New accounting standard will hurt Rolls-Royce’s bottom line, CFO says

A new accounting standard that prohibits accelerating revenue recognition will hurt Rolls-Royce Holdings PLC’s short-term results, the aircraft engine manufacturer’s chief financial officer said in a presentation on Wednesday.

IFRS 15 will initially “have a negative impact on our reporting,” said CFO David Smith. However, the “net present value” of the business will not change, he added.

According to analysts, Rolls-Royce’s reporting will be more transparent under IFRS 15, the new standard for customer contracts.

“The standard requires a business to recognize revenue after a customer obtains control of a good or service,” a spokesperson for the International Accounting Standards Board, the organization told the origin of IFRS standards. This makes it more difficult for businesses to speed up or delay revenue.

Rolls-Royce said in a presentation that the underlying revenue for its new engines last year would have been about £ 734million ($ 913.46million) lower than reported under the new standard and that maintenance service revenues for these engines would have been around £ 210million lower. .

Rolls-Royce typically sells large aircraft engines at a loss of around £ 1-2million each and then makes a profit by servicing them. For more than ten years, Rolls-Royce, within the framework of its “Total Care” program, has been able to compensate for the losses by reserving part of the service revenues earlier.

IFRS 15 prohibits this practice and requires the company to recognize losses immediately. Service revenues cannot be recognized until actual work has taken place. “Revenue recognition will be tied more to the sale of an engine than to its lifespan,” said Smith. Losses for engine sales would be more apparent under IFRS, Smith said.

The company reported 2015 underlying revenue of £ 3.3bn for new engines and £ 3.7bn for services. For 2016, Mr Smith forecasts negative cash flow of around £ 100-300million.

Mr Smith said accounting rules would weigh on profits until 2020, with reported profits expected to benefit from the change perhaps by 2025.

“This is a very long-term endeavor,” said Russell Solomon, analyst at Moody’s Investors Service. “Most of the feedback is generated in the second or third phase of an engine’s life cycle,” he said.

The new standard provides more clarity for investors, said Phil Buller, analyst at Barclays Capital.

“IFRS 15 removes some of the fog. In the future, Rolls-Royce will report like any other industrial company, ”he said. This could have an impact on the company’s dividend policy as well as on its share price.

“Rolls-Royce’s profitability will be drastically reduced,” said Mr. Solomon. “There won’t be a lot of profits for the next two years, which calls into question the sustainability of their current dividend,” he said.

Over time, the company’s weakness relative to its competitors may become more apparent, Solomon said.

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