Revenue Recognition Problems in the Communications Equipment Industry
1 – In late 2000, Lucent announced that revenues would be adjusted downwards by $679 million as a result of revenue recognition problems. Yet the firms market capitalization plummeted by $24.7 billion. Why do you think the market reacted so negatively to Lucent's announcements of the problems?
There is usually a grey zone between aggressive accounting, which is the use of legitimate accounting methods to achieve business purposes, and fraudulent financial reporting, which is the intentional misrepresentation of financial information for business purposes. In this particular case, the company shipped …show more content…
So it is important to remember that any balance sheet account is a potential location for give an incorrectly reported amounts.
Physical Capacity: it is important to verify whether the reporting company has the physical capacity installed to generate the amount of revenue being stated.
Finally, I list bellow a few checklist questions that may guide ones' judgment whether firm is likely to face revenue recognition problems:
What is the company's revenue recognition policy (before, at or after delivery or performance)?
Were there any changes in the revenue recognition policy?
Are there any unusual changes in revenue reported in recent quarters?
How does quarterly changes in revenue compare with industry or selected competitors?
Review disclosures of related-party transactions.
Are there signs of overstated account receivable or other accounts that might be used to offset premature or fictitious revenue?
From the annual data we can clearly see that the receivables growth outpaced sales growth. We can also notice the whopping increasing in days' receivable. These signs alone should be enough to put a red flag on the financial report.
4 – Assess whether any of Lucent's competitors are likely to face revenue recognition problems in the coming quarters?
Applying the same methodology explained in question 3,