According to an article from the Wall Street Journal, Clamping Down on Potential Revenue Recognition Fraud, the following recognition issues have contributed to many financial frauds:
• Improper cut-offs: Holding the books open beyond the end of an accounting period to record end-of-period sales or “stealing sales” from later periods;
• Bill and hold arrangements: Certain sales agreements that allow goods to be sold but not shipped to a customer and are “held” in a company or a third party’s warehouse;
• Sham related-party transactions: Recording intercompany transactions as external sales, and sales of assets from one related party to another;
• Fictitious sales: Shipment of product to a non-existent customer, sales recorded based solely on purchase orders, sales recorded for canceled, or duplicate orders;
• Round tripping: Sale of product with an agreement to repurchase, recording transactions that occur between two companies for which there is no economic benefit to either company;
• Channel stuffing: Offering distributors or other third parties short-term discounts incentivizing them to overbuy, inducing customers to order more goods than they normally would through offers of discounts and other incentives;
• Side agreements: Agreements created outside of the normal and proper recording channels); and
• Early delivery of product/recognizing revenue prior to “earning” or “realizing” the value: Engaging in soft sales, recognizing full amount of revenue on contracts where services are due, recognizing full amount of revenue on fees collected up front instead of deferring or amortizing.
Revenue recognition occurs when the revenue is earned under the accrual basis of Accounting. Under the Cash Basis, revenue is recognized only when cash is collected.
Those seem to be easy to follow principles. But are they?
Why do so many financial reporting frauds then seem to involve Revenue Recognition?