Morgan Stanley: 25% of Big Firms to See Shift Under Revenue Rules

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By Amanda Iacone

Up to 25 percent of the largest companies in the U.S. could report significant changes on their financial statements as they apply new revenue recognition rules this spring.

Companies ranging from General Electric Co. to agricultural firm Monsanto Co. and video game-maker Electronic Arts Inc. are expected to report potentially material changes due to implementing the new accounting standard, according to a Morgan Stanley analysis of revenue recognition disclosures included in recent quarterly and annual reports for the companies listed on the S&P 500.

First quarter reports—due out in the next few weeks—will be the first time public companies have to apply the new rules, which standardize how and when companies report revenue from contracts, leases, and product sales.

The shift in baseline earnings could be in the billions of dollars for companies, the Morgan Stanley analysis said.

Real estate giant CBRE Group Inc., for example, expects a revenue shift of more than $4 billion because of changes to how it reflects reimbursed service costs, according to the investment firm’s analysis.

Most Predict Little Impact

A majority of these companies expect the new accounting standard to have no material impact on their financial reports, Morgan Stanley said.

“What we are seeing here is a lot of companies’ current revenue recognition practices appear to fit within the framework,” said Todd Castagno, an accounting and tax policy analyst for equity research at Morgan Stanley in New York.

Still, the significant shift in earnings for some companies could take investors by surprise, Castagno told Bloomberg Tax.

Investors will want to read deeper than just the top revenue line because some of the changes will filter into expenses as well, he said. Retail companies, for example, are re-evaluating how they record loyalty programs as liabilities, Castagno said.

Companies like AT&T Inc. and Verizon Communications Inc. plan to spread out the cost of sales commissions rather than immediately expense those costs, which would temporarily highlight earnings, he said.

Suchchanges, coupled with the accelerated reporting of revenue, will cause a one-time boost to earnings and revenue but won’t alter the underlying economic performance of a company, Castagno said.

More Than Accounting

The accounting changes represent a paradigm shift that will take several years for investors and businesses to fully adapt to, said Edward Li, an associate professor of accounting at Baruch College in New York.

“This is going to have some fundamental change to the way firms are doing business,” Li said.

Companies might reconsider the timing of when they sign new contracts, when they deliver a good or product, and when they collect the payment—all to smooth out revenue over the course of a year, Li said.

Adopting the new rules could be a confusing time for investors and the markets. The new rules give companies the flexibility to determine how best to apply the standard, resulting in what Li called “fuzzy” revenue.

Li predicted that some companies will have to issue restatements to correct revenue errors and that these first-quarter reports are a sign of more changes to come.

To contact the reporter on this story: Amanda Iacone in Washington at aiacone@bloombergtax.com

To contact the editor responsible for this story: S. Ali Sartipzadeh at asartipzadeh@bloombergtax.com

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