Uber Technologies Inc. has warned in its financial statements for two years that a potential reclassification of its drivers from independent contractors to employees would change a key calculation it makes when tallying the top line of its income statement.
A Biden administration proposal released this week that makes it easier to classify gig workers as employees threatens to turn that accounting risk into reality.
The method Uber uses to record its revenue each quarter is based on the assumption that its customers are not the end users who order rides or takeout on their phones, but the drivers themselves. If — and it’s a big if — the Department of Labor’s plan pushes more drivers to be classified as employees, labor-dependent companies like Uber and Lyft Inc. would have to make the counterintuitive argument that their customers are also their employees. This raises accounting issues.
“It would raise really, really a lot of questions from auditors and regulators about whether it makes sense,” said Bruce Pounder, executive director of GAAP Lab, an accounting consultancy.
Determining who is a customer in a business transaction is a central part of the revenue recognition accounting rules that publicly traded companies began complying with in 2018. This affects a separate determination: which party is a “principal” or the supplier of goods or services. , and which part is an agent who is simply arranging a sale.
A change in worker classification adds an extra layer of complexity to that determination, said Brandon Gipper, associate professor of accounting at the Stanford Graduate School of Business.
“It feeds into that evidence that they look at to decide what is the right way to recognize revenue – who is responsible for service delivery or inventory risk?” said Gipper.
All of these judgments play a part in calculating revenue, the first line of a company’s income statement. Determining the revenue calculation method does not change the profits of the business if all other factors remain the same. But earnings are such a closely watched line item for investors that companies choose to carefully communicate any potential changes to it.
For Uber, the key judgment on driver classification and potential revenue impacts was important enough to flag in its 2021 and 2020 year-end 10-Ks. Being forced to classify drivers as employees, workers or even quasi-employees “may impact the presentation of our current financial statements, including revenue, cost of revenue, incentives and promotions,” Uber said.
Lyft in its latest 10-K also highlighted the potential reclassification of workers as a risk, but did not elaborate on specific revenue accounting implications.
When considering a worker’s status, the Biden administration’s plan would use an expanded multifactor test of economic realities to determine whether the worker is truly in business for themselves. It also lists other circumstances that could result in classification as an employee, including whether the work is an integral part of the business of the business, among other factors.
The proposal would replace a Trump-era plan that placed greater emphasis on how much control workers had over their jobs and earning opportunities, and made it easier for them to be classified as entrepreneurs.
Both Uber and Lyft downplayed the effect of the Labor proposal in statements this week. Uber welcomed the proposal and said it takes a “measured approach” that brings the worker classification test back to the Obama era.
Lyft, which like Uber considers its drivers to be customers and counts them for revenue accounting purposes, said the proposed rule had no immediate or direct impact on the company and its business model. The proposed rule also won’t change how it classifies its drivers, the company said in a blog post.
The Ministry of Labor itself does not expect widespread reclassifications of workers if the plan takes effect. While the agency has more legal leeway to argue that a worker is an employee versus a contractor, this essentially reverts to an approach that was used under the Obama administration. Companies using independent contractors have had ample time to develop and refine their legal cases to defend these relationships.
“I doubt that companies that have relied on independent contractor models will, in response to this rule, take steps to change their model,” said Michael Schulman, partner at the global employment and labor group. Morrison Foerster.
Companies could very well argue that if there is no change in their activities and in the way they identify their customers, it will not affect their accounting. But U.S. accounting rules don’t give black-and-white answers on how to determine the customer in a revenue transaction, so companies will have to weigh any potential new evidence to make the call, said Robert Rostan, director finance from Training the Street, an accounting education firm.
“That’s evidence that they potentially need to change their revenue recognition, but I don’t think that’s enough evidence to tip the scales,” Rostan said.
Any whiff of potential reassignment of workers is significant enough for companies to specify a risk in their financial statements, said Nerissa Brown, professor of accounting at the University of Illinois Gies College of Business.
“Disclosure regulations force you to think about general business risks, and of course there are always risks associated with implementing accounting rules,” Brown said.
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