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Diebold Inc, the automated teller machine maker, was alleged by the Securities and

Exchange Commission (SEC) because of its manipulation of earnings from 2002 to 2007,
misstating at least $127 million pre-tax earnings. Not only the company had to pay $25
million settlement and the CFO stepped down, but also its chief executive—who wasn’t
involved in the accounting fraud—agreed to reimburse the company over $470,000 in
cash, 30,000 shares of stock and options for 85,000 shares (WSJ, book1 #2).

Began in 2005, General Electric Co. (GE) filed its restatement twice, was prompted to
make three disclosures about other accounting errors and faced civil charges by SEC, for
among other frauds, its improper timing of revenue recognition on its locomotive sales
(WSJ, book1 #7&8).

The broad requirements of revenue recognition under U.S. GAAP are defined in the
Standards of Accounting Bulletin (SAB) No.101: revenue is generally realized, or
realizable and earned when 1) persuasive evidence of an arrangement exists, 2) delivery
has occurred or service has been rendered, 3) the sellers price to the buyer is fixed or
determinable, and 4) collectability is reasonably assured.

For example, VaxGen, an anthrax vaccine producer, mis-recognized in 2005 the $754
million contract to be paid only after its delivery of vaccine in the early 2006 (WSJ,
book2 #6). With repeated postpone of its financial statements, its external auditor
KPMG found “material weakness” in its accounting and a “lack of adequate depth of
accounting knowledge”; and subsequently VaxGen was delisted from the NASDAQ stock
market (WSJ, book2 #6).

Under the current U.S. GAAP, revenue is recognized under the earning process approach
with revenue recognized when earned and realized or realizable; whereas the proposed
contract-based model recognized revenue based on the net increase in contract position,
i.e. the net increase in contract asset or net decrease in contract liability. With current
practice, revenue is recognized as goods are delivered or services performed, or
estimated and recognized with the percentage completion method based on the
proportion of cost incurred. Under the new model, revenue is recognized when a
performance obligation is satisfied, i.e. when assets are transferred to customers who
obtain control over the asset. In a multiple-element, multiple-delivery contract, revenue
is recognized separately as performance obligation is fulfilled which in turn, depends on
when the assets underlying the obligation is transferred to customers. The amount to be
recognized is estimated as the stand-alone selling price of the assets transferred. In
current practice, either a whole bundle is recognized as a single unit or the elements are
accounted for separately based on vendor-specific objective evidence (VSOE) or other
third-party evidence (TPE) of fair value.

Furthermore, there is no standard to account for the service revenue recognition, a


significant gap given the vast number of revenue recognition standards in the U.S. GAAP.

In addition, if the promised asset comprises of more than one elements or

deliverables, revenue associated with each performance obligation should be recognized

individually based on when the customer possesses the elements or deliverables. For

example, a warranty in a contract is a performance obligation, and the asset to be

transferred is the repair/replacement service. Under current practice, warranty cost is


accrued as an expense in the period when the related goods are sold while the total sales

revenue is recognized at point of sale. However, measured by performance obligation, the

revenue related to providing the warranty service is deferred and is recognized when the

repair/replacement service is performed (table paper). The rationale is that customers

always pay a portion of the selling price on the warranty, either priced separately or

included in the bundle with the goods; hence, warranty itself comprises an asset and its

transfer is complete only after the service is performed.

Exhibit 1. Summary of recent SEC allegations again companies that were involved in

revenue misrecognition.

Date Company SEC allegation


September Green Mountain SEC was investigating its revenue-recognition practice
2010 Coffee Roasters, and its relationship with a vendor, requesting documents
Inc. and other supporting information. (WSJ, book I, #1)
June 2010 Diebold, Inc The company manipulated its earnings at least from
2002 to 2007, overstating its pre-tax income by $127
million. Chief executive agreed to reimburse cash bonus
and stock options. (WSJ, book 1, #2)
October Cadence Design The company recognized the revenue associated with
2008 Systems, Inc some customer contracts signed in the first quarter,
whereas they should be recognized over the life of the
contracts starting from the second quarter, resulting in a
$24 million overstatement of revenue in the first
quarter. (WSJ, book 1, #6)
September, General Electric SEC started investigating GE since 2005, and prompted
2008 Co. GE to make two financial restatements and three
disclosures. Multiple accounting errors were involved,
among which the timing of revenue recognition
concerned about booking the sales of locomotives from
2000 to 2003. (WSJ, book 1, #8)
July 2007 International Among other accounting errors, its Japanese subsidiary
Rectifier, Inc was responsible for pre-mature revenue recognition.
(WSJ, Book 1, #9)
March 2007 Dell, Inc The company delayed filing its 10-K with SEC due to
SEC’s investigation of its revenue recognition practices
as well as other issues, e.g. acruals, reserves and some
balance sheet items. (WSJ, book 1, #11)
November Comverse Delayed filing its 10-K with SEC due to errors in revenue
2006 Technology, Inc recognition for certain contracts as well as in the
recording of certain deferred tax accounts and the
misclassification of certain expenses. (WSJ book 1, # 12)
January VaxGen, Inc The company mis-recognized in 2005 the $754
2005 million contract to be paid only after its delivery of
vaccine in the early 2006. With repeated postpone of
its financial statements, its external auditor KPMG
found “material weakness” in its accounting and a
“lack of adequate depth of accounting knowledge”;
and subsequently the company was delisted from the
NASDAQ stock market (WSJ, book2 #6).
November, Nortel Networks, SEC investigation revealed revenue recognition
2004 Corp. problems in its optical networking and enterprise-
network revenue between 1999 and 2000. (WSJ, book
2, #8)
August Bristol-Myers Channel stuffing: inflated sales by over $2.5 billion
2004 Squibb Co. over 7 years by inducing wholesalers to buy more
drugs than they can sell. SEC levied civil penalties of
$75 million. (WSJ, book 2, #9)

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