Revised Revenue Recognition Standards: The Impact on M&A Transactions

August 2, 2017

For an investor to properly assess a company’s financial performance and potential, it’s absolutely necessary that he or she analyzes the entity’s revenue. In the past, investors needed to be familiar with the distinction between the two main revenue recognition guidelines: Generally Accepted Accounting Principles (GAAP) and International Financial Reporting Standards (IFRS). In 2014, the Financial Accounting Standards Board (FASB) and the International Accounting Standards Board (IASB) issued new guidance on revenue recognition, which created a single, principle-based model.

Now, another new revenue standard is looming on the horizon — and it’s poised to be one of the biggest accounting changes to hit businesses in recent years. FASB reports that public companies would begin to apply the revised standard to annual reporting periods taking place after Dec. 15, 2017, while non-public entities would begin this process after Dec. 15, 2018 — with interim reporting periods within annual reporting periods beginning after Dec. 15, 2019. However, non-public entities can elect to adopt the new revenue standard early, as of the following:

  • Annual reporting periods beginning after Dec. 15, 2016, including interim periods.
  • Annual reporting periods beginning after Dec. 15, 2016, and interim periods within annual reporting periods beginning one year after the annual reporting period of initial application of the new revenue standard.

What does all this mean for your business? Keep on reading: Here’s everything you need to know about this new standard and how it will affect your M&A transactions moving forward.

The Financial Model

While the new standard will impact nearly all entities across the public and private sectors, it does present some unique considerations for companies that are eyeing an M&A transaction. For one, the revised regulation will affect how and when companies recognize revenue. Acquirers will need to analyze the associated impact on the target and develop a clear understanding of what must be represented to both lenders and co-investors in the transaction.

As companies contemplate what revenue assumptions must be built into their financial model (and how that model will change under the new standard), it will be critical for acquirers to obtain a holistic view of a target’s financial picture. In other words, acquirers must look at a target’s accounting from both a historical perspective and — as it relates to revenue recognition — on a go-forward basis. For example, a target may be generating a recurring revenue stream. The acquirer needs to ask, on an accrual basis, whether that revenue stream in the target’s financial standards will be reflected on a recurring basis, or whether it becomes peaks and valleys in the financial statements.

Acquirers also need to consider which transition method (a full retrospective method or a modified retrospective method) the target has selected, as this will impact the level of comparability. As the acquirer, ask yourself: Do the lenders require you to understand what the GAAP financial statements would look like on a retrospective basis for comparability?

The Overall Value

Under the new standard, companies are no longer required to obtain vendor-specific objective evidence (VSOE) of fair value for undelivered elements in order to recognize revenue. This means that the timing of revenue recognition could be accelerated. Previously, revenue was deferred over a period of time.

Given the impact on information systems and processes, acquirers must also evaluate the readiness of a target and consider whether there will be implementation costs in order for the target to transition to the new revenue standard. And the ripple effect doesn’t end there: Those entities looking to finance an acquisition using debt, or those that have co-investors who require certain debt covenants to be set, should be aware that such debt covenants could also be impacted by the new standard.

The revised accounting standard has a variety of far-reaching implications. To ensure compliance, turn to an experienced transaction specialist to help you navigate the changing revenue recognition landscape.