In the past several days I have done cursory research on around 50 companies and ended up finding two companies where I actually started reading their most recent annual reports.
I only made it through a small portion of each company’s most recent annuals before deciding that I was not interested in doing further research into them for various reasons and I wanted to share something that I found with you.
The most recent company I stopped research on I found what seems to be a giant red flag. The following is a direct quote from its most recent annual, emphasis is mine.
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“We record revenue from certain license agreements upon cash receipt as a result of collectability NOT being reasonably assured.”
That is the first time I have seen any company I have researched say they will record revenue when NOT being reasonably assured of the collectability of said revenue.
My question to you since I know most of you have being doing this far longer than I have, is how common is the above situation and shouldn’t that be some kind of problem with auditors, regulators, and authorities?
I am going to continue looking for another company to research but wanted to ask you about this as I thought it could be something to learn from.
I will post some more links in the coming days as well.
I presume it would only make sense in a certain specialized industry, although I can’t think of any industry that fits the bill…What company is it, or what business do they operate in?
Thanks for your comments.
I do not feel comfortable mentioning the name of the company since it is very small with a market cap of only around $150 million.
The company protects copyrighted things from being stolen; movies, music, pictures, etc, with most of its revenue coming from licensing out its patents to other companies.
This is the first time I have seen anything like this and it made me very curious. It is also another reason we should all read annual reports as I would have never noticed this without reading the AR.
If it is a US GAAP reporting company, it has to follow the four basic revenue
recognition criteria set forth in SAB No. 101:
1. Persuasive evidence of an arrangement exists.
2. Delivery has occurred or services have been rendered.
3. The seller’s price to the buyer is fixed or determinable.
4. Collectibility is reasonably assured.
Otherwise, if collectability is not reasonably assured, they should recognize revenue only upon receipt of cash. Maybe the latter is what they meant and what they do.
PS. If they’re chasing down people who owe money that they don’t want to pay — if that’s what their business is — that that IS what they mean.
Thanks again for the help Red. I have seen the GAAP guidelines before which is why I was very surprised to see that sentence in its annual report.
I went back and reread the section and I do not see anything about it receiving cash in those cases. The whole revenue recognition section from the beginning is how you would normally expect it to be except the one sentence I quoted is thrown in the middle of the section, and then they go on to keep explaining how they recognize revenue. That one sentence being in the middle of everything else made it look like it was put there on purpose so it would be missed, at least that is how I perceive it, it’s weird.
Maybe your PS is the explanation as they have been dealing with litigation over a patent fight recently.
Even if it is done for legitimate reasons, it still makes me queasy as I have read some financial accounting books where they tell you things to look for that might be problems, and one of the red flags is to look for companies doing things like recognizing revenue before they should so it immediately bothered me.
Maybe I’m backwards, but I read that as the opposite of what you seem to have stated.
The way I see it, they are not recording revenue until they have actually been paid, thereby ensuring not to record any revenue that turns out to be bogus.
Thanks for your comments.
I don’t know maybe it is how they worded it, that entire sentence bothers me.
Maybe it is also that they just threw that one sentence in the middle of the entire revenue recognition section which makes it looks like its supposed to be missed.
After reading it over and over again, rereading the entire section, and the help in the comments section above, and even after making a bit more sense of it, it still bugs me, : )
no, its pretty obvious man. they DON’T record any revenue until they receive cash BECAUSE collectability of the revenues is uncertain.
they are applying conservatism in their reporting… sketchy revenues? fine, don’t record revenue until cash is received.
although that is kind of a problem, their customers seem iffy
I concur. It seems like there ought to be a comma in that sentence though.
I dunno, the way it’s phrased sounds like when collectability is not reassured, they record the sale after receiving cash. Sounds reasonable to me.
Without knowing the expected percentage of non-collectability (maybe it’s low), who knows if this works for them or not.
To James and Meowmeow
Thanks for your comments.
I should have clarified my most recent comment response. I do now understand that what they are stating in that sentence is legitimate.
It looks like I was just reading the original situation wrong as it looked to me like they were trying to hide something by throwing that one sentence into the middle of the entire section.
It appears to have raised another issue though as a few of you have mentioned about the companies customers ability or inability to make payments.
At least my instincts were partially right that something might be going on with the company that I am not comfortable with, something to probably steer away from since I am a very conservative investor, and to move on to looking for another company to research.
Thanks for the help everyone.