Tesla’s revenue growth looks better than it should thanks to a disclosure shortcut

Tesla Inc.’s shortcut to new revenue-recognition rules artificially boosted revenue growth in quarterly results reported this week, a growing issue as the new rules governing companies’ recognition of revenue continue to be adopted.

TeslaTSLA, -0.39%this year adopted a new revenue-recognition rule, ASC 606, which changed the way it accounts for automobile sales with a resale value guarantee and cars leased through its leasing partners. The effect is a higher revenue total for the car maker starting in 2018, because the sales are now generally accounted for as sales with a right of return, rather than as operating leases.

However, when Tesla compared its results from the second quarter of this year with results from the year-earlier quarter, it did not adjust the previous year’s results to conform to the new standard. That results in an apples-to-oranges comparison that artificially inflates its growth rate.

Tesla reported in its earnings release that year-over-year automotive sales growth for the three months ending June 30 was 47%, from $2.287 million in 2017 to $3,358 million in 2018. However, Tesla calculated this growth percentage by comparing the most recent quarter’s revenue with a 2017 revenue figure that was prepared under the old revenue standard.

If 2017’s second-quarter revenue had also been reported under the new standard, the percentage revenue growth for the second quarter, year-over-year, would have been smaller — 39% — if calculated based on the same increase in net revenue for the period, $134 million, as Tesla experienced in the first quarter of 2018.

Tesla did tell investors in its first-quarter filing with the Securities and Exchange Commission what the impact of the new standard was on its automotive revenue for the three-month period as of March 31, 2018.

Automotive revenues as of March 31, 2018As reported under ASC 606Balances without adoption of new standardImpact
Automotive Sales$2,561,881$2,262,843$299,038
Automotive Leasing 173,436 338,375(164,939)
Cost of automotive revenues
Cost of auto sales$2,091,397$1,875,272$216,125
Cost of auto leasing 104,496 225,581(121,085)
Auto gross margin19.7%19.2%

Source: Tesla’s first quarter 10-Q filing with the SEC.

In the second quarter, Tesla played down this lack of comparability by ignoring it. Tesla does not say anywhere that 2018 figures are prepared using the new revenue-recognition rule while the 2017 revenue and gross margin figures used for comparison are based on the old revenue standard and match those reported last year before the new rules were adopted. Columns of numbers that put 2018 and 2017 revenue and cost-of-sales numbers side by side are not labeled based on the standard used to prepare them.

Investors, however, can’t accurately compare the 2018 revenue, gross margin and net income reported under the new revenue standard with 2017 numbers, since Tesla, like some 85% of public companies, did not provide detailed information about those adjustments to investors based on the shortcut method it chose to implement the new standard.

Automotive gross margin for the second quarter, which ended June 30, under the new revenue standard was 20.6%. For the first quarter ended March 30, it was 19.7%. Gross margin for the second quarter of 2017, under the prior standard, was reported as 27.9 %, meaning the year-over-year comparison of 2018 and 2017 results in a negative number.

Quarter ending 6/30/2018 – ASC 606 (new standard)Quarter ending 3/31/2018 – ASC 605 (prior standard)Quarter ending 6/30/2017 – ASC 605 (prior standard)Quarter ending 6/30/2017 adjusted for ASC 606 impact reported in 1Q 2018Change 1Q to 2Q 2018 reported in Tesla press releaseChange 2Q 2018 over 2Q 2017 reported in Tesla press releaseChange 2Q 2018 over 2Q 2017 adjusted to new revenue standard
Automotive revenue$3,357,681$2,735,317$2,286,616$2,420,71523%47%39%
Automotive cost of sales$2,666,654$2,195,893$1,648,011$1,743,051
Automotive gross margin on a GAAP basis20.6%19.7%27.9%28%

Source: Data from Tesla’s second quarter earnings release.

A Tesla spokesman told MarketWatch that gross margins are slightly lower under the new methodology. The company, he said in an email, is complying with the new revenue-recognition rules allowing prior-period consolidated financial results to be reported under the accounting standards that were in effect for those periods. He added that other companies, including in the automotive sector, are reporting current and prior-period comparisons in the same way. The 10-Qs also provide a detailed breakdown of the impact of the new rules.

Tesla is right that it is not alone in approaching its earnings in this manner. MarketWatch reviewed data provided by research firm Audit Analytics for companies that implemented the new standard on a modified retrospective basis and where the new rules had a significant, positive impact on revenue.

Many companies that saw a material positive impact are playing down the lack of comparability between 2018 and unadjusted 2017 revenue, gross margin and net-income figures when they are shown alongside each other and when companies calculate percentage-growth figures on a year-over-year basis.

See: Rambus earnings approach sows confusion

That goes against the entire rationale for the new rule, said Paul Chaney, the E. Bronson Ingram professor of accounting at Vanderbilt University. “The Financial Accounting Standards Board created a transition method that trades off comparability for ease of implementation,” Chaney told MarketWatch. “The resulting lack of comparability violates an important objective of the new standard — comparability.”

The new rules are supposed to improve comparability by eliminating industry-specific accounting for revenue under U.S. GAAP — or generally accepted accounting principles, the standards for financial accounting and reporting that all companies listed on U.S. exchanges are required to follow — and implementing a principles-based, single revenue-recognition model across industries and around the globe.

Tesla, like 85% of public companies, implemented the new revenue standard using the “modified retrospective” method, which means it did not recast prior-period results, as some companies, including General Electric Co.GE, -0.23%and Microsoft Corp.MSFT, +0.44%did.

Read: How new accounting rules boosted Tesla’s numbers

Plus: Tesla says it did not ask suppliers for cash back

Investors now need to read earnings releases extra-carefully, Chaney told MarketWatch. “You cannot compare changes in revenue from one year to the next if different revenue-recognition rules are used for the numbers being compared.”

How can companies try to minimize this confusion, which will persist during this first year of transition and longer for companies that have yet to adopt the new revenue rules?

“Companies need to clearly label the income statement columns as ‘605 Revenue’ or ‘606 Revenue’ to be clear,” Chaney told MarketWatch. “There will be a temptation to recast the current year’s earnings using the prior standards [or ‘605’] to show trends. However, this approach should be considered a non-GAAP disclosure, since 605 is no longer GAAP.”

Tesla shares, despite a noteworthy midyear downturn, have gained about 12% in 2018, while the S&P 500SPX, +0.46%has gained 6% and the Dow Jones Industrial AverageDJIA, +0.54%has gained 3%.

Also: Tesla short sellers are sitting on a paper loss of nearly $2 billion after stock rally

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