Revenue Recognition from Barter Transactions
One earnings quality issue arises from barter transactions. A good example of this is provided in Financial Statement Analysis : A Global Perspective and excerpted below.
Internet companies often exchange rights to place advertisements on each other’s Websites (that is, barter). Should the company record the revenue based on the fair market value of the space and a related expense of the same amount? Or should both be ignored since they offset each other? The net result has no impact on earnings, but early stage companies are often valued based on revenues rather than earnings or cash flow (often because they have no earnings or cash flow). Companies could inflate their values by recording barter transactions as “revenue” even if these arrangements did not produce earnings or cash flow for the respective entities.
In 1999, the FASB Emerging Issues Task Force (EITF) declared that revenue from such barter transactions should be reported only if the fair value of the advertising surrendered in the transaction is determinable based on the entity’s own historical practice of receiving cash, marketable securities, or other consideration that is readily convertible to a known amount of cash for similar advertising from buyers unrelated to the counterparty to the barter transaction.
Analysts may go further, and consider whether other transactions between companies are barter-like and whether the financial statements should be adjusted to treat them as such.
For more information, see all articles on: Adjusting Reported Financial Statements, Financial Statement Analysis, Fundamental Analysis, Securities Regulation See also:
The Intelligent Investor: The Classic Text on Value Investing
Financial Statement Analysis: A Practitioner's Guide, 3rd Edition
Managing Investment Portfolios: A Dynamic Process (CFA Institute Investment Series)
