Many software companies, including Microsoft, could see significant changes in their revenue patterns with the rollout of the revenue recognition standard that takes effect at the end of the year, according to a new study.

The study, from the financial analysis technology company Calcbench and the blog Radical Compliance, attempts to identify which companies in the software sector are most likely to experience significant changes in their revenue patterns, and then to see what they have disclosed to investors so far about the implications of the impending standard. Microsoft officials have publicly discussed the standard at accounting conferences and conferred with the Financial Accounting Standards Board about it, but many other software companies have said little.

The study notes that when Microsoft reported 2017 revenues on August 2 under the new revenue standard for the first time, the software giant had to adjust its 2016 revenues upward by 6.8 percent and its 2017 revenues upward 7.3 percent. Other companies may need to adjust downward.
 
“This should set off alarm bells for at least some investors,” said Calcbench CEO Pranav Ghai in a statement. “We found lots of companies that could potentially see material changes in their revenue reporting—not definitely, but potentially—and yet they’ve disclosed very little to investors, even with the new standard taking effect only four months from now.”
 
The new revenue recognition standard will go into effect for public companies’ next fiscal year after Dec. 15, 2017. For companies with a fiscal year-end date of Dec. 31, the new standard will apply with quarterly reports starting in January.

Software companies could see special challenges because many have signed long-term contracts with customers. Until the new standard, revenue from those contracts was recognized incrementally over the lifetime of the contract. But under the new revenue recognition standard, much of that money could be recognized immediately.
 
That might give some sporadic boosts to software sales, but it will also introduce more volatility from one quarter to the next, depending on when large contracts are signed. In the reporting period when the software company first adopts the new standard, it could disrupt the companies’ balance sheets as deferred revenues (that is, revenue for future years of contracts) suddenly move from their holding pen on the balance sheet to a one-time surge of revenue on the income statement.

“No company is going to ‘lose’ revenue because of the new standard, but quite a few numbers could move around in their timing or how they’re reported,” said Radical Compliance CEO Matt Kelly in a statement. “The question is how well software companies understand those possible changes, and how well they’ve communicated those possibilities to investors.”

The study, released Wednesday, found the average ratio of deferred revenues to current liabilities in the software sector from 2014 to 2016 to be 43 percent. Then the study examined that ratio for more than 400 individual companies that name Microsoft as a peer, to determine which firms depended the most on long-term contracts. Calcbench and Radical Compliance found 38 companies with “DR/CL” ratios above 80 percent, and 11 of them had ratios of more than 100 percent.

Within the set of 11 companies, seven said they were still trying to determine whether the new standard would have a material effect on the timing and nature of their revenue patterns. Of the 27 other companies with DR/CL ratios of 80 to 100 percent, one-third of them anticipate a material effect. (By way of comparison, in a separate analysis by Calcbench and Radical Compliance of disclosures by the 30 companies in the Dow Jones Industrial Average, only 10 percent reported in their 2016 annual reports they expect a material change from the new standard.)
 

Revenue recognition impact on financial reporting

“We’ve found some software firms saying they expect a material change, but they still don’t know exactly when they’ll adopt the new standard, or what method they’ll use,” said Ghai. “We found others with high DR/CL ratios expecting to implement the standard by January, but don’t yet know the possible materiality. Our study doesn’t necessarily mean the companies will experience trouble— but we do give ammunition to analysts and investors who want to ask more direct questions. The time for direct questions is upon us.”

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Michael Cohn

Michael Cohn

Michael Cohn, editor-in-chief of AccountingToday.com, has been covering business and technology for a variety of publications since 1985.