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Revenue Recognition - ASC 606 Roundup: 5/20/2019

Posted by Graham Hulme on May 20, 2019 8:30:00 AM

To quickly identify ASC 606 information in the below links, click on the link, hit Control + F, enter the text “606”, “2014-09”, or “ASC” and go to your search results.

To quickly identify key areas, open each link and search for “606” or “2014-09” in the text.  

This week’s blog focuses on recent examples where companies made revenue recognition errors leading to restatements.

Recent Earnings Calls Transcripts

Notable takeaways:

Notable portion of the transcript in its 15th and 16th references to ASC 606:

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“If I’m limited to one question, my question is for John. John, how should we think about the impact of 606 on a quarterly basis for the remainder of the year? Will it be a tailwind to both revenue and margins for each quarter relative to 605?”

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“Sure. No, I think as we have talked about at Analyst Day and further in December at our Earnings Call. Overall, 606 does not have a material impact to our results. What we’re seeing in Q1 is the pull forward of revenue by recognizing some OEM contracts upfront that otherwise would have been recognized throughout the year. But otherwise we don’t expect a material impact for the year.”

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“And if I could slip in a quick follow up. The $20 million ARR benefit from ASC-606. How does that split between Document Cloud versus Creative in the quarter?”

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“So that was a cumulative catch-up adjustment against the $7 billion base of ARR. So really quite immaterial and the split that’s really more in the Creative versus Document.”

Our thoughts: 

Analysts are moving beyond asking about ASC 606 in terms of looking for clarifications on backward looking historical results when compared to ASC 605.  Now the landscape has changed to one where companies must be prepared to provide guidance on a forward-looking basis specific to 606 while comparing it to what would have been the results under 605.

Notable takeaways:

Notable portions of the transcript in its 3rd through 15th references to ASC 606:

Michael Gordon – COO and CFO

“We’ve implemented ASC 606 on a full retrospective basis, which means we have recast our prior results for fiscal 2019 and prior periods under the new revenue recognition standard. There are two primary ways ASC 606 impacts our financial results. First, revenue recognition. Enterprise Advanced transactions will now have a portion of the contract value recognized upfront while the remainder will be recognized ratably over the contract term.

As a reminder, most contracts are annual. However, for an illustrative three-year contract under 606, we will now recognize the term license component for all three years upfront. This will result in greater variability and reduced comparability in our quarterly revenue results. It’s important to note that the adoption of 606 will not impact how Atlas revenue is recognized.

Second, sales commission capitalization. 606 broadens the scope of capitalized commissions. Now, under 606, all incremental costs, including commissions and payroll taxes, as a result of closing a deal, are capitalized. Previously, only direct, deal-specific commissions were capitalized under 605. Additionally, the estimated amortization period is generally longer under 606 as compared to 605. This has the impact of modestly lowering our reported sales and marketing expense.”

“There are additional dynamics that investors should keep in mind under 606. First, when we sign multiyear Enterprise Advanced deals, we will need to recognize the term license portion of the future year license revenue upon initial delivery, regardless of whether they prepaid the entirety of that contract.

Second, as a result, our year-over-year growth in any given period may be more variable when the year ago compare had a greater amount of upfront revenue due to the timing of multiyear deal signings. To be clear, this would not be indicative of slowing business momentum on a function of revenue recognition accounting dynamics. One example of this will occur in Q3 of fiscal 20, which faces a very difficult compare under 606 as we signed several, very large multiyear deals in Q3 of fiscal 2019.

Third, revenue will more closely follow the pattern of historic booking trends. Q3 has historically been our largest quarter for new bookings and consequently subsequent renewals with Q1 historically the lowest. As a result of this, sometimes Q1 revenue under 606 will decrease than the prior Q4. This happened in the Q1 of fiscal 2018.”

Our thoughts: 

The company covers a lot of ground in its remarks regarding its adoption and impacts of ASC 606.  The is in the minority in terms of how it adopted by going with the full retrospective method as most companies have gone with a modified retrospective method.  As a proactive measure, the company did a good job of presenting this information, and then offering practical, intuitive, examples to illustrate the new standard’s impacts. 

Notably, the company provided a clear explanation as to why the timing of revenue recognition changed, and how this will impact its financial results, as a means to educate readers out of the gate.  This is a good template companies should follow when presenting ASC 606 information to consumers of their financial statements.

Additional notable portions of the transcript in its 23rd reference to ASC 606:

Unidentified Analyst

“What percentage of the total contract do you – are you recognizing upfront for the enterprise contracts? And does your guidance assume a similar percentage of multiyear contracts for FY20 versus FY19?”

Dev Ittycheria – President and CEO

“Sure. So, there’s certainly been some variability. We have not assumed any major changes in terms of the mix. So, certainly to the extent that that mix varies, that will impact the results. It varies in terms of the question of how much of the upfront license, obviously it effects on the duration of the contract as well as on the product mix but in general it’s roughly in the area of [technical difficult] is the current estimate, although obviously as things continue to move to change, we will update that accordingly. And as you can see from a macro perspective, if you look at the full year, it has effect about 5% on overall revenue.”

Our thoughts: 

This is another example where forward-looking guidance is the focus of the analyst’s ASC 606 question.  The response hedges a bit about committing to an exact percentage, but does eventually present a backward, actuals-based, answer.  Going forward, companies need to be prepared to answer these types of ASC 606 guidance questions.

Articles

Our thoughts:  This article hits on a topic that has been lightly covered to date in terms of the potential for fraud under the new accounting standard.  All intentions of the new standard aim for the exact opposite, but the reality is that complexities of the new standard, combined with its broad scope, open the door for improper actions on the part of companies (intentional or unintentional).  Additionally, our experiences have shown that it’s not uncommon for auditors within the same accounting firm to have different opinions on how ASC 606 should be interpreted and applied to a company’s business practices.  Thus, it’s all new territory for the firms tasked with validating and confirming that companies are properly processing according to ASC 606.

With these factors in play, and many more, companies must be their primary advocate to push for clarity on the standard and ensure that it’s being applied correctly and is in the future.  On the flipside, investors, analysts, etc. must have a curious and investigatory eye on companies until such point as a repeatable and reliable set of financial results are put forward by companies complying with ASC 606.

We encourage you to visit http://www.softrax.com for information on how SOFTRAX can help your company and you handle ASC 606.

Topics: Revenue Recognition, ASC 606, IFRS15, SEC Comments

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