Earnings reports are about to get a lot more useful, if you read the footnotes

Earnings reports are about to get a lot more useful, if you read the footnotes

By Jason Karaian @jkaraian May 29, 2014

Of all the accounting concepts, revenue seems like the simplest. When a customer pays you for a product, you record it as revenue.

But nothing in accounting is ever that straightforward, and CFOs’ ability to game what they report as revenue has a long and sordid history. Fiddling with how and when to record sales as revenue has played a part in just about every big accounting scandal in the recent past, including at Enron and WorldCom.

When companies sell complex products or services that are delivered over long periods of time, and include promises of upgrades or maintenance as part of a package, the rules on when to recognize that revenue are fiendishly complex. And where there is complexity, there is a temptation to exploit it in order to flatter financial results, sometimes fraudulently.

That’s why it’s a big deal that US and international accounting bodies announcednew joint standards on revenue recognition yesterday. The convergence project has been in the works for more than 10 years and will replace around 200 ad hoc rules and industry-specific standards. (Told you that revenue accounting is a minefield.)

The new standards, which come into force in 2017, won’t affect the amount of revenue a company reports, but could alter its timing. For various reasons, software companies are likely to record revenue more quickly than in the past, while automakers will need to defer it for longer. In general, a standardized international approach to measuring revenue has been broadly welcomed by the business world, especially by investors who want to make apples-to-apples comparisons of company accounts in different countries.

You can read much more about the standards from the usual suspects: DeloitteEY,KPMG, and PricewaterhouseCoopers. The truly intrepid can go direct to the source(warning: 150-page pdf, may induce drowsiness.)

Back to the future

In this thicket of accounting jargon, one thing caught Quartz’s eye. Among the new disclosure requirements introduced by the new regime, companies must reveal details on the pricing and timing of their “remaining performance obligations,” more commonly known as a backlog. Today this is mostly ad hoc and voluntary; the new standards will move this valuable forward-looking information into the audited, attested body of an earnings report (in a footnote, naturally.)

This is a subtle but “enormously important” change in the tone of a company’s accounts, Brian O’Donovan of KPMG tells Quartz:

Financial statements are largely about the past, but the reason people read them is to try to make predictions about the future. This shifts that balance. It feels qualitatively different.

Analysts often pepper executives with mundane questions about the sequencing of contracted sales on conference calls—now they can just look to the report for answers, leaving time to discuss more substantive matters (one would hope.) But this requires them to delve into a report’s footnotes, where the juiciest detailsabout company performance increasingly reside. And so the world’s most important accounting bodies have provided yet more evidence that it pays to read the fine print.

 

About bambooinnovator
Kee Koon Boon (“KB”) is the co-founder and director of HERO Investment Management which provides specialized fund management and investment advisory services to the ARCHEA Asia HERO Innovators Fund (www.heroinnovator.com), the only Asian SMID-cap tech-focused fund in the industry. KB is an internationally featured investor rooted in the principles of value investing for over a decade as a fund manager and analyst in the Asian capital markets who started his career at a boutique hedge fund in Singapore where he was with the firm since 2002 and was also part of the core investment committee in significantly outperforming the index in the 10-year-plus-old flagship Asian fund. He was also the portfolio manager for Asia-Pacific equities at Korea’s largest mutual fund company. Prior to setting up the H.E.R.O. Innovators Fund, KB was the Chief Investment Officer & CEO of a Singapore Registered Fund Management Company (RFMC) where he is responsible for listed Asian equity investments. KB had taught accounting at the Singapore Management University (SMU) as a faculty member and also pioneered the 15-week course on Accounting Fraud in Asia as an official module at SMU. KB remains grateful and honored to be invited by Singapore’s financial regulator Monetary Authority of Singapore (MAS) to present to their top management team about implementing a world’s first fact-based forward-looking fraud detection framework to bring about benefits for the capital markets in Singapore and for the public and investment community. KB also served the community in sharing his insights in writing articles about value investing and corporate governance in the media that include Business Times, Straits Times, Jakarta Post, Manual of Ideas, Investopedia, TedXWallStreet. He had also presented in top investment, banking and finance conferences in America, Italy, Sydney, Cape Town, HK, China. He has trained CEOs, entrepreneurs, CFOs, management executives in business strategy & business model innovation in Singapore, HK and China.

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