The quote “An ounce of prevention is worth a pound of cure” is as prudent today as first written by American forefather Ben Franklin. As it applies to revenue recognition, the axiom is a truth we (at Tensoft) hold to be self-evident.
Yet according to a 2014 report by Audit Analytics, revenue recognition accounted for the sixth largest restatement issue at SEC registered public companies. A whopping ninety-six companies were forced to restate previous financial filings due to improper revenue reporting, the second highest year on record since the depth of the worldwide financial crisis. Given the mounting reputational, regulatory, legal and monetary risks and consequences, the idea of managing complex accounting rules without appropriate controls remains a dubious conundrum.
Take for example a recent restatement from Osiris Therapeutics (NASDAQ: OSIR). Since the accounting revelations emerged one month ago the stock price has fallen a staggering 40% and erased over $275 million in market capitalization, while triggering a material weakness in internal control over financial reporting disclosure. On what has been reported to be less than five million dollars of restatements (a significant portion already reallocated to other quarters), financial reporting integrity was instantaneously marginalized with the bar now set higher as a result.
The issues reported involve distributor contracts and improper period recognition. These are issues which Tensoft’s revenue lifecycle management application could have helped avoid, if not avert, through the proper application of programmatic controls and process automation.
One transaction related to the timing when the distributor achieved full regulatory approval to sell product in a specific country. Using Tensoft, Osiris could institute a rules-based milestone to the contract amount under question to apply revenue within the actual quarter the event occurred. Instead, recognition was applied prematurely and hence erroneous.
Another Osiris issue stemmed from a contract that sets an agreed-upon minimum price. While it is hard to predict all future events that will impact previously recognized revenue (including changes in management estimates), with the Tensoft application one can build into the process the estimates and reserves associated with the change – to have a system and a systematic process that supports decisions as they occur and as future events impact previously recognized revenue.
Finally, restatements were required for distributor transactions where persuasive evidence of an arrangement was not met and subsequently price was not fixed or determinable. As such, it was determined Osiris needed to recognize revenue upon inbound cash receipts. The Tensoft revenue solution supports external future events that impact revenue – such as a revenue and expense hold until cash collection is confirmed. Outside systems – from help desk applications to financial transactions to delivery and usage measurement can all impact revenue – the Tensoft solution is designed to incorporate the full range of external inputs to the revenue recognition process.
The highlighted example coupled with the idea of using an audit-ready, contract through revenue application should be heeded by public registrants and firms contemplating IPO as a preventative approach in navigating the pitfalls of complex technical accounting. Simply adopting a revenue policy without instituting systemic automation may result in costly amendments to reported financials in accordance with SEC constitutionality.
For more information about Tensoft’s products and services for revenue recognition, please visit our website, or contact me.