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Home>UPDATE: This new accounting rule could radically change how some companies recognize revenue

UPDATE: This new accounting rule could radically change how some companies recognize revenue

UPDATE: This new accounting rule could radically change how some companies recognize revenue

09/27/2017

By Tien Tzuo

Investors should watch how executives address ASC 606 in third-quarter earnings

Uber's reported revenue is being cut in half (https://www.ft.com/content/74447ca2-6b0b-11e7-bfeb-33fe0c5b7eaa?accessToken=zwAAAV1b-P5Ykc90RHyiawsR59O_6zP-DFt-qg.MEUCIQCggv2x1Wc8wWglosLzWaMuQvtu8ax2DMcliclw9ZFklgIgaAjhP4RcrzrsUqRYjq0nwxRlgsuKPqdCh5f3YIyd6Sk&sharetype=gift). IBM plans to spend an unexpected $35 million-40 million (http://www.fasb.org/cs/BlobServer?blobkey=id&blobnocache=true&blobwhere=1175823787092&blobheader=application%2Fpdf&blobheadername2=Content-Length&blobheadername1=Content-Disposition&blobheadervalue2=296388&blobheadervalue1=filename%3DREVRECR.ED.0026.IBM_CORPORATION_GREGG_L._NELSON.pdf&blobcol=urldata&blobtable=MungoBlobs). And General Motors might have to reduce its balance of earnings (http://www.marketwatch.com/story/new-rule-forces-big-car-makers-into-big-changes-in-how-they-count-revenues-2017-07-27) by $1 billion next year. Why?

New accounting standards ASC 606 and IFRS 15 (https://www.zuora.com/guides/asc-606-ifrs-15-new-revenue-standards-will-impact-subscription-companies/?utm_medium=website&utm_source=zuora&utm_campaign=laser) will force companies to completely re-evaluate when and how they account for their revenue. Right now, thousands of accountants are scouring through old contracts to determine whether their sales need to be booked differently.

After 12 years of work, the Financial Accounting Standards Board (FASB) and their international counterpart the International Accounting Standards Board (IASB) issued new standards for recognizing revenue from contracts with customers in 2014. The goal was to simplify and harmonize revenue recognition practices globally. The new standards are based on one overarching principle: "Companies must recognize revenue when goods and services are transferred to the customer, in an amount that is proportionate to what has been delivered at that point."

But for those that don't put in the work now, misappropriation of standards might cause revenue recognition errors (http://archives.cpajournal.com/2006/1206/infocus/p12.htm). These errors are the No. 1 reason for restatements, which history shows us can lead to firings (http://ww2.cfo.com/accounting-tax/2007/11/is-a-restatement-a-cfos-kiss-of-death/), stock-price drops (https://www.alacra.com/acm/2033_sample.pdf), jail time (http://www.newsday.com/news/new-york/sanjay-kumar-former-software-executive-released-from-prison-1.13280974) and a tarnished reputation (https://www.wsj.com/articles/the-unspoken-signals-in-earnings-releases-1418619058).

If you've been in Silicon Valley as long as I have, you might remember when the CEO and CFO of CA Technologies went to jail (http://www.newsday.com/news/new-york/sanjay-kumar-former-software-executive-released-from-prison-1.13280974) for falsely reporting $2 billion of revenue in 1999 when numerous license agreements were finalized after reporting periods had closed.

"With the FASB ASC 606 accounting rules, we get lunatic things like software companies recognizing term licenses upfront despite not getting the cash. This is what Enron did and, as I recall, that episode didn't work out super well for anyone," said Richard Davis, an analyst at Canaccord Genuity.

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