The new revenue recognition standard allows for two transition methods. One is a kind of hybrid “retrospective with a cumulative effect” approach, where in the year of adoption a company records the cumulative effect and goes forward (with some significant “old GAAP” disclosures). The other is full retrospective implementation.
The full retrospective implementation comes with a lot of baggage beyond the amount of work it might require.
One question is what about the five-year summary? In Form 10-K is it necessary to retrospectively adjust the two earliest years in the five year summary along with the three years in S-X audited financial statements? The SEC staff has addressed this question and said this is not necessary. The CorpFin Financial Reporting Manual now states:
11100 REGISTRANT FINANCIAL INFORMATION
11100.1 Selected Financial Data
A registrant elects to adopt the new revenue standard using the full retrospective approach. Must it apply the new revenue standard when reporting selected financial data (S-K Item 301)) for periods prior to those presented in its retroactively-adjusted financial statements?
No, but registrants must provide the information required by Instruction 2 to S-K Item 301 regarding comparability of the data presented.
This second question is a lot more intricate. What if a company does an S-3 after the first quarter of implementation? To set this issue up, here is a fact set:
Company year-end: December 31
Revenue Recognition Standard adoption date: January 1, 2018
Full retrospective method of adoption is used. In this method, for the 2018 Form 10-K the years 2016, 2017 and 2018 would be presented using the new revenue recognition standard.
Now assume that in 2018 (thus before the December 2018 Form 10-K is filed), the company reports for the first quarter of 2018 and files Form 10-Q on April 30, 2018. If the company then files an S-3 to raise capital on May 31, 2018, the previous Form 10-K for the year ended December 31, 2017, would be incorporated into the Form S-3. That Form 10-K would have financial statements for 2017, 2016 and 2015. The financial statements for 2015 are the key issue here, as they would not be required in the December 31, 2018 Form 10-K. But, since they are incorporated into the S-3 and the company has adopted the new revenue recognition standard, Item 11(b) in Form S-3 will apply (emphasis added):
Item 11. Material Changes.
(a) Describe any and all material changes in the registrant’s affairs which have occurred since the end of the latest fiscal year for which certified financial statements were included in the latest annual report to security holders and which have not been described in a report on Form 10-Q (§249.308a of this chapter) or Form 8-K (§249.308 of this chapter) filed under the Exchange Act.
(b) Include in the prospectus, if not incorporated by reference therein from the reports filed under the Exchange Act specified in Item 12(a), a proxy or information statement filed pursuant to Section 14 of the Exchange Act, a prospectus previously filed pursuant to Rule 424(b) or (c) under the Securities Act (§230.424(b) or (c) of this chapter) or, where no prospectus is required to be filed pursuant to Rule 424(b), the prospectus included in the registration statement at effectiveness, or a Form 8-K filed during either of the two preceding years:
(i) information required by Rule 3-05 and Article 11 of Regulation S-X (17 CFR Part 210);
(ii) restated financial statements prepared in accordance with Regulation S-X if there has been a change in accounting principles or a correction in an error where such change or correction requires a material retroactive restatement of financial statements;
(iii) restated financial statements prepared in accordance with Regulation S-X where one or more business combinations accounted for by the pooling of interest method of accounting have been consummated subsequent to the most recent fiscal year and the acquired businesses, considered in the aggregate, are significant pursuant to Rule 11-01(b), or
(iv) any financial information required because of a material disposition of assets outside the normal course of business.
This would seem to require that the new revenue recognition standard be applied to the year ended December 31, 2015.
Not a happy outcome!
This question has come up in earlier accounting standard transitions, and the SEC Staff is clearly aware of this issue. Wes Bricker, Deputy Chief Accountant, said this in a recent speech:
“I am also aware that registrants have expressed concern about the requirement to provide restated financial statements when a Form S-3 registration statement is filed after the registrant has filed its first Form 10-Q reflecting adoption of the revenue standard. This requirement to restate the financial statements means that companies that adopt the revenue standard under a full-retrospective transition approach would be required to restate an additional year in its Form S-3 to show the effect of the new revenue standard on that earlier period.
While this issue is not specific to the new revenue standard, the pervasive impact of the new revenue standard amplifies the issue.
To this, I would observe the transition provisions in the new revenue standard reference existing GAAP, which provides for an impracticability exception to retrospective application if, for example, a company is unable to apply the requirement after making every reasonable effort to do so. OCA is available for consultation if a registrant believes that, based on its facts and circumstances, a retrospective application of the new revenue recognition standard to all periods required to be presented in a Form S-3 is impracticable.”
The actual language he refers to in the excerpt above is from ASC 250:
250 – 10 – 45 – 5
An entity shall report a change in accounting principle through retrospective application of the new accounting principle to all prior periods, unless it is impracticable to do so.
250 – 10 – 45 – 9
It shall be deemed impracticable to apply the effects of a change in accounting principle retrospectively only if any of the following conditions exist:
- After making every reasonable effort to do so, the entity is unable to apply the requirement.
- Retrospective application requires assumptions about management’s intent in a prior period that cannot be independently substantiated.
- Retrospective application requires significant estimates of amounts, and it is impossible to distinguish objectively information about those estimates that both:
- Provides evidence of circumstances that existed on the date(s) at which those amounts would be recognized, measured, or disclosed under retrospective application
- Would have been available when the financial statements for that prior period were issued.
That’s where this issue is for now, and this could well be a problematic issue for any company raising capital in the year of adoption of the new revenue recognition standard!
As always, your thoughts and comments are welcome!