The accounting industry has undergone a variety of scandals over the years. The now infamous Enron incident and similar occurrences have dealt a major blow to the accounting profession and have left many wondering whether the information that companies provide about themselves are accurate representations. After all, the purpose of accounting is to provide meaningful and decisive information about a company to its interested parties. Whether this is the government, creditors, suppliers, shareholders or potential investors; they all rely on the information that is provided to them by accounting systems and the related assurances that the accounting profession provides. Thus, in order to ensure proper financial analysis of a corporation, interested parties must become familiar with the window dressing techniques or tactics that some corporations undertake.
CHANNEL STUFFING
In our current economic environment, where any fresh piece of information moves the the stock of a company or where only the facade of strong short term financial measures are considered, the need to meet expectations and estimates is a force that pushes corporate managers to artificially improve financial benchmarks. At the end of the fiscal year, this motive is especially powerful and encourages deception and manipulation.
One of the many accounting techniques that companies use to hide their underlying performance is channel stuffing or trade loading. This practice is usually undertaken by companies who want to paint a brighter picture of their financial condition than their current situation. Channel stuffing accomplishes this by artificially inflating revenue through fictional sales. The Securities and Exchange Commission defines channel stuffing as the "practice of shipping more goods to distributors and retailers along the distribution channel than end-users are likely to buy in a reasonable time period." This move momentarily increases sales by shipping more goods than what the distributers can sell, which allows managers to present higher revenues, both in the financial statements and in the eyes of the general public. This picture thought is fleeting and once the distributers begin returning a company's goods or products, adjustments have to be made and reality begins to sink in. These adjustments restore the company's financial statements to their true state and undoes the effects of trade loading. To compound to this, a company may also face additional expenses related to shipping and warehousing of the excess products.
Channel stuffing is an illegal practice and violates the revenue recognition principle. Channel stuffing fraudulently improves the financial condition of a company and as direct result raises the value of a company's stock. The SEC considers this a deceptive implementation of accounting principles and is therefore unlawful. As the SEC states, "usually, distributors retain the right to return any unsold inventory which calls into question whether a final sale has actually occurred." The revenue recognition principle dictates that two requirements need to be satisfied before revenue is recognized. One, that revenue is earned by providing goods and services, and, two, that revenue is realized, or that payment for goods and services be received in the form of cash or something that can be converted to a known form of cash. Channel stuffing meets the first criteria, revenue is earned because a company delivers goods or services, but it does not meet the second criteria, because it is uncertain whether the company has a right to receive payment since the customer has the right to return the goods bought.