Monday, April 14, 2003

Is That Revenue for Real?

A little over a year ago Duke Energy declared it had finished its "best year ever," despite Enron's collapse and the other problems afflicting the energy business at the time. It reported revenue of $60 billion, by that measure making it the 13th-largest U.S. corporation.

But the "best year ever" didn't look so great the following June, when a task force at the Financial Accounting Standards Board reached a new consensus on how to account for energy trading. Reversing a position taken in 1998, it decreed that energy trades should be recorded on a net, not a gross, basis. In other words, if a company trades an energy futures contract for $100,000 and makes a $2,000 spread on the trade, it should recognize as revenue only the $2,000.

Whoosh. Duke Energy restated its revenues going back to 1997. With 2002 sales of $15 billion, the company ranks 115th on this year's Forbes Sales 500. The stock has fallen from $37 to $13 over the past year.

A lot of puffery has been going into the top line. According to the Huron Consulting Group, a Chicago firm focused on corporate finance and restructuring, revenue recognition problems were behind 85 of the 381 accounting restatements of public companies in 2002. Typical mischief: recording a sale without accounting for the fact that the buyer has the right to return the goods, or, worse, hasn't even taken title to them; counting revenue from deals with unfulfilled obligations (such as future consulting services).

In February the Securities & Exchange Commission filed fraud charges against eight past and present employees of Qwest Communications. The SEC says that, among other things, Qwest cooked up false internal documents to justify treating a $34 million equipment sale as something that could be booked in its June 2001 quarter. Qwest has overstated revenues in other ways, for example, by swapping fiber-optic capacity with other telecom companies. As of the latest tally the company had restated its 2001 revenues downward by $1.3 billion, or 7%.

From July 1997 to July 2002 the SEC launched 227 investigations of suspected financial misreporting, 126 of them relating to revenue recognition. Improper timing of sales is the biggest offense--borrowing from the next quarter in a desperate effort to make the analysts happy for this quarter. The SEC also found 80 cases of utterly fictitious revenues and 21 cases of improperly valued revenue, such as the right-of-return cases mentioned earlier.

Full story (reg. required) at Forbes.com