Question

1a. Please go to the library link and locate an article by Douglas R. Carmichael titled "Hocus-Pocus Accounting." Please read the article and then identify and discuss the issues related to revenue recognition. In your responses, give thought to what you have read in your e-book, lesson, and Becker material. Also, what types of tests would the auditor design to uncover some of these issues?

Answer 1

GAAP : GAAP (generally accepted accounting principles) is a collection of commonly-followed accounting rules and standards for financial reporting. The acronym is pronounced "gap." GAAP specifications include definitions of concepts and principles, as well as industry-specific rules.

GAAP requires that revenue recognition be based on whether the revenue is realized or realizable and earned . Revenues commonly are recognized at the time of sale , usually meaning delivery . Because revenue recognition on bill-and-hold transactions departs from this general practice, the auditor must know how and why a company maintains that using this method is justified. In recent enforcement actions, the SEC said a transaction must meet all of the following conditions to justify revenue recognition.

Issues related to revenue recognition :

• The company must have from the customer a fixed commitment to purchase, preferably in writing.
• The buyer—not the seller—must have requested the transaction and must have a substantial business purpose for a bill-and-hold deal.
• There must be a fixed delivery date that is reasonable and consistent with the buyer's business purpose.
• The seller must not retain any significant specific performance obligations, such as an obligation to assist in resale.
• The goods must be complete and ready for shipment and not subject to being used to fill other orders.
• The exhibit, a confirmation request letter, is an example of how the independent auditor can confirm whether a transaction meets the revenue-recognition conditions.

In planning the audit of all revenue transactions, the auditor must understand the client's industry, business and products as well as its procedures for accepting orders, shipping goods, billing and recording sales and removing product from inventory. When a client engages in bill-and-hold transactions, he or she should determine whether the transactions comply with the SEC's criteria.

There is a long history of other types of revenue-recognition manipulations involving related parties that are connected with fraudulent financial reporting such as

• Sales without substance, including funding the buyer, for example, so collection is assured.
• Sales with a commitment from the seller to repurchase that, if known to the auditor or SEC, would preclude revenue recognition.
• Sales with a guarantee by an entity financed by the seller of what would otherwise be viewed as an uncollectible receivable.

Fraud risk factors. Many related-party transactions are linked to fraud. The auditor should view the risk factors as a warning that fraud may exist, as required by SAS no. 82. If the auditor sees any one—or a combination—of the following risk factors, he or she should react accordingly:

• Significant related-party transactions outside the ordinary course of business or with unaudited entities.
• Significant unusual or highly complex transactions, especially those close to the end of a reporting period.
• Significant bank accounts or operations in tax havens for which there appears to be no clear business justification.
• An organizational structure with a high degree of complexity that is without apparent business purpose.
• Difficulty in determining who controls the entity.