Premature revenue recognition appears to be the recipe of choice for cooking the books.” So quipped Walter Schuetze, chief accountant in the Securities and Exchange Commission’s Enforcement Division, in a recent speech. Revenue-recognition issues accounted for about 50 percent of fraud cases in a study by the Committee of Sponsoring Organizations of the Treadway Commission of 200 SEC probes. It’s no wonder, then, that following its bulletin on materiality (see “Playtime Is Over,” September), the SEC is expected to release pointed guidance on properly recognizing revenue.
What’s unclear about revenue recognition? “Revenues are not recognized until they’re earned,” says the Financial Accounting Standards Board. “Revenues are considered to have been earned when the entity has substantially accomplished what it must do to be entitled to the benefits represented by the revenues.” Such basic instruction is followed by specific guidelines according to industry. Yet the temptation to prematurely recognize revenues remains overpowering for many companies. Aided by such techniques as bill-and-hold arrangements (which normally don’t qualify as sales), channel stuffing, and side agreements, companies book revenues before they are truly earned.
A recent SEC enforcement case highlights another tricky aspect of revenue recognition: when the buyer has the right of return. A former vice president of sales and marketing at Micro Component Technology Inc., a manufacturer of semiconductor testing equipment, based in St. Paul, Minn., was accused of pushing right-of-return agreements with customers and then prematurely booking revenues with the help of a former CFO. As a result of recognizing revenues from several conditional sales, the company materially overstated its financial results for its October 1993 initial public offering, and the first and second quarterly reports in 1994.
The upcoming bulletin should serve as both a laundry list and an “exhortation” to play by the rules, says Robert Waxman, of Corporate Finance Advi-sory, in New York. “They have the bully pulpit, and they’re ringing the bell.”