The rules were approved three years ago, but as observers have recently noted many US companies appear to be unprepared or in denial. Top enterprises recognize that markets prefer warnings, however unpleasant, which imply thought and planning rather than surprises. JL
Francine McKenna reports in Marketwatch:
The goal is to improve comparability by implementing a single revenue recognition model across industries and across the globe. The new rules eliminate industry-specific accounting for revenue. Aerospace & defense, automotive, telecommunications, media and entertainment, engineering & construction, pharmaceuticals & life sciences, and technology sectors will see changes that create performance obligations, which can affect the timing of revenue recognition, and price variability, which can affect the amount of revenue recognized.
It’s coming. The finish line for implementing a new standard for recognizing revenue is less than six months away—January 2018—but many companies are still just thinking about how the race will end, despite clear indications the results will have a profound affect on how they report top line results.
The new rules were approved in 2014, after almost 15 years of work by regulators and companies to finalize the details. The goal is to improve comparability by implementing a single revenue recognition model across industries and across the globe. The new rules eliminate industry-specific accounting for revenue under U.S. GAAP, the standards for financial accounting and reporting all companies listed on U.S. exchanges must follow, and introduce a principles-based approach that more closely aligns with International Financial Reporting Standards, or IFRS.
Global audit, tax and consulting firm PwC writes that aerospace & defense, automotive, telecommunications, media and entertainment, engineering & construction, pharmaceuticals & life sciences, and technology sectors will see the biggest changes. They seem to still be in denial, however. PwC reported that only 40% of companies were more than 50% complete as of January 2017 in understanding the impact of the changes on their company, and 22% of companies had not yet started their assessment.
The standards focus mainly on the revenue from contracts with customers. In some cases those contracts will be easily identifiable and information about their terms and conditions will be readily available. In other cases, companies have to look at activities and transactions in a new way.
In preparation for the 2Q earnings season, MarketWatch took a look at some specific issues by industry, with the help of PwC’s industry specific guides, and identified some companies in those sectors that have already made disclosures in the first quarter about potential impact. MarketWatch reporters will be watching and reporting on any new disclosures about the impact of the new standard during this coming earnings season.
Media and Entertainment
The new standard eliminates previous media industry-specific revenue recognition guidance and imposes new criteria to determine how revenue will be recognized, in particular license revenue. That change will significantly affect many entertainment and media companies. Media and entertainment industry may now accelerate revenue recognition for certain types of licenses while others could be deferred.
Time Warner Inc. TWX, +0.27% made a detailed disclosure in its first quarter filings with the SEC of the potential impact of the new standard on its business model. Time Warner expects to see new deferrals related to future leased library content that will primarily impact its Home Box Office segment. Currently revenue is recognized once access to the library is granted to the licensee.
Time Warner also says revenue for the renewed license term will not be recognized until the date the renewal term begins, compared with now, when it is recorded on the date the renewal is agreed to contractually. This new deferral will primarily impact its Warner Bros. segment, but also, to a lesser degree, its Home Box Office and Turner segments, according to the filing.
Finally, revenue from licenses of symbolic intellectual property such as brands, trade names and logos will be deferred too, primarily for the Warner Bros. segment.
Financial Services and Banking
Banks and financial services firms will not see as many changes to their core business as some other industries, but the impact will still be felt, according to recent disclosures. The new accounting standards don’t apply to revenue related to financial instruments, including loans and securities, but revenue from other contracts with customers, including various kinds of fees in their underwriting, asset management, and brokerage business, as well as any private equity-related investments are affected. The asset-management industry will also see changes in accounting for upfront fees, upfront costs, and performance-based fees. For example, the new standard will require upfront fees to be deferred or recognized immediately, depending on whether or not the customer activity includes a distinct service that is provided upfront.
Asset managers will now recognize sales commissions—the incremental costs of obtaining a contract with a customer—as an asset, not an expense, if it expects to recover those costs. Return-based performance fees are now considered variable consideration, so the asset manager will recognize revenue when the amount becomes fixed and is no longer subject to reversal, such as at redemption.
Both Morgan Stanley MS, -0.24% and Invesco Ltd. disclosed in the first quarter that performance fees, including carried interest, are under evaluation. Morgan Stanley said that if it determines the fees are within the scope of the new rules, there will be a significant delay in the recognition of these fees as revenue in the future.
Automotive
Automotive industry companies, including suppliers, dealers, original equipment manufacturers and their finance affiliates, will be significantly affected by the new revenue standard, which replaces all current revenue recognition guidance for companies reporting under U.S. GAAP or IFRS. The automotive industry will have to adopt new accounting for preproduction activities, such as design and tooling arrangements, marketing incentives like cash rebates, volume rebates, repurchase options, product warranties, contract costs, and lease financing arrangements.
New accounting for warranties could result in revenue deferral. Customer contracts containing repurchase options will now be accounted for as a lease when the customer has the right to require the company to repurchase the vehicle and the customer has a significant economic incentive to exercise that right. That will happen if the market price of the vehicle is less than the contract repurchase price when the customer becomes eligible for the option.
Tesla Inc. TSLA, -0.26% ended its popular resale value program for the entry-level Model S in July 2016. That buyback program guaranteed the resale value of a Model S after three years when purchased through one of Tesla’s loan financing plans. As of the end of first quarter 2017, Tesla had $1.29 billion recorded in resale value guarantees and still reports $311.7 million in deferred liability for the program.
Delphi Automotive PLC. DLPH, +0.23% disclosed its most significant potential impact will likely be accounting for guaranteed reimbursements of certain preproduction engineering, development and tooling costs related to products manufactured for customers under long-term supply agreements. These reimbursements from customers are currently recorded as cost offsets, but under the new standard guaranteed recoveries may be recognized as revenues.
General Motors Co. GM, -0.74% said that it expects to see earlier recognition of certain sales incentives and fixed fee license arrangements. Certain transactions with daily rental car companies may also qualify, the company said, to be accounted for as a sale as opposed to the current accounting as an operating lease.
Retail
Retail and consumer products companies will be broadly affected because they offer a wide array of customer incentives such as coupons, rebates issued at the point of sale, free products, price protection, or price matching programs to their customers. That creates additional performance obligations, which can affect the timing of revenue recognition, and often introduce price variability, which can affect the amount of revenue recognized.
Revenue recognition for loyalty rewards, a customer contract liability, will be later than before, but recognition of gift card breakage income, as highlighted in an earlier MarketWatch article, will be faster in most cases.
Franchise agreements common to the retail and consumer industry will probably be accounted for as rights to access intellectual property or IP, so revenue will be recognized over time. Extended warranties will be recognized over the warranty period but standard product warranties that are not sold separately will most likely follow current guidance. Technology
Technology companies—software, cloud computing, internet, semiconductors, hardware / equipment, and clean-tech—frequently provide multiple products or services to their customers as part of a single transaction. Hardware vendors sell extended maintenance contracts and consulting along with the hardware, and vendors of software licenses may provide professional services in addition to the license.
For these companies the new revenue recognition standard will replace all industry-specific revenue guidance, including software revenue recognition guidance under U.S. GAAP. For software and software-related transactions, in particular, companies will have much different timing for revenue recognition of licenses than in the past.
A “sell-through approach” is also common for technology companies that use dealers or distributors. Under the new standard, revenue is recognized when a customer obtains control of the product, even if they have a right of return or a price protection option. That compares to prior practice where revenue was recognized once the risks and rewards of ownership transferred to the end consumer.
Revenue recognition for service revenues such as consulting and manufacturing services, including business strategy services, supply-chain management, system implementation, outsourcing services, and control and system reliance may also change under the new standard depending on whether the performance obligation is satisfied at a point in time or over time. The new standard will require substantial judgment by companies in determining when revenue can be recognized for licensing transactions based on when the customer obtains control of the rights to use the intellectual property.
Intel Corp. INTC, +0.55% said in its first quarter filing that its assessment had identified a change in revenue recognition timing on its component sales made to distributors. “We expect to recognize revenue when we deliver to the distributor rather than deferring recognition until the distributor sells the components,” Intel wrote. The company also identified a change in expense recognition timing related to payments to customers related to cooperative advertising programs. Those expenses will now be recognized in the period the marketing activities occur, rather than at time of sale.
Xerox Corp. XRX, +0.10% said in its first quarter filing the accounting for typical transactions, which are the majority, is not expected to change. However, revenue recognition for more complex contracts may be affected and the company is currently assessing “the types and amounts of costs that may be eligible for deferral under the new standard.”
Industrial products and manufacturing
Industrial products companies like 3M Co. MMM, +0.17% will see changes from multi-step transactions with distributors. In those cases, companies will have to allocate some of the transaction price in the contract to those goods and or services, even if they will be provided by a third party and delay revenue recognition until those goods or services are delivered. The new standard could, for example, impact the timing of revenue recognition for some transactions where software industry-specific guidance is currently used and is now being replaced.
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