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May 29 (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.