REVENUE RECOGNITION

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REVENUE RECOGNITION
Accounting Day 2008
May 12, 2008
Wayne R. Pinnell Managing Partner Haskell White
LLP
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Revenue Recognition

• Revenue Recognition Overview
• Basic Revenue Recognition Criteria
• Multiple Elements in Revenue Recognition
• Other Revenue Recognition Considerations
• Company Internal Control Considerations
• Frauds Involving Revenue Recognition
• Auditor Considerations
• US GAAP vs. IFRS
• Conclusion and Q A

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1. Revenue Recognition Overview

• There are hundreds of references in
  authoritative guidance and interpretations under
  US GAAP covering revenue recognition.
• There are general standards and numerous
  standards written to apply to specific industries
  or situations.
• Codification from FASB came out Q1-2008.
  (http//asc.fasb.org) You can register and access
  the website for free.

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1. Revenue Recognition Overview

• Some of the more common revenue criteria include
• FASB Concepts Statement No. 5 (the foundation)
• SEC Staff Accounting Bulletin (SAB) 104 applies
  to public companies, but is generally considered
  applicable to all companies
• SFAS 66 applies to real estate
• SOP 97-2 and its related interpretations applies
  to software
• SOP 81-1 applies to contract accounting
• EITF 99-19 applies to gross revenue as principal
  vs. net as agent
• EITF 00-10 guidance on accounting for shipping
  handling fees
• EITF 00-21 applies to multiple deliverable
  arrangements

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2. Basic Revenue Recognition Criteria

• FASB Concepts Statement No. 5 (December 1984)
• Revenues of an enterprise during a period are
  generally measured by the exchange values of the
  goods or services. Recognition of revenues in a
  given period requires that the revenues meet two
  criteria. The revenues must be
• Realized or realizable, and
• Earned

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2. Basic Revenue Recognition Criteria

• When is revenue realized or realizable?
• Revenue is realized when products, merchandise or
  services or other assets are exchanged for cash
  or claims to cash
• Revenue is realizable when related assets
  received or held are readily convertible to known
  amounts of cash or claims to cash
• When is revenue earned?
• Revenue is earned when the entity has
  substantially accomplished what it must do to be
  entitled to benefits represented by the benefits
  of the revenue. In other words, the earnings
  process has been completed.

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2. Basic Revenue Recognition Criteria

• Major recent revenue recognition standards
• In October 1997, the AICPA issued Statement of
  Position 97-2 on Software Revenue Recognition to
  address the evolving practices in the software
  industry.
• In December 1999, the SEC issued Staff Accounting
  Bulletin No. 101 on Revenue Recognition to
  summarize existing GAAP on the subject
  adopting the basic principles from SOP 97-2. The
  SEC later amended SAB 101 with the issuance of
  SAB 104.

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2. Basic Revenue Recognition Criteria

• SAB 104 and SOP 97-2 indicate that revenue is
  generally realized or realizable and earned when
  ALL of the following four criteria are met in
• Persuasive evidence of an arrangement exists
• Delivery has occurred or services have been
  rendered
• Sellers fee is fixed or determinable
• Collection is reasonably assured

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2. Basic Revenue Recognition Criteria

• Persuasive evidence of an arrangement is based on
  the Companys customary and agreed upon business
  practice which may require a
• Signed contract
• Purchase order
• Electronic communication
• Credit card authorization

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2. Basic Revenue Recognition Criteria

• Persuasive evidence of an arrangement exists
• Complete contract is signed by both parties
  before period end. If contract is not signed by
  either party, terms and conditions are not final,
  revenue cannot be recognized.
• Does contract include all terms and conditions?
• Are there any side letters/agreements? Such
  agreements may include cancellation, termination,
  or return provisions that could affect revenue
  recognition
• No revenue can be recognized unless persuasive
  evidence of an arrangement exists, even if
  delivery has occurred.

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SAB 104 Discussion Question (summarized)

• Is there Persuasive Evidence of an Arrangement?
• Facts Company A delivers product to Company B
  prior to quarter end. Company As normal and
  customary business practice for this class of
  customer is to enter into a written sales
  agreement that requires the signatures of the
  authorized representatives of the Company and its
  customer to be binding. Company A prepares a
  written sales agreement which is signed by their
  authorized representative prior to quarter end.
  Company Bs purchasing department has orally
  agreed to the sale and stated the contract will
  be approved the first week of the next quarter.

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SAB 104 Discussion Question (summarized)

• Question Can Company A recognize revenue in the
  current quarter?
• Interpretive response Revenue cannot be
  recognized in the current quarter. As a result
  of Company As business practice of requiring a
  written sales agreement for this class of
  customer, persuasive evidence of an arrangement
  would require a final agreement that has been
  executed. Company Bs execution of the sales
  agreement after the end of the quarter causes the
  revenue from the transaction to be recognized in
  the subsequent period.

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2. Basic Revenue Recognition

• Delivery has occurred or services have been
  rendered
• Delivery can vary based on the nature of the
  product
• Physical transfer
• Electronic transmission
• Availability for download
• Installation/Training requirements
• Customer acceptance
• If the undelivered element(s) are essential to
  the functionality of the delivered element(s),
  delivery may not have occurred

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2. Basic Revenue Recognition Criteria

• Delivery has occurred or services have been
  rendered
• Shipping terms impact revenue recognition, i.e.
  FOB shipping point vs. FOB destination
• Title and risk of loss must transfer
• The Companys policy of replacing goods damaged
  in shipment at no charge to the customer creates
  FOB destination terms for revenue recognition
  purposes

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2. Basic Revenue Recognition Criteria

• Delivery has occurred or services have been
  rendered (cont).
• Bill and hold arrangements should be uncommon.
  It must be requested by the customer and has
  several other conditions specified in SAB 104
• Revenue should not be recognized when customers
  have an unconditional right of return

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SAB 104 Discussion Question (summarized)

• Has Delivery Occurred?
• Facts Company Z has an arrangement to deliver
  its products to Company A on a consignment basis.
  Pursuant to the terms of the arrangement,
  Customer A is a consignee, and title to the
  products does not pass from Company Z to Customer
  A until Customer A consumes the products in its
  operations. Company Z delivers product to
  Customer A under the terms of their arrangement.
• Question May Company Z recognize revenue upon
  delivery of its product to Customer A?

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SAB 104 Discussion Question (summarized)

• Interpretive Response No. Products delivered to
  a consignee pursuant to a consignment arrangement
  are not sales and do not qualify for revenue
  recognition until a sale occurs. The staff
  believes that revenue recognition is not
  appropriate because the seller retains the risks
  and rewards of ownership of the product and title
  usually does not pass to the consignee.

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SAB 104 Discussion Question (summarized)

• Has Delivery Occurred?
• Facts Company A receives purchase orders for
  product. The customer is not ready to take
  delivery of the product for various reasons
  including lack of space and delays in customers
  production schedules. Company A ships the
  product to a third-party warehouse but retains
  title to the product and payment is dependent
  upon delivery to a customer specified site.
• Question Can company A recognize revenue when
  the product is shipped?

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SAB 104 Discussion Question (summarized)

• Interpretive response Revenue cannot be
  recognized. Delivery generally is not considered
  to have occurred unless the customer has taken
  title and assumed the risks and rewards of
  ownership of the product. This could be
  considered to be an inappropriate bill and hold
  transaction.

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SAB 104 Discussion Question (summarized)

• Has Delivery Occurred?
• Facts Company E is an equipment manufacturer
  whose main product is generally sold in a
  standard model. The contracts for sale of that
  model provide for customer acceptance to occur
  after the equipment is received and tested by the
  customer. The acceptance provisions state that
  if the equipment does not perform to Companys E
  published specifications, the customer may return
  the equipment for a full refund or a replacement
  unit. Title to the equipment passes upon
  delivery to the customer. Company E does not
  perform installation or other services on the
  equipment and tests each piece of equipment it
  sells before shipment.

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SAB 104 Discussion Question (summarized)

• Question Company E receives an order from a new
  customer for a standard model of its main
  product. When should Company E recognize revenue
  from sales of this piece of equipment?
• Interpretive response Revenue should be
  recognized upon delivery of the equipment. While
  the SEC staff presumes that customer acceptance
  provisions are substantive provisions that
  generally result in revenue deferral, that
  presumption can be overcome. Although the
  contract includes a customer acceptance clause,
  acceptance is based on meeting Company Es
  published specifications for a standard model.

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SAB 104 Question (paraphrased)

• Have all conditions related to Delivery been met?
• Facts Assuming the same facts as the previous
  example. Company E enters into an arrangement
  with a new customer to deliver a version of its
  standard product modified as necessary to be
  integrated into a customers new assembly line
  while still meeting all of the standard published
  vendor specifications. The customer may reject
  the equipment if it fails to meet the standard
  published performance specifications or cannot be
  satisfactorily integrated into the new line.
• continued
  gtgtgt

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SAB 104 Question (paraphrased)

• Have all conditions related to Delivery been met?
• Facts (cont) Company E has never modified its
  equipment to work on an integrated basis in the
  type of assembly line the customer has proposed.
  Company has designed the equipment to meet the
  standard published performance specifications
  with the modifications necessary, but Company E
  is unable to replicate the new assembly line
  conditions in its testing.

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SAB 104 Discussion Question (summarized)

• Question When should Company E recognize
  revenue from this transaction?
• Interpretive response The contract includes a
  customer acceptance clause that is based in part
  on customer specific criterion and Company E
  cannot demonstrate that the equipment shipped
  meets that criterion prior to shipment.
  Therefore, Company E should wait until the
  product is successfully integrated at its
  customers location and meets the
  customer-specific criteria before recognizing
  revenue.

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2. Basic Revenue Recognition Criteria

• Sellers fee is fixed or determinable
• A fee required to be paid in a set amount that
  is not subject to refund or adjustment.
• If it cannot be concluded that a fee is fixed or
  determinable at the outset of an arrangement,
  revenue should be recognized as payments from
  customers become due (assuming all other
  conditions for revenue recognition have been
  satisfied).

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2. Basic Revenue Recognition Criteria

• Additional factors impacting the fixed or
  determinable assessment include
• Extended payment terms outside the Companys
  customary terms or over 12 months. Can be
  overcome if Company can show a history of full
  payment.
• Cancellation privileges
• Forfeiture or refund clauses
• Customer acceptance clauses/right of return
• Concessions reduce the present value of amounts
  due under the original terms and can include
• Additional discounts
• Future products at no fee or a reduced fee
• Extension of payment terms
• Additional payment terms

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2. Basic Revenue Recognition Criteria

• Collection is reasonably assured
• An assessment of collectibility should be made
  prior to recognition of revenue and should
  address differences amongst customers
• Collectibility assessments of new customers
  should be more diligent
• Policy should establish time lines for review of
  customers creditworthiness (annually)
• It is about the customers ability to pay, not
  their willingness
• Need adequate documentation of assessment
• In general, bad debt expense and revenue should
  not be recorded for the customer in the same
  period

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Sample Software Company Issues

• Former client, V had sales agreements for
  license fees of 2.0M. In turn, licensee was to
  sell and install the software to an end user.
  The final price payable to Z was dependent upon
  sale to end user, and licensee did not need to
  pay until sale was completed with user.
• While there was persuasive evidence of an
  arrangement, delivery had not occurred, the price
  was not fixed and collection was not reasonably
  assured in the absence of an end-user customer.

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3. Multiple Elements in Revenue Recognition Under
EITF 00-21

• EITF 00-21 was issued to address the increased
  complexities that exist when companies offer
  bundled products and services.
• These bundled products and services often
• Involve delivery of products and services at
  varying times
• Have varying payment terms and payment streams
• The arrangements could create separate units of
  accounting for the elements of the
  product/services in the package deal.

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3. Multiple Elements in Revenue Recognition Under
EITF 00-21

• Multiple revenue elements in one arrangement
  could include
• the delivery or performance of multiple products,
  services,
• the rights to use assets
• initial installation, initiation, or activation
  services
• Payment arrangements can include consideration
  as
• a fixed fee or fixed fee coupled with a
  continuing payment stream corresponding to the
  continuing performance, and
• the amount of the payments may be fixed, variable
  based on future performance, or a combination of
  fixed and variable payment amounts.

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3. Multiple Elements in Revenue Recognition Under
EITF 00-21

• In an arrangement with multiple deliverables, the
  delivered item(s) should be considered a separate
  unit of accounting if ALL of the following
  criteria are met
• The delivered item(s) have value to the customer
  on a stand alone basis
• There is objective and reliable evidence of the
  fair value of the undelivered item(s)
• If there is a general right of return for the
  delivered item, delivery or performance of the
  undelivered item(s) must be considered probable
  and substantially in control of the vendor

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3. Multiple Elements in Revenue Recognition Under
EITF 00-21

• The arrangement consideration allocable to
  delivered item(s) that does not qualify as a
  separate unit of accounting within the
  arrangements should be combined with the amount
  allocable to the other undelivered items within
  the arrangement.
• The appropriate recognition of revenue should
  then be determined for those combined
  deliverables as a single unit of accounting.

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3. Multiple Elements in Revenue Recognition Under
EITF 00-21

• The following steps should be followed in
  reviewing multiple elements
• Identify deliverables
• Determine if there is a higher level of
  literature (SFASs, SOPs, FASB Interpretations
  and Technical Bulletins)
• Measure the arrangement consideration (must be
  fixed and determinable)
• Separate the deliverables

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3. Multiple Elements in Revenue Recognition Under
EITF 00-21

• The following steps should be followed in
  reviewing multiple elements (cont.)
• Allocate the arrangement consideration (should be
  based on fair value contractually stated prices
  for individual products and/or services in an
  arrangement with multiple deliverables should not
  be presumed to be representative of fair value)
• Identify the revenue model

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EITF 00-21 Example 1

Facts CellularCo runs a promotion in which new
customer who sign a two-year contract receive a
free phone. The contract requires the customer
to pay a cancellation fee of 300 if the customer
cancels the contract. There is one-time
activation fee of 50 and a monthly fee of 40
for the ongoing service. The same monthly fee is
charged by CellularCo regardless of whether a
free phone is provided. The phone costs
CellularCo 100. Further, assume that CellularCo
frequently sells the phone separately for 120.
continuedgtgtgt
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EITF 00-21 Example 1 (cont.)

Facts (cont) CellularCo is not required to
refund any portion of the fees paid for any
reason. CellularCo is a sufficiently
capitalized, experienced, and profitable business
and has no reason to believe that the two-year
service requirement will not be met. CellularCo
is considering whether (a) the phone and (b) the
phone service (that is, the airtime) are
separable deliverables in the arrangement. The
activation fee is simply considered additional
arrangement consideration to be allocated. The
phone and activation are delivered first,
followed by the phone service (which is provided
over the two-year period of the arrangement).
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EITF 00-21 Example 1 (cont.)

Evaluation The first condition for separation is
met for the phone. That is, the phone has a
value on a standalone basis because it is sold
separately by CellularCo. The second condition
for separation also is met because objective and
reliable evidence of fair value exists for the
phone service. Finally, there are no general
rights of return in this arrangement (third
condition). Therefore, the phone and the phone
service should be accounted for as separate units
of accounting.
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EITF 00-21 Example 1 (cont.)

• The total arrangement consideration is 1,010.
  The fair value of the phone service is 960 (40
  x 24 months), the price charged by CellularCo.
• The fair value of the phone is 120, the price of
  the phone when sold separately by CellularCo.
• Without considering whether any portion of the
  amount allocable to the phone is contingent upon
  CellularCos providing the phone service,
  CellularCo would allocate the arrangement
  consideration on a relative fair value basis as
  follows
• 112.22 1,010 x (120 120 960) to the
  phone and 897.78 1,010 x (960 120
  960) to the phone service.
• However, because a free phone is provided in
  the arrangement and the customer has no
  obligation to CellularCo if the phone service is
  not provided, 62.22 (assuming the customer has
  paid the nonrefundable activation fee) is
  contingent upon CellularCos providing the phone
  service.
• Therefore, the amount allocable to the phone is
  limited to 50 (112.22 - 62.22), and the amount
  allocable to the phone service is increased to
  960.

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EITF 00-21 Example 5

• Facts Company S is an experienced home
  appliance dealer. Company S offers a number of
  services with the home appliances it sells.
  Company S regularly sells Appliance W on a
  standalone basis, but they also offer
  installation and maintenance services. Company S
  does not offer installation or maintenance
  services for Appliance W unless they sell the
  appliance. Their pricing for Appliance W is as
  follows
• Appliance W only 800
• Appliance W with installation 850
• Appliance W with maintenance only 975
• Appliance W with installation and
  maintenance 1,000

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EITF 00-21 Example 5 (cont.)

• Facts (cont.)
• The amount charged by Company S for installation
  (50) approximates the amount charged by
  independent third party installers.
• Appliance W is sold subject to a general right of
  return. If a customer purchases Appliance W with
  installation and/or maintenance services, in the
  event Company S does not complete the services,
  the customer is entitled to a refund of the
  portion of the fee that exceeds 800.
• Assume that a customer purchases Appliance W with
  both installation and maintenance services for
  1,000. Company S believes it is probable that
  the installation will be performed satisfactorily
  to the customer. Assuming the delivery of
  Appliance W and its installation occur in
  different accounting periods and that the
  maintenance services cover a one year period, how
  should the 1,000 of revenue be recognized?

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EITF 00-21 Example 5 (cont.)

Evaluation The maintenance services are
separately priced at 175 and should be accounted
for based on the guidance of FTB 90-1 on a
straight line basis over the maintenance term
unless some other basis is objectively determined
to be more appropriate. Regarding Appliance W
and the installation fee, the first condition for
separation is met because it is sometimes sold
separately by Company S. The second condition is
met as there is objective and reliable evidence
of the fair value of the installation service.
The third condition is met because performance of
the installation service is probable and the
control of Company S.
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EITF 00-21 Example 5 (cont.)

Company S would allocate 175 of the arrangement
to maintenance services and recognize in
accordance with FTB 90-1, as noted above.
Company S would allocate the remainder of the
consideration (825) to Appliance W and the
installation service based on their relative fair
values. Appliance W would be allocated 776
(825 x (800 divided by 800 50)) and
installation would be allocated 49 (825 x (50
divided by 800 50)).
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EITF 00-21 Example 8

Facts Company B sells computer systems. On
April 20, a customer purchases a computer system
from Company B for 1,000. The system consists of
a CPU, a monitor, and a keyboard. On April 30,
Company B delivers the CPU to the customer
without the monitor or keyboard. Each of the
items can be purchased separately at a cost of
700 for the CPU, 300 for the monitor, and 100
for the keyboard. The CPU could function with
monitors or keyboards manufactured by others, who
have them readily available. The customer is
entitled to a refund equal to the separate price
of any item composing the system that is not
delivered. The arrangement does not include any
general rights of return. Company B is evaluating
whether delivery of the CPU represents a separate
unit of accounting.
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EITF 00-21 Example 8 (cont.)

Evaluation The first condition for separation is
met for the CPU as it is sold separately by
Company B. The second condition for separation is
met because the fair values of the undelivered
items (keyboard and monitor) are objectively and
reliably determined based on the price of that
equipment when sold separately by Company B. The
third condition for separation is met because
there are no general rights of return. Therefore,
the CPU should be accounted for as a separate
unit of accounting.
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EITF 00-21 Example 8 (cont.)

Evaluation (cont.) Without considering whether
any portion of the amount allocable to the CPU is
contingent upon delivery of the other items,
Company B would allocate the arrangement
consideration on a relative fair value basis.
Therefore, the portion of the arrangement fee
otherwise allocable to the CPU is 636.36 (1,000
700 1,100), of which 36.36 (636.36 -
1,000 - 400) is subject to refund if the
monitor and keyboard are not delivered.
Therefore, the amount allocable to the CPU is
limited to 600, which is the amount that is not
contingent upon delivery of the monitor and
keyboard.
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4. Other Revenue Recognition Considerations

• SOP 97-2 provides guidance on when revenue should
  be recognized and in what amounts for licensing,
  selling, leasing, or otherwise marketing computer
  software. May need to consider 97-2 and EITF
  03-05 when there is embedded software in products
  that may be essential to the functionality to the
  product as a whole.
• As noted previously, 97-2 contained the four
  basic revenue recognition criteria now included
  in SAB 104.
• EITF 99-19 provides guidance on reporting revenue
  gross as a principle versus net as an agent.
  Revenue and cost or revenue must be netted when a
  company acts as an agent or broker.
• Key determinants here include consideration of
  whether Seller ever took title and risk of loss
  to inventory in the overall sales process.
• Net accounting is appropriate when revenue earned
  is tantamount to a commission.

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4. Other Revenue Recognition Considerations

• EITF 00-10 provides guidance on accounting for
  shipping and handling fees and costs.
• Amounts billed for SH are included in revenues
• Accounting policy needs to be set for treatment
  of costs and are generally included in Costs of
  Sale. If classified outside of COS and
  significant, disclosure of amount and
  classification is required.
• SOP 81-1 provides guidance on accounting for
  performance of construction and production type
  contracts. Generally provides guidance for
  revenue recognition on long-term contracts.
• Generally requires the percentage-of-completion
  method of accounting.
• High risk area due to inherent nature of
  estimates required
• Common in construction and longer-term
  development projects including custom software.

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4. Other Revenue Recognition Considerations
(cont.)

• Bill Hold Such are generally not recorded as
  revenues, unless meet stringent guidelines of SAB
  104 including
• Risk of ownership passes to buyer
• Customer has written commitment to purchase
• The buyer must request the bill and hold
• Fixed delivery schedule in line with buyers
  business
• Seller does not retain specific performance
  obligations
• Goods segregated from rest of seller inventory
• Goods must be complete and ready for shipment

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4. Other Revenue Recognition Considerations
(cont.)

• Channel Stuffing Sales are boosted or pushed to
  customers in amounts higher than they can
  promptly sell. (Hint Watch out for those sales
  returns after QE/YE)
• Side Agreements Formal or informal agreements
  that significantly alter the terms of sale. This
  also existed at Software Client V discussed
  previously.

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4. Other Revenue Recognition Considerations
(cont.)

• Right of Return (SFAS 48) When a seller gives
  the buyer the right to return the product,
  revenue from the sales transaction shall be
  recognized at time of sale only if all of the
  following conditions (a-f) are met
• a. The seller's price to the buyer is
  substantially fixed or determinable at the date
  of sale.
• b. The buyer has paid the seller, or the buyer is
  obligated to pay the seller and the obligation is
  not contingent on resale of the product.

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4. Other Revenue Recognition Considerations
(cont.)

• Right of Return (cont.)
• c. The buyer's obligation to the seller would not
  be changed in the event of theft or physical
  destruction or damage of the product.
• The buyer acquiring the product for resale has
  economic substance apart from that provided by
  the seller.
• The seller does not have significant obligations
  for future performance to directly bring about
  resale of the product by the buyer.
• The amount of future returns can be reasonably
  estimated

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5. Company Internal Control Considerations

• Companies should have documented policy on when
  revenue is to be recognized including the
  following considerations
• What constitutes evidence of an arrangement which
  should consider varying practices for different
  products and customers
• Policy for customer acceptance of product and
  customer returns
• Delivery shipping methods and what constitutes
  delivery
• Typical credit terms
• Criteria and evaluation policy for determining
  credit worthiness of new and existing customers

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5. Company Internal Control Considerations

• Procedures should be established for identifying
  unusual terms and conditions that may impact
  revenue recognition
• Be careful when using industry revenue
  recognition principles, they may be wrong

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6. Frauds Involving Revenue Recognition

The National Commission of Fraudulent Financial
Reporting sponsored a study of incidences of
fraudulent reporting, as reported in SEC
Accounting and Auditing Enforcement Releases from
1985 through 1997. Researchers found
inappropriate revenue recognition in 50 percent
of the cases. Some Examples of Fraudulent
Revenue Reporting Peregrine Systems, Inc., a
software developer. In order to meet analyst
expectations, management entered sham deals with
software resellers. When uncollectible
receivables began to build, management obtained
loans against the receivables that were treated
as sales of receivables. Peregrine restated
2000-2002 financial statements reducing revenue
by 507,000,000.
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6. Frauds Involving Revenue Recognition

ZZZZ Best Company, Inc. A home carpet cleaning
company that created tens of millions of
fictitious revenues from non-existent restoration
contracts. Records and paperwork were
manufactured using copy machines and phony
letterhead. Over 200,000,000 of market value
evaporate in three months after discovery and the
Companys assets ultimately sold at auction for
62,000. California Micro Devices, Inc.
Revenues were recorded on products not yet
shipped or even ordered. Revenues were not
reduced for returned products. The Company also
paid distributors handling fees to accept
shipments of products for which they had
unlimited rights of return and booked those
shipments as sales.
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6. Frauds Involving Revenue Recognition

Campbell Soup Company In the late 1990s,
Campbells recorded sales of product shipped to
and stored in its own warehouses and trucks.
They also reported sales incentives as SGA
instead of reductions of gross revenue. They
also recorded large guaranteed sales at the end
of periods sales for which the customers had an
unconditional right to return the product. Crazy
Eddie, Inc. This discount audio/video retailer
sold extended warrantees for which the underlying
costs were actually borne by the manufacturers
and used deceptive sales practices to steer
customers to higher priced products. Also, in
order to retain the appearance of same store
sales growth, wholesale shipments to other
retailers were recorded as retail sales with
higher gross profit by not relieving the full
cost of inventory (also overstating inventory).
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7. Auditor Considerations

• PCAOBs Report on 2004, 2005, and 2006
  Inspections of Firms who audit no more that 100
  issuers was released in October 2007. Inspectors
  identified deficiencies relating to testing of
  issuers revenues, including failures to
• Perform any or adequate substantive procedures to
  test existence, completeness and valuation of
  revenue
• Review contracts or appropriately evaluate the
  specific terms and provisions
• Test whether revenue was recorded in the
  appropriate period
• Corroborate management representations
• Perform adequate substantive analytical
  procedures on revenue

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7. Auditor Considerations (cont.)

• Audit Engagement Basics
• Understand the clients business observe them in
  action ask questions.
• Understand the risks and potential for fraud.
  SAS 99 requires auditors to presume there is a
  risk of material misstatement in revenue.
• Be diligent in analyzing revenue its not as
  easy as it looks!
• Follow good audit procedure basics
• Read contracts carefully understand the business
  purpose
• Test Cut-off of transactions
• Confirm material transactions/contract terms
• Corroborate management representations
• Be professionally skeptical at all times!

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8. US GAAP vs. IFRS (its coming fast!)

• Hundreds of references in US GAAP vs. ONE
  principle (IAS 18) under IFRS.
• IFRS revenue from the sale of goods recognized
  only when risks and rewards of ownership have
  been transferred, the buyer has control of the
  goods, revenues can be measured reliably, and it
  is probable that the economic benefits will flow
  to the company (seller).

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8. US GAAP vs. IFRS (its coming fast!)

• IFRS revenue from rendering services
  recognized in accordance with long-term contract
  accounting, including considering the stage of
  completion, whenever revenues and costs can be
  measured reliably and it is probable the economic
  benefits will flow to the company (seller).

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8. US GAAP vs. IFRS (its coming fast!)

• IFRS Multiple Elements IAS 18 requires
  recognition of revenue on an element of a
  transaction if that element has commercial
  substance on its own otherwise, the separate
  elements must be linked and accounted for as a
  single transaction. (No other specific guidance,
  yet.)

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8. US GAAP vs. IFRS (its coming fast!)

• IFRS Construction Contracts IAS 18 requires
  the use of the percentage-of-completion method if
  certain criteria are met. Otherwise, revenue
  recognition is limited to recoverable costs
  incurred. (Completed contract method is not
  permitted.)

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9. Conclusion and Questions Answers
Wayne R. Pinnell Managing Partner Haskell White
LLP
16485 Laguna Canyon Road 3rd Floor Irvine, CA
92618 T [phone] F [phone]
12707 High Bluff Drive Suite 200 San Diego, CA
92130 T [phone] F [phone]