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Day 6

Fraud in Revenue Recognition

The rules have changed over time to help prevent fraud, but we thought it would be fun to explain how companies can bend the rules to make their financial statements look better than they really are. After watching the video below, scroll down to the bottom for your homework.

Your Homework

Which of the following are considered improper revenue recognition practices:

a) A pharmaceutical manufacturer approaching the close of a financial quarter ships an excessive amount of prescription medicine to wholesalers and books the entire amount as revenue knowing that there is a high probability that the product will be returned by wholesalers in the following quarter due to overstock.

b) A software company gains 1M new subscribers who opt for the upfront discounted annual price rather than the monthly subscription. The software company collects all the cash and recognizes the entire revenue at month one.

c) A theme park company enters a non-binding exploratory agreement with an international land developer and decides to account for 100% of the licensing royalty revenue it will collect if the deal goes through in its revenue forecast.  

Scroll down to see the answer.

Answer

All three are improper revenue recognition decisions.

a) Bristol Myers Squibb was charged in federal court for channel stuffing.

b) Regardless of cash collection, the revenue needs to be spread over time including an average churn rate for customers for that line of business.

c) Business development initiatives are not guaranteed revenue, especially if non-binding. The revenue being forecasted should be hedged or not reported at all as a forecast.

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