Early Indicators Predict an Uptick in Revenue Recognition Accounting Failures

We have been asked several times whether or not the adoption of the new revenue recognition standard will cause an increase in the number of restatements and control failures. While it may be early to say, our review of SEC filings provides a strong indication that we will see an uptick in revenue recognition accounting failures.

Back in October, based on the analysis of Q2 filings, we found that some companies seemed to be struggling with the ASC 606 adoption. For most of the companies, the moment of truth came on December 15, 2017, the deadline to begin reporting with the new standard.

As we were working on the Q3 update, we identified a number of companies for which the controls were found to be ineffective and a material weakness was directly attributed to the lack of progress in the ASC 606 implementation.

ICTV Brands for example:

Adoption of New Accounting Standard, ASC 606

…noted a material weakness in internal controls over financial reporting, noting that the Company has not substantially or timely commenced its evaluation process to implement controls and identify the impact to its consolidated financial statements of adopting ASU No. 2014-09, Revenue from Contracts with Customers, which provides for a single five-step model to be applied to all revenue contracts with customers as well as requires substantial additional financial statement disclosures. The Company is required to adopt the new standard effective January 1, 2018. Without having substantially evaluated the impact of the new standard on its consolidated financial statements, there is more than a remote likelihood that a material misstatement and/or disclosure omission will not be prevented or detected in its interim or annual financial statements with periods beginning January 1, 2018.

The interpretation of this disclosure is, in fact, quite simple: if the standard is not implemented timely and accurately, there is more than a remote likelihood that the revenue may not be recorded in accordance with the new GAAP.

In another example, on February 6, 2018, Axalta Coating Systems [AXTA] indicated that in the process of implementing ASC 606, the company identified and corrected immaterial errors in the timing of revenue recognition of rebates and pricing concessions. The errors were previously disclosed in the quarterly report dated August 3, 2017.

Revision of Prior Year Financial Statements

During the three months ended June 30, 2017, as part of Axalta’s efforts to analyze the impact of the 2018 U.S. GAAP accounting adoption of ASU 2014-09, “Revenue from Contracts with Customers (Topic 606)”, Axalta identified and corrected errors that affected previously-issued consolidated financial statements. Axalta determined that these corrections were immaterial to the previously-issued financial statements; however, Axalta has revised certain amounts in the previously issued condensed consolidated financial statements to reflect those errors, including revisions to the condensed consolidated statement of operations for the three months and full year ended December 31, 2016, as discussed further below.

Axalta has corrected the errors in the timing of revenue recognition by estimating the additional rebates and pricing concessions at the time of sale to distribution customers and reducing net sales by $2.0 million ($0.7 million after tax) and $4.7 million ($3.0 million after tax) for the three months and full year ended December 31, 2016, respectively, as a result. These corrections did not have a material impact on the 2017 consolidated financial statements.

The supporting data is available for purchase as part of Audit Analytics’ Exploratory Research. Our analysts engage in this research to help better understand current and developing market conditions, and track the latest disclosure trends and regulations as they impact financial reporting. For more information or addtional ASC 606 analyses, email us at info@auditanalytics.com or call (508) 476-7007.