Technical difficulties with new Revenue Recognition rules

The recent draft rules proposed by the Financial Accounting Standard Board concerning the revenue recognition rules would not just change the way accounting folks would recognize and record the revenue, but it would also require the companies to change or revamp their accounting systems.

One such situation will be in implementing the draft rule of assigning fair value to bundled products. Under the draft rule companies will have to use the relative selling price method, which allocates revenue for bundled products on a percentage to assign fair value rather than the popular residual allocation method, which assigns a straight dollar amount of revenue to each element of a bundled product.

Generally Enterprise Resource Planning (ERP) systems built for software revenue recognition are configured to handle the percentage method, while most ERP systems are programmed to handle the residual allocation method. So most non software companies will have to revamp their ERP system to comply with the rule if and when it becomes a rule. Will it be a small tweak in the system or a work around situation or will it be an opportunity for small or even large vendors to come up with stand alone products catering to this niche market, only time will tell.

Convergence of Revenue Recognition

One accounting principle that is omnipresent in the accounting of all companies, be it public or private, domestic or private, billion dollar company or a startup, is the “Revenue recognition principle”.  Presently, US Generally Accepted Accounting Principles (GAAP) offers more than 100 pronouncements regarding when and how to book revenue, including industry specific rules for 25 different sectors.  The variations of the rules definitely leads to comparability issues among different companies, but due to the type of work different organizations do it is almost required to have variations in the rule. A construction company that uses the percentage of completion method to recognize revenue, will show a warped picture if it were to recognize the revenue only when the final sale of the property was done. If it takes 5 years to construct and sell, the company would be a loss making company for the five years as there will be costs associated with the construction but no revenue to show!

With the GAAP and IFRS convergence on full swing, the goal is to have a converged revenue recognition principle by the second quarter of next year. But consider this, under IFRS there are just two broad revenue rules augmented by four interpretations. A hundred pronouncements vs two broad rules; how do you come to a middle ground. This will be a major challenge for the standard setters and more so for all the companies that have to comply with the converged standards. Would it be more effective and show a clearer picture is something only time will tell.

Bristol-Myers Squibb

In August 2004, SEC files an enforcement action against Bristol- Myers Squibb alleging that Bristol-Myers used earnings management schemes to distort the true performance of the company and harmed the company’s shareholders. During 2000 and 2001 the company engaged in fraudulent schemes to inflate its sales and earnings in order to create the false appearance that the company had met or exceeded its internal sales and earnings targets and Wall Street analysts’ earnings estimates. The company inflated it’s 2001 revenue by $1.5B by channel stuffing (mainly two of its wholesalers McKesson and Cardinal). The company had to reduce reduced net sales by more than $1.4 billion for 2001, $678 million for 2000, and $376 million for 1999. The company increased sales for the six months ended June 30, 2002 by $653 million. It also reduced net earnings from continuing operations by $376 million, $206 million and $331 million in the years ended 2001, 2000 and 1999, while net earnings from continuing operations were increased by $201 million in the six months ended June 30, 2002. The company also agreed to pay $100 million civil penalty and $50 million to be set aside for shareholder’s who were harmed by the fraud.