27 February 2018

CFA Institute: Paper on the revenue recognition requirements

Authors examine the top 10 questions investors should consider as they review year-end 2017 results and consider first quarter 2018 reporting as it relates to the adoption of the new accounting standard.

Effective 1 January 2018, revenue for all companies following US GAAP and IFRS will be recognized under a new accounting standard. The degree of change resulting from this standard will vary by company and industry. The new standard replaces substantial prescriptive US GAAP guidance with principles that are highly, but not completely, converged with IFRS, which offered minimal guidance on revenue recogni­tion prior to this standard. In 2018, all investors should be aware and consider the impact of the standard. To that end, this paper includes a series of analytical considerations for investors. Much of what has been written on the standard has focused on how it should be applied by accountants, and not on how it should be analysed by analysts and investors. In this paper, the top 10 questions are examined, which investors should consider as they review year-end 2017 results and consider first quarter 2018 reporting as it relates to the adoption of the new standard.

Although companies should already be disclosing the impact and method of adoption, research shows that these impacts have not been well disclosed as of the third quarter 2017. Most companies will follow a modified retrospective method of adoption, which will leave investors with little trend information upon which to consider the impact of the transition on their analysis. While a handful of companies have early adopted—and have been fairly effective at their communications—investors should develop their own expectations related to the companies they follow or invest in as well as the nature of the changes in their respective industries.

Furthermore, investors should be aware that more than simply revenue may change as a result of the new revenue recognition standard. Costs associated with obtaining contracts with customers and taxes also may change. To that end, investors need to be mindful of all the financial statement effects and their related impact on ratios. Investors also should recognize that cash should not be affected by the adoption of the new standard, unless a company’s current taxes in future periods are computed based on book rev­enues or unless companies alter their contracts with customers in advance of transitioning to the new stan­dard. Accordingly, valuations should not change significantly despite a change in EBITDA, net income, or earnings per share (EPS) resulting from the transition to the new revenue standard.

Full paper

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