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Recent Enforcement Actions Stemming From Accounting Estimates

March 10, 2024

This is the third and final instalment in a series of articles on “The risks associated with accounting estimates”.

The SEC has continued to bring enforcement actions against filer’s non-compliance with accounting standards

2023 was a busy year for accounting enforcement cases brought by the US Securities and Exchange Commission (SEC) against corporations, corporate officers, auditors and the firms they represent.  

Several of the actions brought involved revenue recognition. This is a mainstay of accounting related cases due to the importance of revenue as a standalone measurement of the health of a corporation, and in boosting profitability and assets as a means of meeting or exceeding shareholder expectations.  

On the opposite side, corporations were also found to have inappropriately deferred costs or applied accounting estimates deemed inconsistent with what was known within the business during the relevant period, including in areas of impairment. We discuss several of these below.

Revenue recognition

"In what is sometimes surprising to non-accountants, accounting for revenue in accordance with GAAP can involve considerable judgment and estimation."
Construction projects and Estimates at Completion (EAC) Accounting

This is especially relevant for construction and engineering companies that deliver long-term contracts to customers. Companies may recognize revenue as the project progresses based on the estimated overall profitability and percentage stage of completion at the measurement date. However, where a loss is anticipated, the full extent of the estimated loss must be recognized immediately.  

In 2023, the SEC brought a proceeding against the CEO and CFO of McDermott International Inc related to an LNG plant construction in Cameron. The company’s Project Cost Team had estimated that the loss on the project could exceed $1.1B based on certain future cost projections. However, the company deviated from its regular process for evaluating costs to completion (including remedial measures to address cost overruns). The SEC concluded that this had incorrectly reduced the loss to approximately $490M.  

Traditional Revenue Recognition Schemes: Bill & Hold including Distributor Sales

It is worth noting that not all revenue recognition schemes involve the use of complex estimates. During 2023 the SEC brought actions against at least two companies and/or its officers for engaging in “bill-and-hold” revenue schemes (see Evoqua Water Technologies Corp and USA Technologies / Cantaloupe Inc).

Revenue may be recognized under “bill-and-hold” arrangements, but GAAP requires that certain conditions be met. This includes the request being initiated by the customer, and the delivery schedule being fixed. Evoqua Water invoiced customers for the product but delivered the product at a later date, without the knowledge and request of the customer.  

In the case of USA Technologies, a more complex arrangement was established. The company did not meet the criteria for revenue recognition in that:

  1. it initiated the request to the customer that they agree to purchase product that it did not have an immediate need for,
  2. shipped the product to a third party for storage, and  
  3. allowed the customer to ‘cancel’ the order within 90 days. USA Technologies also shipped product to customers that they had not ordered or had explicitly told the company that they wanted other devices.
Other revenue recognition schemes

Some revenue recognition schemes are even less complicated. The SEC brought an action against the auditor of FTE Networks Inc. for audit failures associated with a scheme to overstate revenue from purported construction projects that had not yet been billed, or contracts that had been completed and billed but not paid. However, these involved fictitious revenues where there was no evidence of an arrangement with an existing customer.  

In the case against SAExploration Holdings Inc, the SEC charged the company and ex-CEO for an alleged scheme where $140m of contracts were entered into with an Alaskan company, purported to have been a third party but that in reality was controlled by the CEO and CFO. The defendants recorded revenue despite the Alaskan company not requesting the services and having no intention of paying for invoices issued. The defendants misappropriated $12m of funds from SAExploration, routing half of the amount back into the company to provide the appearance that the Alaskan company was settling its invoices. The other half was embezzled by the defendants.

Other examples of actions brought by the SEC for fictitious, premature revenue recognition or non-binding sales orders included cases against the CFO of Osiris Therapeutics Inc and the Financial Controller of Pareteum Corporation.

Minimize costs

"In addition to maximizing revenue, companies seeking to enhance results may look to reduce or defer costs, often through the manipulation of accounting estimates."

Estimates are required in several areas including asset impairment, warranty or maintenance claims/expenses, and provisions for losses (e.g., loans at a financial institution). During 2023, the SEC brought cases against companies and/or their officers in each of these categories.

Identification and Estimation of Impairment Charges

China based Future Fintech Group8 had several business units experiencing downturns or increased competition. These triggering events required testing for impairment to assess if the carrying value of assets (operating assets and assets under construction) exceeded their fair value. While the company recognized impairment losses, its estimates failed to identify, based on available evidence at the time, that impairment charges were required in earlier periods and at larger amounts.

The SEC also took action against the CFO and COO of Celadon Group9, who were alleged to have purchased and sold trucks at inflated prices – in some cases double or triple the fair market value. This was to conceal the company’s failure to write down the trucks’ net book value and take impairment charges. By manipulating the value of the assets there would be no apparent impairment trigger and/or estimated inputs to the impairment assessment would be inaccurate.

In a third case, the SEC alleged that Roadrunner Transportation Inc. engaged in multiple schemes to defer or spread expenses over multiple periods to achieve EPS targets provided to investors. One scheme accounted for earn out agreements entered into as part of M&A transactions as contingent purchase obligations recorded at “fair value” at the acquisition date. The earn out was contingent on the acquired companies’ EBITDA which in fact had fallen short of expectations. This should have reduced the fair value estimate for the earn out obligation. However, in estimating the earn out obligations the company inflated EBITDA projections to support overstated valuations that would signal to investors that the acquisitions were successful and would create a “cushion” that could be released in future periods to assist in meeting EPS estimates.  

Estimates for Warranty & Maintenance Costs  

Companies will frequently include as part of sale transactions warranty and future maintenance services. Such obligations create a potential liability that must be estimated and recorded in the financial statements. The CFO of View Inc. was charged with knowingly underestimating warranty provisions by failing to incorporate into the estimate, costs associated with the shipment and installation that had been agreed with customers, related to replacement windows that were sold under warranty.  

Power Plug Inc, a hydrogen fuel cell provider for electric cars, similarly failed to properly account for extended maintenance contracts. Customers would make an upfront payment for such services, such income being treated as deferred revenue, recognized over the life of the contract. When expected future service costs are projected to exceed revenues over the remaining term of the contract, the company is required to record an accrual for the loss. Errors were made in the estimation of maintenance costs: a) the company incorrectly reclassified certain fuel costs as R&D so did not include such costs in the estimates of future expenses, and b) failed to include other costs including service costs and stock warrants issued to large customers.  

Loan Losses
"Significant estimates are also required within the financial services sector, including the likelihood of loans defaulting and losses being incurred."

In the case of Malvern Bancorp, the SEC charged the bank and its CFO for repeatedly failing to timely recognize and account for loan loss provisions related to large commercial real estate loans. The commercial property was in a debt restructuring, had lost its primary tenant and had failed to secure a replacement. It failed to identify that it was a troubled debt restructuring loan (i.e., an impaired loan). Per ASC 310-10-35-22, when a loan is impaired, “a creditor shall measure impairment based on the present value of expected future cash flows discounted at the loan’s effective interest rate, except that as a practical expedient, a creditor may measure impairment based on […] the fair value of the collateral if the loan is a collateral-dependent loan."  The bank’s inputs to the estimated future cash flows failed to include, or excluded, certain known facts thereby overstating the cash flows and future value and reducing the impairment charge.


Accounting cases are complex and can take time to investigate and conclude. It would not be surprising to see an increase in accounting enforcement actions in the months and years ahead.

Many of the cases that are cited above relate to conduct prior to the covid pandemic and its subsequent impact on the economy, including inflation, supply chain disruption and the operating models of companies. All of these changes may well have had a significant impact on cost projections, the timing of client deliveries, and financing and credit arrangements, all of which feed into accounting estimates. It would not be surprising to see an increase in accounting enforcement actions in the months and years ahead.  

Read the full series  

For an overview of what lawyers need to know about accounting judgments, watch our 45-minute webinar here.

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