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Tech Industry

The Starting Line: A sale by any other name

Although most companies are on track, some are getting tripped up on recording their revenue--and are costing investors billions of dollars in the process.

Making a sale sounds pretty cut-and-dry, but you'd be surprised. Determining when to call a sale a sale has left many companies stymied.

The hubbub lately revolves around "recognizing revenue," which simply means the point at which a company can consider a sale completed and record the revenue earned in its books. So what do you need to recognize revenue? Well, according to the Securities and Exchange Commission, four criteria are required: evidence that an arrangement between the buyer and seller exists, delivery of a product or rendering of a service, a set or determinable price, and an assurance that payment can be collected.

OK, so far this doesn't sound too complicated. But apparently it can be trickier than it sounds. When the SEC officially spelled out those requirements back in 1999, they were considered so complex that the commission was forced to delay compliance two times, to allow companies to go through their books, overhaul their practices and take any charges necessary.

The good news is that most companies had been complying all along. Less than two out of 100 companies reporting in the third quarter of last year needed to make an accounting change, and four in 100 reporting in the fourth quarter needed to make changes.

However, companies are still getting tripped up on the issue.

• PurchasePro was recently forced to delay reporting its fourth quarter due to accounting problems. The company was apparently combining revenue from software sales--which can be recognized in advance of the actual sale to the end user--with revenue from advertising, which is recognized over the life of the contract. PurchasePro also apparently had problems determining whether one of its customers would be able to pay the bills.

• Lucent Technologies also ran into trouble with defaulting customers. The telecom-equipment vendor loaned money to emerging service providers, and then saw the risk of default skyrocket as those companies struggled.

• Recent reports have questioned Computer Associates' accounting policies after it switched methods. Last year, the company changed its accounting policies to a subscription-based system, reporting revenue over the life of a contract as opposed to in one lump sum. While that method allowed the company to report smoother sales figures, critics charged that it allowed the company to cover up what were actually declining sales. The company has denied the accusations.

• E-business software maker MicroStrategy had one of the more high-profile revenue missteps. Last year it was forced to restate its sales and earnings for 1997, 1998 and 1999. The restatements revealed that the company had lost money rather than made a profit in 1999, and earned only about half of what it had previously reported in 1998.

The line between fraud and aggression
To be fair, some of the issues facing tech companies are difficult. Do you book a sale when a product gets shipped to a distributor, or when it gets sold to an end user? Accounting rules can allow both methods depending on several factors.

Most of the problems out there don't stem from blatant attempts at fraud, but "aggressiveness," said Craig Kirsch, vice president of consulting firm eMarket Concepts. Kirsch spent 12 years with Arthur Andersen before heading to the consulting company.

During the heyday of the tech market, investors struggled to find ways to value companies that had little or no earnings. With the traditional price-to-earnings ratio rendered useless, revenue figures were one of the statistics focused on. So it's natural that companies would try to make that number look as good as possible, he said.

For instance, in the e-marketplace field, companies questioned whether to count as revenues the total value of a transaction that went through or the percentage of the transaction collected as a fee.

"Logic tells you you should only be recognizing revenues to the extent that you're generating fees," Kirsch said. "But when these companies were running up high nobody knew how to value them. One of the ways was revenue."

In that example, the inflated revenue figure would be deflated by counting the nonfee portion of the revenue out as a cost of goods sold, leaving the bottom line unchanged. So an auditor looking at those books may have figured, "no harm, no foul," and let it go, Kirsch said.

"Nobody wants to miss the new Microsoft. They look at these things and say, 'We're not hurting anybody here, let's not be aggressive,'" he said.

Now that the market has turned around, however, the books are getting a closer look.

In a recent speech, SEC Chief Accountant Lynn Turner pointed out that problems with revenue recognition have a much wider impact than just the affected companies.

"In recent years, investors have lost tens of billions of their savings, that they worked to earn, as a result of financial fraud involving improper revenue recognition," Turner said. "And at some point in time, investors are going to lose more than their money, they are going to lose their trust in the numbers and the system and people who produce and audit them. We cannot and shall not let that happen."