Down the road: Look for more companies to report changes.
GAAP are the rules companies are supposed to use when preparing their financial reports. Although revenue is a fundamental concept that one might think would have been ironed out by the accounting rule-makers years ago – it wasn’t. GAAP evolved with somewhat different revenue recognition concepts for different industries or situations. Accounting rule makers have been grappling with resolving these concepts. In the USA, it is the Financial Accounting Standards Board (FASB) that develops these rules. The FASB’s new accounting standard for revenue recognition is now effective for public companies. For many companies the new rules will not create major changes, but for some others, it will. Among the more notable is Tesla…
and Tesla has reported increased car sales thanks to these rules.
Tesla’s reported automotive sales increased about $300 million – Instead of reporting “Automotive Sales” of $2.3 billion, as it would have under the old rules Tesla reported automotive sales of $2.6 billion, under the new rules, as announced its Form 10Q for its fiscal quarter ended March 31, 2018. That’s an increase of $.3 billion…or about $300 million…from a rulechange.
Was that “increase” due to an increase its underlying activities? NO
Did it “sell” more cars? Well…
The $300 million increase was not caused by a change in the level customer of “transaction” but rather a change in that certain “leasing” activities heretofore reported as “Automotive Leasing” revenue are now – considered by the accounting rules – as automotivesales. Indeed, under the new rules Tesla reported about $165 million lessAutomotive Leasing revenue…thus offsetting a bit more than half of the increase it reported in its Automotive Sales.
Tesla described the increase is its Automotive Sales was due to “vehicles leased through our leasing partners… with a resale value guarantee… now generally qualify to be accounted for as sales with a right of return”. While, on the other hand, “for certain vehicles sales with a resale value guarantee and vehicles leased through leasing partners prior to 2018, we have ceased recognizing lease revenue starting in 2018”. Thus, these transactions – vehicles leased with resale value guarantees – now qualify under GAAP as sales revenue transactions, not leasing revenue transactions; so that revenue stream has been diminished.
The new GAAP standard defines revenue as: Inflows or other enhancements of assets of an entity or settlements of its liabilities (or a combination of both) from delivering or producing goods, rendering services, or other activities that constitute the entity’s ongoing major or central operations. (Source ASC 606-10-20).
What are the rules?
The level of complexity for implementing the new rules will vary. The new rule has five over-arching steps – but each of these steps has entity and circumstance specific implications.
- Identify the contract
- Identify performance obligation(s)
- Determine price
- Allocate the price, if appropriate
- Recognize revenue
To people who follow the development of accounting rules the new FASB revenue recognition standard has been a hot topic for years – the process of issuing a new accounting standard like this one takes a lot of time – with exposure drafts, public roundtables, deliberation and re-deliberation of comments provided by interest parties along with an attempt to unify the standards with international accounting rules…the process has gone on for years. And with concerns over whether companies will be able to re-tool their bookkeeping systems to keep up with the new rules the effective date was pushed back.
Some surveys had suggested that many companies were behind in their implementation efforts. GAAP changes typically don’t attract headlines – the Tesla announce did shine a spotlight on the change. Not all companies will report a material change – and not all will report a change due to the same reasons reported by Tesla. The financial reports of the companies should provide details and background as to the nature and scope of any changes.
Some changes might impact compliance with restrictive covenants or amounts due under existing agreements.
If you read financial statements you should be on the lookout for further announcements of the implementation of the new GAAP standard for companies that you are interested in.
Andrew M. Mintzer, CPA is a forensic accounting with the Los Angeles office of Hemming Morse, LLP. He is a past chair of the California Society of Certified Public Accountants.