The ac­count­ing change you can­not af­ford to ig­nore

New stan­dard is set to change the way com­pa­nies recog­nise rev­enue from a con­tract

Shares - - DISCLAIMER -

Anew ac­count­ing stan­dard from Jan­uary 2018 called IFRS 15 will af­fect the way com­pa­nies recog­nise rev­enue from a long-term con­tract. We be­lieve it could im­pact eq­uity val­u­a­tions as earn­ings fore­casts may have to change for some com­pa­nies.

Out­sourcers and other con­trac­tors are among the types of com­pa­nies which could be af­fected. Their con­tracts are of­ten based on the pro­vi­sion of a ser­vice over sev­eral years. The way rev­enue from this con­tract is recog­nised and re­ported to the mar­ket has his­tor­i­cally been open to in­ter­pre­ta­tion.

NO CASH IM­PACT

On 7 Septem­ber sup­port ser­vices firm Capita (CPI) be­came one of the first busi­nesses to clar­ify the im­pact of IFRS 15 as it re­stated its 2016 re­sults. The out­come was a 30% write-down to earn­ings be­fore in­ter­est and tax from £481m to £335m. Though im­por­tantly there was no im­pact on cash flow per­for­mance.

The mar­ket was not too alarmed by the news with the shares ul­ti­mately down just 2% on the day.

In­vest­ment bank Liberum says: ‘Go­ing for­ward rev­enue is ex­pected to be more evenly phased over the life of con­tracts and ac­tive soft­ware li­cences in line with the de­liv­ery of val­ued out­comes to clients and, con­se­quently, the tim­ing of prof­its is re-pro­filed.’

It adds Capita will ‘recog­nise lower prof­its or losses in the early years of con­tracts where there are sig­nif­i­cant up­front re­struc­tur­ing costs or higher op­er­at­ing costs prior to trans­for­ma­tion, with a com­pen­sat­ing in­crease in prof­its in later years.

‘The to­tal net im­pact at the group level is a func­tion of the bal­ance of con­tracts in early or late stage of their life cy­cle at tran­si­tion to IFRS 15.’

WHO ELSE MIGHT BE AF­FECTED?

Liberum notes many com­pa­nies have not yet im­ple­mented the changes and sees ‘more sur­prises in the pipeline’ with aerospace and de­fence, con­struc­tion, soft­ware, sup­port ser­vices and tele­coms firms most sus­cep­ti­ble.

To high­light the risks, it has screened for stocks with the high­est long-term re­ceiv­ables and amounts re­cov­er­able on con­tracts as a per­cent­age of rev­enue.

This could be a sign the com­pany has been book­ing most of the rev­enue from a con­tract up­front, some­thing which will no longer be pos­si­ble un­der the new rules.

A se­lec­tion of rel­e­vant names is shown in the ac­com­pa­ny­ing ta­bles. (TS)

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