In the case of Lucent Technologies, Inc. ("Lucent"), the recognition policies proved to be unfortunate in light of the SEC action against them.
Generally, one of the most reliable methods for revenue recognition is the critical event basis. When a critical event takes place within the operating cycle, such as a final sale, there are few questions regarding the recognition of the revenue. This more conservative method is "justified because the price of the product is then known with certainty; the exchange has been finalized by delivery of goods, leading to an objective knowledge of the costs incurred" which allows the revenue from the transaction to be accurately recorded (Riahi-Belkaoui 45). This results in a faithful representation of the company's underlying financial condition because it is unbiased and verifiable. In terms of relevance of the information, the company may take the position that, since investors use the data to make decisions regarding timely investments, they should be given information that presents the company in the best possible light. This approach can result in more aggressive methods, like the ones used by Lucent, via a scheme of issuing credits to recognize revenue as soon as possible. ...
Revenue should be recognized at the final sale.
In the case of Lucent, the company's actions demonstrate the worst aspects of ignoring conservative revenue recognition. They chose to use any means necessary to present investors with a positive picture. Lucent's management decided that it was more important to show higher levels of income than engage in a faithful representation of true financial condition. The problem for Lucent was that investors were relying on the overstated revenues as a basis for owning the company's shares, and when the true revenue numbers were revealed, the stock lost over five percent of its value. Management's decision to massage the numbers toward the higher revenue representation was a poor one. This case demonstrates the down-side of tampering with information to meet sales goals so that investors will be please. It is far better to use a reliable methodology. Lucent's aggressive revenue recognition policies ultimately hurt the company because they were dishonest and biased.
When a vendor has an ownership interest in a customer, it is easier to engage in these practices. By using the leverage of customer ownership, Lucent could claim the revenues it originally reported while knowing that renegotiated terms would result in subsequent credits against that revenue. The issue is one of control. Rising to the level of collusion, Lucent could over-ship to its partner/customers, show the gross revenue on its financials, and then control the final customer cost through credits. The failure to book the impending credits, when management knew that such reporting would temporarily meet the sales targets but ultimately result in reduced revenues, was