Lucent Case Study

2. What financial statement adjustments will Lucent have to make to correct the revenue recognition problems announced in late 2000? Lucent recognized revenue when persuasive evidence of an agreement exists, delivery has occurred, the fee is fixed and determinable, and collection of the resulting receivable, including receivables of customers to which Lucent has provided customers financing, is probable.

For sales generated from long-term contacts, primarily those related to customized network solutions and network build-outs, Lucent generally uses the percentage of completion method of accounting. After the incident that SEC forced Lucent to restate the its financial results leading its stock price to decline 8. 5% in 2000, Lucent now records the sales revenue when the customers buy the Timing of revenue recognition is a crucial part in revenue recognition. According to US GAAP, revenue should be recognized when it is realized/realizable and earned (FASB, 1984, Para. 83).

However, a number of software firms recognized revenue prior to product delivery or service performance in the past, which potentially violated one or both of the conditions of the revenue recognition principle. In response, AICPA released Statement of Position (SOP) 91-1 in Dec. 1991, which stipulated that if collectability is probable, license revenue should be recognized upon delivery and service revenue should be recognized ratably over the service arrangement. The research question for this article is: How revenue recognition timing affects attributes of reported revenue?

This question is interesting because: 1) revenue recognition timing is important in financial reporting and standard setters have devoted much attention, 2) very limited empirical research examining revenue recognition timing has been conducted, 3) software revenue recognition is unique as transfer of rights is achieved by license rather than on-the-spot sale of products. The main hypotheses for this article and their intuitions are: 1) Early revenue recognition increases the timeliness of reported revenue.

Its intuition is: early revenue recognition better influences decisions by providing more timely information. 2) However, it will lead to greater uncertainty in reported revenue. Its intuition is: changes may not be foreseen at the time of contract signing. 3) Time-series predictability of revenue is lower under early revenue recognition. Its intuition is: early revenue recognition results in higher estimation error and therefore reduces the time-series predictability.