Accounting Standard Transitions May Be Rocky for Emerging Growth Companies
The Securities and Exchange Commission (SEC) cuts emerging growth companies some slack when it comes to their financial reporting requirements. Section 2(a)(19) of the Securities Act permits qualifying Emerging Growth Companies (EGCs) to use streamlined disclosure and auditing requirements. EGCs can also defer the adoption of accounting standards updates until the time when a private company would adopt.
The deferral period is particularly attractive when it comes to the adoption of significant accounting updates, such as the changes to revenue recognition under ASC Topic 606. EGCs that delayed their revenue recognition adoption, however, may find themselves in hot water if they have subsequently lost their EGC status. The SEC recently provided some additional clarification about what public companies should do when that occurs.
What is An Emerging Growth Company?
Public companies qualify for emerging growth status for the first five years following their IPO, unless they reach one of the following milestones:
- Annual gross revenues reach $1.07 billion or more;
- Issues more than $1 billion in non-convertible debt in the previous three years; or
- Qualifies for large accelerated filer status
Among other financial reporting simplifications, EGCs have the option of making a one-time election to defer all accounting standards updates until the date of private company adoption. The decision must be made when an EGC is first required to file a statement or report to the SEC. It can later decide to “opt in” to the public company requirements, but once the decision to “opt in” is made, it cannot be undone. EGCs can also decide once they made the accounting standard deferral election to early adopt certain standards. Companies on the cusp of losing their EGC status may want to give early adoption a closer look.
Revenue Recognition Consequences
But what happens when a company loses its EGC status during the accounting standard deferment period? The question is coming to a head now with Topic 606 adoption. The SEC provided some additional clarity around the issue during a recent public company accounting conference.
Public companies were required to adopt revenue recognition for their fiscal years beginning after Dec. 15, 2017, including interim financial statements. Companies that had EGC status and made the deferral election will not need to adopt revenue recognition until fiscal years beginning after Dec. 15, 2018 (generally 2019 reporting). So the first financial statement under the new guidance would be the 2019 Form 10-K. EGCs would apply the quarterly reporting updates starting in 2020 (though it’s highly recommended that 2019 quarterly reporting use the new revenue recognition guidance).
If a public company lost its EGC status in 2018, it would be required to apply the Dec. 15, 2017, effective date required for public companies. For example, a public company with a calendar year end that lost its EGC status effective Dec. 31, 2018, would be required to adopt Topic 606 for all of its financial information, including its quarterly filings. Its 2018 Form 10-K would need to be prepared under Topic 606. It would not be required to amend its Form 10-Q filings.
Things get harrier if the EGC status was lost sometime during the year, say on June 30, 2018. Then, a public company with a calendar year end would be required to apply Topic 606 as if the company had adopted it on Jan. 1, 2018, in the quarter Form Q filing following June 30, 2018. Relief for companies required to switch adoption dates mid-year may be available, but these companies would need to consult with the SEC for more information.
Companies that lose their EGC status any time during 2019 will generally be safe from having to revise 2018 financial reporting. For example, a calendar year-end company that knows its status is lost on Dec. 31, 2019, will still be able to adopt the revenue recognition standard for its financial year beginning Jan. 1, 2019. It would also not be required to amend its Form 10-Q filings.
The potential consequences of losing EGC status do not end once Topic 606 is adopted. In addition to a myriad of narrower focused accounting standard updates, new accounting standards on leasing and credit losses that will often require complex or difficult implementations similar to the new revenue recognition guidance are due to be adopted by public and private companies in coming years. The slate of significant to-be-adopted accounting standards will mean EGCs will continue to be aware of the potential implications of losing EGC status.
How Can Emerging Growth Companies Navigate Their Requirements?
Emerging growth companies will need to be aware of how their status affects their major accounting standards transition. Companies that are on the brink of surpassing either the annual gross revenue or issuance of non-convertible debt parameters may want to consider early adoption of certain accounting standards. An accounting professional who is experienced with complex accounting standard adoption may be able to provide more information about how your company can prepare to navigate its transition.
For specific comments or questions about revenue recognition for emerging growth companies, please contact Mark Winiarski of MHM’s Professional Standards Group at 816.945.5614 or firstname.lastname@example.org. Published on March 05, 2019