Making sense of revenue recognition: revenue "mis-recognition," the leading cause of restatement, has been soaring, likely due to the myriad of more than 200 pronouncements by standard-setters. FASB has revenue recognition on its agenda--for 2007.

• Author: Cheney, Glenn A.
• Position: Revenue recognition

Three thousand years ago, revenue recognition was not a problem. You traded so many goats for so many sacks of wool. When you got home, you looked at what you had. It was your revenue.

But then somebody invented money, turning goats and wool into slugs of cast iron and copper. Then somebody invented bookkeeping, and then accounting, and the next thing you know, goats, wool and coins have been replaced by derivatives, securitizations, stock options and 10-Ks. Suddenly, some mighty big companies aren't exactly sure what their revenues are, and every once in a while somebody ends up in jail because of it.

The symptoms of revenue recognition problems show up in financial statements. For a while, the revenue recognition line says one thing, but a few months later--whoops!--a restatement rolls out a different figure. Now, most of those "whoopses" are born of innocent error, but many are evidence of fraud.

Fraud or goof, it hurts. Restatements are to financial officers what fumbles are to quarterbacks. They're not only embarrassing to the CFO but expensive for the company and startling for shareholders, who can't help but wonder whether the restatement is a case of accounting confusion or unveiled shenanigans.

Revenue "mis-recognition" is the leading cause of restatement, and the rate of restatements has been soaring. In 2005, there were 1,295 restatements, according to a Glass, Lewis & Co. study--one for every 12 public companies registered in the U.S. That's almost twice the 2004 number and three times the number in 2002. In fact, the study found from 1997 to 2005, a total equal to 30 percent of U.S. public companies had filed restatements.

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A big part of the problem is the myriad of standards--a complicated and unclear mishmash of over 200 pronouncements issued by the Financial Accounting Standards Board (FASB), the Accounting Standards Executive Committee (AcSEC) of the American Institute of Certified Public Accountants (AICPA), the Accounting Principles Board (APB), the U.S. Securities and Exchange Commission (SEC) and the Emerging Issues Task Force (EITF).

At the core is an inconsistency in FASB's conceptual framework, the philosophical underpinnings of the board's accounting standards. Concepts Statement No. 5 defines revenues in terms of changes in assets and liabilities, while Concepts Statement No. 6 uses recognition criteria based on notions of realization and completion of an earnings process.

The board is overhauling its conceptual framework, even as it works on the standard on revenue recognition. Todd Johnson, FASB senior technical advisor, has been working on both projects.

"The goal is to set some sort of principle that will deal with all the complications," Johnson says. "Unfortunately, people think we're going to change the accounting for everyone. You won't find that...