The idea of harmonizing accounting standards across borders – making it simpler for people to read a company’s financial statement, regardless of what jurisdiction it’s based, because everyone agrees on one set of rules – is a compelling one.
But any type of disruption to established accounting practices is sure to involve a degree of pain. And that’s exactly what GPs are expecting now that the Financial Accounting Standards Board (FASB), which sets US accounting standards, and its international counterpart the International Accounting Standards Board (IASB), have finally released a converged standardon the recognition of revenue.
It was a massive project, six years in the making. And once the dust settles, it should allow GPs (and other readers of financial statements) to compare and contrast the top-line growth of companies worldwide more simply. Importantly, the converged revenue standard replaces more than 200 industry-specific revenue recognition requirements under US GAAP, and enhances the limited guidance found in the international financial reporting standards (IFRS). All good stuff for an industry that regularly scans hundreds of financial statements before cherry-picking a company for investment.
However, until these changes take effect, GPs are being warned by their accounting advisors that it’s anyone guess what rules companies will follow during the various different transitional periods. For public companies following US GAAP, the new rules take effect for annual reporting periods beginning after December 15, 2016. Private companies following US GAAP get an extra year to adapt – but have the option of doing it early, alongside their public counterparts. Meanwhile, companies using IFRS must apply the new revenue standard for reporting periods beginning on or after January 1, 2017 – but they can begin doing so today, regardless of their public/private status. In practice, this means companies will start taking different paths in how they measure revenue, as they decide whether early adoption makes sense for them.
For GPs, this transitional period represents a bit of a due diligence nightmare. Managers must now go through a more extensive fact-finding mission to see which revenue recognition model a company is using before it can be lined up against comparable companies for valuation purposes. Even if a GP deals only in the US, meaning the new revenue standard can’t be used until at least 2017, it must see that none of the companies it uses for benchmarking purposes could possibly be using IFRS (and thus be potential early adopters). Revenue is also a key metric for how the industry measures fair value, meaning a portfolio company’s exit value could experience a sudden swing because of the way it measures revenue.
To be clear, the new revenue standard should eventually be a major step forward in the accounting world. But private fund managers need to be keenly aware of its impact in the years ahead. Reforming established practices is invariably painful, and this will be no exception.