Investors and lenders frequently use Earnings Before Interest, Tax, Depreciation and Amortization (EBITDA) to establish covenants and make investment decisions. Companies may also use EBITDA to measure performance and assist with internal reporting and employee compensation arrangements.
Three significant accounting changes on the horizon could impact EBITDA, and the business processes that rely on it. Investors and lenders should prepare for how the following affects companies’ EBITDA calculations and be prepared to reposition financial arrangements if the need arises.
Non-public entities are required to adopt the new revenue recognition guidance in Accounting Standards Update 2014-09, Revenue from Contracts with Customers (Topic 606) for annual periods beginning after Dec. 15, 2018 (calendar year end 2019). Several provisions in Topic 606 could affect a company’s EBITDA.
Performance bonuses and other forms of variable consideration may need to be recognized earlier than under previous guidance. Take the following example: A construction contractor has a two-year contract that contains a bonus if safety metrics are met at the end of the project. Under previous guidance, the bonus would have been recognized at the project’s end. Under Topic 606, the contractor concludes that the estimated performance bonus amount should be recognized, and pulls forward recognition of a portion of that bonus to year one of the contract. All other things being equal, this would be increase net income and EBITDA in the first year and decrease it in the second year.
Also changing is the guidance around commission expenses. Commissions may be capitalized on the balance sheet as an asset and amortized over the term of the contract with the customer, or even longer. The effect of the change would cause deferrals of expenses, increasing EBITDA in earlier periods as compared to prior guidance.
In February 2016, the Financial Accounting Standards Board (FASB) issued ASU 2016 02, Leases (Topic 842) which also may have an impact on EBITDA. A lessee with a treatedas- finance lease under Topic 842 would recognize interest expense (similar to a capital lease under prior guidance), and for an operating lease, recognize a lease expense. Changes in lease classification or lease structure (now that all leases will be required to be presented on the balance sheet) could have a significant impact on EBTIDA. Other changes, such as the accounting for initial costs and the allocation decision between lease and non-lease components could have longterm ramifications for EBTIDA as well.
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