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Sarbanes-Oxley, revenue recognition, and whistleblower protection

Employees of publicly traded companies who complain about fraudulent revenue recognition are protected from retaliation under the federal Sarbanes-Oxley Act.

Revenue recognition is a fundamental business requirement that a company shall not recognize revenue until it is realized, or realizable, and earned by the company. Sales-based performance incentives, management pressure to meet revenue growth goals, and aggressive analyst projections can increase the risk of fraudulent revenue recognition. The same concern exists when a company sees changing trends in shipments into, and sales from, a sales channel or separate customer class that could be expected to significantly affect future sales or returns.

Transactions must meet the following criteria before revenue is legally recognized:

  • There is persuasive evidence of an arrangement.
  • Delivery has occurred or services have been rendered.
  • The seller’s price to the buyer is fixed or determinable.
  • Collectability of payment is reasonably assured.

Below are some examples of schemes companies use to fraudulently misstate revenues.

Conditional sales — The transactions are recorded as revenues even though the sales involve unresolved contingencies or terms that are amended with side agreements which often eliminate the customer’s obligation to keep the merchandise.

Sham sales — Company representatives falsify inventory records, shipping records, and invoices and record the fictitious transactions as sales.

Premature revenues before all the terms of the sale are completed — Generally, this scheme involves recording sales after the goods are ordered but prior to shipping them to the customer.

Barter or “swap” deals – The company agrees to swap unwanted merchandise it sold to a customer for new products or services.  Or, the company agrees to accept something non-monetary from the customer for goods and services. These transactions should be treated as an exchange of assets rather than a sale.  Under an exchange, a company can’t book any extra revenue except to the extent that the value of the asset it sells is greater than the value of the asset it buys.  Barter transactions affect revenue recognition.  Companies must include the fair market value of bartered goods when calculating revenue.

Pamela A. Smith
Law Office of Pamela A. Smith
233 Needham Street, Suite 540
Newton, MA 02464


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