Accounting Observer > Public Blog - NEC Goes On GAAP Hiatus

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NEC Goes On GAAP Hiatus

Location: Blogs AAO Weblog (Public)
Posted by: Jack Ciesielski	10/27/2006 7:07 AM
Interesting 6-K filing by Japanese electronics giant NEC: it seems that the company is having trouble preparing its financial results on a United States accounting principles basis. This isn't something new challenge for NEC, so it's a little unusual to see it happening now. The company will be reporting results on a Japanese basis for the current year; they gave no indication that they'd be switching back to U.S. GAAP. NEC's financials for the fiscal year ending March 31, 2006 were audited by Ernst & Young ShinNihon under Japanese auditing standards - not the same standards as required in the United States by the Public Company Accounting Oversight Board. After the report was filed with the Japanese regulators, the auditors "requested further analysis" for a revenue recognition issue; this caused a delay in filing the firm's 20-F with the SEC, and was announced on September 28. It still will file (eventually) the 2006 20-F on a U.S. GAAP basis; although they make no commitment to further filings, it would be strange not to continue reporting on a U.S. basis once the bugs have been worked out. The company admits that it will take "considerable time" to prepare its financials on a U.S. basis for the first half of fiscal 2007 (the current year) because of the problems in getting resolution on 2006. So, it's switching to Japanese GAAP in its future financial releases. Needless to say, this is going to hose the analysts who have been following the company on a U.S. basis - and don't know reporting under Japanese GAAP. What's the hold-up? Being a foreign issuer, NEC doesn't report on its internal controls yet. But the auditors have found problems neverheless: The September 28 filing states that the current internal controls do not "ensure that all significant U.S. GAAP adjustments and reclassifications, presentations, and disclosures" are included in U.S. GAAP financials; the company lacks specific policies and procedures for dealing with transactions under U.S. GAAP; and the company lacks personnel with the "appropriate knowledge, experience, and training in the application of U.S. GAAP at its headquarters' corporate controller division or its various business units and subsidiaries." Damning stuff, and not uncommon in the United States when firms were going through their first Section 404 reviews. The net result of those weaknesses led to the delay in filing: problems were found in revenue recognition, income taxes, accruals and reserves, and research and development expenses. Basically, in much of the income statement. The real sticky issue, as noted in yesterday's filing seems to be the revenue recognition issues in NEC's "IT Solutions" group. Apparently, this is a services group that enters into customer arrangements that have more than one facet to them: the firms is committed to delivering multiple elements of a contract over various stages of an agreement's life. The iron rule of revenue recognition (one of the iron rules, anyway) is that you don't recognize revenue before you've delivered goods or provide services - even if you've been paid in advance. NEC's auditors "requested further analysis to support the relative fair value of maintenance and support services provided as part of multiple element contracts": it's what's needed to parse out the different components of a contract, each component with a possibly different revenue recognition pattern. So the relative fair values of each can ultimately have a big impact on the timing of revenue recognition. Given that these contracts often span more than one year, it's not unlikely that there could be issues with previous years' documentation that have an effect on FY 2006 also. That would only add to the time needed to finish the job.

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