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Revenue recognition problems in the communications equipment industry

Hire Writer 2 What are the specific revenue recognition problems faced by Lucent?

  • In fact, the products were not passed on to the customers, because of their weakened financial condition, and Lucent had already verbally agreed to take back the equipment;
  • This means that Lucent was selling products extending financing rather than collecting cash;
  • Thus, they were highly dependent on that client and had most likely build up a close relationship with them, both concerning equipment sales and credit granting;
  • There were four different reasons for the adjustment;
  • The lack of a proper internal reporting organization or of efficient external auditors therefore is a sign of increased risk of revenue misrepresentation;
  • The fact that these reports were approved and published suggests awareness and involvement of the board of administrators in the revenue-recognition problems.

There were four different reasons for the adjustment. In fact, the products were not passed on to the customers, because of their weakened financial condition, and Lucent had already verbally agreed to take back the equipment. Therefore, the sales could not be accounted as revenues.

Revenue-Recognition Problems in the Communications Equipment Industry Essay

As the credits were meant for use at a later date without an actual sale of equipment taking place, these could not be accounted as revenues in the fourth-quarter. In our treatment of the accounting figures we found it necessary to make assumptions relating to tax rates and COGS, as the information is not given directly.

However, we do not know the costs of neither intangible nor tangible assets due to a lack of information and thus assume a representative cost mix that is proportional to total revenues. On the balance sheet this is reflected in the increase of inventories for tangible sales, and other current assets for intangible sales.

The lack of a proper internal reporting organization or of efficient external auditors therefore is a sign of increased risk of revenue misrepresentation. It is also important to mention that the events described in the case occurred before the Sarbanes-Oxley Act was enacted.

This means that, at the time, financial statements did not require a seal of approval from top management in order to be published. The fact that these reports were approved and published suggests awareness and involvement of the board of administrators in the revenue-recognition problems.

Investors will typically overreact at the first sign of negative news from a company, triggering sharp sell offs in stock, as was the case with Lucent, during the height of the dotcom bubble.

  • Cash Flow Returns should therefore stabilize again in the near future;
  • On the other hand, Nortel does not depend on any single client;
  • This could mean that Nortel is trying to attract customers by aggressively offering financing;
  • Therefore, the sales could not be accounted as revenues;
  • It is also important to mention that the events described in the case occurred before the Sarbanes-Oxley Act was enacted;
  • Secondly, when companies rely on a distribution network rather than on direct sale it is easier for them to engineer revenue-boosting activities e.

This means that Lucent was selling products extending financing rather than collecting cash. Secondly, when companies rely on a distribution network rather than on direct sale it is easier for them to engineer revenue-boosting activities e.

Thirdly, relying on big clients accounting for a large percentage of revenues increases may enhance corporate relationships, thus facilitating non-transparent verbal agreements or offbalance-sheet operations e.

In addition, any changes in accounting practices and assumptions accounted for in the income statement should be investigated closer as a possible case of accounting fraud, as in the case of Lucent. This is enough to say that a revenue recognition problem exists, but certainly warrants further investigation.

Finally, incentives of a more general nature to accounting malpractice include regular evaluation of company credit quality by rating agencies, and distorted compensation incentives for management. This could allow them to boost their revenues by selling excessive amounts to distributors close to the end of a quarter and taking the equipment back afterwards. On the other hand, Cisco does not rely on a single client, but has a diversified client base.

Thus, they were highly dependent on that client and had most likely build up a close relationship with them, both concerning equipment sales and credit granting. This increases the risk of false revenue recognition due to either channel stuffing or the sale of equipment meant to be taken back if not sold close to the end of the quarter. This could be a red flag for revenue-recognition issues as services may have no clear delivery date and thus allow revenue management.

Revenue-Recognition Problems in the Communications Equipment Industry Case Solution

This could mean that Nortel is trying to attract customers by aggressively offering financing. On the other hand, Nortel does not depend on any single client.

However, this movement by itself is not a red flag and could be due to other factors, which calls for a more detailed investigation. We can see that the suspicious decrease in cash flow return is mainly due to a substantial increase in sales and can also be seen in a substantial increase in accounts receivables.

  • This means that Lucent was selling products extending financing rather than collecting cash;
  • In addition, any changes in accounting practices and assumptions accounted for in the income statement should be investigated closer as a possible case of accounting fraud, as in the case of Lucent;
  • This is a very good sign and means that these two still manage to collect their receivables in a timely manner although sales increase rapidly;
  • There were four different reasons for the adjustment;
  • However, this movement by itself is not a red flag and could be due to other factors, which calls for a more detailed investigation;
  • This could mean that Nortel is trying to attract customers by aggressively offering financing.

This is a very good sign and means that these two still manage to collect their receivables in a timely manner although sales increase rapidly. Cash Flow Returns should therefore stabilize again in the near future. How to cite this page Choose cite format: