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 alter a key calculation it makes when it tallies the top line in its income statement.
A Biden administration proposal released this week that makes it easier for gig workers to be classified as employees threatens to turn that revenue accounting risk into reality.
The method Uber uses to record its revenue every quarter hinges on the assumption that its customers aren’t the end users ordering rides or takeout on their phones—but the drivers themselves. If—and it’s a big if—the Department of Labor plan pushes more drivers to be classified as employees, gig work-dependent businesses like Uber and Lyft Inc. would have to make the counterintuitive argument that their customers are also their employees. This raises accounting questions.
“It would really, really cause a lot of questions to arise from auditors and regulators as to whether that makes any sense,” said Bruce Pounder, executive director of GAAP Lab, an accounting consulting firm.
Determining who a customer is in a business transaction is a central part of revenue recognition accounting rules that publicly traded companies started complying with in 2018. It affects a separate determination: which party is a “principal,” or the primary supplier of goods or services, and which party is an agent that merely arranges a sale.
A worker classification change throws an extra layer of complexity into that determination, said Brandon Gipper, associate professor of accounting at the Stanford Graduate School of Business.
“It feeds into this evidence they’re looking at to decide what the proper way is to recognize revenue — who is on the hook for providing services or inventory risk?” Gipper said.
All those judgments play into calculating revenue—the top line in a company’s income statement. Determining the method of how to calculate revenue doesn’t change company profits if all other factors stay the same. But revenue is such a closely watched line item for investors that companies choose to carefully communicate any potential changes to it.
For Uber, the key judgment about 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 our current financial statement presentation including revenue, cost of revenue, incentives and promotions,” Uber said.
Lyft in its most recent 10-K also highlighted potential worker reclassification as a risk, but didn’t spell out any specific revenue accounting implications.
When reviewing a worker’s status, the Biden administration plan would use an expanded multi-factor economic realities test to determine whether the worker is truly in business for themselves. It also lists more circumstances that could cause classification as an employee, including whether the work is integral to the company’s business, among other factors.
The proposal would replace a Trump-era plan that placed greater emphasis on how much control workers have over their duties and their opportunities for earnings, and made it easier for them to be classified as contractors.
Both Uber and Lyft downplayed the effect of the Labor proposal in statements this week. Uber welcomed the proposal and said that it takes a “measured approach” that returns the worker classification test to the Obama era.
Lyft, which like Uber considers its drivers as customers and accounts for revenue accounting purposes, said the proposed rule has 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 Department of Labor itself doesn’t expect widespread worker reclassifications if the plan takes effect. While the agency will have more legal discretion to argue that a worker is an employee versus a contractor, it’s essentially going back to an approach that was used during the Obama administration. Companies using independent contractors have had ample time to develop and hone their legal arguments to defend those relationships.
“I doubt that companies that have relied on independent contractor models are going to, in response to this rule, take steps to change their model,” Michael Schulman, a partner in the Morrison Foerster global employment and labor group said.
Companies could very well argue that if there’s no change to their business and no change to how they identify customers, there would be no impact to their accounting. But US 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, CFO of Training the Street, an accounting education firm.
“It is evidence they’d potentially need to change their revenue recognition, but I don’t think it’s enough evidence to tip the scales,” Rostan said.
Any whiff of potential worker reclassifications is important enough for the companies to spell out a risk in their financial statements, said Nerissa Brown, accounting professor at the University of Illinois Gies College of Business.
“The disclosure regulations require you to think through general business risks and, of course, the implementation of accounting rules always has risk involved in it,” Brown said.
— With assistance from Rebecca Rainey.