Saturday, October 23, 2010

No Barter in Revenue, especially for Finacial Companies!

Revenue Recognition:

Should the Revenue Recognition Model Include and Recognize Barter Transactions?

Andrea Psoras

May 16, 2004

BUS 221 Professor Alan Glazer

Revenue Recognition:

Should the Revenue Recognition Model Include and Recognize Barter Transactions?


Some 'publicly-owned' enterprises are pushing the financial reporting envelope too far by compromising relevant and reliable numbers for higher reported revenues (Kieso, et al. 2004, p. 901). They facilitate financial reporting compromise with the use of 'barter' transactions as a heterogeneous component of revenue. When the seller in a barter transaction has accepted a good or service in exchange for the good sold or service rendered (presuming rights of ownership going to the buyer), it has received an asset that fails the realized/realizable test for revenue. At this point, since adoption by the SEC on January 22, 2003, Regulation G prohibits the presentation of inaccurate or misleading non-GAAP financial measures (E&Y 8/03 p. 13, 16). Any method that reports barter transactions as part of revenue uses a (non-GAAP) method that misrepresents the true financial status demonstrated in GAAP compliant financial reporting of a publicly traded enterprise. Further, the stock exchanges require listed firms annually to report financial statements adhering to GAAP, which would prohibit the use and subsequent reporting of barter transactions as a component of revenue.

Moreover, with the Concept 6 definition of Revenue Recognition giving equal Income Statement treatment of the fair value of changes in Balance Sheet and contingent items, the Net Income number has become polluted with unrealized non-cash gains, while the discretionary power of agency to value their Balance Sheets arguing 'fair value' permissible under US GAAP, management at bigFinancial Institutions may use even inflation producing changes in their Balance Sheets and other contingencies such as OTC derivatives has the power to virtually 'print' money via their Income Statement revenue recognition of these non-cash (often unrealized) gains, beyond every one else in society which has to engage in transactions in order to enjoy remuneration and wealth development. The FASB has to some degree, 'anointed' agency at bigFinancials which are also the Interest and Swaps Dealers Association - the OTC derivatives trade association, to enjoy a new feudal status that the discretionary power of fair value gives to agency and its CPA and other advisors.

With many of these OTC derivatives activities including barter transactions where in the nature of their swap of one security for another many of these transactions fail to realize to cash, and with the sovereign governments - that is - the voters' wallet being the ultimate backstop in all ISDA agreements, agency can write any sort of derivative contract, value it at virtually any value justifiable, while the voter is the new serf in this wealth transfer the crippled financial reporting model facilitates and contributed to giving us the financial 'crisis' and financial system 'collapse' while agency at the bigFinancials enjoyed compensation beyond what most people even in developed world would ever see over the life time of their work and investments.

A Description of Purpose

This paper describes issuers’ practices, methods, and flaws of the use of and recording for barter revenue vs. non barter revenue transactions and considers whether barter should be recognized as revenue. The author compares barter vs. non-barter transactions as a revenue component and whether barter satisfies the tests for GAAP revenue recognition of having been earned and realized/realizable to cash and claims to cash.

An Introduction of Revenue Recognition with Respect to Barter Transactions

Should the revenue recognition model permit the use of barter transactions - that is, non cash or equivalents exchanged between buyer and seller for goods sold or services rendered to a counterparty (Sondhi 2004)? Keeping in mind how the financial reporting model’s underlying theme of companies operating as a ‘going concern’ predicates the assumption of management’s “good faith” conduct, When companies recognize revenue, they assert that a transaction actually occurred, and was recorded on a timely basis at the proper amount. A revenue transaction occurs when a company transfers goods or services to a customer, the earnings process has been substantially completed, and the likelihood of collection (realizability of cash and claims to cash) is reasonably assured (Sondhi 3/1/04; Kieso, et al. 2004).

When reporting barter transactions as revenue, however, management ignores important economic and public reporting concepts for publicly traded enterprises. As the word barter means to cheat (American Heritage Dictionary 1981), there is no coincidence the definition foreshadowed the recent spate of flawed reporting practices, including the recognition of barter transactions as a component of revenue. In the late 1990’s in one quarter, experts estimated that barter transactions summed to greater than 10% of revenues of all internet companies (Kieso, et al. 2004, p.901). Managements of many of those companies, although operating in a sophisticated commercial environment, reported barter as a component in revenue, and thereby contributed to the pervasive erosion in reporting quality. Concerns in the late 1990s became greater at the SEC when many ‘new economy’ (specifically internet companies, AOL among, them), included barter transactions in their reported revenue, but infrequently reported positive earnings figures (Computer Wire News 2002).

Revenue was becoming the accounting figure that some investors were using to value these companies. When revenues include barter transactions, this creates distortion and a misrepresentation, while eroding comparability among (peers and) other publicly traded companies. (The SEC expressed concern over the distorted revenue figures and lack of comparability with the valuation (albeit, equally flawed) practice based on earnings.) The Chief Accountant expressed concern about the portion of revenues coming from barter transactions such as advertising exchanges with similar companies. He wanted to make certain that the information issuers reported to investors reflected a true, reliable picture of what is really occurring with revenues, and that those numbers are reliable, while eliminating the distorted financial misrepresentations management was making in general, and in the internet industry in particular (Kieso, et al.2004, p.901 citing Wyatt; MacDonald 1999).

Other market participants, meanwhile, such as the issuer community and Congress, had made the financial reporting model and the FASB convenient whipping boys for the failures of agency, administrative regulation, and political interests. With regulators eventually began focusing on revenue reporting in a number of sectors, that encouraged the FASB take Revenue Recognition as a project (Kieso, et al. 2004, p.901).

The development (referring to FASB’s project) comes on the heels of a push by the Securities and Exchange Commission to crack down on what it sees as an explosion of transactions that falsely created the impression of booming business (as indicated in revenues), from energy and telecommunications, to Internet companies and retailers... illusory "swap" trades that boosted their apparent business... so-called fiber-optics swaps at telecommunications companies such as Global Crossing Ltd. and Qwest Communications International Inc. that boosted their revenue. Regulators are also scrutinizing other types of "round-trip" transactions, including some barter deals and vendor-financing arrangements that may have boosted revenue but lacked economic substance (Pulliam 2002).

With respect to revenue recognition, compared to derivative accounting, says Patricia McConnell, an analyst at Bear Stearns, "there isn't any single standard for revenue" (Pulliam 2002).

A Discussion of Methods/Types of Barter and Non Cash verses Non-Barter Transactions Recognized in Revenue

Managements of publicly traded enterprises practicing most cash or non-cash exchanges as a part of the business model account for their financial performance via public representations. In the GAAP accrual accounting model, the enterprise’s revenue should match associated expenses incurred while producing its goods or rendering its services. The measurement and tests (realized-realizable and earned) for recognition of associated revenue earned must represent that the enterprise has sufficient or insufficient means to satisfy expenses and other liabilities it incurred. When (and if) the earnings process is complete, monetary and non-monetary transactions are recorded at the fair value of the products delivered or services received, whichever is more readily determined (Sondhi 2004).

Further, rules exist that enable companies to determine whether barter transactions are monetary or non-monetary transactions (FASB, EITF No. 01-02). When the cash exchanged represents more than 25% of the fair value of those exchanges, such must be treated as monetary transactions (Sondhi 2004; FASB, EITF No. 01-02). In addition, “a FASB panel has ruled that firms may report barters as part of their revenue providing they have a history of receiving cash for similar [in this case, advertising] transactions” (Bitner 2002).

Fair value of a non-monetary asset transferred to or from an enterprise in a non-monetary transaction should be determined by referring to estimated realizable values in cash transactions of the same or similar assets, quoted market prices, independent appraisals, estimated fair values of assets or services received in exchange, and other available evidence. If one of the parties in a non-monetary transaction could have elected to receive cash instead of the non-monetary asset, the amount of cash that could have been received may be evidence of the fair value of the non-monetary assets exchanged, assuming rights of ownership have passed to the buyer (APB Opinion No. 29).

How and what sorts of other barter (sic) transactions have users reported?

Some, often qualified as ‘tech’, sectors using non-monetary transactions similarly are attempting to use barter in their revenue recognition. (when asking what resulted from their experiment with ad hoc accounting, with respect to barter transactions included in revenue?) Exchanging of goods or services for in-kind or similar ‘assets’ with a counterparty and recording the exchange as revenue became more common with the advent of the ‘new economy’ and the popularity and public ownership of “dot coms” ( i.e., internet enterprises). Barter transactions or “round-trip” of cash in barter-type transactions came into vogue, which the SEC began scrutinizing. Round-trip transactions are similar to barter transactions except that in a "round trip" transaction, one company sells a product for cash to another company, which in turn sells an equivalent product back to the initial seller for a similar price, with each company recognizing revenue on its "sale" it is attempting to claim (Petri 2002). Many internet companies exchanged advertising space with each other, where an equal amount of revenue and expense was reported, without any effect on cash flow and net income. The ‘swapping’ in time included more than merely ad space. Major telecom companies began swapping fiber optic capacity as a way to make an argument for reporting higher revenues (Radigan 2002).

Other relevant works have arisen from AICPA - SOP, FASB - EITF; SEC - SAB, IASB, and ASB. Asearch through the FASB material about barter transactions in revenue produces “Accounting for Barter Transactions Involving Barter Credits” (FASB. EITF No. 93-11), where one has to read carefully to find the prose associated with revenue: “The issue is whether Opinion 29 (APB Opinion No. 29), should be applied to an exchange of a non-monetary asset for barter credits and, if so, the amount of profit or loss, if any, that should be recognized ” (FASB, EITF Issue No. 93-11). Other authoritative work advising on exchanges that fail revenue tests state that gains are recorded at the carrying amount of products delivered, which is generally zero (APB 29 -Other Non-Monetary Transactions; FASB Statement No. 63; FASB, EITF No. 99-17; FASB, EITF No. 01-02; Sondhi 2004).

Analysis of Sorts and Methods of Non Barter vs. Barter in Revenue

Importance of Adherence to the Conceptual Framework For Revenue Recognition

The subjectivity of what occurs between parties exchanging goods and services in a barter transaction somewhat erodes comparability with past periods as well as comparability with peers, assuming peers are generating realizable revenue. Further, some notion seems to exist that the financial reporting model must compensate for what appears to be vestiges of inferior commercial practices from earlier economic paradigms (Psoras 2004).

Aside from the ordinary tests for recognizing revenue - such as whether the earnings cycle is completed, and is a nearly closed contract considered earned - without some other bright line test, self-dealing, ambitious management can use barter transactions as a component of revenue (FASB, Concepts Statement No.5, paras.83,84; Concepts Statement No.6, paras. 29, 32, 33) to inflate revenues. As the public reporting model assumes good-faith’ in management and financial reporting practices, the perceived lack of ‘rules’ in revenue recognition and reporting tempts management misrepresentation or even deceit or fraud, and gives rise to strong accusations about ambiguities in the current definition of the components of earned revenue. In general, the “FASB has ruled that firms “may report barters as part of their revenue, provided they have a history of receiving cash for similar (in this case, advertising) transactions”. This less-than-airtight rule provides the kind of gray zones these firms need to maintain their illusions” (Bitner 2002), the FASB had neglected requiring the tests for revenue with barter transactions in advertising, in this case.

Arguably, questions will arise regardless of the integrity of management - for example, is ‘fair value’ less subjective or more subjective? Fair value should be established by reference to the recent history of cash sales of the same products or services in similar sized transactions (Sondhi 2004). How quickly can revenues be recognized? Is delivery the date of sale? Even after providing services, do the customers need to be billed to demonstrate ‘earned’ for recognition purposes? Recognizing other benefits for use of enterprise resources as time passes or as assets are used in an arms’-length transactions - is revenue recognized at the sale of any other assets other than those produced as goods for sale (Kieso 2004, p. 904)? Has management effectively priced its goods produced or services rendered assuming ‘right of ownership’ has passed to the buyer, meanwhile accepting an exchange of anything less than cash or claims to cash? Perhaps management is accepting non-cash assets from counterparties in arms’- length transactions for those goods or services, then recognizing those assets in revenue?

Meanwhile, what cash and related resources has the enterprise used to pay its obligations? Investors, creditors, and counterparties must question the ‘going concern’ status of an enterprise when, for example, when the firm used stock sales as a virtual operating method to raise cash to fund its ordinary obligations, partly because the firm’s use of barter transactions as attempts to generate revenue failed to realize into sufficient cash to operate the enterprise. In conjunction with sales, methods of marketing products and services were said to make it difficult to develop guidelines for recognizing revenue in all situations.

With respect to many of these questions, management failed to properly use the GAAP revenue recognition concept where realized/realizable into cash and earned are the tests for revenue recognition. The notion that difficulty existed when determining revenue recognition in ‘new industries’ arose, and meanwhile became worse when management also opposed ethically answering when and how they should recognize revenue. In turn, management put pressure on their accountants to waffle when answering the question (Radigan 2002).

Analysis of Sorts of Barter and Non-cash Transactions. With Respect to the Conceptual Framework

One could say barter transactions as components of revenue fail to meet GAAP standards for realizability, sufficient completion of the earnings process, comparability, and representational faithfulness. In addition, generally the value of what the buyer offers the seller has been the amount recognized by the seller, presuming an arms’ length transaction, which leaves a host of problems with respect to optimizing the firm’s value given its ordinary operating constraints.

The staff (SEC) believes that revenue generally is realized or realizable and earned when all of the following criteria are met: persuasive evidence of an arrangement exists; delivery has occurred or services have been rendered, the seller's price to the buyer is fixed or determinable, and collectability is reasonably assured.... In the absence of authoritative literature addressing a specific arrangement or a specific industry, the staff will consider the existing authoritative accounting standards as well as the broad revenue recognition criteria specified in the FASB's conceptual framework that contain basic guidelines for revenue recognition (SAB No. 101, A.1).

These SEC guidelines fail to demand clearly defined realizability of measurable revenues, mentioning little about barter, later adding,

Because revenue recognition generally involves some level of judgment, the staff believes that a registrant should always disclose its revenue recognition policy. If a company has different policies for different types of revenue transactions, including barter sales, the policy for each material type of transaction should be disclosed... (SAB No. 101, A.1).

The Commission has omitted discussing barter as a part of ‘revenue’, and how barter violates the realizability test, while barter can seem to satisfy the other criteria the SEC confirmed from SOP 97-2, which coincidentally also is used in “Accounting by Producers or Distributors of Films”, SOP 00-02, as well as to many other contexts. It again gives appearance of some delicate dance around defining revenue, the recognition of components of it, and how barter may or may not be included as a component recognized in GAAP revenue.

The use of barter as a means of commercial, counterparty exchange adds a subsequent, poorly and subjectively measured component to revenue recognition for the enterprise. As a method to receive an asset exchange for a good sold or service rendered, and thus for the seller to include barter as revenue, barter fails the realizability test. Some experts seem to respect the use of barter in revenue, however, and are interested in whether the recognized value of products or services should be fair value, book value, carrying value, or using any of those values as the cost basis of the goods or services received in exchange (Sondhi 2004). The realizability matter remains open and unresolved even where (a monetary transaction exists when) the cash in the exchange represents 25% or more of the fair value of those exchanges (FASB, EITF No.01-02, “Interpretation of APB No. 29”; Sondhi 2004). Under Opinion No. 29, the gain fails to count as a revenue component when the amount realized is less than full value of the asset sold or given up to the buyer. Moreover, APB Opinion No. 29, as well as its ‘Interpretation’, avoid the complex issue of inclusion or consideration of a barter as a component of revenue, even though the authoritative material attempts to resolve the issue over selecting the fair value most readily determinable for either the assets received or relinquished (FASB, EIFT No. 01-02). Has management engaged in a fair transaction? Has management developed a transaction where the true value of all the assets in the transaction summed to less than fair value for the goods sold or services rendered? Again, that concern gives rise to questioning management competence, professionalism, business judgment, and duty of ‘care’ to the shareholders (Mallor, et al.2001, p.909, 910).

How have other barter users reported their transactions? What resulted from their experiment with ad hoc accounting? Other ‘swapsters’ have included companies exchanging software, databases, broad-band capacity, and fuel in addition to many other goods and services. These included in revenue items go far beyond ‘ad’ exchanges between internet companies (Sondhi 2004; IOMA 2003). There is no overall effect on net income or cash flows, although the timing of the revenue and expense may differ. Although this issue often is discussed in the context of internet companies, it also applies to advertising barter transactions in other industries. As an epitaph , “such barter transactions got tossed out when many content sites lacking in cash went out of business, and the surviving ones had to grow up and find real sources of revenue” (Orr 2002; Lawler 2000). Meanwhile, the AICPA’s “Software Revenue Recognition” added 4 other revenue tests (AICPA, Statement of Position-97, para. 2).

“The SEC has also found that many internet companies wrongfully book revenue for barter transactions in which they exchange advertising with another internet Company” (Auerback 1999). Some dotcoms also boost their revenue by bartering advertising with other web-based firms (Stewart, McLaughlin 2001). “Aggressive accounting treatment of sales is now spreading beyond internet companies” (Auerback 1999). Lucent Technology “used a variety of accounting gimmicks in order to produce a "blow-out" fourth quarter. On the surface, the period was marked by a strong increase in "sales". However, such sales are produced in a rather circular manner, where it engages to a significant degree in the practice of taking an ownership position in such companies, then lending money to the start-up to enable the latter to buy their equipment” (Auerback 1999).

Perhaps related to lack of a real sales transaction with realizable revenues, the SEC “ruled invalid telecom wire access rights exchanged between telecoms, whose managers had used the de facto wash exchanges to boost their revenues, even though the telecoms had purchased and sold the access to their networks with one another” (Radigan 2002). The SEC also voided the round-trip sales that had been recognized as separate transactions. Further, the seller recognized the sale immediately while capitalizing the ‘expense’ and amortizing the cost of purchased access on another network over the life of the ‘deal’, sometimes the time spanning more than 25 years. Again, the SEC appeared reluctant to draw a line on failures of corporate good faith and in business judgment practices with regard to circular exchanges for wire access, while management attempted to portray these round trip ‘sales’ as legitimate sales, even though no valid business reason existed for these round trip maneuvers other than to misrepresent revenues (Radigan 2002). Management felt pressed to find new sources of revenue and used this ploy. The SEC ruled many of these transactions as “round-trip”, and as a result, prohibited the barter transactions from affecting the revenue of those firms.

Television and Broadcast (and eventually, so as to justify for GAAP purposes their barter exchanges, the dotcoms) referred to “Financial Reporting by Broadcasters” (FASB Statement No. 63), as well as at one time looking to “Revenue Recognition by Television ‘Barter’ Syndicators” (FASB, EITF No. 87-10), and “Accounting for Advertising Barter Transactions” (FASB, EITF No. 99-17), with the dotcoms’ exchanges never having realized revenue (FASB Statement No. 63, paras. 8, 14), although the FASB (Statement No. 139) amends it by adding broadcast is subject to “Accounting by Producers or Distributors of Films” (AICPA, Statement of Position-2, para. 21), which indicates “An entity sometimes licenses programming to television stations in exchange for a specified amount of advertising time on those stations. Although these transactions qualify as non-monetary exchanges, according to GAAP revenue, technically one precludes these transactions from revenue (APB No. 29; as interpreted by "Accounting for Barter Transactions Involving Barter Credits", FASB, EITF Issue No. 93-11; FASB Statement No. 139; FASB Statement No. 53).

Utility, power, and broadband barter and round trip transactions often involved counterparties in the same line of business. Two companies swapped the same commodity in these situations, with each company recognizing revenue from the exchange, even though little of economic substance actually had transpired. A company intent on disguising barter transactions or "round tripping" may try to do so by running the transactions through an intermediary rather than dealing directly with the ultimate counterparty. “For example, if two companies agree to buy each other’s products, exchange invoices and checks, the question is, are these transactions really substantive, and should they be recorded at the full invoiced value?” (Petri 2002), in substance which fails the realized-realizable test.

Barter transactions in Revenue Introduce Other Operating Problems

With the inclusion of barter transactions as part of revenue, management is carelessly and imprudently considering introducing a cash deficit in the revenue recognition cycle as well as eroding financial reporting quality. Barter also promotes a management notion that it can engage in commerce while ineffectively pricing, and in turn charging, for the goods and services it renders, meanwhile disserving its stakeholders and non management shareholders. Barter also promotes the notion that management can avoid establishing optimal pricing for its goods and services, yet engaging in a commercial environment that functions on a unit of exchange for the money of account concept. Our ‘money of account’ is the US Federal Reserve Note, also known as cash. Management and employees of firms using barter as a means of exchange are interested to enjoy the fruits that their 'work' ordinarily would produce, however, with barter failing to complete the revenue cycle, they now have operations needing liquidity, yet lacking the necessary cash typically produced from revenues realized when earned test (FASB, Concepts Statement No.6, para.29). All stakeholders except senior management of such enterprises are finding disjointing, the flawed pricing and costing practices of their businesses conflicting with their needs to participate in society in the meaningful way they desire (Concepts Statement No. 6, para. 29).

Where some managements were selling company stock in a rising market to raise cash for ordinary operating expenses, however, representing itself as, and reporting to be a going concern, we saw management and commercial failure-bankruptcy when many of these firms’ main operations produced insufficient cash and a greater proportion of its realized and realizable revenues. Any strategy using the firm’s stock sales to raise liquidity to satisfy its operating obligations violates the going concern principle and could be judged as to be a signal of management liquidating into virtual and often actual bankruptcy. “E”-businesses had displayed many of the factors that gave rise to these going-concern issues. They had proven highly sensitive to general economic downturn and decreases in consumer confidence. Consideration of their cash generating abilities on one side and cash needs on the other should have alerted auditors as to whether they would need additional sums of cash in the first 2 years to continue operating (Tackney, Day 2002).

Foreign GAAP on Barter Transactions In Revenue

The UK’s IASB model for revenue does not assume realizability, i.e., cash and claims on cash: “... whether the revenue from the sale is collectible and measurable” (IAS18.14-19; PricewaterhouseCoopers 2002). Tthis is what they indicate, however:

The general principle of revenue recognition under UK GAAP is that can't recognize revenue unless you have an asset as a result of a transaction or, at least, a smaller liability to show for it. Under the Urgent Issues Taskforce Ruling, dot com ad barters transaction couldn't be recognized as increasing a company's sales unless it could have been made for cash (Williams, CA 2003).

Notwithstanding, the ASB definition omits the realizability test for revenue produced from the exchange of goods and services. Unless FASB and other domestic participants in the US reporting system, and the other participants on the international level in IASB promulgation and require demonstration “conclusively that the deal was a genuine cash transaction and not an artificial stitch-up" (Stewart, McLaughlin 2001), issuers may, and perhaps will use barter and report heterogeneous items in revenues, where not all of those items realize the money of account (FASB Concept Statement No. 5). Apparently, the British reporting model would permit barter in revenue under the following framework: a transaction (barter or otherwise) should give rise to revenue if, on its completion, the entity has been rewarded for eliminating the risks previously outstanding in the relevant operating cycle (Barden 2001) which appears somewhat to fail a conservative definition for the matching principle.

Other Factors Related to Barter Transactions in Revenue

Even the accounting model calls for transactions to be completed in our money of account: “Prices and labor savings do not exist without a monetary unit of account that is necessary to promote exchange” (Sontheimer 1972). Cashless societies and primitive economies are dysfunctional (Sontheimer 1972 -Introduction) partly because barter violates liberty (typically enjoyed in an arms’ length exchange with the money of account as the operative medium of exchange) from a counter party in a fair exchange using the money/unit of account for goods and services (Psoras). With this in mind, failing to close the revenue cycle, then making representations otherwise about the viability of the publicly traded enterprise, is a ponzi scheme to the non-management shareholders and the market in general. Further, in times of crisis or when management needs cash flows to expand operations and activities, the prolific use of barter transactions has interfered with, and deteriorated the necessary cash flow and wealth development that builds important reserves and pools of capital for progress. Even in business combinations where buyers are interested to full value for their purchase, experts have been questioning targets’ revenues and recognition practices (Basile 2000). For example, Enron’s activities failed to produce sufficient cash to extinguish its claims and obligations, in part because it used its common stock as collateral for some of those activities. When stock sales failed to provide sufficient resources for its obligations, it skuppered its operations and colluding with its bankers, crafted a bankruptcy (Psoras 2002).

Ineffective boards’ of directors and audit committee oversight seemed to feed the inflated revenue problems. The lack of independent expertise is troublesome not merely for fear that the new rules will not be met but also for providing meaningful board oversight on thorny new questions ...such as how to handle emerging revenue-recognition issues like barter transactions” (Elkind 2000). Further, management and the other self interested parties, players such as the VC and PE firms, and investment banks, which invest in enterprises with insufficient revenue and sometimes flawed revenue models, began pressuring the revenue model. With the pervasive flaws erupting in reported revenue, the FASB commenced its revenue recognition project. Meanwhile, the group of players merely want a legitimize Enron-esque business practices at the expense of the reporting model. And with this, SROs are permitting grand scale fraud to let these public reporting miscreants have access to the equity markets.

If the enterprise is selling stock to produce cash to operate the company, while failing to produce sufficient cash from operations, management is at risk with the market direction to help meet its obligations. Among other prudence this violates, included are themes of transparency, although the cash flow statement reveals most origins of cash. Likewise, other appropriate items under GAAP, in good faith as a going concern management reports to counterparties and stake holders including other claimants, not only absentee owners who are risk takers. These other claimants would be subject to their own shareholder lawsuits if engaging in commercial activity with such a noncredit worthy and unstable counterparty, and would be obliged to do business on a cash basis. While revenue is generally recognized when service is rendered or merchandise is shipped, various problems may cast doubt on the economic substance of the transaction (Martin 2002). So inflated revenues can be related to management misdeeds, and not necessarily to weakness in revenue recognition and the GAAP reporting and model.

As the markets are gamed by large institutions, investment banks, and senior management insiders, this triangle is pirating from and defrauding ordinary shareholders and employees who ignorantly invested in these poorly conceived and poorly run enterprises. Bowen, Davis, and Rajgopal examined “factors hypothesized to influence the reporting of advertising barter revenue and grossed-up sales levels. Their study found that firms with greater cash burn rates and higher levels of activity ... (which were chatted up on message boards were) consistently associated with barter and grossed-up revenue reporting. This suggests that the pressure to seek external funding and the extent of active individual investor interest in a firm influence Internet managers' use of allegedly aggressive revenue-reporting practices” (2002).

Opinions of Other Experts

Some experts seemed reluctant to take a strong stance against including barter in revenues, perhaps because they are self-interested. What follows includes some opinions of some experts’ published and knowledgeable in the matter.

Dr. A. C. Sondhi seems to have given it a pass, as he avoids answering the realizability failure of barter recognized in revenue (Sondhi 3/1/04). DeMark and Dell’Area similarly avoid addressing the realizability aspect. In this quotation, comment about the advent of the internet and its effect on commerce. They omit or avoid indicating the internet barter revenue failed to realize cash, and they omit explaining why barter involving internet companies exists uniquely among other enterprises that have used some sort of barter, although not for revenue in the way the internet companies had used.

The Internet has also wrought changes in the practice of barter transactions, the exchange of goods or services instead of cash between companies. ...That guidance, however, does not always hold when applied to Internet-based barter transactions. Internet companies have embraced web-based advertising, accounting for $8 to $10 billion of activity. Barter accounts for an estimated 5% of this total revenue. The exchange of advertising is especially appealing to startups because the company receives the services without a cash outlay, and the barter arrangement may allow companies to utilize excess Internet capacity while receiving some benefit in return (DeMark, Dell’Area 6/1/02, p.56).

Barden, a member of the U.K.’s Accounting Standards Board likewise appears to permit including barter in revenue recognition, but again avoids or omits addressing the realizability test (Barden 9/30/01). Moreover, the weakness in the language of the SEC’s SAB No. 101 puts at risk maintaining any substantive definition of revenue recognition unless the Commission confirms that revenues must be realized, that is, result in money or claimes to it to the ‘seller’.

CONCLUSION - History and -we hope not - Prologue?

Merely because an arm can be attached surgically to where a leg once had been, that should not be done. Similarly just because the barter exchange can be done, this is not adequate justification for including it as a component of revenue. Affirmation of the realizability test is missing for barter transactions, however, although realized-realizable into cash and claims to cash is a key test for any transaction that is presumed recognizable for revenue, while all enterprises may report only realized-realizable and earned items as revenue according to GAAP.

Moreover, regulation and legislation may have ended the ‘debate’. At the present time, barter transactions included in revenue fail to conform technically to criteria required for GAAP revenue. It is now is prohibited from being included in the reporting model for publicly traded companies following, the SEC’s adoption of Regulation G (1/22/03). This regulation explicitly prohibits the presentation of inaccurate or misleading non-GAAP financial measures, and the passing of the Sarbanes-Oxley Act 2002, where its Section 906 requires management certification of periodic reports that “fairly present the financial conditions and operating results of the issuer”, meanwhile complying with GAAP (Ernst & Young 8/03, pp. 13, 16). As the inclusion of barter fails to meet the Concept definition of realized/realizable, and earned revenue, such remains outside of GAAP.

The FASB added Revenue Recognition as a project partly to accommodate player demands. It is repairing the 'revenue recognition' model’s ambiguities that acted as holes through which management exercised poor business judgment and, self-dealing; and ad hoc contract practices proliferated, which were imprudently approved by the accountants and ignored or overlooked by the investment community (Mallor, et al 2001, p. 909, 910). FASB is attempting to remedy agency failures elsewhere in the corporate model that had the appearance of reporting failures, failures blamed on the reporting and revenue recognition model (FASB 3/24/04. Project Updates: Revenue Recognition, The Board at this meeting made no mention about gains, so one could assume gains remain subject to the realizability tests.). No proposed changes in the FASB’s criteria for revenue recognition related to realized or realizable -- assets received must be readily convertible to known amounts of cash or claims to cash (FASB Concepts Statement No.3, para.83). Without a bright line test for recognizing revenue only when the cash or claims to cash are realized and earned, there seems to be no way to avoid what Adam Smith and many others have described as the problems of agency, where management has a tendency to act in a self-dealing way. As a result of stimulated corporate access to the public equity markets, the age-old problem of management failures of good faith and ‘clean-handed’ business judgment now appear to be proliferating at the expense of the reporting model, with heightened attention on the top line, i.e., revenue recognition.

The proper accounting for exchanges of non-monetary assets is controversial (Kieso, et al 2004. p. 482). Current GAAP prohibits exchanges for similar productive assets to be considered as revenue or gain unless completion of the earnings process has occurred. Per a gain, it should not be recognized because the good or service could have been sold presumably at fair value, although a loss should be recognized immediately, although the current prevailing practice deems exchanges between dissimilar products at ‘fair value’ has completed the earnings process (APB Opinion No. 29; Sondhi, 2004), assuming fair value is easily determinable. Perhaps immediate recognition of gains on the exchange of dissimilar assets relates to notions of a fair transaction, whereas exchanges of similar assets leads to questions about the business purpose embodied in arm’s length transactions (APB No. 29; Kieso 2004. p.482). In the event that the transaction includes monetary consideration, also known as ‘boot’, a portion of the earnings process is assumed to be completed and a partial gain is recognized, based on the amount of the ‘boot’ (Kieso 2004. p.483).

Strong reasons exist for rejecting permissibility of barter transactions as revenue. This paper argues that barter is a poorly measurable, imprudently and carelessly considered management practice that can produce deterioration in the revenue generating cycle. If a seller accepted bartered goods or services and reported this as revenue because it wants to use assets to exchange for a future good or service, receiving payment in anything else similar in fair value other than what is realizable in the money of account and claims to it, the circumstances of the barter exchange breach the earnings cycle for the unforeseeable future. Based on that, barter transactions have failed the revenue test, while also perhaps failing the arms length, arms’ length, fair value assumption on which the public reporting model is based.

The use of and reporting barter transactions as revenue promotes a management notion that it can engage in commerce while ineffectively pricing and, in turn, charging others for the goods and services it provides, meanwhile disserving its stakeholders and non management shareholders. Including barter in revenue further promotes the notion that management can avoid establishing optimal pricing for its goods and services, yet desiring to engage in a commercial environment that functions on cash and readily exchangeable equivalents.

Including barter transactions in revenue fails to complete the revenue cycle with respect to realized-realizable. It is inferior for measurement purposes and fails to produce cash on which the company and employees rely for operating activity and remuneration purposes. Employees, nonmanagement shareholders, and stakeholders of such enterprises are finding that the flawed pricing and costing practices of businesses do not contribute to society in the meaningful way the stakeholders desire. The result becomes a progressive moral hazard, with associated market scams that enrich a few insiders, while fleecing the ordinary investor and the less powerful stakeholders.

When barter reporting issuers participate in the equity markets, as under the deceit of ‘new economy’ companies, their shares tend to attract (pirate) market ownership at the expense of other listed issuers and investors who own shares in more substantial companies that have been harmed partly resulting from the ‘new economy’ propaganda. NASD, NYSE, and the other organized exchanges should not list companies that attempt to sustain themselves by using market liquidity schemes. Such practices should provide a red flag to regulators. To attempt to erode the reporting model, however, so as to give the appearance that such companies are earning sufficient revenue to sustain their operations is a larceny to the ordinary investor, as well as a commercial failure. When virtually the entire dotcom sector practiced barter, the deceit rises to the level of a grand scale fraud to satisfy the self-dealing and self- enrichment interests of a few managements; private equity and venture capital investors, and investment bankers who are looking to cash out in a ‘take-the-money-and-run’, pump-and-dump scheme.

Financial statements under the barter scenario are too subjective for comparison and leaving the company shareholder lawsuits. Use of such practices, and expecting the reporting model to contort accordingly, also presumes that the market is either efficient and the share price of a barter user accurately reflects the company’s worth, or inefficient -- to give them an advantage -- with the latter being more true as market players during the bubble bought anything whether or not management reported GAAP and the stock buyer knew that. Management practicing barter as part of its revenue model assumed the markets were inefficient and opaque because in disingenuously reporting its status, it felt the ‘investor’ would think more highly of their stock and buy it. Meanwhile, there was no logic to most equity buying during the Bubble; management could have reported anything and people still would have bought (shares).

The FASB should end the debate with an effective definition for revenue recognition that excludes from the reporting model barter transactions as components in revenue. Users of accounting statements are looking at far more craven frauds within accrual accounting, where the reporting model itself deceives the user on the true status of the publicly traded enterprise, similar to the dotcoms and Enron using common shares sales to generate cash flow for operating, and as collateral for off-balance sheet activity practiced during, and simultaneously producing the bubble.

As a result, we should reject the use of barter in the revenue recognition model and keep high the 'bar' (that is, the quality of revenue and the recognition and quality of financial reporting). Any method used to report barter revenue permits a lowering of the reporting bar. Inclusion of barter gains in the reporting model might be possible, perhaps in a valuation account in Shareholders’ Equity, in the event there is an increase or decrease in the amount received for the goods sold or services provided by the seller.


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** All cites of FASB, SFAC, and EITF are from Financial Reporting and Research System 2003, John Wiley & Sons, 2004, aka FARS 2003. In addition, this REFERENCE LIST also includes indirect references.

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