Early adopters of the new revenue recognition standard tend to be big companies with little change to their reported revenue numbers, but more substantial change to disclosures.
Alphabet, for example, the parent company of Google, has seen little difference in its timing and pattern of revenue recognition after adopting the new-five step method, said Amie Thuener, vice president and chief accountant. “The biggest change for us was to the footnote disclosures, not the financials themselves,” she says. “We had to change some of our processes and controls, but it was mostly around what information we gather for footnote disclosures and the way we gather it.”
Calendar-year public companies are facing a Jan. 1, 2018 deadline to begin following the new rules on revenue recognition, adopted into Generally Accepted Accounting Principles in 2014 under Topic 606 in the Accounting Standards Codification. Back in mid-2015, hearing demands that companies needed more time to prepare, the Financial Accounting Standards Board deferred the required effective date of the massive new rules by one year, to Jan. 1, 2018, for calendar-year public companies.
At the same time, however, FASB also permitted early adoption as of the original timeline, which was Jan. 1, 2017. A handful of companies exercised that option and are already issuing financial statements under the new requirements. But the number of companies that elected that path is not big, nor are the differences in their financial statements under the new standard compared to the old.
Alphabet fits into that bucket. The company has reported in 2017 that it adopted the standard under the modified retrospective method, meaning it applied the new accounting to contracts that were not complete and all new contracts going forward as of Jan. 1, 2017. The majority of public companies are expected to use that method, relying on disclosures to provide historic context. The alternative is to follow the full retrospective method, which requires applying the new accounting to historic results presented in financial statements.
Alphabet reduced its opening retained earnings by $15 million on Jan. 1, 2017, to reflect the cumulative effect of adopting the new revenue recognition approach. So far, the company says the new accounting has increased revenue by $32 million through three quarters. Its third-quarter revenue alone was $27.8 billion.
“The effects of the new standard really didn’t have that material of an impact on their financial statements. We’re talking about some of the largest companies, domestically, in the world, so they most likely have larger accounting and finance teams to be able to deal with something of this magnitude.”
Michael Stevenson, National Assurance Partner, BDO USA
In terms of disclosure, the company’s latest quarterly report devotes nearly three pages to text and tables, explaining how the company generates and recognizes revenue through only a few different business models. Disclosures disaggregate revenue by type and geographic region, and they address arrangements with multiple performance obligations, deferred revenues, practical expedients, and exemptions.
The company was already well down the path of implementing the new accounting when FASB announced the deferral, says Thuener, so Alphabet decided to go forward and meet the original effective date. “We looked down the pipeline at a lot of other stuff coming, like leasing and financial instruments,” she says. “Given the relative impact to our financial statements from a materiality perspective for revenue recognition, we thought it was best to keep to the original timeline so we could then get focused on other standards that were coming.”
Indeed, Alphabet’s disclosure on new accounting pronouncements coming after revenue recognition is extensive. Accounting Standards Update No. 2016-01 on the recognition and measurement of financial instruments takes effect Jan. 1, 2018. The requirement in that standard to measure equity investments at fair value will produce some volatility in reported income, the company has disclosed.
A year later, the company will adopt ASU 2016-02 on lease accounting, bringing most lease-related assets and liabilities on to corporate balance sheets. Alphabet expects that standard to have a material effect on its balance sheet, but it is still working on changes to processes and controls and is exploring the possible use of an optional practical expedient provided in the standard.
Examples of early adopters
Microsoft: Microsoft adopted Topic 606 beginning 1 July 2017, and its management has disclosed8 that it will bill hardware makers for Windows 10 at the time of sale rather than through the life of the hosting computer hardware because the software is a distinct product. If the new approach had been applied for year ended 2016, Microsoft’s revenue would have been US$6 billion (7% higher) than was stated.
Alphabet: Alphabet adopted Topic 606 at the beginning of January 2017 and this has yielded minimal changes. Revenue increased by US$14 million in the first quarter and the “Day 1” change in equity increased by US$15 million, which was largely attributable to nonadvertising revenue.9 Alphabet’s first quarter 2017 10-Q reported that
As it relates to Google’s other revenues, the most significant judgment is determining whether we are the principal or agent for app sales and in-app purchases through the Google Play store. We report revenues from these transactions on a net basis because our performance obligation is to facilitate a transaction between app developers and end users, for which we earn a commission. Consequently, the portion of the gross amount billed to end users that is remitted to app developers is not reflected as revenues.
The distinction between principal and agent is one of the key judgments that companies will need to make to determine whether either a gross or net presentation of revenue is appropriate.
Raytheon: Raytheon, a U.S. aerospace and defense player, adopted Topic 606 on 1 January 2017. Raytheon’s Chief Accounting Officer Michael Wood participated in an investor-oriented webcast hosted by the Financial Accounting Standards Board (FASB) on the implications of the changes for the aerospace and defense sector industry.10 The Raytheon spokesperson indicated that minimal impact has occurred. In its 2016 10-K, Raytheon states that
The impact of adopting the new standard on our 2015 and 2016 total net sales and operating income is not material. The immaterial impact of adopting Topic 606 primarily relates to the deferral of commissions on our commercial software arrangements, which previously were expensed as incurred but under the new standard will generally be capitalized and amortized … The impact to our results is not material because the analysis of our contracts under the new revenue recognition standard supports the recognition of revenue over time under the cost-to-cost method for the majority of our contracts, which is consistent with our current revenue recognition model.
Source: CFA Institute
8See Microsoft’s PowerPoint slides online: Frank Brod and Chris Suh, “New Accounting Standards and
FY18 Investor Metrics,” 3 August 2017, accessed 7 September 2017, https://view.officeapps.live.com/op/
bd475a49-90ec-1e3a-fbdd-102cad6153f7; the transcript of the commentary from Microsoft’s management
is also available online: Chris Suh and Frank Brod, “MSFT New Accounting Standards and FY18
Investor Metrics Conference Call,” 3 August 2017, accessed 7 September 2017, https://view.officeapps.
docx?version=0c01400c-37fa-5faf-2694-9c84fabf3372.9In the first quarter of 2017 (2016), Google’s advertising quarterly revenues were US$21.4 billion (US$18
billion) representing 86.5% (89%) of total revenue with nonadvertising revenue accounting for 13.5% (11%)
of total revenue.10FASB Webcast and Webinar Series, Aerospace and Defense Revenue Recognition Webcast with GE and
Raytheon, 11 May 2017, accessed 17 September 2017, http://fasb.org/cs/ContentServer?c=Page&pagename
The latest 10-Q for Alphabet has less to say about how the company will be affected by the new standard on credit impairment, which takes effect in 2020, but the company is expecting a big effect when it adopts ASU 2016-16 on income taxes, which generally accelerates the recognition of tax consequences for asset transfers among entities under common control. Alphabet expects to make an adjustment to retained earnings of $600 million to $800 million to reflect unrecognized income tax effects.
Finally, a new goodwill impairment test under ASU 2017-04, which actually simplifies the process of determining if goodwill should be written down, is expected to be immaterial for Alphabet.
After three quarters following the new rules, Alphabet continues to “refine and adjust” its systems and processes to comply with the new revenue standard, says Thuener. The company is working on automating the overall process to streamline reporting, she says.
With hindsight, Thuener says the company could have benefitted from having a dedicated project manager overseeing the implementation effort. “Looking back, that would have been helpful,” she says. “There’s a lot of coordination across the organization.” That’s a change the company is making to its adoption of other big standards following revenue recognition.
Thuener says the company found it helpful to engage its auditors early in the adoption process. Although calendar-year companies are fast approaching the required effective date, certainly if companies haven’t already brought their auditors up to speed on their plans, now is the time, she says.
Google’s parent is among only a small number of public companies that have already adopted the new standard. Others include Microsoft, Raytheon, Ford, General Dynamics, UnitedHealth Group, First Solar, and Workday. There’s a common theme among companies that chose to be the pioneers, says Michael Stevenson, national assurance partner at audit firm BDO USA.
“The effects of the new standard really didn’t have that material of an impact on their financial statements,” says Stevenson. “We’re talking about some of the largest companies, domestically, in the world, so they most likely have larger accounting and finance teams to be able to deal with something of this magnitude.”
Early adopters appear to have taken the new standard seriously, says Steve Quinlivan, a partner in corporate securities at law firm Stinson Leonard Street. A recent white paper by the CFA Institute even calls out Microsoft as a standout in giving plenty of quantitative and qualitative detail about how it would be affected by the new accounting. Microsoft began following the new standard on July 1, 2017, and reported to investors the new accounting accelerated revenue such that its 2016 revenues would have been 7 percent higher had it followed the new standard that year.
Quinlivan notes with some interest that if early adopters are any indication, companies may likely to say less about revenue in their management discussion and analysis under the new standard because more is required in footnote disclosures.
“We’ve seen a lot of different approaches and a lot of comments in MD&A to say let’s not duplicate anything that’s in the footnotes,” says Quinlivan. “If you can judge the magnitude of change by what’s in the financial statements, the (Securities and Exchange Commission) has taken the position these days that you don’t have to be redundant in MD&A.”
Every company will analyze its own facts and circumstances to decide what to say in M&A about the new standard, says Quinlivan, but he is advising companies to be sure they cause investors no surprises. “The early adopters seem to have sent enough signals so that, as far as I know, there haven’t been any surprises,” he says.
As the bulk of public companies sprint to the finish line with their implementation activities, both Quinlivan and Stevenson said it’s reasonable to expect late filings and increased reporting of material weaknesses in internal control in the early part of 2018. “I continue to have the feeling that the post-implementation efforts may be just as great as the initial adoption itself,” says Stevenson.
Given the complexity of the effort and the significant number and magnitude of challenging decisions companies have to make, followed by reviews by auditors and regulators, companies are likely to see their assumptions and judgments challenged. “There may be more to the back end than we might have already seen on the front end,” says Stevenson.