By Francine McKenna, MarketWatch
Financial services firms, including the biggest commercial and investment banks, are slowly but subtly admitting that new standards for recognizing revenue that take effect in the first quarter of 2018 may have a significant impact on how they record and reflect key components of their top lines.
Since the new accounting standards don’t apply to revenue related to financial instruments, including loans and securities, banks have been saying—and most analysts have repeated—that the new revenue recognition guidance won’t have a material impact on bank income statements.
However, several big commercial and investment banks hinted in their last quarterly filings with the SEC in May that there may be more to come in other income areas, and those changes may be significant, according to disclosures made to the Securities and Exchange Commission.
For more complex businesses that use long-term contracts, such as global financial services firms but more typically defense and construction companies, the new guidance could significantly affect the amount and timing of reported revenue. Companies such as IBM /zigman2/quotes/203856914/composite IBM +0.30% , SAP /zigman2/quotes/203458330/delayed DE:SAP +0.66% and Oracle Corp. /zigman2/quotes/202180826/composite ORCL +0.28% that have multiple revenue streams from hardware, software, and services, as well as biotech companies will also be see a significant impact from the new standard.
Consumer-focused businesses such as brick-and-mortar retailers, restaurants, and personal service businesses where cash is collected at the point of sale, may see some changes too, but only in very limited areas, such as recognition of gift card breakage or loyalty card revenue.
Banks like Citigroup Inc. /zigman2/quotes/207741460/composite C -2.54% , Wells Fargo & Co. /zigman2/quotes/203790192/composite WFC -2.76% , Fifth Third /zigman2/quotes/207561596/composite FITB -3.68% , State Street /zigman2/quotes/209758976/composite STT -2.40% and Goldman Sachs Group Inc. /zigman2/quotes/209237603/composite GS -1.74% have now acknowledged the potential impact from the new standard for multiple revenue streams that are not derived from interest income and expense or investment gains, according to a MarketWatch analysis of recent disclosures based on data provided by research firm Audit Analytics gleaned from SEC filings.
“There is ample leeway within the definition of contracts to take a “minimalist approach to disclosure.”
Vincent Papa, The CFA Institute
Exposure for financial services companies is based on the way the new standard reframes how revenue from contracts with customers is recognized, in particular the impact of the bank’s role in the transaction—as principal or agent. If the bank has control—for example it assumes all the risks and rewards of ownership or bears all of the responsibility to provide the goods or services—it is likely the principal in the transaction and will report the revenue on a gross versus a net basis.
The textbook case on how a company can really get these esoteric concepts very wrong is Groupon Inc. /zigman2/quotes/207356672/composite GRPN +8.05% , said Vincent Papa, a Ph.D., CPA, and CFA and the interim head of financial reporting policy for the CFA Institute, the global association of investment professionals. Groupon’s presentation of revenue on a gross rather than net basis during its 2009 to 2011 reporting periods “proved misleading and resulted in a significant capital market correction of its valuation,” which then prompted an SEC inquiry and Groupon’s restatement of its results, Papa wrote in his report, “Watching the Top Line”.
Citigroup said in its 10Q filed in May that it expects a change in presentation to gross from net for expenses associated with underwriting activity. Wells Fargo is also changing presentation of underwriting costs to gross from net, writing that its broker-dealer would have to present costs for its underwriting activities “in expenses rather than the current presentation against the related revenues.”
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Fifth Third says the bank’s revenue recognition processes for wealth and asset management revenue, corporate banking revenue, and card and processing revenue “may be affected.” But it is still evaluating the impact on credit card interchange fees and related rewards programs. State Street said the new standard’s change to principal and agent determinations “may result in changes to gross or net treatment of revenue and expenses but would not affect net income.”
All four banks plan to implement the change using the modified retrospective approach for reporting the impact, rather than a full retrospective approach. That means that the adjustment will be recorded on a cumulative basis only to the opening retained earnings balance, rather than as a restatement of prior period amounts.