What happens when a mistake in revenue recognition is made?
If a company reports its revenue aggressively then the company might have overstated revenue numbers in their current financial statements and may have to re-adjust it in future.
Case study 1: Below is the snapshot of an Indian Listed company who had re-adjusted their revenue numbers of past in future reporting owing to “Aggressive revenue recognition” at their end.
Source: Q1 FY22 Report
Source: Con-call. To maintain anonymity we haven’t disclosed the company's name as well as analyst and management name:)
Case Study 2: Another example of aggressive revenue recognition has been taken below for a firm (whose name we won't be disclosing . Just by looking at the FY17 figures in AR 2017 and AR 2018, you will realise that the figures were restated from 70 Cr topline to a 55Cr topline! (More than 20% correction in historical figures)
When asked about this in the concall discussion, the management replied:
Now, our point is, if the firm had to refund the payment made by the client as per the contractual terms, it shouldn't have been recognised as revenue in the first place! It should have been a part of Contract Liabilities or advance from the customer! (i.e. unrealised revenue).
One couldn't have caught it beforehand by reading revenue recognition policy, however, since analysts kept a close eye on the Revenue reversals, they were able to catch and ask in the concall discussion.
To conclude, this is why we should never start to look at any revenue figures without understanding the company's revenue recognition policy first (especially check if there have been any changes in the same) and while analysing figures, prefer to punch data rather than downloading it from data vendors because you won’t have clarity of what adjustments are to be made in that data before jumping to analyse the data. Moreover, while doing time series analysis, learn to adjust numbers to make them comparable before jumping the gun. Numbers can be made comparable by either adjusting the old figures or the new ones, whichever takes least effort.