Most U.S. public companies are well underway with preparations to adopt the new GAAP revenue recognition standard. It is also important to consider the impact the new standard will have on financial statements required in a registration statement on Form S-3. This Sidley Practice Note addresses matters that companies planning to file a new Form S-3 should consider before adopting the new revenue recognition standard using the full retrospective transition method. While this Practice Note specifically discusses the new revenue recognition standard, the concepts illustrated are equally applicable to companies adopting any new accounting principle involving a material retrospective application, whether required or elected, or for companies reporting a discontinued operation or a change in reporting segments.

The New Revenue Recognition Standard

In May 2014, the Financial Accounting Standards Board (FASB) issued Accounting Standards Update (ASU) No. 2014-09 (Topic 606) “Revenue from Contracts with Customers,” which requires entities to recognize revenue when promised goods or services are transferred to customers at an amount that reflects the consideration that the entity expects to receive in exchange for those goods or services, a comprehensive change from the current revenue recognition guidance. The new standard is effective for most U.S. public companies beginning with the first quarter of fiscal years beginning after December 15, 2017. For a calendar year reporting company, the new revenue recognition standard is effective January 1, 2018, and financial statements reflecting the new standard would be first reported in the first quarter 2018 Form 10-Q.

Adoption Methods for the New Revenue Recognition Standard

Companies may choose to use either the full retrospective transition method by applying the new revenue recognition standard across all years presented in the financial statements or the modified retrospective transition method by applying the cumulative effect of the new standard as of the date of adoption.1

A calendar year reporting company using the full retrospective transition method would apply the new standard to its first quarter 2018 financial statements in its Form 10-Q and at the same time would retrospectively revise its first quarter 2017 financial statements for comparability. Full year 2017 and 2016 financial statements would be retrospectively revised at the time of filing the 2018 Form 10-K in 2019.

In contrast, a calendar year reporting company using the modified retrospective transition method would reflect the cumulative effect of the adoption of the new standard in its first quarter 2018 financial statements in its Form 10-Q but would not retrospectively revise its first quarter 2017 financial statements. Similarly, full year 2017 and 2016 financial statements would not be revised at the time of filing the 2018 Form 10-K in 2019.

Form S-3 Requirements When Adopting a New Accounting Principle

If there has been a change in accounting principle requiring a material retroactive restatement of financial statements, then registrants filing a Form S-3 or a post-effective amendment to the registration statement (including a Form 10-K filing treated as an amendment to satisfy Section 10(a)(3) of the Securities Act of 1933) after the date of filing financial statements reflecting the change in accounting principle2 are required to include or incorporate by reference restated financial statements reflecting the change in accounting principle.3 This requirement must be satisfied at the time of filing the Form S-3 or post-effective amendment by the restatement of three full years of financial statements, the periods covered by the Form 10-K, as well any subsequent quarterly periods covered by Form 10-Qs, required to be incorporated by reference.

A registrant that adopts the new revenue recognition standard as of January 1, 2018 using the full retrospective transition method will be required to retrospectively revise its full year 2017, 2016 and 2015 financial statements to reflect the new standard if it files a Form S-3 after its first quarter Form 10-Q, unless retrospective revision is impracticable.4 This could be accomplished by filing a Form 8-K under Item 9.01 to include such financial statements as an exhibit. Such a filing would then be incorporated by reference into the Form S-3. In the absence of the need to correct a material error, Form 10-K/A should not be used to file retrospectively revised financial statements.5

It is important to note that the registrant would be required, in these circumstances, to retrospectively revise its full year 2015 financial statements to meet the requirements of Form S-3, even though it would not otherwise be required to retrospectively revise such financial statements at the time of filing its 2018 Form 10-K.6

Steps to Consider Before Retrospectively Revising Financial Statements

To avoid the burden of retrospective revision of full year 2015 financial statements, companies adopting the new revenue recognition standard using the full retrospective transition method that have an effective Form S-3 that will expire7 after the date of filing financial statements reflecting the new revenue recognition standard (i.e., the date of filing the first quarter 2018 Form 10-Q for companies adopting as of January 1, 2018), or companies that otherwise expect to file a Form S-3 after that date, should evaluate whether it would be beneficial to file a new Form S-3 in advance of such date (or well in advance of such date, for companies other than well-known seasoned issuers, to allow for the possible delay caused by SEC staff review).

Of course, companies that plan to adopt the new revenue recognition standard using the full retrospective transition method and report the adoption after the filing of the 2018 Form 10-K will incur no additional burden. In addition, companies conducting a take-down from an effective Form S-3 registration statement after filing financial statements reflecting the adoption of the new revenue recognition standard using the full retrospective transition method would not need to file any retrospectively revised financial statements (or a post-effective amendment) because implementing the full retrospective transition method for revenue recognition in and of itself would not be a “fundamental change.”8 Companies that are filing a registration statement other than on Form S-3, notably a registration statement on Form S-8, may need to consider a different analysis altogether.9