Risk & Compliance

Investors on Rev Rec Changes: Who Cares?

The changes to GAAP accounting for revenue recognition won't have a material effect on companies' finances, investors say.
David McCannDecember 13, 2017

Amid all the consternation plaguing companies about getting up to speed on the new revenue recognition rules, there’s one thing they don’t have to worry about: investor reaction to any resulting changes in their financials.

Sure, there will be some accounting adjustments, especially around when to recognize revenue based on customer contracts and when to record sales-compensation expenses. For many companies, such changes will cause bottom lines to rise or fall, depending on their particular circumstances.

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But those effects won’t last for long, and they won’t have much or any actual financial impact on companies. Rather, revenue or expenses will merely move from one reporting period to another. After two or three years have gone by, any changes a company was obliged to make almost surely will have offset one another.

“This GAAP accounting change doesn’t affect cash flow and won’t have much economic impact,” said Christopher Marangi, a portfolio manager at investment firm Gamco, during a Tuesday webinar hosted by investor relations adviser Clermont Partners. “We’ve only talked a little bit about this within our firm. It’s not been a big focus.”

Even to the extent some investors may be thinking about revenue recognition right now — the new rules take effect for fiscal years that start after Friday, Dec. 15 — they will be preoccupied with other matters come January. “There’s going to be so many other issues that investors and investor relations teams [will be focused on], in particular the tax-law change that’s coming,” said Elizabeth Lilly, founder and president of Crocus Hill Partners, an investment firm specializing in small-cap equities.

The topic of the webinar was non-GAAP reporting, based on a Clermont Partners survey showing that investors are paying much more attention to non-GAAP information than to the officially sanctioned numbers. “If we believe that non-GAAP metrics are really what’s driving valuations, [the changes to revenue recognition] will be an interesting test of just how powerful non-GAAP metrics are in the market,” Marangi said.

Baruch Lev

Baruch Lev Baruch Lev

Another panelist, Baruch Lev, professor of accounting and finance at New York University’s Stern School of Business, strongly criticized the hefty new revenue recognition standard, ASC 606.

“I don’t think a rule that stretches over 709 pages is reasonable,” Lev said. “This is accounting gone mad.” The Financial Accounting Standards Board worked on the new rules for many years. Still, after FASB released its exposure draft in May 2015, the rules’ effective date had to be delayed for a year because “it was so complex, no one understood it,” Lev noted.

According to Lev, FASB needlessly responded to an avalanche of comments on the exposure draft by adding more and more details to the standard, addressing very specific scenarios.

“Basically, the rule didn’t change anything,” he continued. “Revenues are recognized when a good or service is delivered and when cash or a reasonable accounts receivable is received. This thing which takes me exactly 10 seconds to explain in a class is still the backbone of the 709 pages. The rest are details which I really don’t think are very important.”

In an interview with CFO, Lev also noted that the new standard fails to distinguish among four “very different” causes for revenue growth: price, volume, M&A, and foreign exchange.

“It’s extremely important for investors to understand where topline growth comes from,” he said. “Foreign exchange is mainly beyond managers’ control. Volume is clearly under managers’ control. Price effects are generally long-term, while M&A is frequently transitory. Some companies provide a partial breakdown of these effects, but there’s nothing secret about this information.”