Revenue Recognition Practices (1).
Analysts label stock markets as bubbles when market prices appear to lose contact with intrinsic value. The run up of the prices of Internet stocks in U.S. markets in the 1998 2000 period, in the view of many, represented a bubble. During this period, many analysts adopted PIS as a metric for valuing Internet stocks with negative earnings and cash flow. Perhaps at least partly as a result of this practice, some Internet companies engaged in questionable revenue recognition practices to justify their high valuations. In order to increase sales, some companies engaged in activities such as bartering Web site advertising with other Internet companies. For example, Internet Revenue.com might barter $1,000,000 worth of banner advertising with RevenueIsUs.com. Each would show $1,000,000 of revenue and $1,000,000 of expense. Although neither had any net income or cash flow, each company’s revenue growth and market valuation was enhanced (at least temporarily). The value placed on the advertising was also questionable. As a result of these and other questionable activities, the U.S. SEC issued a stern warning to companies. International accounting standard setters have begun a study to define revenue recognition principles. The analyst should review footnote disclosures to assess whether the company may be recognizing revenue prematurely or otherwise aggressively.