Combing through changes in reporting standards
Shares in Quebec engineering company SNC-Lavalin Inc. tumbled more than 27 per cent earlier this week after reporting it "cannot achieve the necessary required level of agreement at this time with the client to meet the IFRS standards for revenue recognition." The company's mining segment posted a loss of up to $350 million from an unnamed project in Latin America that prompted many investors to take a deeper look into the company’s books.
It was the latest high-profile example of how new accounting standards with more stringent disclosure rules have injected a little more uncertainty into corporate earnings season.
So, what do investors need to know when it comes to the International Financial Reporting Standard for revenue recognition (IFRS 15)? Below, BNN Bloomberg looks at five questions – and answers – into what you should look out for.
1. What is IFRS 15?
The goal of IFRS 15 – rules which most publicly-listed Canadian companies have adopted – is to ensure firms report useful information to investors and other stakeholders about the nature, amount, timing and uncertainty of revenue and cash flows arising from a customer contract. “It focuses on obligations instead of title transfer. It’s more of a control model,” said Dean Braunsteiner, a chartered professional accountant and leader of PwC Canada’s mining group.
It sounds simple: A company can recognize revenue after the transfer of risk and rewards has taken place – or, in other words, after a transaction is complete. But for companies (in particular those with long-term contracts which have multiple components that are delivered in phases), it can be much more complex and result in either earlier recognition of revenue (eg. due to variations in estimates) or later recognition (eg. due to deferring revenue for performance obligations).
2. When did the standard take effect?
IFRS 15 came into effect on Jan. 1, 2018. It is one significant change in a series of alterations to accounting standards.
It permits a "modified retrospective" approach, which means it allows companies to start using IFRS 15 from Jan. 1, 2018 onwards without going back to prior years. Any difference between the accounting under the old and new approaches is recorded as an adjustment to the opening balances of retained earnings on a firm’s balance sheet.
“This is where you will find out what the financial impact of the standard is on a company,” said Braunsteiner.
A company could go back and restate all of its prior accounting to follow IFRS 15 but many companies follow the modified approach for convenience and because it may not make sense to apply a new standard to an old transaction. Understanding this change is important because, as Braunsteiner points out, “if a company went back to the beginning, this would provide a clear picture on historicals so that you can model the future in a more precise way.”
3. Why does it matter?
The new standard can have an impact on revenue which drives profit recognition. “There is a possibility that revenue recognized over long-term contracts will be more variable than before and can make it more difficult for analysts and investors to model a company's future profitability or revenue growth,” said Braunsteiner. Because IFRS 15 may change the revenue recognized, it can have an impact on earnings and compliance metrics like debt covenants.
4. Does it make it easier or harder to interpret earnings reports?
Harder. Braunsteiner says IFRS 15 now requires companies to provide more information to investors including more granular disclosures by the company. So, if there are outstanding performance obligations that the company has to complete, it must be described in financial reports. “In fact, companies will disclose more details on the types of revenue being recorded,” said Braunsteiner.
The information should provide investors with more insights into the company's activities, trends and where there is future growth or declines in revenue. “It may provide insight to whether or not a particular contract is profitable,” Braunsteiner added. “When a company segments its financial reports (by business segments or projects for example), you can break out what the costs are from the different streams of revenue.”
5. What should investors be looking for in earnings calls and financial statements?
“Investors should be looking at transition disclosures in the financial statements to understand how the changes have impacted the timing of revenue recognition or what the historical impact has been,” Braunsteiner said.
“The footnotes to the financial statements require numerous disclosures of policies and the impact of adoption as well.”
Cathy Miyagi is a segment producer with BNN Bloomberg based in Toronto, and is also a chartered professional accountant (CPA, CMA).