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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.
individually based on when the customer possesses the elements or deliverables. For
revenue related to providing the warranty service is deferred and is recognized when the
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
Exhibit 1. Summary of recent SEC allegations again companies that were involved in
revenue misrecognition.