For the past year, we have been monitoring the progress made by U.S. public companies towards implementation of the new revenue recognition standard known as ASC 606. In December 2016, we looked at companies who were planning to early-adopt the provisions. Then, back in June, we checked in again on the progress of the S&P 500 towards completion. We noted at the time, that many companies seemed to be under-prepared.
This is a serious issue. The new standard is very complex and could involve major changes to processes – especially affecting accounting processes, but also even HR and IT. It is rare that such a momentous accounting standard gets released, and it will have a major impact on the financial statements of many U.S. public companies.
Now, with only three months to go until the new revenue recognition standards kick into effect, we expanded our analysis to Q2 filings by those companies included in the Russell 3000.1
Only a handful of Russell 3000 companies – 21 in total – have already adopted and implemented ASC 606, 11 of which disclosed the use of the full-retrospective method. A few more companies have indicated that they plan to adopt early, but haven’t done so yet. Overall, the results of our analysis suggest that many companies might be struggling to meet the deadline.
In order to assess where a company stands in its progress towards implementation, we considered a number of factors. Relying on the quality of a company’s disclosures in their recent Q2 financial statements, we looked at:
• adoption method used
• materiality and quantitative impact on retained earnings and/or revenue
• revenue streams and areas of accounting affected
• over-all progress of the implementation efforts
Before we get into the analysis of these disclosures, it is important to say something about SAB 74. SAB, short for “Staff Accounting Bulletin”, 74 is guidance issued by the SEC that requires companies to provide disclosures about the anticipated impact that new accounting standards will have on the company’s future financial statements. That is to say, for most companies, it is required for them to disclose something about the implementation of ASC 606.
Most Russell 3000 companies have provided a disclosure in their Q2 filing. But for 148 companies, for one reason or another, we were unable to find such a disclosure. Some companies, certainly, may not have any revenue that falls within the scope of the new standard, so it makes sense that they wouldn’t disclose anything.
The original version of this article listed 5 out of the 148 companies (Intel, Bunge, Chubb, Travelers, and Progressive) for which we could not find a Q2 disclosure.
After the original release of the article, we were contacted by one of our readers to clarify that Intel provided a robust qualitative ASC 606 disclosure in its 2016 annual report. Additionally, the July 1, 2017, 10-Q (the quarterly report which was the subject of this post) included the following footnote:
Note 2: Recent Accounting Standards stated that “the tables below describe impacts from newly issued standards as well as material updates to our previous assessments, if any, from our 2016 Form 10-K.”
In other words, there were no material updates to the disclosure made in their 2016 10-K.
Bunge Ltd (BG) included an ASC 606 disclosure in their annual report. For Bunge, the standard is not expected to have material impact on results of operations, financial position, or cash flows, but may require expanded disclosure. Bunge indicated that the analysis was almost complete, so, perhaps, no Q2 updates were necessary.
For Chubb, Travelers, and Progressive the standard is not expected to be material, so, perhaps, no Q2 updates were necessary.
There is more than one way to provide an update. Bristol Myers is a good example of a company with a substantial 10-K disclosure. In the Q2 update, Bristol Myers, in addition to referring readers to the 2016 10-K, also listed Contracts with Customers as one of the standards to be adopted.
Now let’s turn our attention to the four key areas of ASC 606 implementation disclosed in Q2 reports, namely (1) Adoption Method, (2) Materiality Assessment, (3) Revenue Streams Affected, and (4) Overall Implementation Progress.
One of the key determinations that companies are required to make in implementing the new standard is which adoption method to use. Two methods are allowed: the full retrospective method, which requires restatement of previously filed financial statements; and the modified retrospective method, where the impact on previous years is shown as an adjustment to retained earnings.
Almost 50% of Russell 3000 companies were still undecided as to which adoption method to use. This may indicate that a significant number of companies are not far enough into their analysis to even make the determination. With just three months to go for most companies, this clearly looks like an issue. For larger companies that are part of the S&P 500, only 28% did not disclose expected adoption method. The takeaway of that distinction is that smaller companies are more likely to fall behind with the implementation.
Materiality assessment and quantitative impact
Next, we looked at the number of companies that provided at least some point of reference for materiality or a ballpark quantitative impact.
We did not, of course, expect many companies to be able to provide final numbers at this time. If they could, they probably would have adopted the new standard already. We did, however, expect most companies to have at least some sense of the impact, albeit as a preliminary range or even just a percentage of the revenue within the scope of the standard.
Based on the chart above, less than one-third of Russell 3000 companies (30%) indicated that the standard will affect at least one area of accounting. It is important to note that just because no accounting changes are expected, that should not be perceived as a lack of any impact at all. For example, there could still be material changes in other disclosures such as the disaggregation of material revenue streams. The remaining 70% of companies evaluated were either not able to determine the impact or determined that the standard is not going to be material to any areas of accounting.
From a quantitative perspective, only four companies that did not yet adopt the standard provided an estimated impact on the retained earnings. An additional four companies provided at least some ballpark estimate of the impact on revenue. And more companies provided an estimate of the percentage of revenue within the scope of the standard.
Revenue streams and specific areas of accounting affected
The materiality discussion would be incomplete without looking at the revenue streams affected. The table below lists specific revenue streams that would be materially affected by the standard.
Granted, in some of the cases, while some revenue streams are materially affected, the overall impact to the financial statements may not be that significant. Yet, in some cases, impact of the standard is going to be positive to the bottom line. From an investor perspective, if the positive impact on a particular revenue stream brings an extra penny per share – this change should be noted.
Overall implementation progress
Finally, we looked at how companies described their overall implementation efforts. We looked for any qualitative signs of progress, such as language indicating that the review is substantially complete.
At least 54 companies described their review as being in early stages, and another 266 did not provide any specific details. 90 companies reported that their accounting review is practically complete. The remaining 2,300 companies characterized their process as “ongoing”.
Only a handful of entities being at the late stages of implementation is consistent with concerns raised by some stakeholders and industry observers that many companies may not have sufficient time to complete the analysis and implement the required changes by the mid-December deadline. For example, see the “ASC 606 clock is ticking: It may be time for brute force” publication released by PwC.
SEC Comment Letters
In our June update, we discussed that some companies received comments related to insufficient level of details. Since June, the number of companies receiving these letters increased to at least 18. Yet, in some cases, ASC 606 comments might be a little more subtle, and may not even reference ASC 606 explicitly. An example below is from CORRESP filing of CBRE Group (CBG):
“1. Considering that you have consolidated revenues in excess of $13B for the year ended December 31, 2016 and that; based on the information disclosed throughout your filing, you have revenues from multiple lines of business, please tell us why you do not provide disaggregated information of your revenues for each line of business.
The Company is currently amidst adoption efforts relative to the new revenue recognition guidance that is effective on January 1, 2018, including providing disaggregated information on its revenue. Under the existing guidance, the Company has historically taken the position that all revenue is from real estate services and provided some information on line of business performance within its MD&A discussion. Given the comment above, the Company will add disaggregated information on its revenue to its consolidated and segment MD&A tabular disclosures, beginning with its Form 10-Q for the quarter ended June 30, 2017.”
So, what do we expect to see in the upcoming months, in particular in Q3 filings? First, we would hope to see more companies reporting that their ASC 606 reviews are substantially complete. We would also expect to see more disclosures about the anticipated quantitative impacts of implementation.
Another area where disclosure is likely to evolve substantially is Internal Controls Over Financial Reporting. At least 500 companies disclosed that ASC 606 may have an impact on ICFR, yet only 11 disclosed actual changes in internal controls due to the standard.
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The article was corrected on October 11, 2017, to clarify that this analysis is focusing on Q2 updates and not on the entire 2017 disclosure. In addition, the article was corrected to incorporate feedback received from one of our readers.
1. Population is based on index download of 2,970 companies as of September 2017. Of those companies, 2,737 companies disclosed implementation efforts of ASU 2014-09 between July 1, 2017 and September 25, 2017; 148 companies filed financial statements but had no ASU 2014-09 disclosure; 58 had not yet filed their financial statements for the quarter; and 27 were no longer filing with the SEC.↩