Issues with revenue recognition have been around for decades. The American Institute of CPAs and the U.S. Securities and Exchange Commission have tried to provide detailed guidance to assist companies in their revenue determinations for complicated transactions. Ultimately, the appropriateness of revenue recognition boils down to the facts and circumstances of a given sale. There certainly are intricate revenue recognition rules (especially related to software), but many of the issues about premature recognition result from the normal blocking and tackling required by Staff Accounting Bulletin No. 104, "Revenue Recognition," which requires persuasive evidence of a sales arrangement, delivery, a fixed or determinable sales price and that collectability is reasonably assured.

Public companies can improve their chances to avoid revenue recognition issues by enhancing the information that is obtained from a company's own sales personnel by implementing a sales checklist and/or sales certification. There has been a tremendous effort made by public companies to provide revenue recognition training to their sales personnel. Training is a good first step, but material covered is easy to forget and often doesn't provide the level of detail that might make the light go off in a salesperson's mind for identifying a potential revenue recognition problem. Assuming that the sales personnel do not have an accounting background, it is unrealistic to expect them to understand and appreciate the significance certain situations may have on revenue recognition simply from having taken some training—save those salespeople that create fake purchase orders or other fraudulent activity. Salespeople are on the front lines with the customer and often have greater insight into the reasons for the transaction, as well as other facts that may be potentially accounting-determinative. By implementing a sales checklist to obtain information from the sales personnel, public companies are better positioned to appropriately analyze revenue recognition on the front end and to defend such determination, if questioned, on the back end.

Here are some examples where the sales personnel are in the most likely position to have an awareness of the facts that may challenge revenue recognition:

  • Side Letters – Side letters are oral or written promises that are made by a salesperson that essentially negate a term within the official sales documentation. This may seem to the salesperson to be an innocent gesture to alleviate a customer's concern but could have revenue recognition implications. From an extension of the right to return the product to the lengthening of the payment terms, these modifications can create challenges to revenue recognition. A proactive request of the sales personnel can help elicit the existence of these letters/promises and can deal with the accounting consequences prior to premature recognition.
  • Channel Stuffing – This revenue recognition issue stems from sales to a customer that already has a large amount of inventory of a public company's product. Personnel who are not immersed in accounting might wonder why it matters how much inventory a customer has. It matters because selling to a customer who already has excess quantities of a public company's inventory may lead the customer to ask for a concession in the future. That is, if a customer cannot use/sell the inventory in time to pay for the product, it might (1) ask to return the product, (2) ask to extend the payment terms, (3) ask for a further discount or (4) worst of all, never pay for the product because the ability to pay would require the customer to sell the product to its own customers. This typically is not an issue for a customer that is taking advantage of an end-of-quarter sale in order to capitalize on the public company's promotion and that may slightly bloat its inventory but does become an issue for a customer that has at least two quarters' worth of inventory on hand. Although sales personnel may not always have an acute awareness of the exact inventory level of each client, they are much closer to the facts than accounting personnel.
  • Contingencies – There are many other circumstances that can serve to challenge revenue recognition. The technical accounting term for these situations is "contingencies," but these situations simply encompass any other facts that may cause a customer not to pay for a product the public company is selling. For example, a customer intends to install the product it is purchasing at a specific place where a lease is required but has yet to obtain the lease. If, ultimately, the lease is not executed, this may cause the customer to reject the purchase—whether or not it has the right to do so. Once again, these facts may sound as if they are the customer's issues and not something about which the public company needs to concern itself; however, some situations can create challenges to revenue recognition. A company is not required to seek every last detail about a customer's reason for the purchase and surrounding circumstances, but if the salesperson is aware of the particulars, such issues should be considered when recognizing revenue. A sales checklist can help identify and address the potential for problematic contingencies.

Sales Checklist/Certification – A sales checklist or sales certification is a process where individual sales personnel answer questions about the facts surrounding a given sale that may have accounting implications. Each sales person provides an affirmative certification by answering questions about the circumstances surrounding their sales with the goal of identifying any challenges to revenue recognition that are known to exist. As you consider your strategy for the sales checklist and/or sales certification, keep these points in mind:

  • Try to find the right balance between a checklist for each sale and a quarterly checklist/certification for all sales made by every individual salesperson during a quarter. For companies with relatively few sales, a checklist for each sale usually is preferred. However, sometimes a hybrid approach makes the most sense—where sales over a certain amount have a specific sales checklist, but those below that threshold are covered by a quarterly sales certification.
  • Do not use accounting jargon—like "contingencies"—in the checklist/ certification. The best way to get the facts is to be clear. If there are specific examples that you have encountered in the past, use those examples for your questions. The more a salesperson can relate to the questions, the better the information you will get.
  • It already is extra work so design the checklist/certification to be simple and easy to complete. Try to keep the checklist/certification to one page with yes/no questions. This should save time for everyone involved in the process but still accomplish the desired objective.
  • Consider whether there are additional personnel within the sales process who should be included. For example, depending on the roles at a given company, customer service representatives or sales assistants may have a detailed awareness of the circumstances surrounding a sale.
  • Be sure that the responses to the sales checklist/certification are reviewed by accounting personnel—not merely collected and stored away. The last thing you need is for a salesperson to do exactly as you have asked and provide the facts, only to have accounting file the checklist/certification away without addressing the potential challenge to revenue recognition. Be sure to assign responsibility for both the review and retention of the checklist/certification to specific parties.

Sales Checklist/Certification Questions to Consider – By reflecting on revenue recognition issues that have arisen in the past, by considering revenue recognition issues that have been challenges within the company's industry and by analyzing recognition issues that a company faces, public companies can develop the most relevant and appropriate questions to include in the sales checklist/ certification. It can be beneficial for accounting personnel to brainstorm with sales personnel when developing the checklist/ certification questions. Here are some sample questions to consider related to the revenue recognition issues discussed above:

  • Have you made any promises (oral or written) to a customer that it may return the product if not satisfied and/or can't resell the product?
  • Have you made any promises (oral or written) to a customer that it will not have to pay if not satisfied and/or can't resell the product?
  • Have any discounts been extended to a customer that are not included in the purchase order?
  • Are the payment terms triggered by delivery (for example, a customer does not have to pay until after installation)?
  • Does the customer believe it has the right to terminate or cancel the order for reasons other than those included in the order?
  • Are there any other payment terms or arrangements not written with the order?
  • Have you asked a customer to purchase more product than is needed or can be used within a reasonable period of time?
  • For companies that use distributors: Are you aware of any distributors that have more than six months of inventory but continue to make significant purchases?
  • Are you aware of any issues with payment, satisfaction or anything else that a customer has mentioned to you?
  • The sales checklist/certification will not solve all your recognition problems, but it will help bridge the information gap between sales and accounting, help avoid premature revenue recognition and provide evidence of the public company's diligence in its revenue recognition process should insiders or outsiders later question the revenue recognition determinations.

The views expressed herein are those of the author and do not necessarily represent the views of FTI Consulting, Inc. or its other professionals. (c)FTI Consulting, Inc., 2011. All rights reserved.