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Cooking the Books: Stretching the Principles of Revenue Recognition

John is CFO at a venture-backed tech startup with revenues of $20 million and approximately 80 employees. He's worked at the company for several years, and now reports to Ralph, the company's newly hired CEO.

The company had been doing really well, but recently big customers have been placing fewer orders and Ralph is feeling pressure to show growth. This pressure is amplified because the company is venture-backed, and the investors expect results.  While the company did well in the first round of funding, if they don't perform now, they may have trouble with gaining sufficient funding in the second round, which could mean the end of the company.

All of this was on John's mind when Ralph came to him about recording a major order that was still under negotiation. The deal had not gone through, although both parties expected to complete the deal in the next week. With the current quarter ending in the next few days, including this order would give a significant boost to the company's financial reports. Nonetheless, under the generally accepted accounting principles (GAAP), it is clear that this order does not qualify as revenue.

Even so, Ralph was adamant about John booking the order, which could make all the difference in the company's ability to stay afloat. John knew that doing so would constitute fraud; particularly because the Sarbanes Oxley Act requires the CEO and CFO to sign off on all quarterly reports. At the same time, John knew that this order could make all the difference.

What should John do?

Posted June 2013

Comments Comments

Modupe Sarratt said on Jul 29, 2015
John should considered that any practice of dishonesty is a fraud for bad business. Fraud is a downfall for and will not boost the company financial report if the deal did not go thru. However, I think John could indicated having negotiating a deal that has potential to boost the company financial state if the deal go thru. The old saying "Honesty is the best policy for best practice" means you will never go wrong with acting on the truth because the truth set you free.
Gene Severance said on Jul 31, 2015
Obviously, John should not commit fraud. However, in the notes section the pending contract should be identified, the dollar value and difference noted by changes in financial ratios
Christian said on Oct 29, 2015
John should call the CEO and tell him his concerns and benefits of doing things John way. If the CEO agrees with John that they should do it then all is ship shape. If Ralph disagrees then he should not commit fraud.
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Tags: Fraud and Corruption, Mid Career, Technology