On Revenue Recognition, Transparency Isn’t Paying

On Revenue Recognition, Transparency Isn’t Paying

Finally, they’ve arrived. The long-awaited changes to revenue recognition rules are in full effect for the first time this reporting season, and they bring with them the promise of better information for investors. At least that’s the theory – but how are things going in practice?

It’s still early days. The takeaway from two high-profile case studies, however, will not cheer information-hungry investors. In fact, one could make an argument that the less information companies provide under the new revenue-recognition standards, the better they fare.

There’s a dollop of hyperbole in that statement, but consider the case of Alphabet. By mid-2017, Google’s corporate parent had indicated that it would be an early adopter of the new revenue recognition standards. If any SEC personnel took that as evidence that Alphabet would be forthcoming with its financials, they soon realized the error of their ways. Over the course of nearly six months, the SEC experienced the sensation of ramming its head against a wall as it tried in various ways to ask Alphabet why it has not broken out revenue for its YouTube business, only to meet resistance.

This seems like information investors should have under revenue recognition standards that encourage transparency; after all, if YouTube were its own public company, it would probably be in the S&P 500. But Alphabet has a colorable defense for withholding it. Under the new rules, investors are supposed to receive “the same information as the top executive,” and Alphabet’s top exec, Larry Page, purports not to see YouTube’s financials. In Alphabet’s Russian-nesting-doll-like structure, a single doll holds Google, YouTube, and other products. Page, Alphabet says, sees only a single, undifferentiated revenue number for the Google doll. After months of back and forth, the SEC threw up its hands and appears to have given up the fight.

In contrast to Alphabet, General Electric just filed an annual report “full of disclosures about the new revenue recognition rules and tax reform that impressed with its level of detail and overall transparency.” Guess what? It swiftly got punished, losing 3.5% of its share price before the next open. Granted, GE doesn’t seem to be facing any inquiries from the SEC, but its experience is instructive. To help investors, the company chose to apply the “full retrospective approach,” under which it will recalculate earnings per share using the new standard for 2016 and 2017 as well as 2018. This will give investors a better basis to assess GE’s performance over time. Unfortunately, media confusion about the changed 2016-17 numbers “seemed to leave the impression that GE’s recasting of the prior period numbers was the result of an error or misstatement.” Sigh.

One can hope that in the long run, well-intended efforts to provide information don’t backfire, and that corporations don’t learn to shield their information with structuring gimmicks.. Unfortunately, the short run is telling a different story.

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