Internet Problem 14-1: Revenue Recognition Fraud Essay Sample

The Securities and Exchange Commission ( SEC ) found that Bally Total Fitness Holding Corporation. a countrywide commercial operator of fittingness centres. fraudulently accounted for three types of grosss it received from members. The SEC besides charged the audit house and six spouses for their functions in the accounting misdemeanors. Visit the SEC’s web site ( World Wide Web. sec. gov ) and search the nexus to “Litigation Releases” to turn up Litigation Release 20470 issued on February 28. 2008 against Bally Total Fitness Holding Corporation to larn more about this gross fraud. Required:

a. Read the release and the attach toing ailment in this affair and briefly summarize the three types of alleged gross frauds. B. Tax return to the gap page on the SEC’s web site and seek the nexus for “Press Releases” to turn up the December 17. 2009 proclamation of the SEC’s charges against the audit house and the six spouses. c. Read the imperativeness release and briefly summarize the SEC’s description of the nature of audit hazard associated with the Bally’s audit battle. d. Read the ailment against the audit battle spouse. who served as the 2001 and 2002 battle spouse. What factors caused the audit house to acknowledge Bally as a high hazard audit client for 1996-2003?


The undermentioned replies are based on the SEC’s Litigation Release No. 20470 and related imperativeness releases associated with the fraud at Bally Total Fitness Keeping Corporation:

a. Harmonizing to the SEC imperativeness releases and Litigation Release No. 20470. Bally fraudulently accounted for three types of gross it received from members: induction fees. postpaid dues. and reactivation fees.

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Initiation fees: Bally fraudulently and prematurely recognized gross from induction fees. Part of the monetary value of a Bally wellness nine rank was a erstwhile induction fee that was either paid in full when the member joined or was financed over a period of clip. typically 36 months Regardless of how the induction fee was paid. accounting criterions prohibit Bally from acknowledging all the grosss from induction fees instantly. Alternatively. accounting criterions require that Bally acknowledge induction fee gross over the full rank life. This means that for members who maintained their ranks beyond the funding period. or initial period of rank. Bally was required to postpone induction fee gross and acknowledge it over the estimated rank life. non over the term of the initial period of rank. However. Bally prematurely recognized its members’ induction fee gross over a period that was non merely shorter than the estimated rank life. but in most cases even shorter than the initial period of rank.

Personal Training Servicess: In add-on to selling wellness nine ranks. Bally besides sold personal preparation services ( i. e. . exercising Sessionss with personal trainers ) . Some clients prepaid for Sessionss with personal trainers. Accounting criterions require that gross from postpaid personal preparation services be recognized merely when earned. which is when the personal preparation services were really provided. Bally. nevertheless. recognized gross related to personal preparation services before those services were really provided. Reactivation Fees: Bally besides fraudulently recognized gross from unpaid dues on inactive ranks. Not all Bally members who completed their initial rank contract term renewed their rank. Alternatively. they ceased paying dues. Those members who had paid all sums due under the initial rank contract. but who had so stopped paying monthly dues for six months or longer. were solicite by Bally for “reactivation. ” Under that offer. nonchurchgoing members could rejoin by paying a “reactivation fee. ” which was lower than an “initiation fee. “

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Accounting criterions prohibit Bally from acknowledging any gross from “reactivation fees” until after the reactivating members had entered into adhering contracts. Rather than follow with accounting criterions. Bally merely projected the figure of reactivating members that it anticipated rejoining up to three old ages into the hereafter. and so recognized those anticipated but conjectural reactivation fees as gross. The company recognized that conjectural gross over a period composed of: ( a ) the mean delinquent period ( that is. the period between when members stopped paying their monthly dues and when they reactivated ) ( B ) the mean reactivation period. In ulterior old ages. they abandoned this methodological analysis and adopted a modified hard currency footing of accounting for reactivation fees.

B. Yes. there is a imperativeness release by SEC’s against audit houses and six spouses.

c. The imperativeness release notes that the SEC’s order against the audit house ( Ernst & A ; Young ) finds that the house identified Bally as a hazardous audit because its directors were former E & A ; Y audit spouses who had “historically been aggressive in choosing accounting rules and finding estimations. ” and whose compensation programs placed “undue accent on reported net incomes. ” Out of more than 10. 000 audit clients in North America. E & A ; Y identified Bally as one of E & A ; Y’s riskiest 18 histories and as the riskiest history in the Lake Michigan country.

d. Based on ailment against John M. Kiss who served as the battle spouse for the 2001 and 2002 audits.

Harmonizing to the ailment. E & A ; Y recognized Bally as a hazardous audit and designated Bally as a “close monitoring account” from at least 1996 through 2003. A “close monitoring account” represented one that presented a hazard that created a “significant opportunity the house [ E & A ; Y ] will endure harm to its repute. monetarily. or both. ” Bally was designated as a close monitoring history for several grounds. including. among other things. that Bally’s manager’s were former E & A ; Y audit spouses who were “difficult” and had “historically been aggressive in choosing accounting rules and finding estimations. ” The ailment notes that the directors had placed undue accent on keeping stock monetary values and that direction used “ ( un ) dependable … appraisal procedure [ es ] or questionable judgements. ” Bally’s compensation programs placed undue accent on reported net incomes. E & A ; Y’s internal counsel notes that a “history of ‘aggressive’ applications of accounting policies could bespeak a sensitivity to misstate the fiscal statements. “

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