combine that good or service with other promised goods or services until it identifies a bundle of goods or services that is distinct. In some cases, that would result in the broker-dealer accounting for all the services in a contract as a single performance obligation. Therefore, based upon current contract wording if the broker-dealer is unable to attach a performance obligation to that non-refundable retainer, the receipt of that retainer would not be recognized as revenue until performance obligation, usually the closing of a deal, has happened. By deferring the revenue this would also impact the broker-dealer’s aggregate indebtedness calculation.
So what is a Broker-Dealer to do?
The new standard does call for the use of judgment. Broker-Dealers should carefully review the wording of the contracts that they have in place currently. Consideration should be given to modify those contracts or at least modify new contracts going forward. Another option would be to look at or project how many retainers the Broker-Dealer will receive in a given period and is it material in relation to the total revenue for that period?
It is possible that additional clarity will be forthcoming. The AICPA Broker-Dealer task force has a working draft Issue #3-5 Investment Banking and M&A Advisory Fees that currently discusses this issue and comments are due to the Task Force by February 15, 2018. DSW&D will continue to monitor developments in this area so check back frequently for updates or contact your DSWD representative.