With the new ASC 606 rule now in effect and earnings season in full swing, we are beginning to see how different companies changed the way they account for revenue. For some, it will improve fiscal 2018 financial results. If a company shows revenue improvements during its quarterly call, trying to deduce what is organic growth (for example, due to the increase in customer base and number of subscriptions sold) and what is the effect of the new rule could be difficult.
The rule, ASU 2014-09, “Revenue from Contracts with Customers” (codified as ASC 606) standardizes and simplifies how companies record revenue in customer contracts. It went into effect for fiscal years beginning after December 15th, 2017, and covers how businesses report the nature, amount, and timing regarding contracts with customers.
Audit Analytics’ preliminary analysis of the earnings releases identified about 70 companies that noted ASC 606 in the context of the 2018 guidance. Out of the 70 companies, 20 have quantified impact on revenue guidance and ten companies quantified effect on the expected 2018 EPS. (For a list of companies, contact us at email@example.com.)
Based on the preliminary sample above, companies with negative impact were more likely to quantify the impact on 2018 EPS. For six out of the ten companies, the standard is expected to have negative impact, and for four companies, the impact on 2018 EPS guidance is expected to be immaterial.
For the companies that did not early-adopt the standard, the earnings reports that are currently being released will still reflect the old accounting rule since these are financial statements for 2017. Still, we expect to see some quantitative or other dollar-impact disclosure and perhaps some 2018 guidance that will incorporate the impact.
In subsequent earnings reports we will start to see the impact of ASC 606 in financial statements, as nearly 80 percent of the Russell 3000 firms should have adopted the new standard by January 1st, 2018, if their fiscal year ends on or around Dec. 31. For the other 20 percent, the adoption date depends on their fiscal year end.
The impact might not be as significant for companies that sell products and receive revenue at one time, such as retailers. For companies that sell recurring services like subscriptions or licenses, the rule may improve the results. Here’s why: under the previous law, if Activision Blizzard [ATVI] sold a 12-month software product license in June 2016, it could only apply six months of revenue to its books. It would not be able to count on the next six months of revenue until 2017. Under ASC 606, it can count all the revenue at once, improving the 2018 results going forward.
We will be required to recognize as revenue a portion of the sales price upon delivery of the software, as compared to the current requirement of recognizing the entire sales price ratably over an estimated service period.
Considering many life-science sector and technology companies license products, the new standard will likely improve their financial results when they release their first-quarter earnings reports in coming months.
For analysts trying to compare 2017 and 2018 revenue and expenses, going back and forth could be difficult. Even the historical comparison might not always be available. Part of that stems from the two methods companies may use to make the adjustment.
The first method companies can use is called full retrospective, restating all their revenue and expenses for the prior period. The advantage of this method is that analysts will be able to compare current revenue with past revenue to see the adjustment’s impact. This is especially helpful if the impact on financial statements is material.
The second way is a modified method, where the company will adjust retained earnings in the current period and recognize revenue under ASC 606 going forward. The modified method is easier to implement and most of the companies are likely to use this option. From the investor’s perspective, the disadvantage of this method is that, unlike the retrospective method, we would not get the historical perspective. But no matter which method the company chooses, trying to get clarity on a 2018 revenue and earnings-per-share growth won’t be easy. Even the retrospective method that allows for a historical perspective doesn’t always help going forward because we don’t know how it will affect 2018’s outlooks, and we won’t understand how much revenue growth is due to the change in the accounting.
Not all companies noted the new revenue recognition rule in their 2018 guidance discussions. And even the companies that provided the reference had no consistency in how they disclosed it.
As an example, let’s look at two companies in the telecommunications industry that have already provided references to how they are reporting the impact of the rules.
Verizon Communications Inc [VZ] is showing earnings-per-share guidance before the impact of the new revenue recognition standard. For 2018, Verizon expects the following:
… Low single-digit percentage growth in adjusted EPS, which includes the dilutive impacts from a full year of depreciation and amortization costs from 2017 acquisitions, the Straight Path acquisition expected to close later in the first quarter, and the ongoing impact of last year’s data center divestitures. This is before the impact of tax reform and the revenue recognition standard.
Meanwhile, the guidance provided by AT&T Inc [T] explains how the new standard affects EPS, but not by how much.
On a standalone basis, including the impact of tax reform and the new ASC 606 revenue recognition standard, we expect in 2018: Adjusted earnings per share in the $3.50 range.
During this earnings season analysts should be mindful of how companies change the way they report guidance to understand whether or not financial results improved because of accounting. Analysts should also keep in mind that the rule in some cases will also affect both revenue and earnings per share, while in other cases there will be an offsetting impact – revenue and expenses will grow by about the same amount.
A version of this article was previously available on FactSet to subscribers of our Accounting Quality Insights.
Update: the article was updated from its original version to indicate that six out of ten companies that quantified impact on the EPS outlook had negative impact. The original version of the article stated that the impact was negative for five companies.
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