But before you train your eyes towards the results section, you should take a moment to familiarise yourself with the basic tenets of ASC 606 (Accounting Standards Codification) and IFRS 15, particularly as their implementation is likely to have a marked effect on the way many companies go about booking revenues, particularly in the software, outsourcing, technology and telecoms industries (IFRS 9, which determines how companies should classify and measure financial assets and liabilities for accounting purposes, also comes into force from the start of next year).
The underlying principle behind the new standard places the onus on companies to “recognise revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services”.
Without going into undue detail, it means that revenue must only be recognised when a company supplies a promised good or service to a customer – not when the company undertakes activities connected with the promised good or service. So, the emphasis effectively switches to what the customer is getting from the seller and when – it sounds wholly intuitive, but companies have come under criticism for playing a little too fast and loose with their revenue policies.
In September, outsourcing heavyweight Capita (CPI) got ahead of the curve, when it hosted a presentation for institutional investors and analysts outlining the impact of early adoption of IFRS 15. Although the group stressed that the new treatment wouldn’t affect the lifetime profitability of contracts, related cash flows, or most transactional businesses, it resulted in a reduction in underlying revenue from £4.6bn to £4.4bn, along with a re-statement of underlying operating profit for 2016 from £481m to £335m. More starkly, net assets of £483m switched to net liabilities of £553m. Under the new treatment, the group ended 2016 with deferred income of £1.6bn, an increase of £1.3bn, representing cash received in 2016 for services delivered (or to be delivered) but not recognised as revenue until 2017 or later.
The issue again came to the fore two months later, when engineering contractor GKN (GKN) decided to abort the appointment of Kevin Cummings as chief executive designate, after the group revealed additional write-downs of between £80m and £130m on revised assumptions on programme inventory and receivables for aerospace plants in North America (which Mr Cummings had been heading up). It’s hard to say whether GKN would have avoided the overstatement under the IFRS 15 standard due to the opaque nature of its contracts with the US military, but the changes will have a profound effect on the way many companies account for contract receivables and inventory. Some, such as BAE Systems (BA.), have already calmed investors by pointing out that the adoption of the new accounting standard would have no impact on the way contracts are managed.
