Top-Line Watch: Investor Wherewithal Required to Monitor Revenue Reporting
Recent stock market reactions to news of potential revenue misreporting (e.g., Valeant, IBM, Boeing, and Tesco) signal the importance that investors attach to revenue as a performance measure, valuation input, and indicator of management’s stewardship effectiveness and integrity.
The International Accounting Standards Board (IASB) and Financial Accounting Standards Board (FASB) concurrently issued new and largely converged revenue recognition standards in 2014 that will take effect by 2018. While not much may change in the revenue reporting of many businesses under the new guidance, there will likely be changes in amount and timing of revenue for other business types (e.g., software, telecommunication, certain contract manufacturers, and long-term construction companies). Furthermore, the new guidance will be characterized by an increased need for management judgments on certain aspects of revenue recognition, such as a need for companies to estimate probable, unrealized revenue.
What Warrants Scrutiny?
Given the importance of revenue, it is essential for investors and other capital market participants to ensure they have the wherewithal required to effectively monitor if and how company management revenue recognition judgements are a faithful depiction of companies’ value-creation patterns. To that effect, CFA Institute has issued a white paper, Watching the Top Line: Areas for Investor Scrutiny on Revenue Recognition Changes, highlighting a selection of issues within the standard that warrant investor scrutiny. These include: transition requirements, multiple deliverables within a contract, licenses, gross versus net presentation of revenue, and customer credit risk. In addition, a follow-up white paper will address long-term contracts and uncertain revenue.
Monitor Implications of New Guidance for Specific Companies
An overarching message worth emphasizing is an ongoing clarification on how to implement the standard by financial statement preparers and auditors participating in the IASB and FASB joint transition resource group. At the same time, the specific implications of the new guidance as far as changes in amount and timing of revenue across all business models are yet to be fully spelt out. In other words, there is an ongoing journey of discovery, and at this stage, investors need to be having a dialogue with managers of the companies that they follow on the implications of the new guidance. They also need to closely monitor revenue reporting trends in the run up to the 2018 adoption date.
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