Time for the master’s accounting class: Today, we are going to cover changes in revenue recognition

policies and how that effects reported results. This is important for domestic and foreign companies
because GAAP has a new standard pursuant to ASC 606 and IFRS has IFRS 15.

Let’s start with the most important thing to remember: the balance sheet often needs to be restated
when revenue recognition standards change. Here is an example from $TSLA which I have been rumored
to be short (gee thanks II and I specifically said “no comment”):

As you can see in the prior screenshot from $TSLA, the balance sheet experienced a massive change. The
sum of which was that the accumulated deficit is approximately $600 million less under new accounting
rules than it was under the old rules.

In the case of $TSLA, this happens because leases are now recognized much more similarly to
automotive sales, whereas under the prior revenue recognition rules leases were recognized over the
term of the lease.

If $TSLA had been using the prior revenue recognition method, it would have been reporting higher
revenues, and subsequently, high gross profits and lower net losses. That’s exactly what happened in
the most recent quarter as can be seen here:
So enough about $TSLA. Let’s turn our attention to $EROS which is going to report its Q1 (June Q)
financials tomorrow. $EROS also has new revenue recognition rules coming into effect this quarter
pursuant to IFRS 15.

Last year, $EROS seemed to think IFRS 15 was material when it disclosed it “expects the impact of
adopting the new guidance to be material on digital and ancillary services.” Here’s the full excerpt from
the November 3 6-K:
When $EROS filed this, I thought it was an amazing admission that it had been recognizing revenues for
content it was contractually obligated to deliver but which had not yet been produced. That struck me
as very aggressive and I thought it might explain what I saw as high A/R.

But these disclosures at $EROS changed again when the company filed its 20-F. It now stated that “we
cannot yet predict how it will impact our…revenues” – here’s the screenshot from p 15:

So what changed at $EROS? Well, there’s another important disclosure on pp. 77-78 of the 20-F which
states that the company will make an “adjustment to the opening balance of equity” or “apply IFRS 15 in
full to prior periods”:
This is important because $EROS may reduce the opening balance of its Reserves in Shareholders’ Equity
and balance this out by reducing the opening balance of its Trade and Other Receivables in assets.

However, it is possible that IFRS 15 does not have an impact on the opening balance of its Reserves and
A/R. If this occurs, I believe $EROS’s A/R will continue its steady march upward on the B/S absent any
write-downs or factoring/novation. That’s what $EROS has guided to:

IFRS 15 should dictate that $EROS produces a new opening balance sheet to reflect the new revenue
recognition standards. For people not paying attention to these changes, this might appear to be a
positive as the new A/R ending balance is lower than the not yet restated B/S.

Over the subsequent periods, $EROS could then appear to benefit by recognizing revenue under IFRS 15
which it had already recognized under the prior revenue recognition standard. Under Option 2, $EROS
could do this without ever restating its prior income statement financials.

The easiest way for investors to see what changes were merely driven by new accounting standards
would be for $EROS to give a restated balance sheet with its earnings release, but I think that’s unlikely
to come for many months, if ever
Without a restated opening B/S, there are two ways investors will be able to figure out what’s a real
improvement in A/R for $EROS and what is just a change in revenue recognition policies. The first is to
use the closing B/S A/R and CF statement as relates to A/R:

Closing Trade and Other Receivables at 6/30/2018 A

Plus: 3-month Movement in Trade and Other Receivables from CF Statement B
Restated Opening Trade and Other Receivables at 4/1/2018 A+B=C

Trade and Other Receivables at 3/31/2018 per 20-F D

Minus: Restated Opening Trade and Other Receivables at 4/1/2018 C
Implied Reduction in Trade and Other Receivables for 4/1/2018 Balance Sheet D-C=E

As an example of the above, if $EROS ends with $200mm of A/R and the CF statement shows A/R as a
use of cash of $50mm then the restated opening balance (“C” above) is $150mm and IFRS 15 caused a
$95 million reduction in A/R ($245mm from B/S minus $150mm restated opening balance)

The problem with this method is that $EROS has been reducing the A/R balance it shows on its B/S by
novating A/R to a third party and thereby removing them from its balance sheet per page F-23 of its 20-
F:

As a side note, I believe the reason changes in A/R on $EROS FY 2018 CF statement don’t bridge the
opening and closing B/S is because the company novated A/R off its balance sheet. This of course makes
DSOs look lower than they would if no novation had occurred

If $EROS novated more A/R in the Q ending 6/30, the prior methodology will not give an accurate
estimate for the opening B/S. Instead, a second estimate could be calculated using the company’s
Reserves account on its B/S. Here’s a snapshot of how that changes period to period:
As can be seen in the “Statement of Changes in Equity,” Reserves are mostly retained earnings, which is
where I expect any adjustments to equity will take place when $EROS adopts IFRS 15

Any change to equity at $EROS from adopting IFRS 15 will need to have offsetting changes elsewhere in
the balance sheet to keep it balanced. I think almost all of those changes will come in the opening
balance for A/R, since it relates to revenue recognition

To estimate the opening balance for A/R at $EROS using the Reserves account in Shareholders’ Equity,
the following steps should be taken:

Closing Reserves on B/S at 6/30/2018 A

Minus: Net Income attributable to holders of EROS B
Minus: Share based compensation C
Plus: Estimated shares issued on exercise of options D
Estimated Opening Reserves at 4/1/2018 A-B-C+D=E
Minus: Reserves from 20-F at 3/31/2018 F
Estimated (Decrease)/Increase in opening A/R Balance E-F=G
There’s an estimate in line item “D” above. $EROS options exercise appears to have been around 50% of
stock comp each of the past two years and that’s what I’ll be using as my estimate.

So what do I recommend? I think you should do both when $EROS reports and then you probably need
to use some judgment.

In my opinion, if investors in $EROS aren’t careful, they could end up believing the company has solved
its A/R problems and is highly profitable when the opposite could be true… and all because of IFRS 15.

And if all of this is too much, just look at free cash flow. Cash from operations minus content spend for
$EROS. I’m betting it’s negative.