IRS Clarifies 'Recurring Item' For Accrual Method Businesses

The IRS has clarified the treatment of certain liabilities under the Internal Revenue Code's recurring-item exception to the economic performance requirement of the all-events test.

Under the all-events test, an accrual method business can accrue a liability in the year in which the liability is fixed and determinable and economic performance has occurred.

Under the recurring-item exception, discussed in IRC Section 461(h)(3), a business can accrue a liability in the year it is fixed and determinable, regardless of economic performance. However, the business must satisfy certain conditions, including that the liability is either:

  • Not material or
  • Better matched to the related income in the earlier year.

In a new ruling, the IRS has clarified the "not material" and "better matching" requirements in the context of a one-year lease liability and a one-year service contract liability.

For service contract-type liabilities, the recurring-item exception applies differently depending on whether the contract is for the provision of services, as distinguished from insurance or warranty-type contracts.

For liabilities arising out of the provision of services to the business, the company must satisfy either the "not material" or the "better matching" requirement.

  • For liabilities arising out of the provision of insurance, warranty or similar service contract liabilities, the "better matching" requirement is deemed to be met.
  • A business wishing to change its accounting method to conform to the new ruling must follow the automatic change in accounting method provisions in Revenue Procedure 2011-14.

Read more in Revenue Ruling 2012-1.

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