A common method for inflating revenues and profits is to ship more inventory to customers than they order. Business Week illustrates two instances in which the revenue recognition criteria may have been compromised. Using a practice known as “trade loading,” RJR Nabisco, the second largest cigarette producer in America, would ship more inventory to wholesalers than the wholesalers could resell. The excess inventory would eventually be returned, but RJR would book the revenue and profit when the cigarettes were originally shipped. Management stopped this practice in 1988, and the result was a $360 million decrease in operating profits for 1989. Another company, Regina Co., took trade loading several steps further. In a hurried effort to compete in the upright vacuum cleaner market, Regina skipped proper testing of its product, the Housekeeper. The result was that 40,000 units, or 16% of sales, were returned. Regina’s solution was to lease a building to store the returned items and make no entries to record the returns. In a continued effort to make Regina’s stock attractive, the firm began to record sales when goods were ordered, not when they were shipped. Furthermore, to ensure that projected sales figures were achieved for the fiscal year ending June 30, 1988, the company generated $5.4 million of fictitious sales invoices for the last three business days of the year.
SOURCES: Wafecia Konrad,“RJR Nabisco,” Business Week, February 19, 1990; John A.
Byrne, “Regina,” Business Week, February 12, 1990.
1. Do these transactions of RJR Nabisco and Regina satisfy the revenue recognition criteria as set forth by the FASB?
2. If RJR Nabisco has open contracts with distributors that require distributors to attempt to sell all inventory shipped to them, does trade loading violate the revenue recognition criteria?
3. Regina recorded revenue when goods were ordered rather than when the goods were shipped. Does it really make a difference when the journal entry is made?
4. As Regina’s accountant, what would you do if the president of the company who was fined $50,000 and sentenced to one year in jail asked for your assistance in “cooking the books”?