Case Analysis: Revenue Recognition Fraud in HealthSouth & Satyam

This essay delves into the critical area of revenue recognition and its susceptibility to financial fraud, highlighting that revenue is a key metric attracting investors and a common target for manipulation. It defines revenue recognition abuse as either deliberate mistiming or outright fabrication, noting fabrication is easier to detect but still prevalent. The discussion features two prominent examples: HealthSouth Corporation, which allegedly inflated earnings by $2.7 billion post-public offering, and the Satyam Scam, involving creation of fake invoices, recognition of unearned gains, and overstated revenue of $1.15 billion due to misused funds. Furthermore, the essay outlines the five steps of revenue recognition according to the Financial Accounting Standards Board (FASB), including identifying the contract, performance obligations, transaction price, allocation of prices, and proper revenue recognition based on probable economic benefits and reliable measurement as per IAS 18. The essay emphasizes the importance of adhering to these steps to prevent mistiming or misstatement of revenue.

Revenue is and always has been the key attraction of any business.
Revenue, being the direct and main source of achieving the profit
objective of any business is like the main course which satisfies the
appetite of an investor. Having said that one needs no explanation why
revenue is the subject of many financial frauds.
Revenue Recognition Fraud: (Epstein, 2015) A revenue recognition
abuse includes –
 Deliberate mistiming of recognition of otherwise valid revenue, or
 Outright fabrication of revenue that does not deserve recognition
at all
While deliberate mistiming of recognition of revenue is hard to judge,
it’s comparatively easier to expose cases of fabricated revenue. But
companies will still resort to fabrication since the scope of
overstatement of revenue by mistiming can’t be stretched beyond a
point. Over the course of history, we have seen many accounting
frauds of which majority involved inflation of revenue. Let us take 2
such examples for our discussion.
HealthSouth Corporation (2003):
(Lupica, n.d.) Immediately after going for a public issue during the year
1996, HealthSouth Corp. reported huge losses which forced Mr. Richard
M. Scrushy, the founder of the company to instruct the accounting
personnel to resort to the fabrication of revenue. It was alleged that
the company falsely inflated the earnings by $2.7 billion. The company
clearly had an opportunity of avoiding this fraud by being more honest
towards the investors.
Satyam Scam (2009):
("Satyam scam: All you need to know about India's biggest accounting
fraud", 2015) Satyam Scam is a perfect example which covered almost
all the possible ways of inflating revenue by the time it occurred. From
the creation of 7500 fake invoices, recognition of unearned foreign
exchange gain, the creation of 500 fake customers and recording
mindboggling $194 million, the company managed to overstate their
revenue by $1.15 billion. The main cause for committing the fraud as
confessed by Mr. Ramalinga Raju (founder) is that he misused the
funds of the company by investing them in acquiring land and other
properties to gain in real estate boom. Top tier management should

abstain from misutilization of company’s funds to avoid repetition of
another Satyam Scam.
Five steps of Revenue Recognition:
(Shoemaker, 2018) The Financial Accounting Standards Board (FASB)
put forth new revenue recognition rules which outlined five steps for
recognition of revenue which are as follows:
Step 1: Identify the contract with a customer
This involves identification of key terms of the contract and
establishing the commercial substance of the contract. For example,
analyzing the terms of agreement gives us information about the
timing of cash flows and revenue accrual. Ignorance of this criteria
may result in mistiming of revenue recognition.
Step 2: Identify the performance obligation in the contract.
This involves the identification of specific obligations, the fulfillment of
which will lead to revenue. For example in case of telephone services,
the service should be performed continuously but the performance
obligation can be broken down into a specific period, the completion of
which will make the supplier of service eligible for revenue.
Step 3: Determine the transaction price:
This step involves jotting down all the sources of revenue involved in
the transaction and ascertaining the value of the revenue obtained. For
example, a single contract of a lending may involve multiple revenue
flows such as interest, inspection charges, processing charges, etc.,
Step 4: Allocate the prices to performance obligations:
Let us continue with the above example. The timing of the flow of each
type of revenue requires completion of specific obligation. Sanction of
loan is the trigger for accrual of processing fee and lapse of an agreed
time period is the trigger for accrual of interest. If the prices are not
allocated to the performance, it may lead to confusion in ascertaining
the value of revenue to be recognized and ultimately results in

postponement of otherwise valid revenue recognition owing to
uncertainty.
Step 5: Recognise Revenue:
Many time considerable judgment is involved in recognition of revenue
especially due to accrual concept where cash receipt is not the criteria
for recognition of revenue. As per IAS 18, Revenue, revenue should be
recognized when the following conditions are met:
 It is probable that the economic benefits from the revenue flow to
the enterprise; and
 The revenue can be measured reliably
Once the said conditions are satisfied the company can recognize
revenue in the books of accounts.

Bibliography:
Shoemaker, S. (2018). 5 Steps of the New Model of Revenue Recognition for Franchisors. Retrieved from
https://www.entrepreneur.com/article/320117
Lupica, C. HealthSouth, Inc.: A Case of Corporate Fraud. Retrieved from
https://stakeholder11.wordpress.com/2014/11/24/healthsouth-inc-a-case-of-corporate-fraud/
Satyam scam: All you need to know about India's biggest accounting fraud. (2015). Retrieved from
https://www.hindustantimes.com/business/satyam-scam-all-you-need-to-know-about-india-s-biggest-
accounting-fraud/story-YTfHTZy9K6NvsW8PxIEEYL.html
Epstein, B. (2015). Revenue Recognition: The Easy Route to Financial Reporting Fraud - Epstein + Nach
LLC. Retrieved from http://www.epsteinnach.com/commentary/revenue-recognition-easy-route-
financial-reporting-fraud/