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Assignment Content Competency Evaluate accounting-related legal and ethical business implications. Student Success Criteria View the grading rubric for this deliverable by selecting the “This item is graded with a rubric” link, which is located in the Details & Information pane. Scenario During your weekly meeting, the Director of Accounting has shared with you the topics discussed at a recent Association of Certified Fraud Examiners (ACFE) meeting. Of particular interest was the agenda item about how some companies have gotten in regulatory trouble with the SEC over their revenue and expense recognition practices. While you both are confident that there are no issues relating to this at your company, you both decided that you wanted to learn more about these cases. The Director of Accounting wants you to research two such cases and write a summary report to present at the next Accounting Department meeting. The director believes that understanding what has happened to other companies in this area of accounting can help prevent issues in your company. The Director provides you with the SEC website that they have used in the past to do article searches: www.sec.gov Instructions You are asked to select two recent SEC actions against companies (not individuals) that relate to revenue and expense recognition and Prepare a Word document that: summarizes reasons for the SEC actions. identifies the SEC issues related to accounting data and/or operations and the remedial actions assigned and/or penalties given to the company. critiques the remedial actions/penalties. Gives an opinion as to whether you believe they will be effective in preventing future violations by the company. Companies in the United States are broadly broken down into two categories: public and private. The distinction between the two types leads us into our discussion about the financial statements disclosures that are required based on U.S. regulations. This type of company is large in size  This can be either a public or private company. There is a misconception that private companies are small but there are actually a lot of large companies that are privately owned.  Granted permission by the SEC to sell securities to the public  This would be a public company. The SEC must grant a company permission to sell securities on the public stock exchange.  Not required to disclose their financial information to anyone  This would be a private company. They can decide if and how they would disclose their financial information. Public companies are required to provide full disclosure. Traded on the stock exchange   This would be a public company. Although private companies cannot trade on a public stock exchange they may still be able to sell a limited amount of shares without registering with the SEC.  When we cover financial statement disclosures, we will focus on public companies, as private companies are not required by law or regulations to disclose financial or operating information. Financial disclosures generally come from two sources: (1) SEC Disclosure Laws and Regulations and (2) Generally Accepted Accounting Principles (GAAP). Security and Exchange Commission (SEC) The Security and Exchange Commission is the main rule making body that affects public company financial disclosure. The SEC regulations have statutory authority and have changed over time. The most dramatic recent change was in 2002 when the Sarbanes Oxley Act (SOX) was passed as a result of a number of accounting scandals and the bankruptcy of Enron in 2001. SOX requires that public companies disclose specific financial and operational data to the SEC and shareholders. Specific requirements include an annual report, called a Form 10K, where the content is strictly governed by federal statute. Form 10K includes detailed financial and operating disclosures as well as management’s answers to specific questions about the company’s operations. In addition, the SEC requires that the financial statements are audited and attested to by an independent CPA firm. The financial statements include two years of balance sheets and three years of income statements and statement of cash flows. In addition, there must be five years of selected financial data. Generally Accepted Accounting Principles (GAAP) The Financial Accounting Standards Board (FASB) is the independent organization that establishes financial reporting standards companies must follow in preparing audited financial statements. While the SEC and FASB are two separate independent organizations, FASB is recognized by the SEC as the designated accounting standard setting authority in the professional accounting profession. In other words, these two entities cooperate and rely upon each other. Generally Accepted Accounting Principles require that certain financial and operating information be disclosed in a company’s audited financial information. While these required disclosures do not have the force of law as SEC regulations, they do in some cases exceed SEC requirements. Resource(s) Wiley GAAP 2019 : Interpretation and Application of Generally Accepted Accounting Principles What is Revenue Recognition? Revenue recognition is the process of recording revenue on our income statement. Although this sounds pretty straight forward, and most of the time it is, there can be some ambiguities as to the precise moment revenue should be recorded and in which accounting period. Fortunately, we find guidance within Generally Accepted Accounting Principles (GAAP). The timing of when we recognize revenue is really a combination of two accounting principles: (1) the matching principle and (2) the revenue recognition principle. By using these two concepts, we can identify the precise period in which to record the revenue from an economic transaction. Let’s review these concepts: MATCHING PRINCIPLE  The Matching principle requires us to match expenses with their related revenues in the same period.  REVENUE RECOGNITION PRINCIPLE  The revenue recognition principle requires us to realize (record) revenue when it is earned.  COMPLEX REVENUE TRANSACTIONS  The general rule is we will recognize revenue when a qualifying event has occurred, and the amount is measurable. However, as it is true with many rules, there are exceptions. There are also complex  Revenue is the cornerstone of any business. Every business depends on sales. This is often referred to as the “top line” because it is the first line of the income statement. If the top line is not correct or accurate, then net income will not be correct or accurate. Let’s look at the how we determine when revenue is earned. Revenue is realizable when it has been earned. This means that the goods or services have been provided AND payment is reasonably certain. In other words, the revenue generating activity is complete. In accrual accounting, the receipt of cash can be a separate transaction from the earning of revenue and payment is not a requirement for revenue to earned. The general rule is we will recognize revenue when a qualifying event has occurred, and the amount is measurable. However, as it is true with many rules, there are exceptions. There are also complex transactions that can make the timing of the recording of revenue difficult. Consider the situation where a company has signed a three-year contract to provide a number of services over those three years. The contract provides just a total dollar amount for all services over the three-year period. When does the revenue get recognized? At the end of the contract, after all the services are provided? To handle difficult or complex revenue situations such as the one described above, the Financial Accounting Standards Board (FASB), along with the International Accounting Standards Board (IASB), issued the Accounting Standards Codification (ASC) 606 with provides a uniformed framework for how to recognize revenue from contracts. The previous framework was more industry specific and very fragmented. The underlying concept in ASC 606 is that revenue is recognized when the delivery of goods or services matches the amount of consideration expected. To help with the determination, there is a five-step process to follow: 1. Identify the contract(s) with the customer 2. Identify the performance obligations 3. Determine the transaction price 4. Allocate transaction price to the performance obligations 5. Recognize revenue as each performance obligation is satisfied While this framework is a positive step in the standardization of revenue recognition of contracts, there can still be steps in this process that can require a significant amount of judgement and detailed evaluation. Resource(s) Wiley GAAP 2019 : Interpretation and Application of Generally Accepted Accounting Principles What is Expense Recognition? Expense recognition is the process of recording expenses on the income statement. As with revenue recognition, this sounds pretty straight forward, and most of the time it is. However, there can be some ambiguities as to the precise moment and amount an expense should be recorded and in which accounting period. In order for our financial statements, in this case the income statement, to be accurate and provide useful information to managers, it is important that revenues in any given period are matched with expenses incurred in generating those revenues. The expense recognition concept is similar to revenue recognition concept, as we will rely on the matching principle for guidance in helping us record expenses. The matching principle states that expenses should be recognized in the same period as the revenues to which they relate. If this were not the case, then the income statement would not give us an accurate depiction of the actual net income was from month to month. It might even show inconsistencies that do not really exists that could lead management to make erroneous decisions. Let’s take a look at the flow of expenses though the financial statements. This diagram depicts how costs affect the balance sheet and income statement. As you can see from the diagram, things we purchase for the business (as indicated by the box on the left labeled “Cost of Items Purchased”), basically take one of two paths. (1) The balance sheet to income statement path. If we buy something, but don’t immediately use it, consume it or sell it, then the cost is recorded on the balance sheet until the point in time in which we do use it, consume it or sell, and it is at that time we recognize the expense (move it from the balance sheet to the income statement) to match expenses with revenues. (2) The direct to income statement path. If we purchase something and immediately use it consume it or sell it, the expense is recognized on the income statement immediately. For costs that follow the first route (balance sheet then income statement), note how we use the balance sheet as kind of a “parking lot” for costs we have not yet incurred or recognized. Typical costs that follow this route are inventory, prepaid expenses and long-term assets. Think of this as “using” an item. A factory truck gets “used” over time. So, we allocate the amount “used” in the appropriate income statement period. This is what is known as depreciation in an accounting sense. Costs that follow the second route (recognized immediately on the income statement) are usually called period costs. We will often find that some expenses are difficult to “match” with revenue. Some examples are administrative salaries, rent, and utilities. These expenses are charged to expense in the period with which they are associated. This usually means that they are charged to expense as incurred. Regardless of how the costs flow through the financial statements, the concept and intent are the same. Make sure that expenses are recognized in the appropriate period. The appropriate period is defined as when the revenue that they earn was recorded. In other words, when we recognize a dollar of revenue on the income statement, we must recognize ALL the expenses that were incurred in earning that same dollar of revenue.