Financial Accounting Blog

Thursday, September 04, 2003 - Recognizing the Unrecognizable Article in stresses the importance of due diligence and reveals six key tests an acquiror should consider regarding revenue recognition practices before making an acquisition.

"Revenue recognition has perennially been one of the hottest of the SEC’s buttons, but perhaps never more so than now. During the past year the Commission has mounted high-profile investigations of such brand name companies as Xerox, Lucent and K-Mart, as well as several energy and telecommunication companies. SEC staff members have also recently said that the Commission will conduct a sweeping investigation into revenue recognition practices across a range of industries.

Such intense focus on revenue recognition raises at least two concerns for dealmakers. First, this may well be a case of smoke indicating real fire. Studies of detected accounting irregularities have found that more than half of the fraudulent financial reporting cases involves overstated revenue. If a target’s revenues are important in pricing a potential acquisition, the reliability of reported revenue is obviously critical.

Second, given the level of attention that the SEC is paying to this issue, almost any publicly held target’s past revenue recognition practices could be the subject of a post-acquisition SEC investigation. If the parties structure the acquisition as a stock purchase or a merger, the problem will become the acquiror’s."

- posted by Gordon Kwok