Tax Method Accounting Change Required for Change in Book Recognition on Multiple-Deliverable Contracts

By Yuan Chou, J.D., LL.M., Bethesda, Md.

Editor: Kevin D. Anderson, CPA, J.D.

Tax Accounting

Taxpayers using the one-year deferral method under Rev. Proc. 2004-34 to recognize advance payments on multiple-deliverable contracts (MDCs) for federal income tax purposes should note that a change in the underlying revenue recognition method used for book purposes could trigger a tax accounting method change in the year of the change. In Chief Counsel Advice (CCA) 201151022, the IRS discusses the rationale behind this method change and outlines the appropriate steps for obtaining the IRS’s consent to use the revised book method in determining the inclusion of advance payments in gross income under Rev. Proc. 2004-34.

The Facts

In the CCA, a taxpayer provides goods, services, and other applicable items under an MDC, which requires the taxpayer to provide bundled products and services to customers in exchange for advance payments. The goods and services are provided at different points in time and over different time periods. For financial statement purposes, the taxpayer presently defers the advance payments until the MDC is fully complete, that is, until all goods and services are provided. For federal income tax purposes, the taxpayer also properly defers the advance payments under Rev. Proc. 2004-34. Under Rev. Proc. 2004-34, accrual-basis taxpayers are permitted to defer all or part of certain advance payments by (1) including the advance payment in gross income for the tax year of receipt to the extent recognized in revenues in its applicable financial statement for that tax year, and (2) including the remaining amount of the advance payment in gross income for the next succeeding tax year.

The CCA explains that, in the tax year beginning Jan. 1, 2011, the taxpayer adopts new FASB standards for income recognition from MDCs for financial statement purposes. The new FASB standards are Accounting Standards Update (ASU) No. 2009-13 and ASU No. 2009-14, both effective for fiscal years beginning on or after June 15, 2010.

Before these standards were issued, if a separate deliverable was not subject to valuation under vendor-specific objective evidence (VSOE) or third-party evidence (TPE), income from delivered and undelivered elements was combined into one unit of accounting. Income attributable to that unit was then deferred and recognized as the undelivered elements were delivered. Although the actual deferral period varied depending on the products making up the MDC, income could be deferred until all items were delivered under a given MDC for financial statement purposes.

ASU No. 2009-13 provides guidance on how to separate MDCs into individual units of accounting as well as the amount allocable to each unit of accounting. ASU No. 2009-13 also removes the requirement for objective and reliable evidence of the value of the underlying items of an arrangement, i.e., VSOE and TPE. Absent such evidence, taxpayers may use other methods to estimate income for each unit of accounting when delivered to the customer. ASU No. 2009-14 applies to MDCs that include (1) products with embedded software and (2) nonembedded software that is more than incidental to a product sold in the same arrangement, and it clarifies how revenue should be allocated and measured for these items.

As indicated above, the taxpayer in the CCA adopted ASU Nos. 2009-13 and 2009-14 for its tax year beginning Jan. 1, 2011. The question raised is whether a taxpayer that previously elected to defer advance payments under Rev. Proc. 2004-34 is required to obtain the IRS’s consent if it adopts the new book standards and wants to use the new financial statement method in determining the extent to which advance payments are included in gross income under Rev. Proc. 2004-34.

The Outcome

The IRS concluded that the taxpayer must obtain consent under Sec. 446(e) to use the new financial statement method for MDCs in determining the inclusion of advance payments in gross income under Rev. Proc. 2004-34. The CCA relies heavily on Sec. 446(e), which generally requires a taxpayer that changes the method of accounting on the basis of which it regularly keeps its books, before computing taxable income under the new method, to secure the consent of the IRS. Regs. Sec. 1.446-1(e)(2)(i) similarly provides that “a taxpayer who changes the method of accounting employed in keeping his books shall, before computing his income upon such new method for purposes of taxation, secure the consent of the Commissioner.”

Therefore, the CCA instructs the taxpayer to obtain consent by following the automatic method change procedures of Rev. Proc. 2011-14 unless otherwise prohibited from doing so. Rev. Proc. 2011-14, Appendix Section 15.11, permits a taxpayer to file a detailed statement in lieu of a Form 3115, Application for Change in Accounting Method, with the taxpayer’s original return for the year of change to obtain the IRS’s consent. This automatic change is made on a cutoff basis (i.e., no Sec. 481(a) adjustment) and applies only to advance payments received on or after the beginning of the year of change.

Many taxpayers use the one-year deferral method under Rev. Proc. 2004-34 to recognize advance payments on MDCs for federal income tax purposes. To the extent that there is an underlying change to the new book standards for financial statement purposes, taxpayers may easily overlook that such a change affects the timing of recognizing advance payments for tax purposes because this is a change to the individual unit of accounting within the Rev. Proc. 2004-34 deferral method, rather than a change from the one-year deferral method to a different method. The CCA therefore alerts taxpayers to the requirement to obtain the IRS’s consent in such situations and provides a relatively straightforward procedure for doing so.


Kevin Anderson is a partner, National Tax Services, with BDO USA LLP, in Bethesda, Md.

For additional information about these items, contact Mr. Anderson at 301-634-0222 or

Unless otherwise noted, contributors are members of or associated with BDO USA LLP.

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