May 30, 2008, 12:00 AM

Not So Fast

Delayed gratification is the rule when it comes to recognizing revenue from an online sale.

Many retailers consider their job done once they’ve shipped the order to the customer. Most recognize revenue from the sale at that time. The U.S. Securities and Exchange Commission, however, does not share that view on revenue recognition.

Off-price retailer Overstock.com Inc. was forced in March to restate revenue and earnings for its fiscal fourth quarter after the SEC objected to its practice of recognizing revenue upon shipment. Overstock must recognize revenue, the SEC contended, only when the risk of ownership passes from seller to buyer, a rule that the SEC put into place in 1999.

For online and catalog retailers, that’s generally interpreted as meaning when the customer receives the product, says Doug Hart, a partner in the retail and consumer products practice of accounting firm BDO Seidman. “If goods get lost in shipment, is the customer going to say they have real ownership of the goods they ordered? No. That’s where the SEC is coming from,” Hart says.

While the SEC guidance is binding only on public companies, in the absence of any explicit guidance on revenue recognition for private companies, most accountants recommend the same approach to all clients, Hart says. Adopting the SEC policy is especially important for companies considering going public, and should be implemented well in advance of a public offering of stock, he says.

SEC action

The SEC questioned Overstock’s practice in a letter late last year, and an exchange of letters ensued. Overstock argued that it is more accurate to recognize revenue when the items shipped because the retailer knows for sure when that is, an Overstock spokesman says. But the SEC held its ground and Overstock agreed to change its policy.

Overstock said in a subsequent filing with the SEC that it would estimate delivery date based on the carrier used, whether the item is coming from a company warehouse or another company, the destination and its historical experience, which shows that deliveries typically take one to eight days.

The restatement resulted in Overstock increasing from $5 million to $13.7 million the fourth quarter revenue it deferred to the first quarter of 2008. That was less than 5% of its $300 million fourth quarter revenue. For the year, the change reduced revenue from the previously reported $768.8 million to $760.2 million. The company also deferred expenses, but not enough to offset the entire deferral of revenue. As a result, net loss for the year increased from $44.1 million to $45 million.

The company added that the change would have no significant impact on future reports as each quarter from now on would include a few days revenue from the prior quarter and defer late-quarter sales into the following period.

The SEC imposed no penalty on Overstock, nor did it threaten any action, the Overstock spokesman says.

The SEC’s Enforcement Division has the power to fine a company or its officers for not complying with its rules and to prohibit top company officials from holding posts like chief executive officer or chief financial officer with a public company, Hart says. However, he doubts the issue of shipping versus delivery date would normally be serious enough to warrant the attention of the SEC Enforcement Division.

At the same time, he notes that if a company refused to comply with the SEC request, its auditors would likely withdraw their required certification of the company’s filings. That could lead to such serious consequences as delisting from stock exchanges and investor lawsuits. “Bad outcomes,” Hart says.

But the SEC can move slowly to enforce its rule. Overstock had been counting revenue upon shipment since before it went public in 2002 and only heard from the SEC late last year. Shutterfly, an online photography retailer that went public in 2003, has never been challenged by the SEC, although it states in every quarterly filing that it recognizes revenue when goods are shipped, a spokeswoman says.

SEC staffers closely review a public company’s annual report every three years as a rule, and typically raise questions during those reviews, an SEC spokesman says. While the SEC can miss something in those reviews, Hart says, “Recognizing revenue based upon delivery versus shipment is certainly one of the more straightforward issues and my experience has been that they will ask questions more often than not for companies who recognize revenue upon shipment.”

The SEC detailed its position on revenue recognition in Staff Accounting Bulletin 101, issued on Dec. 3, 1999. The document outlines four conditions that retailers must meet before recognizing revenue, including “Delivery has occurred or services have been rendered.” Jewelry merchant Blue Nile Inc. is among the publicly traded e-retailers that recognizes revenue upon estimated delivery, typically one to three days after shipment, the company says.

For privately held retailers not required to file with the SEC, Hart says the major issue would be whether a company is deceiving investors by recognizing revenue upon shipment rather than estimated delivery date. Since in most cases it would only be a matter of moving a few days’ revenue from one quarter to the next that’s not likely to be the case, he says.

“Even if it’s technically wrong,” Hart says, “if it wouldn’t impact investors’ decision-making it’s not a big deal. You’re not committing fraud.”

Private companies

Among the privately held online retailers that recognize revenue upon shipment are electronics retailer Crutchfield Corp. and general merchandiser ShoppersChoice.com LLC. Another privately held online retailer, Zappos.com Inc., recently changed its policy to recognize revenue upon delivery rather than shipment. “We felt it was the right thing to do,” says Alfred Lin, chief operating officer and chief financial officer at Zappos, who says the move was voluntary.

Recognizing revenue upon shipment is not necessarily inconsistent with the SEC staff bulletin if a retailer is going to try to force customers to track down packages that go missing and file insurance claims, in effect transferring the risk of ownership to the customer, Lin says. “We are in the habit of providing great service, so we do all these things on behalf of the customer,” he says.

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