Revenue Recognition Problems in the Communications Equipment Industry

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Financial Reporting and Analysis – ACG6175 Date: 5/18/09 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…
Lucent's tax rate was 30%, implying that the decline in the Tax Expense and Deferred Tax Liability would be $85.6 million ((679-395)*.3). The full effect of the adjustment would be as follows: 3 – How would you judge whether a firm is likely to face revenue recognition problems? A careful analysis can be helpful in detecting revenue that has been recognized in a premature or fictitious way. The first step should be to notice the first footnote: the accounting policy notes. It is a must read. Besides, among the accounting policies adopted there should be the company's disclosed method of revenue recognition. In reading such note it is important to understand when during the term of a sale or service transaction revenue is recognized. Also it is essential to note that the more that estimates are used in the recognition of revenue, the more open that revenue becomes to creative accounting practices. Usually it is possible to identify some potential characteristic red flags (warning signs) in the following categories: Accounts Receivable: growth in receivables outpacing sales growth and increasing days' receivable. These factors combined are definite causes for concern unless there are obvious operational changes (see exhibits bellow with Lucent's financial data). Steps taken to avert detection: managers willing to deceive financial statement readers may try to cover their tracks. Being aware
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