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This course provides case studies drawn from "real-life" situations involving CPAs in business and industry. It helps you take a proactive, risk-avoidance stance by pointing out common pitfalls and presenting alternative courses of action. You will explore ethical issues encountered by your peers in business and industry from the perspectives of chief financial officer, controller, audit committee chair and counselor to management, in the context of actual regulatory and court proceedings that were resolved both in favor of and against financial managers, officers and CPAs serving on boards of directors. Gain insights from placing yourself in situations that require application and understanding of relevant ethical considerations for CPAs employed in business and industry. You will consider real-world cases that deal with management integrity, financial reporting and disclosure issues, financial fraud, chain of command and communication issues, corporate crises and professional responsibilities in relation to key industry topics such as revenue recognition, materiality and related party transactions, among others. You will leave this course with a renewed sense of appreciation for the pitfalls faced by financial professionals in business and industry and a heightened sensitivity for the types of ethical dilemmas you could face in the future.
Objectives:
Prerequisite: Experience in financial reporting
733591
Chapter 1
Case 1 – Superlative Software Corp. – You Are the CFO
Learning Objectives
Upon completing this chapter, you should be introduced to
Introduction
The following case study is designed to highlight the most common cause of accounting irregularities, busted audits, restatements, and accounting enforcement actions: revenue recognition. Time and again, financial managers are called upon to make business decisions about how (or if) to record revenues from the sale of services or products. Many of these decisions are made in reliance on the representations of officers or employees of the organization, meaning that your integrity can oftentimes be riding on the integrity of others. While maintaining proper internal controls and procedures are instrumental in addressing many of these issues, personal integrity and the willingness to confront difficult choices are a necessary part of effective financial management. A lack of integrity on your part or on the part of others may condemn the organization to joining the ranks of corporate wrongdoers and may expose you to regulatory, civil, or criminal sanctions. Therefore, when you encounter difficult revenue recognition issues, take time to reflect on the regulatory, ethical, and business implications of your decisions and ask yourself: How will this determination look in hindsight, particularly to someone outside of our company?
Focus Points
The Treadway Commission report that analyzed approximately 200 cases of fraudulent financial statement reporting from 1987 through 1997 found that over 50% of these cases involved either the premature recording of revenues or the recording of fictitious revenues. Moreover, the CEO and CFO were implicated in the fraudulent reporting in 83% of the cases. Most of the cases were brought against companies that lacked an audit committee or had an audit committee that met only once each year.
According to the 2001 Securities Litigation Study conducted by PricewaterhouseCoopers, 57% of the federal securities class action lawsuits filed in 2001 included accounting allegations (excluding IPO allocation cases). Improper revenue recognition is the most commonly alleged accounting abuse, with many complaints alleging violation of the criteria in SFAS No. 48, Revenue Recognition When Right of Return Exists.
According to the 2001 Securities Litigation Study conducted by PricewaterhouseCoopers, 57% of the federal securities class action lawsuits filed in 2001 included accounting allegations (excluding IPO allocation cases). Improper revenue recognition is the most commonly alleged accounting abuse, with many complaints alleging violation of the criteria in SFAS No. 48, Revenue Recognition When Right of Return Exists.
Avoid this Pitfall. Educating the sales force that undisclosed side letters or side agreements are unacceptable as a matter of company policy, and will result in their immediate firing, is important to the company avoiding regulatory action. In cases where quarter-end sales are claimed, financial managers are wise to question the timing of the sales and even seek written confirmation from customers if any doubt exists about whether to book revenue from a sale.
The Huron Consulting Group prepared an analysis of financial restatements that occurred in a five year window and concluded that almost 800 companies had restated their financial statements during 1999, 2000 and 2001. The number of restatements increased each year during this period. Based on the restatement activity in the first six months of 2002 and the implementation of financial statement certifications by CEOs and CFOs that started in July 2002, it is reasonable to expect that the number of restatements will again increase in 2002.
In the Exposure Draft for SAS No. 99 Consideration of Fraud in a Financial Statement Audit, the following statement appeared:
In a public entity, because of the ever-present interest of the investors in the viability, financial condition, and operating results of the entity, there is always some incentive or pressure to achieve a given level of financial performance. [Paragraph 54]
This SAS also highlighted several sources of pressure that may increase the risk of fraudulent financial reporting, including
Avoid this Pitfall. If other members of your management team evidence tendencies to internalize these types of pressures, your integrity (not to mention your professional career) may ride on your ability to withstand such pressures. In talking with the other members of management, remind them that once the company takes the first step down that “slippery slope,” it becomes increasingly likely that more steps will have to be taken, thus leading to a “snowball” effect. If you sense that this is where pressures from third parties are likely to take the company, you need to carefully consider whether you want to be associated with the company under these circumstances. It is interesting to note that many cases of fraudulent financial reporting begin as “minor” adjustments that multiply over time and ultimately result in a restatement that finds the company and its officers the subject of regulatory action. Conversely, a management team that deals with these or other pressures in an honest and forthright manner will command the respect of outsiders and is a desirable place for you to be.
Regulatory Issues
FASB Statements of Financial Accounting Concepts (SFACs), SEC Staff Accounting Bulletins (SABs) and a wealth of Statements of Financial Accounting Standards (SFASs), Accounting Principles Board Opinions (APBs), Accounting Research Bulletins (ARBs), AICPA Statement of Positions (SOPs), Financial Reporting Releases (FRRs) and Emerging Issues Task Force (EITF) issuances give general and specific industry guidance for revenue recognition. (See the discussion in the introduction of SAB No. 101 for a non-exclusive listing of revenue recognition releases, including their industry topics.) Unfortunately, revenue recognition or, more to the point, improper recording and/or recognition of revenues, are also prevalent topics in the SEC’s Accounting and Auditing Enforcement Releases (AAERs) involving public companies, their financial executives, and their auditors.
Revenue recognition is now the regulatory enforcement topic de jour. This is a result of the well publicized use of round tripping by Enron, other energy traders and a host of telecommunications carriers. Round tripping involves the recording of revenues from simultaneous or nearly simultaneous trades of financial instruments, capacity, or commodities by two companies. In most instances, round trip trades should have been characterized as exchanges rather than sales.
Avoid this Pitfall. When dealing with a customer of your company that also happens to be a supplier of products or services to your company, be especially cautious about booking revenues, particularly if the timing or dollar amount of purchases and sales between the companies happen to coincide. Remember that these types of relationships will draw a high degree of regulatory and audit scrutiny, so your files should have backup that will help in delineating why the transactions were proper, necessary and in the ordinary course.
Revenue recognition is without doubt the critical accounting policy to be discussed in Management’s Discussion and Analysis (MD&A). Furthermore, the discussion of any critical accounting estimates that underlie revenue recognition is vitally important to regulators and investors seeking to understand the impact of estimates on a company’s financial performance. Remember, however, as the Commission stated in its release on Current Accounting and Disclosure Issues in August 2001, “The disclosure should be concise and to the point; more disclosure is not necessarily better.” In other words, quality, not quantity.
The following four criteria must be met under SAB No. 101 and SAB No. 104 to recognize revenue: (1) persuasive evidence of an arrangement exists, (2) the product has been shipped and the customer takes ownership and assumes the risk of loss, (3) the selling price is fixed or determinable, and (4) collection of the resulting receivable is reasonably assured. These criteria are consistent with those set forth in SOP No. 97-2, which specifically addresses revenue recognition in the context of software sales. SOP No. 97-2 goes on to state that if software upgrades, enhancements or consulting services are included that are integral to the functionality of the software license, then contract accounting is applied and revenue recognition delayed.
733590
Customer Service
Customer Service
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