While most public companies have yet to complete a full year of reporting under new revenue recognition rules, some are already finding reasons to restate.
Technology company Ellie Mae, Inc., for example, determined in late October it needed to restate its first- and second-quarter results for fiscal 2018 because it made mistakes in how it applied the new revenue recognition requirements. The company says it overstated revenue by $2.1 million in the first quarter, then understated it by $400,000 the next. The corrections reduce net income by $1.6 million.
In its application of the new guidance, contained in Accounting Standards Codification Topic 606, Ellie Mae says it “did not adequately constrain variable consideration,” which left too much potential under the rules for revenue to be reversed in a future period. Variable consideration is payment customers make for goods and services that is uneven over time. Companies generally are allowed to recognize revenue only as they determine that significant reversal of revenue is not likely to occur.
Ellie May says it also “identified additional costs to obtain” that should have been recorded to its opening balances upon adoption of the new rules. Costs to obtain sales are more often capitalized under the new rules rather than recognized as an expense. The adjustments reduced retained earnings by $9.8 million as of Jan. 1, 2018, the company disclosed.
The company is one of two dozen through late October that filed a Form 8-K with the Securities and Exchange Commission to alert investors that they should no longer rely on financial statements while the company fixes problems with the ASC 606 adoption at the start of 2018, according to Olga Usvyatsky, vice president of research at Audit Analytics. With 99 8-Ks filed through the same period in 2018, those citing problems with the new revenue rules represent 24 percent of all non-reliance notices.
In 2017, 21 percent of the 105 non-reliance restatements for the entire year could be attributed to problems with revenue recognition under historic rules. Data for less serious restatements, those that revise financial data without undermining reliance or those that provide out-of-period adjustments, are not yet available, says Usvyatsky.
“For a lot of CEOs, CFOs, audit committees, and board members, when they were reading those robust disclosures for the first time, it was an eye opener. A lot of companies are actually still working through what the final product will be regarding that 606 disclosure.”
Brian Christie, Managing Director, FTI Consulting
While some restatements reach back only a quarter or two to reconsider how the company applied the new guidance, others reach back further to reconsider accounting under historic rules as well. Ryder, for example, best known for its truck rental business, disclosed in May that it needed to make an out-of-period adjustment amounting to $11 million to a 2017 quarterly filing.
As the company considered the new guidance under ASC 606 about whether its role in a contract was as the principal party to the arrangement, or an agent acting for another company, it spotted a flaw in its historic reasoning. The determination is important because it dictates whether to recognize revenue on a gross or net basis, which has a big impact on the top-line revenue number.
Ryder reported it had accounted for certain of its freight brokerage agreements as the principal to the contract, which meant including revenue and costs associated with sub-contracted services as part of the gross revenue figures. The agreements should have been reported on a net basis under historic accounting rules, the company said. The correction was not material, Ryder said.
Ryder did not say whether its revision led to any reconsideration regarding the effectiveness of internal control over financial reporting, but other recent 8-Ks have indicated failure to deploy proper internal controls over the adoption itself are to blame for errors.
Intrexon Corp., for example, said in correcting its first quarter 2018 filing that it also made errors in applying the guidance in ASC 606 regarding gross versus net presentation of revenue. “The company concluded these errors resulted from a material weakness as it did not maintain effective controls over the adoption of ASC 606,” Intrexon reported. “As a result, the company has re-evaluated its assessment of the effectiveness of the company’s disclosure controls and procedures for the three months ended March 31, 2018, and has concluded that they were not effective.”
Data so far suggests revenue recognition may be driving an uptick in late filings as well. According to Usvyatsky, 2 percent of late filings in 2018 have cited revenue recognition problems as at least part of the reason for tardy filings. For all of 2017, 1.3 percent of late filings cited revenue recognition woes.
Calendar-year companies that adopted the new accounting on Jan. 1, 2018, soon face their first year-end filing under the new rules, which require companies to follow a five-step process for identifying when and in what amounts to recognize revenue in financial statements. The journey to the new accounting represented some significant technical accounting changes, says Amy Hover, managing director at MorganFranklin Consulting.
“The time, the level of effort, the complexity has been around identifying performance obligations, the determination of whether a promised good or service is distinct, and certainly the timing of the satisfaction of performance obligations,” says Hover. Identifying contract costs has been tricky, she says, as has the determination of whether fulfillment costs should be identified as an asset to be capitalized over time.
“It’s a long list, but it’s all connected,” says Hover. Just like a complicated equation on a math exam, each of the many determinations within the five-step revenue recognition model are critical to getting the right answer, she says. “If you get one step incorrect, the rest of the answers that follow are incorrect.”
And then there are disclosures. “What caught a lot of companies by surprise was the robust nature of the 606 disclosures,” says Brian Christie, managing director at FTI Consulting.
The new standard requires companies to include a great deal more information in disclosures, especially regarding the significant judgments and estimates that factor into the timing and amounts of revenue recognized in financial statements. The standard also required companies to begin making those disclosures not in their first annual filings, but their first quarterly filings reflecting the new rules.
“For a lot of CEOs, CFOs, audit committees, and board members, when they were reading those robust disclosures for the first time, it was an eye opener,” says Christie. “A lot of companies are actually still working through what the final product will be regarding that 606 disclosure.”