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Question 17.3: Revenue Recognition Practices Diebold, Inc. (NYSE: DBD) is a...

Revenue Recognition Practices

Diebold, Inc. (NYSE: DBD) is a leading manufacturer of automated teller machines (ATMs) used in banks, as well as electronic voting machines. Certain of Diebold’s financial results for the years ended 31 December 2006, 2005, and 2004 are summarized as follows:

In its 2006 annual report, Diebold described its revenue recognition practice as follows:

1. The company considers revenue to be realized or realizable and earned when the following revenue recognition requirements are met: persuasive evidence of an arrangement exists, which is a customer contract; the products or services have been provided to the customer; the sales price is fixed or determinable within the contract; and collectibility is probable. (From the Notes to the Financial Statements)
2. Revenue is recognized only after the earnings process is complete. For product sales, the company determines that the earnings process is complete when the customer has assumed risk of loss of the goods sold and all performance requirements are substantially complete. (From the Management Discussion and Analysis)

On 25 July 2007, Diebold announced it would be delaying the release of its earnings for the second quarter due to regulatory questions about the way it reports revenue. The stock had closed on 24 July at $53.71 per share.

On 2 October 2007, Diebold Inc. issued a press release titled “Diebold Provides Update on Revenue Recognition Practice.”

Diebold, Incorporated has been engaged in an ongoing discussion with the Office of the Chief Accountant (OCA) of the Securities and Exchange Commission (SEC) regarding the company’s practice of recognizing certain revenue on a “bill and hold” basis within its North America business segment. As a result of these discussions, Diebold will discontinue the use of bill and hold as a method of revenue recognition in both its North America and international businesses. . . .

The change in the company’s revenue recognition practice, and the potential amendment of prior financial statements, would only affect the timing of recognition of certain revenue. While the percentage of the company’s global bill and hold revenue varied from period to period, it represented 11 percent of Diebold’s total consolidated revenue in 2006. The company does not anticipate that the change in the timing of revenue recognition would impact previously reported cash provided by operating activities or the company’s net cash position. . . .

While the company cannot predict with certainty the length of time it will take to complete this analysis and review, it anticipates the process will take at least 30 days. Upon completing this process, Diebold will be in a position to provide updated revenue and earnings guidance for the full-year 2007.

That day, shares continued a slide that had begun with the announced delay, reaching $44.50. As of late 2007, the stock had fallen more than 20 percent since the initial announcement.

In a document titled “Report Pursuant to Section 704 of the Sarbanes Oxley Act of 2002,” the U.S. Securities and Exchange Commission noted that:

Improper accounting for bill-and-hold transactions usually involves the recording of revenue from a sale, even though the customer has not taken title of the product and assumed the risks and rewards of ownership of the products specified in the customer’s purchase order or sales agreement. In a typical bill-and-hold transaction, the seller does not ship the product or ships it to a delivery site other than the customer’s site. These transactions may be recognized legitimately under GAAP when special criteria are met, including being done pursuant to the buyer’s request.

Based on the information given, address the following problems:

1. State whether bill-and-hold sales are consistent with the revenue recognition practices described in Diebold’s annual report. Explain your response.
2. Describe the incentives for recording revenue on a bill and hold basis.
3. The SEC report notes that bill and hold sales may be appropriate when done at the customer’s request. Explain a circumstance in which a customer may choose to be billed for a product that has not been delivered.
4. Critique the argument in the press release of 2 October 2007 that “the change in the company’s revenue recognition practice, and the potential amendment of prior financial statements, would only affect the timing of recognition of certain revenue.”
5. Describe a warning sign that might alert investors to the presence of improper bill and hold accounting. Illustrate the warning sign for the case of Diebold.

2006 2005 2004
Revenues $2,906,232 $2,587,049 $2,357,108
Net income 86,547 96,746 183,797
Cash flow from operating activities 250,424 102,741 221,610
Accounts receivable, net 610,893 676,361 583,658
Deferred income 170,921 136,135 92,862
Other current liabilities 258,103 228,699 202,713
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