The New Revenue Recognition Standard
(Trends and Developments in ASU 2014-09)
A new accounting standard for revenue recognition (ASU 2014-09) became effective for SEC reporting entities this past year. It will be effective for private businesses and not-for-profit organizations in the calendar year ending December 31, 2018. Now is most definitely the time to be planning for this pronouncement, including working with your accounting and reporting professional advisor to understand nuances in the new pronouncement and its impact on your organization’s revenue recognition policies and procedures.
Many of you have asked what the ramifications of the new pronouncement have been, as seen on the financial statements of SEC reporting entities. What I’ve seen to date include:
- Implementing the new pronouncement has been time consuming and requires a careful analysis of contract terms and deliverables.
- Businesses in a variety of industries have had both acceleration and deferrals of revenues from previous accounting standards.
- There have been significant changes in income statement presentation that have received the focus of regulators and analysts.
Some industry-specific observations and examples include:
General Electric received public scrutiny and experienced a decrease in share price after disclosing the negative effects this pronouncement had on its previously reported revenues and earnings. GE provided full comparative retrospective and re-cast historical financial information for the prior two years as if the new accounting rules had been in place during those periods. It is believed that there was some public misconception on whether the recast of historic financial information was actually an error and correction of prior results verses the impact of adoption of the new rules. GE’s share price rose a bit when some investors realized there was no correction of an error or change in cash flows, and that revenue for these transactions will be recognized at a later date.
Tesla Inc., had a positive financial reporting impact of adopting the pronouncement. Using the modified retrospective approach of implementing the pronouncement, the Company reduced its accumulated deficit that had built up from years of start-up costs and operating losses by $520 million pretax at the start of 2018. Tesla reported that the main reason for the change was that the new revenue recognition accounting standard allowed the Company to recognize revenue from leased cars much faster than the prior rules (the Company can now accelerate the revenue recognition of some car sales to customers or to leasing partners with a resale value guarantee. Those sales will now be accounted for as sales with a right of return instead of leases.)
Uber’s implementation of the new standard has also drawn public scrutiny. The Company will report revenues net of fees paid to its drivers instead of gross with related driver expense reported. Resolution of the principal-or-agent concept is an important one under the new standard that drives how revenue will be recognized and reported. The rules say revenue is presented on a gross basis when the company acts as the principal, but only the net amount it expects to keep after paying the other party is presented when it is the agent. Users of Ubers financial statements argue that driver expenses are important to report and that a gross presentation would be more meaningful than net.
Other retail and consumer products companies have been broadly and widely affected by the new pronouncement. A critical focus on customer incentives such as coupons, rebates issued at the point of sale, free products, price protection, or price matching programs to customers is important under the new standard. These items create additional performance obligations, which can affect the timing of revenue recognition; and often introduce price variability, which can affect the amount of revenue recognized.
Banking and Financial Institutions
JP Morgan reported a positive comparative increase to its revenues under the new standard as a result of presenting certain asset and wealth management expenses that were previously offset against revenue on a gross basis verses a net basis. The company predicts an increase in both reported revenues and expenses of $1.2 billion over previous revenue standards and practices because of the change in presentation required by the new standard.
Wells Fargo recorded a negative $44 million cumulative adjustment as a result of applying the new rules to its contracts. It also changed the presentation of how underwriting costs were reported (to gross from net). The bank also had some changes in presentation to net from gross, such as how its card payment network charges are reported (now netted against card fee revenue rather than presented separately on a gross basis).
A few other lessons that have been learned so far and ways you can help to minimize issues adopting the new pronouncement include:
- The time and effort that goes into evaluating contracts and is something that is best undertaken early in the process and takes more time and effort that originally thought.
- A review of standard contracts under this pronouncement has on occasion precipitated legal modifications in standard agreements to ensure deliverables, rights, and responsibilities are clearly defined and communicated.
- It is critical to have good recordkeeping, and a way to summarize terms and performance obligations inherent in your contracts.
- Until you begin the evaluation process, it is difficult to know the ultimate impact of the pronouncement. If you provide projections to owners, investors, regulators, or financers, the sooner you begin to understand how this pronouncement will affect both the timing and presentation of revenues in your businesses financial statements, the better.
Time is now of the essence. We encourage you to collaborate with your advisors to understand how this pronouncement will affect your business and its financial reporting.
If you have any questions regarding implementation of the new accounting standards, please contact Al Duhaime at 1.800.244.7444.
Disclaimer of Liability: This publication is intended to provide general information to our clients and friends. It does not constitute accounting, tax, investment, or legal advice; nor is it intended to convey a thorough treatment of the subject matter.