With less than four months to go until businesses must follow the FASB’s wide-ranging new revenue accounting rules, many companies have said the accounting overhaul will have a minimal effect on their income statements.
Not so for the software industry, where companies have complex and long-term arrangements with customers, with revenue typically recognized over the life of these contracts. Under the FASB’s new standard, published in May 2014 as Accounting Standards Update (ASU) No. 2014-09, Revenue from Contracts with Customers (Topic 606), many companies will shift to recognizing more revenue at the time of sale — a change that could have a significant effect on companies’ bottom lines.
Microsoft Corp., for example, which adopted the standard early, recorded revenue for the year ending June 30, 2017, of more than $96.5 billion under the new accounting rules, versus $89.9 billion if it had recorded revenues using old GAAP, its annual filing show.
Other businesses in the software industry could also have markedly different revenue results under the new accounting rules — and investors and analysts need to take note, according to a report published on Aug. 23 by financial analysis data company Calcbench and the blog Radical Compliance.
The new standard gets rid of about 200 pieces of industry-specific revenue rules, coming up with a single way for most companies to recognize the top line in their income statements. For software, the standard eliminates the need for “vendor-specific objective evidence” showing that some elements of a contract are still undelivered, and therefore the revenue from those undelivered elements cannot be recognized. With this requirement erased, the new standard will allow companies to recognize more revenue from a long-term contract immediately, the report states.
This will likely lead to companies recognizing revenue from a contract more quickly, but it also could make earnings more volatile from period to period.
If customers buy multi-year software contracts at the beginning of the year “under the new revenue standard, more software companies will report stellar Q1 results every few years … and then doldrums, until the next big contract is signed,” the report states.
Still, the report states it is hard to estimate the exact effects of the new revenue standard on the software industry because while many software companies in their 2016 financial statements disclosed that the new revenue standard would have a material effect, others said they were still evaluating it.
“When you look across the spectrum, it’s not that clear what the heck is going to happen,” Calcbench founder and CEO Pranav Ghai said.
In an Aug. 23 blog post, Vincent Papa, director of financial reporting policy at the CFA Institute, gave a similar warning to analysts and investors, saying it was difficult to assess the effect of the new accounting standard across several industries because few companies have adopted it early, and the rest of them have not spelled out how the change will affect their financial results.
He further cautioned investors and analysts against a “false sense of comfort” that the effect of the standard will have a minimal impact on companies.
“It is not inconceivable that the complexity and multiple, significant judgments of the revised accounting changes could result in more far reaching and diverse impact than is anticipated,” Papas wrote.
The FASB, auditors, businesses, and analysts have long said that the effect of the standard would vary from industry to industry. In June, Google’s technical accounting director at an accounting conference described the effect of the new revenue calculation method as a “rounding error,” noting that the company’s 2016 revenues were $15 million lower than they would have been if calculated under old revenue rules. For a company with $425 billion in revenue, the change was immaterial, he said.
On a FASB webcast in May, General Electric Co. and Raytheon Co. representatives said the companies had to do a lot of work to comply with the new accounting standard, but they did not anticipate a significant shift in reported revenues as a result.
In April, a Moody’s Investors Service report said that while the new rules would not result in dramatically different revenue figures for most companies, the timing of when companies recognize revenue will change. In some cases revenue recognition will be accelerated and in other cases decelerated. This could result in revenue swings from period to period depending on the company and industry.
The FASB published ASU No. 2014-09 alongside the IASB’s IFRS 15, Revenue from Contracts with Customers, after a dozen years of work between the U.S. and international standard-setting boards to come up with a single method for almost all companies worldwide to calculate their revenues.
“This new standard will be a profound change in how companies recognize revenue,” the report states. “It requires them to define economic transactions as a series of performance obligations, where the company can only recognize revenue from a transaction as each obligation within the transaction is fulfilled.”
For in-depth analysis of the FASB’s revenue recognition standard, please see Catalyst: U.S. GAAP — Revenue Recognition, also on Checkpoint.
Additional analysis of the revenue standard can be found on Checkpoint in the Accounting and Auditing Update Service and the SEC Accounting and Reporting Update Service [SARU No. 2014-21] (June 2014): Special Report: Comprehensive Coverage of the New U.S. GAAP Revenue Recognition Requirements.
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