Hard Lessons

In its ongoing war on earnings management, the SEC may have outdone itself with new rules on revenue recognition.

It’s not new GAAP–it just feels like it. When Staff Accounting Bulletin No. 101 was issued by the Securities and Exchange Commission’s office of the Chief Accountant last December, it came with a disclaimer: “This SAB does not change any of the accounting profession’s existing rules on revenue recognition. Rather, [it] draws upon the existing rules and explains how the staff applies those rules.” And by extension, how corporations and their auditors will now be expected to apply them.

In the past nine months, corporations have come to realize that the SEC’s “guidance” on the recognition of revenue will force some major changes to their accounting practices. And along with the changes, there will be one-time charges; in many cases, restatements of prior financial results. There could be SEC inquiries, volatile reactions in the stock market, and, of course, shareholder lawsuits.

The effects, in fact, are already being felt. According to research conducted by Bear, Stearns & Co., some 800 companies mentioned SAB 101 in their 1999 10Ks and 10Qs from the March quarter. Of those, 241 indicated that they had changed their revenue recognition policies or intended to in order to comply with SAB 101.

“SAB 101 is the crown jewel of the SEC’s earnings management initiative,” says Pat McConnell, senior managing director of Bear, Stearns. And, as such, it has unleashed a flood of protest from companies.

Always More Required

It’s been just two years since Arthur Levitt delivered his now famous “numbers game” speech to an unsuspecting audience of business executives and professionals in New York. It was the speech of a lifetime for the SEC chairman. He warned that the quality of reported earnings and the very integrity of the U.S. financial reporting system were being undermined by the relentless pressure to meet Wall Street expectations. He slammed corporate executives for using “accounting hocus- pocus” and “sleight of hand” to make their numbers. He blasted incompetent audit committees and complacent auditors for failing to discover and prevent it. He even called on Wall Street analysts to look beyond the latest quarterly numbers and reward companies for financial transparency rather than deceptive accounting practices.

“I am calling for … nothing less than a fundamental cultural change on the part of corporate management as well as the whole financial community,” exhorted Levitt, now into his eighth year as the nation’s top securities regulator.

Since his speech, the chairman and other members of the SEC staff have fairly rammed cultural change down the throats of the financial community. Last February, at the urging of the SEC, a blue-ribbon panel set up by the New York Stock Exchange and the National Association of Securities Dealers issued recommendations to create independent and financially literate audit committees that would actively assess the quality, not just the acceptability, of financial reporting.

More recently, the SEC has had the accounting profession up in arms because of new rules regarding auditor independence aimed at improving outside monitoring of corporate accounting practices. Meanwhile, in the past two years, the SEC has dramatically stepped up the number of inquiries into suspect accounting practices, and the enforcement actions it takes against corporate executives and auditors for accounting fraud.

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