Top questions for investors about revenue recognition
The CFA Institute has some advice for investors about the main questions they should be asking about the new revenue recognition standard.
In a recent report, Revenue Recognition: Top 10 Questions Investors Should Ask About the Adoption of the New Standard, Sandra Peters, head of the Financial Reporting Policy Group at CFA Institute, an organization for Chartered Financial Analysts, delves into some of the main issues for investors.
The main question, according to Peters, is what’s the impact to cash flow? “Why were there changes made and how do they impact future trends and other analytical considerations? In the series of questions, I say consider all the financial statement effects on ratios and what those may mean for the future in some of those ratios,” Peters told Accounting Today. “If it changes price to book or price to sales, what does that mean on a going forward basis, because the restatement of the financials and all that is backward looking, and investors are more forward looking. What were the consequences in the past and what bearing does that have on the future?”
Most companies are opting to follow the modified retrospective approach to the new standard, she noted. “More people said they were going to adopt the modified retrospective method than disclose what they thought the impact was going to be,” said Peters. “I don’t know how you decide what method you’re going to apply for the adoption if you don’t know how material it is. The more material it is, the more you would actually want to recast the financial statements. Even if companies do adopt in a modified retrospective way with just a debit or credit to retained earnings, we’re advising people there’s information content in that number. What does it tell you? Does it tell you they’re going to recycle some earnings?”
She believes it’s also important for investors to understand it’s not just the revenue number line that’s changing. “Costs may change, particularly if you have long-term contracts,” said Peters. “All the financial statement subtotals may change. All the ratios may change. You need to think about what the consequences of those things are. Even if the change isn’t a big change, adopting a new standard on revenue gives investors an opportunity to ask questions about contracts with customers that they might not otherwise have had the opportunity to ask. Even if the impact isn’t material there’s going to be disclosures, maybe not in the press release, but in the financial statements there’s going to be a disclosure of revenue disaggregated, in what the FASB perceives should be a more detailed level than the segment disclosures, and it needs to be reconciled to the segment disclosures.”
Some investors are worried about how such information will be disclosed. “We’re kind of worried about some of the disclosures other than this disaggregation item, in how boilerplate will they be,” said Peters. “Will people copy from one company to the next? And we won’t see entity-specific assumptions about, or decisions made about, what’s a performance obligation or how much transaction price did we actually allocate to it. I just think investors need to wrap their heads around it, and the changes are just coming now. It will be interesting to see in the first quarter what people say and how it gets construed.”
Some investors may misinterpret the disclosures companies make, as some did when General Electric recently announced the upcoming changes in its financials. “It’s important for the company to do a good communication job on what the consequences will be so that investors understand it and understand what the impact is, or understand why there isn’t an impact,” said Peters.
The SEC has already begun to send CFO comment letters to some of the companies that elected to adopt the revenue recognition standard early. “What was most interesting about those comment letters was there was a lot of discussion about not only revenue but about segment disclosures,” said Peters. “It seemed to me that they were linking the two up.”
She noted that some industries will be more impacted by the new standard than others. “It will be interesting to see how big the number of adjustments are when the modified retrospective method was chosen what that actually represents because it’s one number, but what’s netted in there?” she added.
Peters believes investors should be asking for more disclosures on the disaggregation of revenue. “I think that would be good to see sooner rather than later,” she added.