Proper Recognition

More SEC enforcement actions have focused on revenue recognition than on any other area. Most often, however, the violations have less to do with fraud than with bewilderment about the rules.

On February 28, the day investors expected NCO Group Inc. to release earnings results for fourth-quarter 2004, the provider of business-process outsourcing services instead issued some bad news: it was delaying the release of its financials and changing one of its revenue-recognition policies. In January, the Horsham, Pa., firm received word that the Securities and Exchange Commission was taking issue with its policy.

NCO is not alone. The SEC has brought more enforcement actions related to revenue recognition than to any other area. In most cases, the actions have less to do with fraud than with confusion about the existing patchwork of regulations. According to a study released last summer, 76 percent of senior finance executives say there is a need for a comprehensive statement on how revenue should be recognized. “There has never been a comprehensive assessment,” says Edward Nusbaum, CEO of Grant Thornton LLP and a member of the Financial Accounting Standards Board’s advisory council. “There has been piecemeal guidance put together by industry.”

In 2002, FASB convened a project to research the issue, but it has yet to release any formal findings. A spokesperson at FASB says only that work is ongoing and that there is no timetable for guidance. At issue: how to construct a wide-ranging policy that can be applied across the board, instead of detailed rules that govern revenue recognition across a variety of scenarios.

Instructing companies on how to determine a transaction’s fair market value for sales that include multiple components is particularly complicated. Jennifer Haslip, a CPA who is the CFO of Universal Technical Institute, a for-profit technical training school based in Phoenix, says she wonders how companies will find appropriate market benchmarks for their transactions. “When you start to break apart the individual transactions of different companies, it gets complex,” she says.

Greg Walker, CFO of Magma Design Automation, a software company based in Sunnyvale, Calif., says the rules need to be simplified. “They are too open to interpretation, too complicated,” he explains, “and the basic outcome is that they generate a lot of unnecessary audit fees.”

Nusbaum says he anticipates possible preliminary recommendations from FASB by the end of the year.

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