Revenue recognition: now, later or never?

• Author: Regan, D. Paul
• Position: Accounting

The issues that bear upon the details of how, when and in what amount revenue should be recognized are broad and extremely deep. When it comes to identifying transactions where revenue recognition exists, there are plenty of issues and rules governing the proper accounting treatment auditors and accountants should follow.

FRAUD USUALLY BEGINS SMALL, SOMEWHAT INNOCENTLY

Fraud is represented by intentional misstatements or omission of amounts or disclosures designed to deceive financial statement users.

Financial statement fraud usually starts as a simple "stretch" that people expect to be reversed when actual results improve. This often happens when only a small amount of additional revenue is needed to meet expectations. Those involved believe that the stretch will be a one-time event. The participants are not usually involved in a grand plan or conspiracy--they simply rationalize the misstatements.

But simple plans sometimes grow into more complex schemes that result in material misstatements of financial statements that sometimes cover several years of falsification and manipulation.

Fraud is frequently accomplished by:

* Manipulating, falsifying or altering documents from which financial statements are prepared;

* Misrepresentation or intentional omission of events, transactions or other significant information in financial statements; and

* Intentional misapplication of accounting principles relating to the amounts, classification, manner of presentation or disclosure.

WHY IS REVENUE RECOGNITION SO IMPORTANT?

In its October 2002 Report on Financial Statement Restatement, the GAO said that restatements for improper revenue recognition resulted in larger drops in market capitalization than any other type of restatement. In fact, eight out of the top 10 market value losses in 2000 related to improper revenue recognition. Of these 10, the top three lost $20 billion in market value in just three days.

Some of the most common vehicles used to overstate revenue, according to the GAO report, include:

* Sales contingencies were not disclosed to management;

* Sales were booked before delivery was completed;

* Software revenue was recognized before services were performed;

* False sales agreements and documentation were created; and

* Revenue was reported at gross rather than net.

The GAO report determined that as a result of these improprieties:

* 38 percent of the 919 announced restatements between 1997 and June 30, 2002 involved revenue recognition issues;

* Revenue recognition was the primary reason for restatements in each year;

* More than half of the immediate market losses following restatements were attributable to revenue recognition related restatements; and

* Approximately 50 percent of the SEC's enforcement cases have involved revenue recognition issues.

AN OVERVIEW OF THE RULES

Generally accepted accounting principles call for revenue to be recognized when all of the following requirements are met:

* There is appropriate evidence of an arrangement, such as a signed arrangement or an established historical business practice;

* There has been performance or delivery by the seller;

* The price has been fixed or is determinable. The customer is obligated to pay, concessions or discounts have been determined, and no contingencies or...