Shipping Department Personnel Almost Always Know the Truth

The United States Securities and Exchange Commission (“SEC”) recently issued an Accounting and Auditing Enforcement Release (“AAER”), related to improper revenue recognition by Cantaloupe, Inc., formerly d/b/a USA Technologies, Inc. (“USAT”), a manufacturer and distributor of cashless payment devices. Per the SEC, USAT’s aggressive sales targets caused its employees to undertake two fraudulent revenue recognition schemes.

For the first scheme, USAT employees fabricated “bill and hold” sales transactions: a type of sale that is an exception to the standard revenue recognition criteria requirement for delivery to have occurred before recording revenue. For the second scheme, USAT employees intentionally shipped products that customers never ordered or wanted.

“Bill and Hold” Arrangements

A “bill-and-hold” arrangement involves recording revenue prior to the delivery of the goods to the buyer, a requirement for revenue recognition for all other types of sales. In addition to delivery, the other major requirements to record revenue in accordance with Generally Accepted Accounting Principles (“GAAP”), are that (i) persuasive evidence of an arrangement must exist, (ii) the price must be fixed and determinable, and (iii) collection of the resulting receivable must be reasonably assured.

Because “bill and hold” transactions receive what may be referred to as a “waiver” for the delivery requirement, the SEC requires strict compliance with the following special rules: (i) the risks of ownership must have passed to the buyer; (ii) the buyer must have made a fixed commitment to purchase the goods; (iii) the buyer, not the seller, must have requested that the transaction be on a bill and hold basis; (iv) the buyer must have a substantial business purpose for the bill and hold arrangement; (v) there must be a fixed schedule for delivery of the goods; (vi) the seller must not retain any performance obligations related to the sale; and (vii) the goods must be complete and ready for shipment at the time of the bill and hold transaction.

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Improper Conduct per the SEC

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Per the SEC, near the end of the fourth quarter of fiscal year 2017, to meet quarter-end sales projections, USAT employees enticed a customer to “purchase” products even though the customer did not have a present need for the products. Rather than ship the products to the customer, USAT shipped the products to a third party who agreed to store the devices.

Because the customer would never agree to pay for products that it did not need, USAT extended the payment terms indefinitely and gave the customer the right to cancel the transaction within 90 days. In sum, the customer did not want the products, did not have to pay for them and could cancel the sale, and did not have to accept delivery. As a result, USAT improperly recognized approximately $1.2 million in revenue related to this transaction.

Following a similar pattern, USAT enticed another customer near the end of the third quarter of fiscal year 2018 to “purchase” products for which it also had no present need. USAT arranged to have these products stored in its warehouse on behalf of the customer and provided deferred payment terms. This time the payment terms allowed the customer to defer paying for the products, not just until after eventual delivery, but until after sold by the customer and installed on the end user’s machines. As a result, USAT improperly recognized an additional $0.4 million in revenue related to this transaction.

While documenting the transactions to meet the “bill and hold” requirements, the transactions fail to meet the established requirements when considering the facts. From a technical accounting standpoint, the obvious revenue recognition compliance failures included: (i) USAT initiated the bill and hold treatment, not the customer; (ii) the customers did not have a fixed commitment to purchase the goods and were provided nonstandard, flexible payment terms and an ability to cancel the transaction; and (iii) the transactions lacked a fixed delivery date.?From a plain English standpoint, these transactions reflected the indicia of a fraudulent revenue recognition scheme.

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Intentionally Shipping Wrong Products

To state the obvious, revenue from the sale of products should be recorded for products ordered by the customer, and for which the customer will pay.

Improper Conduct per the SEC

In the second and third quarters of fiscal year 2018, USAT attempted to meet their sales goals for those quarters through another scheme: shipping available products because the actual products ordered were unavailable.

In the second quarter of fiscal year 2018, USAT convinced two customers to order products that they did not want and could exchange at a later date when the products they actually wanted became available. As a result, USAT improperly recognized an approximately $1.5 million in revenue related to these transactions.

Later in the third quarter of fiscal year 2018, USAT falsely reported revenues by intentionally shipping the wrong goods to a customer when the requested goods were unavailable. Additional conduct concerns described in the AAER include USAT shipping the wrong products to a third party to hold them and describing the intentional act of shipping the wrong products as “shipping mistakes” when contacted by customers. The customer “returned” the wrong products in the following quarter. As a result, USAT improperly recognized an additional $0.9 million in revenue related to this transaction.

Per the AAER, versions of this scheme occurred on multiple occasions. USAT improperly recorded revenue for these transactions because it knew that the shipped devices would be returned by their customers, and the customer had no intent to pay for the wrong products. Again, these transactions reflected the indicia of a fraudulent revenue recognition scheme.

Observations and Recommendations

As to “bill and hold” transactions, the best recommendation is to not allow them. They are an exception to the general revenue recognition rules, and often associated with creating an

environment of “making” sales numbers, rather than making actual sales. If the product is not delivered in the accounting period, then it will be in the next period and recognized as revenue upon such delivery. Disclosures regarding backlog and sales commitments can be as effective in describing period activities and results to the market, and without creating the aggressive culture risks of “bill and hold” transactions. As to internal control recommendations for “bill and hold” transactions, from reading the AAER, the appearance of side letters and fabricated documentation makes ordinary course controls appear inadequate. Although an organized “bill and hold” checklist by the accounting department or internal audit may have detected some of the problems.

In contrast, shipping the wrong product should have been detected by standard internal controls to match purchase order information to fulfillment, shipping, and invoice information. The AAER does not provide details on whether such controls existed, and if so, the number of people that may have been involved in overriding such controls.

Most important, if you want to know if there are revenue recognition games being played, ask the shipping department personnel. They almost always know the truth!