Compliance Week reports on the “tectonic shift” anticipated to result from implementation of FASB’s new revenue recognition standard and the impact of that shift on executive pay. The new standard is scheduled to go into effect at the beginning of 2017; however, companies that include revenue goals as part of multi-year compensation performance structures may want to begin now to consider how the new standard will affect those goals.
According to the article, the new standard “reconceives business transactions as a series of performance obligations, with revenue recognized as each obligation within a transaction comes to pass.” As a result, revenue may be more volatile and less predictable, and determining incentives that reward real growth will require serious consideration. Accordingly, companies will need to reexamine definitions, calculations and targets in incentive plans and other performance-based compensatory agreements in light of the new standard, particularly multi-year metrics and targets. Not only will performance goals be affected, one commentator observed, companies that have clawback provisions may also need to reexamine those to determine if they are implicated in any way. (For example, companies electing to apply the new standard retrospectively (e.g., 2016 and 2015 revenues in addition to 2017) may want to ensure that clawbacks are not inadvertently triggered as a result).
One commentator suggested that the impact will be especially severe for companies with revenue “generated by contracts or [that] make commitments as part of the sales process, such as providing support services to customers. ‘Under the new rules, revenue is recognized when contractual obligations are satisfied, rather than based on the type of contracts or payment terms….As a consequence, companies may report lower current revenue if contractual income will be deferred, or less future revenue growth if contractual income will be accelerated.’” Another commentator predicted that many companies “will move away from long-term incentive plans with revenue-based metrics.”
Another commentator cautioned companies to expect a “renewed focus” by proxy advisory firms and institutional investors on disclosures surrounding the determination of performance metrics and targets, particularly “on whether targeted performance levels are sufficiently rigorous.” Targets that are lowered to adjust for the new standard may appear to be simply changes made to make goals “more easily achievable,” requiring that companies provide more transparency and clear disclosure to explain the reasons underlying the decisions made. Companies may need to “develop an easy-to-understand disclosure process to manage investor and proxy adviser concerns and to explain revenue matters that require a more nuanced view of operations.”
The article reports that few companies have yet to take a deep dive into this topic, but more attention is expected after the conclusion of this proxy season. Some companies may also have assumed (or hoped) that FASB would delay the new standard’s implementation date, as has been widely speculated.