Effect On Stock Price Of Financial Restatements As A Result Of Revenue Recognition Errors

Abstract

Revenue recognition came to the forefront of accounting debates several years ago as a result of the meltdown of high tech and telecommunications companies. Many of these corporations had recognized sales in the current periods for contracts that had future deliverables. This created significant misstatements that made some companies that were actually operating in the red seem as though they were profitable. SAB 101 was issued in December 1999 to clarify the basic framework for the proper timing of revenue. As Lynn Turner of the SEC stated in a May 2001 speech, “It was based on four bedrock principles established by GAAP: 1) persuasive evidence of an arrangement exists, 2) delivery has occurred or services have been rendered, 3) the seller’s price to the buyer is fixed or determinable, and 4) collectability is reasonably assured.” These guidelines apparently were not clear enough, as more companies were investigated for revenue recognition problems. This led to the issuing of SAB 103 and 104 in late 2003 that further detailed the specifics of when to recognize revenues. SAB 104 focuses on the areas of bill and hold arrangements, immaterial obligations, and nonrefundable up-front fees, and how all these factors affect cost of goods sold and the resulting revenues. The year after the release of SAB 104 saw additional companies restating their revenues in order to comply with the new standards. You would presume that revenue accounting standards would have naturally evolved over all of these releases to straightforward, robust, and consistent across transactions, industries, and countries. Sadly, however, today’s revenue accounting standards exhibit none of these qualities, and stakeholders are forced to make poorer economic decisions as a result. By research, we found that the gross amount of the restatement did not affect the stock price as much as other factors. But the largest drops were usually connected to companies where the restatement announcement was coupled with other bad news. Industry differences were more pronounced.