Guess what?  It’s the same.

Notwithstanding the debate currently raging about fair-value accounting in this credit crisis, as far as I know, the same revenue recognition guidelines apply whether your company’s revenue is growing in good times, or shrinking in bad times.  All those policies you put in place to comply with US GAAP are still relevant.  The only difference when times are tough is that they will be tested more as pressure on earnings and revenue increases.

Here are some areas that you may be tested on these days.

Side Agreements.  Salespeople may be more inclined to promise things outside the documented arrangement to get an order from a customer.  Now may be a good time to remind everyone about your policy on disclosing such commitments (or get such a policy in place).

Returns.  A downturn is not necessarily a reason to conclude you no longer have the ability to estimate returns under FAS 48 (unless perhaps all your customers are in one industry that is on the verge of collapse).  However, if your practice has never been to offer customers rights of return, stock rotation rights, buy-back arrangements, and the like, then you may start seeing such requests as customers de-risk their own operations.  Trouble is, if you’ve haven’t offered such terms before, you don’t have a history to support your ability to reasonably estimate returns.  Be prepared to have to defer revenue until you can establish a history (which may be a few quarters depending on the length of return cycle you agree to).

Financing.  Resellers and distributors that have had their traditional sources of short term financing for operations either become more expensive or disappear may turn to you as the vendor to help them.  Examples of such assistance are:

• extended payment terms:  this can cause revenue to be considered not fixed or determinable if terms are beyond what you have already defined as “normal”.
• third party financing:  if a bank or other financing source is involved in the transaction, this may change the definition of who your customer is (e.g. if the order comes directly from a leasing company), or may cause you to be incurring incremental risk by participating in the financing (in which case, revenue may have to be recognized as payments are due under the financing arrangement).
• direct financing:  giving a loan or taking an equity stake in a customer not only entails other accounting guidance for that transaction, but could also impact how revenue is recognized (e.g. conversion of outstanding accounts receivable into a longer term note would be considered a concession that would likely make revenue on subsequent sales at least to that customer not fixed or determinable).

Non-standard Arrangements.  Depending on the pressures they face themselves, customers may demand a variety of terms and conditions that you do not routinely deal with.  There is no all inclusive list of what these could be, but some of the more common demands seem to be:  assistance with marketing, commitments to a technology roadmap, PCS buy-downs, and future discounts.  These all have revenue recognition implications that must be assessed at the outset.

VSOE.  All the hard work you did over the past months and years to finally establish VSOE of fair value may be unwound if price reductions impact those elements of your arrangements that typically remain undelivered.  Under the bell-shaped curve approach, lower prices may cause too many outlying transactions.  If you use a stated price approach, not actually charging the stated price when the time comes could lead to a retroactive lack of VSOE of fair value resulting in your losing the ability to apply that method; or worse, a restatement of prior periods if material enough.  Ensure you assess these risks when deciding what element to deep discount.

In the end, bad times may create new and differing facts and circumstances to deal with.  But for any given set of facts and circumstances, the rev rec answer should be the same regardless of the strength of the economy.

My wife (who works for one of the Big 4) said I should entitle this “Working with Auditors” to send a more positive message.  I thought about that and decided that “dealing” with them is still the more accurate verb when I think of interactions between auditors and management.

On the other hand, I certainly would not put auditors in the category of a “necessary evil”.  They are necessary, but they are not evil (for the most part).  While management is responsible for the financial statements, the auditors are the ones putting a signature on the opinion.  None of us should deny they have a key stake.

f you do any public filings of financial statements or otherwise need an opinion on GAAP financial statements, you have to go through an auditor to get them.  If you don’t mind a frustrating audit or review process combined with needless cycles of inefficient discussions, rework, and/or adjusting journal entries, don’t bother reading on.  However, if you want to continue to improve the process of issuing financial statements, here are a few things I’ve noted along the way that tend to create useful paths of least resistance.

Take responsibility for your financial statements.  The audit opinion states the “financial statements are the responsibility of management”.  I still come across some finance executives that think the best way to deal with an issue is to wait until the auditors find it.  This is poor management, not to mention poor control.  However, don’t let your audit team unduly influence your decision when there is a judgment call to make.  Just because it may be a more aggressive position, this does not mean it is objectionable under GAAP, or even inconsistent with their firm’s official position.

Consult and communicate.  Auditors don’t write those memos telling you how to account for transactions like they used to.  However, what they often do now is publish 3-400 page commentaries on certain topics.  Where you have a complex arrangement, these guides are good sources of more fully described interpretations.  And if the arrangement is so complex (provided the transaction is not yet under audit), get the audit team in a room and discuss the issues.  I have not yet found an audit team that is unwilling to do this.  It is not an internal control issue if management is considering all the potential alternatives of accounting for a transaction.

Own the audit process.  Again, they are your financial statements.  So when you get those extensive “to be prepared by client” lists, ensure they are asking for the right things, and update it yourself for any changes in accounts, policies, or any other matters.  And if you are being held to deadlines of various sorts, ensure the audit team reciprocates the emphasis on when things need to be done.  An audit is just another project that needs to be managed like one.

Find productive counterparts.  If you know there is a complex issue to resolve, don’t start with the junior on the job and let him or her escalate it.  Pick the level of responsibility that is required at the beginning of the discussion (at least senior manager or partner) so that any further escalation to their technical group can be done quickly if needed.

Get them comfortable, and get them out.  This works much better if complex issues are resolved during the quarter as deals come in.  At any rate, at some point, once appropriate decisions are made around accounting methodology, and everything is appropriately documented, the audit of the transaction has to have an end (some people call this “pencils down”).  Once you find the remaining issues in your technical memo are your grammar and writing style, that’s a pretty good sign the auditors have what they need.

Some or all of these may seem obvious, but I still observe many management teams struggling with their audit teams.

If anyone has any other helpful hints, feel free to add them via a comment.