The SEC fined Gemstar-TV Guide International $10 million for overstating its revenue by $250 million from 1999 through 2002. Gemstar improperly recorded revenue for expired, disputed, or nonexistent contracts, accelerated the recognition of revenue under long-term agreements, used round-trip transactions to generate revenue for which Gemstar paid money to a third party that used the funds to buy advertising from Gemstar, and improperly reported advertising revenue based on nonmonetary and barter transactions.
KPMG LLP, Gemstar's auditors, was censured for engaging in "improper professional conduct" (Jonathan Weil, "KPMG Is Censured in Gemstar Matter," The Wall Street Journal, October 21, 2004) in connection with its audit work for Gem star. The SEC stated that KPMG allowed Gemstar to record revenue in the absence of customer agreements. According to the SEC, KPMG relied on statements made by Gemstar's executives about its sales rather than gathering evidence to support these statements. 2
What evidence should the auditors have gathered? Suggest a substantive test of balances or of transactions that could have been effective in detecting the misstatement.