Chaos in Corporate America:
New Accounting Rules to Disrupt Every Industry


Listed in The Reformed Broker

Daniel Drew,  1/1/2015

Five Steps

   

The goal of every board is to justify its existence. That's what the FASB and IASB are doing right now, and they don't care if it disrupts every industry in America.

The Financial Accounting Standards Board (FASB) and the International Accounting Standards Board (IASB) are the rulers of the accounting departments in every corporation. They decide what is true and fair, and they determine the proper way to report your financial statements. The IASB consists of 14 "experts," and the FASB has 7 members on the board. In the modern world of unprecedented efficiency, most people have taken fake jobs to give themselves a facade of meaning. What better way to assert your importance on the world than to create new revenue recognition rules for the entire country? That's exactly what our 21 accounting masters of the universe have done for us.

The new rules were first announced on May 28, 2014. The Journal of Accountancy called it a "grand achievement." Grand indeed.

Revenue. Seems simple enough. But anyone who has actually had to deal with the mechanics of recording revenue knows you can run into all kinds of problems and technical questions. For example, let's say you are a small business owner who runs a construction business. Some of your projects last 3 months or longer. The customer pays you an initial installment, another installment half-way through, and the final payment when the project is completed. Do you record the full revenue amount at the beginning of the project? At the end of the project? Or do you record it partially along the way? It's easy for a simple concept to get complicated very quickly - and that complexity is where the advisers, the board members, the paper pushers, the nitpickers, the accountants, the lawyers, and the consultants thrive.

It is true that certain rules are quite necessary. It is also true that most rules are obscure, arbitrary, mind-numbing, infuriating, over-complicated contortions of the obsessive mind. The OCD industry employs millions of people, from KPMG to Deloitte and Toooosh to Disdain Bain Capital. These are the types of people who sit around at lunch time and ask each other questions like these: "Should we use the straight-line depreciation method or the sum of your mom's digits method?" "I wonder how many windows are in New York?" "How can we save our company $2 billion with a Double Irish and Dutch Sandwich tax avoidance strategy?"

Revenue, mental gymnastics, obscurity - this is the essence of corporate America.

The answer to that construction business example is there is no single answer. You can recognize revenue progressively as the project continues, or you can recognize all of it at the end, depending on the situation. The kicker is that you have to recognize expenses in the same way so expenses match revenue chronologically.

Here is the official summary of the new revenue recognition rules in one sentence:
"Recognize 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."
Yes go ahead. Read it again. Read it another 5 times. No matter how many times you read it, you still won't be able to understand it. That's because the sentence is convoluted and makes no sense. But this is exactly what boards do. They create incomprehensible statements filled with jargon that cause you to doubt your intelligence when you fail to grasp it. They create the problem, and then they provide the solution - the explanation: "Recognize revenue when the reporting organization satisfies a performance obligation." Now that's a sentence that actually makes sense. But there's just one problem: this isn't actually a new principle or a new rule. More absurdity from the FASB.

Since there are no broad conceptual differences, it is clear that the painful adjustments will be in the details. The rules are so complicated that the FASB is even considering delaying the deadline, which is currently January 2017. KPMG has created multiple documents to help people understand the new changes. In their executive summary, they wrote:
"Key financial measures and ratios may change, affecting analyst expectations, earn-outs, bonuses, budgeting, and compliance with contractual covenants. IT systems may need to be upgraded or modified for revised requirements to capture additional data necessary to support the accounting and disclosures. Sales and contracting processes may need to be reconsidered. Accounting processes and internal controls may need to be revised for the new standard, which requires significant judgment and use of estimates. There also may be a need to maintain parallel records during transition."
The KPMG unscripted summary: It will be chaos.

Major companies are already warning investors about the new rules. In its 3rd Quarter report, Facebook said they were reviewing the potential effects of it. Coca Cola also mentioned the new rules in their 3rd Quarter report.

Companies that sell products and services in a bundle, or those engaged in major projects, could see significant changes to the timing of revenue recognition. Highly affected industries include telecom, software, engineering, construction, and real estate. KPMG even has forms for executives so they can attempt to understand how their particular industry will be affected. If the company uses a percentage of completion method, they may be required to change to a completion method and vice versa. Revenue recognition could be accelerated or deferred, new estimates will have to be made, and extensive new disclosures will be required - those footnotes that nobody reads. Basically, the accounting department's entire world could be turned upside down. It won't be business as usual.



Industry Effects



This comment about asset managers' performance fees really caught my attention:
"Asset managers who enter into arrangements that include performance-based incentive fees will be subject to the revenue constraint...this may result in some asset managers recognizing revenue for performance-based incentive fees only at or near the end of the contract period."
Most managers get their bonuses at the end of the year, but some might have different arrangements, such as foregoing a management fee and only receiving performance bonuses. If this is the case, your revenue could be confined to the end of the year. However, on another page, the report says the asset manager can recognize revenue early if they deem it is "highly probable" there won't be a significant reversal in their market performance. Thank you FASB for leaving a loophole so wide even Stevie Cohen wouldn't get stuck in it.

Hedge fund managers aside, the largest impact of the new rules will be on the companies themselves. What concerns me the most is that the rules are about revenue, which is the main thing companies manipulate. Under the new rules, revenue from software license transactions may be recognized earlier.

The rule change is so pervasive it's going to be nearly impossible to monitor all the effects of it. The FASB and IASB are unleashing chaos into the corporate world, and the most ruthless are always the ones most qualified to capitalize on the turmoil. The only real revenue acceleration going on here is at KPMG, Deloitte and Toooosh, PricewaterhouseBloopers, and Ernst & Youngin as they rush in to solve the problems created by the FASB and IASB.