Called to Account: Companies are using ‘ghost revenue’ to calculate executive bonuses

Companies like Symantec Corp., Broadcom Ltd., and Norwegian Cruise Line Holdings Ltd. are adding back millions in “ghost revenue” – deferred revenue that accounting standards force them to write off after an acquisition – when calculating executive bonuses.

Under acquisition accounting rules, the fair value of acquired deferred revenues-revenues that are collected in advance of actually earning them-are often less than the amount reported on the acquired companies’ balance sheets. The write-downs become “ghost revenues” for the acquiring company that are added back into revenue numbers according to Generally Accepted Accounting Principles (GAAP) to create adjusted revenue metrics that are reported to investors.

Companies say the write-downs affect comparability and result in numbers that are not representative of what they would have produced if GAAP rules didn’t make them eliminate the revenue.

SEC Deputy Chief Accountant Wesley Bricker warned companies more than a year ago that any non-GAAP metrics that adjust revenue would likely receive a comment letter from SEC staff.

Companies’ rationale for these adjustments would be scrutinized “closely, and skeptically”, Bricker told an audience in New York on May 5, 2016, right after the SEC’s new non-GAAP guidelines were published.

In particular, Bricker criticized what’s called “individually-tailored accounting principles”, replacing GAAP with alternate accounting just because it’s not allowed under the standards.

“Revenue adjustments do more than just adjust from GAAP: they change the very starting point from which other performance analyses flow”, said Bricker.

“Revenue adjustments do more than just adjust from GAAP: they change the very starting point from which other performance analyses flow.”

Using data provided by research firm Audit Analytics, MarketWatch reviewed 14 companies that disclosed acquisition-related deferred revenue adjustments that always increased official revenue numbers reported according to GAAP, the standards all public companies must follow.

In nine cases the adjusted net revenue metric, typically the only adjustment made to revenue, is a non-GAAP metric that is also used when determining financial rewards for executives.

“Non-GAAP adjustments or reconciliations to GAAP income typically adjust reported earnings for one-time or non-recurring items that show an ‘improved’ version of company performance”, said Paul Chaney, the E. Bronson Ingram Professor of Accounting at Vanderbilt University, in an interview with MarketWatch.

“These companies have taken this one step further”, said Chaney.

Companies shown on the table making a permanent adjustment are repeatedly adjusting GAAP revenue over an extended period and hold additional amounts that could be written off and extend the period for future GAAP revenue adjustments. Companies that made temporary adjustments to GAAP revenue made one-time only adjustments based on a recent deferred revenue writeoff.

For example, cybersecurity company Symantec says in its last annual report that accounting rules forced it to write down a total of $144 million of deferred revenues acquired with the purchase of Blue Coat and LifeLock during its 2017 fiscal year that ended March 31.

On the date of the acquisitions the company attributed $220 million of the purchase price for both companies to deferred revenues. Blue Coat was acquired in August of 2016 and LifeLock in February 2017. Symantec then determined that it was required to write-off $144 million of this revenue, because the cost to fulfill the service contracts and actually earn the revenue was estimated to be greater than the amount already collected.

However, Symantec has been adding back some of the written-off revenue each period since the acquisitions. In its first fiscal 2018 quarter the company adjusted revenue upward by a total of $53 million. In its most recent quarter, Symantec increased GAAP revenue by $36 million.

In its earnings release Symantec said it believes that “eliminating the impact of this adjustment improves the comparability of revenues between periods” even though “the adjustment amounts will never be recognized in our U.S. GAAP financial statements. “

A spokesman for Symantec told MarketWatch that the adjustments are decreasing over time. However, Chaney told MarketWatch that companies have one year from the acquisition to adjust the amount of the purchase price allocated to various financial statement lines like deferred revenue. For Blue Lock, that one year expired September 30, 2017. For LifeLock, the company can decide to allocate more to deferred revenue, as well as decide to write off any or all of the remaining $76 million of deferred revenue for both companies.

That gives executives a “cookie jar” that can be used to boost the adjusted revenue metric that drives incentive compensation, Chaney told MarketWatch.

“It’s in their financial interest to not only adjust the purchase price allocation to put more in deferred revenue before the deadline but also to write down more of the total deferred revenue. Every dollar they write down can at least be put to good use as an adjustment to GAAP revenue that increases incentive awards.”

Asked to comment, a spokesman for Symantec told MarketWatch: “Symantec believes its accounting practices are fully disclosed and well understood by the investment community.”

An SEC spokeswoman was not immediately available for comment.

A review of SEC comment letters by Audit Analytics since the May 2016 guidelines were issued did not find any that criticized these adjustments to revenue. That’s despite Bricker’s warnings, and despite the fact they are being used to adjust metrics that drive executive compensation.

Spokespersons for Tyler Technologies, Norwegian Cruise Line Holdings, ResMed, Roper Industries, Broadcom, Willis Towers Watson, Ansys, Intel, Factset Research Systems, Analog Devices, Fidelity National Information Services, Oracle corp, and Gartner Corp did not immediately respond to a request for comment.

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