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Heads, it's revenue: why companies struggle to comply with revenue recognition guidance.

COST OVERRUNS ARE A FACT OF LIFE in large, multiphase construction projects, and it's not unusual for clients of big construction companies to dispute the bills. But bill disputes are problematic from an accounting perspective-they take time and hold up the booking of revenue. So one company, Halliburton Co., a Texas maker of oil drilling equipment, found a way to book significant portions of disputed revenue before the contingencies were removed. In May, the SEC cried foul and announced it would launch an investigation into the accounting practices of Halliburton, the former employer of U.S. Vice President Dick Cheney.

Halliburton is just one of a string of public companies under SEC scrutiny for accounting irregularities stemming mainly from aggressive revenue recognition techniques.

Compounding the problem of corporate financial misstatements are several spectacular cases of apparent outright fraud. Enron's collapse, topped recently by WorldCom, has spawned a media feeding frenzy that is generating additional regulatory scrutiny.

But accounting experts say that the vast majority of restatements have been driven by regulatory changes and deep differences among companies about how to respond to those changes.


Always a complex and contentious aspect of financial reporting, revenue recognition has become a minefield for corporate accounting professionals.

Since 1997, nearly 1,000 publicly traded companies have restated their financial reporting. The growth in restatements had its genesis around 1996, when a confluence of factors spawned what became known in the business press as earnings management-aggressive accounting techniques characterized by a focus on revenue. Wall Street judged high-tech companies based on revenue, creating intense pressure to produce more revenue.

In fall 1998, the situation began to congeal when then SEC chairman Arthur Levitt declared war on earnings management with his "Numbers Game" speech at New York University's Center for Law and Business. In that speech, he accused corporate America of ethical laxity, saying that the once bright line of public duty that kept corporations and major accounting firms separate had eroded into a "game of nods and winks."

Before the decade's end, the SEC cracked down, and in early December 1999, released Staff Accounting Bulletin 101. SAB 101 made it clear that the SEC was going to become much more stringent about revenue recognition.

Technically, SEC staff bulletins provide guidance, but in the real world, they have essentially the same status and impact as FASB-issued standards, and they signal the focus of regulator enforcement to accountants and corporate officers. So, when SABs are issued, corporations begin to change.

"With the issuance of SOP 97-2, later clarified by SAB 101, finance organizations had to enhance the 'Quote-to-Cash' process to ensure additional focus was given to revenue recognition," said Mrinalini Ingram, Cisco System's finance director for Global Revenue Accounting. "We knew we had to create a scalable, systematic process to ensure we maintained our accuracy in revenue recognition." For a first-hand account of how Cisco deals with revenue recognition, visit CalCPA Online at


From there, the SEC released an additional SAB to the profession and corporate America with specific guidance for different industry sectors. In October 2000, it issued an FAQ that further clarified its guidance. Since then, companies have struggled to redefine their accounting cultures as they attempt to steer clear of the SEC's watchful eye. Many haven't been able to avoid the scrutiny.

"I think software companies and other publicly traded corporations have been--with varying degrees of success--struggling mightily to conform to SEC guidance," says Arthur Korn, CalCPA's director of technical services and a veteran auditor. "It's a difficult cultural shift that companies have had to make within their accounting organizations to respond to this kind of SEC guidance, and it's a different process for each of them."

The issues surrounding revenue recognition always have been complex, and because of ever-changing business practices, coming up with bright-line rules is difficult for standard setters. Korn notes that earlier attempts to create uniform revenue recognition standards ultimately failed.

"In the early 1990s, some accounting rule setters tried to establish 'cookbook' standards defining when revenue should be recognized, and their intent was to provide users of financial statements the ability to compare one company to another and know they were comparing apples to apples," Korn reflects. "It quickly became apparent that one size didn't fit all and that standards had to be further refined to apply to specific industries."

Revenue recognition standards were eventually promulgated for long-term contracts and franchisers, for companies where right of return (of merchandise for example) exists, the music industry, the real estate industry and others. Recently, the Emerging Issues Task Force of the AICPA's Accounting Standards Executive Committee completed SOP 97-2, Revenue Recognition for Software companies.

John Lacey, a senior accounting professor at California State University at Long Beach, says there is no aspect of accounting more complex and dynamic than revenue recognition--especially for software companies--so he uses simple concepts to teach it.

"Generally, you can recognize revenue when you do what you are supposed to do," Lacey says. But he admits for some companies or industries that's not easy to determine.

"A coffee company harvests and delivers whole beans, documents the transaction, books the revenue and it's done," says Lacey.

"Software companies sell a site license in which they deliver the programs or applications, maybe they include or promise some training, updates and patches and a toll-free number to provide tech support. In such a case, the question 'When has the company done what it is supposed to do?' isn't as easily answered," says Lacey.


Early reaction to the SEC guidance was strong because corporate officers couldn't be sure what it meant, according to John Dirks, a partner at PricewaterhouseCoopers in San Jose and a member of the AcSEC working group that developed SOP 97-2.

"There is nothing new in SAB 101," says Dirks. "It was merely a clarification of GAAP principles. All the guidance amounted to was a return to fundamentals and a shift to a more conservative stance by many corporations.

"For example, manufacturing companies switched from recognizing revenue on shipment to on receipt; or retailers that had previously decided to take revenue on layaways began to defer until the customer took possession of the goods."

While the criteria for recognizing revenue (see sidebar Page 25) seemed simple enough, the devil was, and to some extent still is, in the details. This is especially true for software companies where complex, nonstandard deals are de rigueur.

Some deals are phased in over a period of years and contain multiple delivery points and multiple products. These can't be unbundled easily for accounting purposes and present an accounting challenge.

Standards and rule setters took up the revenue issue and gave guidance for companies with multiple-element arrangements. According to SOP 97-2, revenue arrangements involving multiple deliverables where standard contract accounting isn't applicable should be divided into separate units of accounting. How that is done is still a matter of debate between regulators, rule setters and private industry.

Revenue arrangements that qualified for this treatment included those that present objective, reliable evidence of fair value to allocate the total fee to the deliverables. Or, revenue arrangements also could qualify for separate accounting if one of the following two criteria is met: The deliverable does not affect the quality of use or the value to the customer or other deliverables; or the deliverable could be purchased from another unrelated vendor.


FASB recently announced it would launch a new attempt to develop a broad, uniform standard for revenue recognition that will apply across a range of industries.

"The intent is to develop a comprehensive standard that applies to business entities in general," says Todd Johnson, FASB senior project manager, who will lead the effort to develop a broad revenue recognition standard. "Our goal is to eliminate inconsistencies in the standards literature, fill in gaps not covered by authoritative literature, and to provide guidance to help resolve issues that arise in the future."

Johnson is keenly aware that the body of literature on revenue recognition has grown ever more complex as rules and standard setting bodies address narrow, industry-specific issues. "When we promulgate a standard and it's expressed as a principle, and companies and their auditors begin to ask for more detailed guidance," he says. "That accumulation of detail drives complexity."

Complexity also comes from companies that feel the standards don't work well for their company or industry. "Many companies want to be exempted from the standards," Johnson says. "But with this new standard, we're going to try to stay on a higher plane, and so in the interest of maintaining simplicity, there may be detailed issues that won't be addressed.

"What companies and the market in general don't appear to understand is that financial statements and the accounting that creates them are the language of a finite system," Johnson continues. "The total income of a company over its lifetime is the same--a fixed number. So, if you accelerate recognition of revenue, the result is that you are taking it out of a future period to apply it to the current reporting period. The inevitable effect of trying to enhance revenue in the current period is that it diminishes the revenue number from what it would have been in the next quarter or year."

Johnson offers a simple analogy to illustrate what he means: "When you push your finger into a balloon, it displaces air and another part of the balloon expands. But when the pressure is removed, it snaps back. There is no escape."

RELATED ARTICLE: Guidance That Launched a Thousand Restatements

Following is a brief summary of SEC Staff Accounting Bulletin 101, Revenue Recognition in Financial Statements, and AICPA's Statement of Position 97-2, Software Revenue Recognition. For more complete information, go to;; and

SAB 101

The general key criteria that must be met to recognize revenue:

- Delivery has occurred or services have been rendered--delivery does not occur until the customer has taken title and assumed the risk of loss.

- Persuasive evidence of an arrangement exists--the nature of the evidence depends on customary business practice i.e., signed contract, purchase order, statement of work, electronic evidence.

- The seller's price to the buyer is fixed or determinable--Any extended payment terms indicate the fee is not fixed or determinable.

- Collectibility is reasonably assured--this is a higher standard than "probable."

SOP 97-2

Current AICPA Accounting Standards Executive Committee (AcSEC) guidance on applying GAAP in recognizing revenue on software transactions.

- Persuasive evidence of an arrangement exists--documented online authorization counts as persuasive evidence.

- Delivery has occurred--applies whether customer is user or reseller. For software delivered electronically, a download by a customer counts as taking possession, but revenue from transactions involving delivery agents of the vendor should be recognized when the software is delivered to the customer, not the delivery agent. If the customer specifies an intermediate delivery site, but a substantial portion of the fee is not payable until delivery by the vendor to another site specified by the customer, revenue should not be recognized until delivery is made to the final destination.

- Vendor's fee is fixed or determinable--A software licensing fee is not fixed or determinable if it is based on the number of units distributed or copied, or the expected number of users of the product. Arrangements that include rights of return or rights to refunds without return, require the vendor to provide a reasonable estimate of the future returns or refunds in accordance with FASB statement 48 "Revenue Recognition when Right of Return Exists."

- Reseller arrangements--if payment is substantially contingent on the resellers success in distributing the product, or if resellers can't pay for the product until it is sold, if the amount of future payments cannot be reasonably estimated, or if the reseller has price protection, then revenue may not be recognized.

- Multiple-element arrangements--a frequent type of software company transaction. Multiple-element arrangements for a single client may charge a basic fee for a group of additional software products such as patches; upgrades and enhancements; post-contract customer support; or services including elements deliverable only on an as-needed or as-available basis.

If contract accounting does not apply, the vendor must account for the revenue from each of the various products based on vendor-specific objective evidence of fair values, regardless of any separate prices stated within the contract for each element. Of course, the portion of the fee allocated to a specific element can only be recognized when the previously stated criteria are satisfied. If insufficient vendor-specific evidence of fair values cannot be obtained for the allocation of revenue to the various elements of an arrangement, all revenue from the arrangement should be deferred ... until all elements are delivered.

SOURCES: PricewaterhouseCoopers; the SEC and FASB

Curtiss Olsen is CalCPA's director of communications.
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Author:Olsen, Curtiss
Publication:California CPA
Geographic Code:1USA
Date:Sep 1, 2002
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