accrual accounting and fair trade compensation

[JRM]

I was talking to a friend who is a low level manager at a local radio station.  His company is a large publicly traded nationwide broadcast company.  He was explaining some questionable accounting to me, and my initial reaction was that this was at best very shady and at worst illegal. 

 

It is common for the radio station for trade services for advertisements (fair trade agreements).  Like most large corporations they use accrual based accounting.  He said whenever they have receive cash compensation they expense it as I would expect; when the goods or services are received.  However, when it is a non-cash trade his boss delays expensing the income well past when the goods or services are actually received.  He said they usually catch up at the end of the year, but not necessarily.

 

The problem is that his boss is compensated with a bonus if he meets his "numbers", and this little gimmick is used to help make his quarterly numbers.  He said this was common practice at other radio stations within the company, at least with all the ones he has spoken to.

 

For those with an accounting background or more familiarity with this type of industry: is this legal?  This is a publicly traded company that files quarterly with the SEC. 

[John Hjorth]

JRM,

 

Are we talking about accrual accounting for a radio station here, with regard to accrual accounting for expenses, or are we talking about accrual accounting for revenue? I'm not sure I understand your question in all details and to full extent.

[JRM]

My interpretation is that they are accruing expenses (inappropriately?) in order to inflate their earnings.  They are booking revenues "on time", but delaying the expenses past when I thought they should have been transferred from the balance sheet to the income statement.

[John Hjorth]

Thank you for elaboration here, JRM,

 

Generallly, in a listed company [anywhere], there are business procedures and internal controls in place - out of control of a low level managers not involved in or responsible for finance & accounting.

 

The principle is generally, that people who have ordered something, from outside the company, are not the people who receive and record the invoices, so that the finance department [not the person ordering something] is keeping track of "invoices received, but yet not approved".

 

Every properly carried out substantive testing at year end or at a hard close before year end, perhaps combined with compliance testing up against approved procedures during the year would reveal this practice, if material, and also if appropriate procedures are not in place. An internal control environment built on some basic principles combined with follow-up is both self-sustaining, self-reinforcing & self-correcting, if people involved are honest and actually thinking while at work.

 

In short, your friend is playing with your friend's job.

[JRM]

That is certainly what I would expect.  I guess my questions is this: is it normal for cash payments to be treated any differently than fair trade payments in accrual accounting?

 

My thought is that it is easy to track the money trail for cash payments.  It can difficult or nearly impossible to prove when goods or services were received under a fair trade agreement.

[John Hjorth]

JRM,

 

Now I understand your question in full, I think, especially your use the term fair trade in this topic. The price of the service or good provided always has to be tested regularly by procurement, comparing procurement by fair trade with procurement later paid in cash.

[JRM]

My question is more about the timing rather than the value. 

 

Let's say a t-shirt company offers $1000 worth of t-shirts to the radio station in exchange for $1000 worth of advertising.  Let's say the radio receives the $1000 worth of t-shirts in month one, and the radio station airs $1000 worth of advertising in month 3.

 

I would think the $1000 in t-shirts would be considered deferred income until end of the month 3 (air the advertisements).  Also, the radio station should expense the $1000 advertising cost at the end of month 3.  Assuming the cost of $1000 worth of advertising is less than $1000.

 

In the situation I'm describing, the radio station is counting the revenue income at month 3, but delaying the expensing of the cost of performing the advertising.

 

This seems wrong to me if this is actually how they are operating.

[Patmo]

Not an expert on the topic but the overarching accounting principles don't change. It's probably just going to be booked to another asset account than cash at some kind of reasonably estimated value.  As far as timing goes, the expense needs to be recorded in the same period as the revenue it was used to generate. From a financial reporting standpoint the period is the year, not quarter. Otherwise it's up to the company to have the internal controls in place to prevent your friend from gaming his bonuses. Somebody else can correct me if I'm wrong, as I'm making statements as if they were facts but I'm not necessarily 100% certain.

 

I must say your question is really hard to decipher. I think in part because it feels like you are mixing up terminology. For example, I think (correct me if I'm wrong) that when you refer to accruing an expense, you mean delaying the booking of the transaction altogether, rather than recognizing the expense as a liability. You also mention expensing the receipt of cash, and I think in some parts you say goods/services are received when you may mean they are delivered. Altogether it's really confusing.

[Patmo]

My question is more about the timing rather than the value. 

 

Let's say a t-shirt company offers $1000 worth of t-shirts to the radio station in exchange for $1000 worth of advertising.  Let's say the radio receives the $1000 worth of t-shirts in month one, and the radio station airs $1000 worth of advertising in month 3.

 

I would think the $1000 in t-shirts would be considered deferred income until end of the month 3 (air the advertisements).  Also, the radio station should expense the $1000 advertising cost at the end of month 3.  Assuming the cost of $1000 worth of advertising is less than $1000.

 

In the situation I'm describing, the radio station is counting the revenue income at month 3, but delaying the expensing of the cost of performing the advertising.

 

This seems wrong to me if this is actually how they are operating.

 

That's easier to follow. You are talking about revenue matching, and you are correct, the cost of advertizing needs to happen in the same period as the revenue was generated. But to repeat myself the legal period is a year, not quarter or month. I'm sure there's a level of materiality that's going to affect this since 10Q's are required to be published and people would flip their shit if Amazon reported all 0's on their quarterly FS, to take an extreme example. But for practical purposes, your buddy is in the clear legally speaking so long as he recognizes the expense in the same year. His employers might have a different viewpoint, though. I'm not one to blame a guy for trying to maximize his outcome given the ruleset given to him, but play with fire and you'll get burned sooner or later.

 

Again, not an expert.

 

https://accountingexplained.com/financial/principles/matching

 

[John Hjorth]

By basic accounting logic, it's not possible to enter the transactions [sale and purchase, sucject to fair trade] to the general ledger by different dates. The only way to get around this [dishonestly], is by booking the sales as revenue and on accounts receiable, and at a later date, the purchase of the T-shirts is entered into the accounts.

 

Auditors analyse cash flow on accounts receiable after balance sheet date. Systematic "netting posting patterns" will at some time end up in the auditors trawl, and be subject to discussion. It's exactly the same as with credit notes issued after balance sheet date related to the years sale. Incoming money, or not.

[JRM]

ok, that's what I thought.  thanks.