4.4: Business Ethics- Examples of Fraudulent Revenue Recognition

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Business Ethics:

Examples of Fraudulent Revenue Recognition^[1]

Below are some more difficulties that you should be aware of. These have more to do with accounting fraud than the legitimate accounting choices enumerated earlier.

Channel Stuffing – Companies sell large amounts of goods to distributors in order to book large profits. Under SEC accounting, it is permissible to book sales for shipped product, less a reasonable allowance for returns. However, channel stuffers may not be able to make reasonable estimates and would therefore be required to defer revenue recognition until return estimates may be projected. This may result in deferring revenue for months. Stuffing occurs when vendors ship merchandise in advance of scheduled shipment dates without buyers’ acquiescence.

Bill and Hold – Revenue is booked even though the product may not have been shipped and payment may not actually be due for a long period. For example, Sunbeam sold charcoal grills in the winter, although they were not to be shipped until springtime; after a change in management, books were restated to eliminate the relevant revenue and profit. This arrangement would be allowed, under SEC accounting, provided the buyer requested it; the buyer must also have a good business reason for the request. Further, the goods must be either already assembled or otherwise ready for shipment before revenue is recognized.

Internet Sales – If an internet site is acting as agent for, as an example, an airline ticket sale, it may only book the revenue it earns. This revenue may be only a commission rather than the full value of the ticket. If it acts as principal, it may book the larger amount as revenue and another amount as expense (the portion which it must return to the airline), showing the net result – which would, in effect, be the commission. Internet companies whose stock prices are sensitive to “top-line” growth prefer to recognize sales as principals. Principal transactions are permitted by the SEC provided the company took title to the product before shipment and “has the risks and rewards of ownership, such as the risk of loss for collection, delivery, or returns…”.

Discussion Question: What are the moral and legal differences between “fraud” and the creative use of accounting methods and assumptions?

Lying speech is an abomination to God, but those who act faithfully please Him.

– Proverbs 12:22

The following section was derived from a report in the New York Times on December 4, 1999, p. C4. ↵