Posted: 16 Aug. 2018 4 mins min. read

Revenue recognition changes can pose challenges for dealmakers

New accounting standard requires M&A analysis upgrade

By: Eric Knachel

With private companies only starting to implement a new revenue recognition accounting standard that public companies already have in place, dealmakers face some unusual and challenging situations. The new accounting rule, known as ASC 606, is based on the principle that revenue should be booked when a vendor transfers control of a product or service to a customer. This sounds simple, but in practice it can require in-depth analysis of contract language and might involve the implementation of new technology and new processes. The breadth of the impact from the new rule makes this new standard arguably the most significant accounting change in decades.

Many public companies faced a January 1, 2018, deadline to comply with ASC 606, but private companies have until January 1, 2019, and that period could extend out longer depending on an organization’s reporting schedule. An online poll conducted earlier in the year of some 5,400 private company executives and professionals found almost half of respondents (47 percent) were in the early stages of implementation or hadn’t even begun. A quarter of respondents said they expected a material impact on financial results due to the new standard.

As private companies search budgets for the resources needed and address other compliance challenges, public company M&A programs will likely be affected. Impacts may be felt in pre-deal valuation uncertainties, during due diligence, and in hurdles to full integration of an acquisition post-deal.

In any transaction, much is driven by financial ratios and trends, and these may well be impacted by how revenue is booked. In an acquisition by a public entity that already is using the new standard of a private entity that has not yet applied the rules, there’s a risk of apples-to-oranges comparison when trying to establish valuation or forecast profits and cash flow.

At the outset of a transaction, an acquirer may well ask for a full analysis of the effect of the new revenue recognition standard. Believing this will be forthcoming, however, may be wishful thinking. What may be more likely is for an acquirer to end up trying to identify revenue streams that will be impacted and then perform a high-level assessment of how the new rules will play out. This may be helpful, or it may be problematic, because the details needed to fully understand the impact of ASC 606 often reside deep in contractual language.

Further along in the deal process, acquirers need to consider the basic issue of how to incorporate a target company’s results into their financial statements in compliance with ASC 606. The public company’s implementation may have required changes to IT systems and development of new processes and controls. If the target private company has not yet adopted the new standard, it’s important to conduct an assessment of how difficult it will be to extend implementation to the acquired operations. Even if the target company has gone through an implementation process, there may be incompatible technologies or conflicting processes.

In a worst-case scenario, full integration could be delayed. The acquirer could end up post-transaction essentially running two systems in parallel, rather than integrating the acquisition right away. This could ruin—or at least delay—the realization of synergies and efficiencies that were central to the deal rationale in the first place.

These are just some of the key issues, albeit important ones, related to this transitional period in the adoption of the new revenue recognition standard. A company might also need to examine bond or private debt covenants that are tied to revenue, because the changeover could cause surprises. Similarly, compensation and bonus formulas often have some kind of revenue component; failure to spell out how the new rules will affect those formulas could lead to the company being blindsided or key employees ending up angry with the result.

What’s the overall takeaway? A well-founded understanding of how the revenue recognition standard may come into play in your deals is vital.

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Eric Knachel

Eric Knachel

Partner | Professional Practice Group

Eric is a senior consultation partner in the Professional Practice Group at Deloitte & Touche LLP with more than 25 years of experience. He leads Deloitte’s revenue recognition subject-matter team and provides guidance to audit practitioners and companies on complex financial accounting and reporting issues involving revenue recognition. Eric holds a bachelor’s degree in accounting from the University of Maryland. He is a CPA and a member of the American Institute of Certified Public Accountants.