Chapter 2, Problem 26QP Bookmark Show all steps: ON Refer to the revenue recognition practices of Qwest Communications outlined in Theory in Practice 1.1. Required a. Use the concept of relevance to argue that firms should record revenue as earned as early as possible in their operating cycles. Was Qwest's revenue recognition policy relevant? Explain. b. Use the concept of reliability to argue that firms should wait until the significant risks and rewards of ownership are transferred to the buyer, and there is reasonable assurance of collection, before recording revenue. Was Qwest's revenue recognition policy reliable? Explain. c. When is revenue recognized under ideal conditions? Why? (Reference Practice Theory 1.1) Theory in Practice 1.1 In July 2002, Owest Communications International services at cost, putting all profit into the equip- Inc, a large provider of Internet-based communi- ment component, which, as just mentioned, was cations services, announced that it was under immediately recognized as revenue despite a con investigation by the SEC. Its share price imme- tinuing obligation to protect the customer from diately fell by 32%. In February 2003, the SEC risk of obsolescence on the equipment "sold." Yet announced fraud charges against several senior another tactic was to recognize revenue from the Qwest executives, alleging that they had inflated sale of fibre-optic cable despite an ability of the revenues during 2000 and 2001 in order to meet purchaser to exchange the cable at a later date. In revenue and earnings projections. retrospect, Qwest's revenue recognition practices One tactic used was to separate long-term were premature, to say the least. sales of equipment and services into two compo- in June 2004, the SEC announced settlements nents. Full revenue was mmediately recognized with some of the officers charged. One officer, for on the equipment component despite the obliga- example, repaid $200,000 of "ill-gotten gains," tion to honour the service component over an plus a penalty of $150,000, and agreed to "cease extended period. A related tactic was to price and desist from any future violations