Question

we discussed revenue recognition and it's complexities.   In this weeks forum, lets continue the concept of revenue recognition.

So many frauds over time have been surrounding revenue that was either not properly earned or shifted from one period to another.

A common trick for shifting in revenue from the following year into the current year is something called stuffing the channel.   When this is done the selling company convinces the buyer to take more merchandise in the current year than they would normally want and offers them an incentive to do so.   Typically that incentive is in the form of a discount and or extended payment terms for the account receivable.  

So lets say the customer would have normally ordered 1 M units in the fourth quarter of the year.   The seller says, look, buy an extra 1 M units that you would have needed in the first quarter anyway, but buy them now and for that, we will give you a 20% discount and extent the accounts receivable terms to 90 day.   (lets assume that 90 days AR terms was not totally outside of industry standard, so while questionable ethically, not an out right fraud)

Question is, is this activity a fraudulent one, ie stuffing the channel to pull in sales.    You all know the answer. It depends, there is nothing necessarily pulling in a sale, if there is a good business reason, and offering sales prices to do so is acceptable.   But, if it is material and will create unnatural deficit in sales in the next quarter, as the customer will obviously not need more goods, it would be a problem if not disclosed.

So it may nor may not be a problem from an accounting point of view.   From a business point of view, how do you view this. As a shareholder, would you be very happy with the actions of management.   Could they have done this to get a bonus they did not deserve.   Potentially cause a fraud. What about the loss of profit on the sale.   Believe it or not, this behavior is not that uncommon. What do you think of the business practice.

Answer 1

Facts of the Case: Revenue Recognition principles to be followed as per accounring standards to give true and fair view of the company financial position.

Company Practice for adding first quarter sale of next financial year in the last quarter of previous year by giving extra discount jut to increase the top line numerice values. Although same need to be recognised on the revenue recogniiton principle and accordingly reflected in the books of accounts. This practice of increasing top line is not fraudulent activity as per accounting principle.

From a business point of view, how do you view this. As a shareholder, would you be very happy with the actions of management.   Could they have done this to get a bonus they did not deserve.   Potentially cause a fraud. What about the loss of profit on the sale.   Believe it or not, this behavior is not that uncommon. What do you think of the business practice.

But if in the eyes of Business practice, Following things are analysed:

Being Shareholder it is an alarming situation because if same thing is happening over a period of time it means performance during the year is very bad and need some strategical changes in its marketing and sales because as they are not able to meet the targets during the year and such non- performance is trying to make up with end year sales with extra discount.

- Giving extra discount means, lossing the Average sale or Standard sale price fixed,

- Extra burden over the purchsing of raw material ( if production), Extra burden in Stock trading ( Blocking of funds) a complete mismanagement over the funds during the last quarter for just increase of Top line figures.

- Increase in related cost like, Wages and salary of Labours , overtime , Requirement of working capital requirement.

- It will impact the next business cycle as if same is not make up with the new supply in the market against the first quarter sale in the fourth quarter of previous year. Then This vicious cycle will run and increase the likelihood of potential fraud actions.

Although the behaviour is not uncommon but same need to be practice over the financial viability of each enterprises and its management.

From above discussion it can be concluded that business practice once or for in the urgent need to hour can be practice but if sam eis practiced over the longer period of time, Raise and eye of management to look into matter and resolve the same and try to avoid the abovr practice.