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Revenue Recognition Trips Up Auditors, Clients

Audit firms that were found deficient during PCAOB inspections usually accepted the way a client company accounted for sales in the past, rather th...
Marie LeoneSeptember 16, 2008

As U.S. and international accounting standard setters work to fix, and then converge, rules related to revenue recognition, preparers and auditors still struggle with proper real-world application of the regs. Indeed, during a meeting held in New York last week, a top official at the Public Company Accounting Oversight Board noted that revenue recognition issues regularly trip up audit firms. Further, a new survey of senior finance executives concluded that revenue recognition is one of the most complex and risky accounting issues of the day.

At the meeting, sponsored by the New York State Society of Certified Public Accountants, revenue recognition topped the list of deficiencies uncovered by the PCAOB in their inspections of audit firms, said Paul Bijou, the deputy director of inspection at PCAOB. Bijou noted that in virtually every review performed by the PCAOB, inspectors “see elements that audit work could be better” with regard to revenue recognition.

Bijou said that trouble spots included the way auditors assessed multi-element contracts, contracts that lead to revenue, revenue “cut offs,” and timing related to acceptance of product.

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For example, when it comes to reviewing contracts that lead to revenue, audit firms that were found deficient usually accepted the way a client company accounted for sales in the past, rather than checking for updates that might have an affect on reporting — such as new shipping terms. He said that PCAOB inspectors often spot changes that may affect revenue recognition processes in footnote section of regulatory filings.

In another example, Bijou cited shifting revenue cut-off dates as being problematic, pointing out that PCAOB usually identifies such actions during periods when bonuses are doled out. Some auditors lack diligence in ferreting out situations in which company executives book revenue early so they qualify for bonuses; or conversely, delay booking revenue after they’ve qualified for their bonus as a way to start the next period off ahead of the game.

Bijou said that the PCAOB team once had a top-ten list of “significant or frequent auditing or quality-control deficiencies” that it culled from its five years of inspections. But this year, the list grew to 11 items. They areas are: revenue, related-party transactions, equity transactions, business combinations and impairment of assets, going concern considerations, loans and accounts receivable (including allowance accounts), service organizations, use of other auditors, use of work prepared by specialists, independence issues, and concurring partner review.

The survey, conducted by and IDC, polled 586 senior finance executives, and found that 42 percent of the respondents believe that revenue-recognition reporting causes the most errors and inaccuracies in financial statements. Contract management, which gained only 14 percent of the vote, came in second, with planning and budgeting (11 percent), and account reconciliations (10 percent) rounding out the top four answers.

Thirty-five percent of the respondents thought that revenue-recognition reporting was the most complex corporate accounting process to manage, while 57 percent asserted that revenue-recognition errors had the highest level of materiality in financial-statement reporting.

Before the end of the year, the Financial Accounting Standards Board is set to release a discussion paper aimed at changing revenue-recognition rules and guidance. One potential area to be addressed is reducing the many industry-specific rules into a single general standard.

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