Free Financial Shenanigans: How to Detect Accounting Gimmicks & Fraud in Financial Reports, 3rd Edition by Howard Schilit, Jeremy Perler Page B

referred to as “mark to model” or “mark to make-believe”).
     
Warning of Premature Revenue Recognition: Companies adopting an acceptable methodology (such as percentage-of-completion or mark to market) that was intended for other industries.
     
    Mark-to-Market Accounting Became a Revenue-Enhancing Drug for Enron. When a company selects a permissible accounting method (such as mark to market) that is intended for a different industry (such as financial institutions) or a different type of transaction, investors should view this act no differently from selecting an approach that is explicitly prohibited by GAAP. (Auditors, take note of this point!) By adopting an accounting methodology that completely belied the economics of its utility business, Enron rapidly accelerated revenue that should not have been earned for many years.
     
    Now it should be clear to you how Enron’s revenues grew at an unprecedented rate—from $10 billion to $100 billion in four short years, while it took most of the others in the elite “$100 billion club” decades longer to reach that lofty peak. Mark-to-market accounting used inappropriately by Enron and undetected (or simply blindly unquestioned) by its auditor can be viewed for what it really was: a “revenue-enhancing drug” that seduced investors.
     
    3. Recording Revenue Before the Buyer’s Final Acceptance of the Product
     
    In the first two sections of this chapter, we focused on the seller’s performance of its obligations under the contract. In the next two sections, we shift our focus to the buyer. This section deals with three types of tricks that produce revenue before final acceptance by the buyer, specifically, recording revenue:
(1)  before the shipment of product to the buyer
(2)  after shipment, but to someone other than the buyer
(3)  after shipment, but while the buyer still has the ability to void the sale
     
    Seller Records Revenue Before Shipment
     
    One problematic and often controversial method of revenue recognition involves so-called bill-and-hold arrangements. Under this approach, the seller bills the customer and recognizes revenue, but continues to hold the product. For most sales, with a few exceptions discussed in the prior section, revenue recognition requires shipment of product to the customer. Accounting guidelines allow revenue to be recognized in bill-and-hold transactions, however, provided that the customer requests this arrangement and is the main beneficiary. For example, if the buyer does not have adequate storage space, it may ask the seller to hold on to the purchased goods as a courtesy. Under no circumstances can early recognition of revenue occur under a bill-and-hold arrangement if the arrangement is initiated by the seller for the benefit of the seller (i.e., to record revenue at an earlier date).
     
    Watch for Bill-and-Hold Transactions Initiated by the Seller . If a seller initiates a bill-and-hold transaction, investors should assume that the seller is attempting to recognize revenue too early. For example, Sunbeam CEO Al Dunlap used a bill-and-hold strategy in order to make the company’s financial performance appear better than it really was by artificially inflating Sunbeam’s revenue.
     
    Sunbeam, anxious to boost sales in its “turnaround year,” hoped to convince retailers to buy grills nearly six months before they were needed. In exchange for major discounts, retailers agreed to purchase merchandise that they would not physically receive until months later and would not pay for until six months after billing. In the meantime, the goods would be shipped out of the grill factory in Missouri to third-party warehouses leased by Sunbeam, where they would be held until the customers requested them.
     
    Nonetheless, Sunbeam booked the sales and profits from all of the $35 million in bill-and-hold transactions. When outside auditors later reviewed the documents, they reversed a staggering $29 of the $35 million and