RPT-Fitch: New Revenue Recognition Rules May Alter Margins

Thu May 29, 2014 4:06am EDT

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May 29 (Reuters) - (The following statement was released by the rating agency)

The latest revenue recognition standards from international and US standard-setters, designed to aid consistency, may alter margins at companies where sale of goods involves a longer-term or multiple-element contract, Fitch Ratings says. But changing business practices, including restructuring of sale agreements, is likely to reduce the new rules' impact by their adoption in 2017.

The rules will affect the timing of revenue recognition, but not overall contract profitability or timing of contract-related cash flows - unless contract terms are altered in response to them. The standard will base all revenue recognition on when the customer gets control over the good or service provided. Control may pass all at once, for example on delivery, or over time. The standard's five-step model will apply to sales contracts to allow the timing and amount of revenue recognition to be deduced.

The new rules should not materially change the credit profile of companies, so ratings are likely to be unaffected. However, some companies may use the transition period as an opportunity to restructure future sales contracts to receive the most favourable revenue recognition. Companies may restructure agreements in a more intuitive way, as terms and conditions linked to existing revenue recognition rules may no longer be required.

The new rules may also provide fresh incentives to structure contracts to accelerate revenue recognition. For example, greater customer specificity might be built into a product so that it has no alternative use for the manufacturer.

This may enable some contract manufacturers to recognise revenue over time, as production progresses, rather than on delivery. Conversely, in revenue recognition for long-term production contracts, companies may change how they measure revenue, and costs incurred, as work progresses. This will be particularly applicable for bespoke, complex goods with long production times.

The rules may also affect "bill and hold" arrangements, where a supplier holds onto the customers' goods after invoicing. The new rules look at when control of the goods passes to the customer, rather than delivery. Nevertheless, booking revenues earlier would not materially affect our credit analysis because we focus on sustainable operating cash flow.

Business practice changes already taking place may mute the impact of the new accounting standard. For example, under new accounting rules a handset sale bundled with line rental would lead to more revenue booked up front. Last year, US wireless carriers introduced equipment instalment plans that separated the cost of line rental from the cost of the handset. This unbundling of products ahead of the new standard's implementation is likely to reduce the accounting impact on revenue and margins.

Fitch regularly publishes accounting research. Our annual update on topical accounting issues for US corporates will be published in June. Further research on revenue recognition will follow.

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