FRRP to investigate revenue reporting during downturn

Regulators are trying to head off a looming spike in revenue reporting manipulation as companies come under pressure to spruce up their earnings figures during the recession.

The UK corporate reporting watchdog, the Financial Reporting Review Panel, is looking into how companies record revenue during the downturn. The panel fears the recession will bring with it an increase in the number of companies that succumb to artificial accounting practices to distort and improve revenues.

Markets are extremely sensitive to revenue numbers. During a downturn, cash flow concerns increase, as does the temptation to book takings early. The practice paints a distorted, albeit rosier, picture of financials. The panel is focusing on the housing industry, which is reportedly using flexible payment arrangements to attract cash-strapped homebuyers.

Ian Wright, head of FRRP’s corporate reporting, said he was aware of credit arrangements which allowed homebuyers to stagger payments over time. “The housing industry is a good example of an industry which is under phenomenal stress,” he said. “We have seen comments about new ways of selling houses, changing the terms and conditions of house sales.”

He said he will be investigating the issue and is reminding businesses to stick to the rules and make the proper disclosures when reporting revenue.

It’s not the first time the FRRP has signaled its concern over the issue. In its 2008 annual review it said revenue recognition criteria “is likely to require greater attention during the coming reporting season”.

The review questioned whether businesses should declare their revenue only after they receive it. Rules on the subject are contained within accounting standard IAS 12, however, some businesses have questioned the “sufficiency of the stated policy”.

There is also widespread concern about the practice within the accounting industry. A KPMG study in July found nine out of ten internal auditors believed there was more pressure to distort earnings numbers. At the time, KPMG partner Tim Copnell believed “most people would accept the fact that this happens when organisations are stretched”.

In 2006, a PwC study found the issue was cited in more then 40% of accounting related court cases in that year.

Wright said he will be keeping a close eye on financial statements, especially as the recession approaches its nadir. “We expect unemployment to peak in 18 months time… Business insolvency lags recession and we know that credit is continuing to be extremely hard to find.

“The issue I would like boards to be thinking more carefully about this year is how their business activity has changed and that the way they do their accounting is absolutely sensible and robust.”