Rasmussen 2013

Accounting Horizons
Vol. 27, No. 1

2013
pp. 91112
American Accounting Association

DOI: 10.2308/acch-50291
Revenue Recognition, Earnings Management,

and Earnings Informativeness in the
Semiconductor Industry
Stephanie J. Rasmussen
SYNOPSIS: Manufacturers that sell products to distributors experience product return
and pricing adjustment uncertainties until the products are resold to end-customers.
Such manufacturers recognize revenue when products are delivered to distributors (sellin), when distributors resell products (sell-through), or under some combination of these
methods (sell-in for some distributor sales and sell-through for others). This study
examines the implications of these revenue recognition methods for a sample of
semiconductor firms during 20012008. Semiconductor firms face rapid product
obsolescence, declining prices over product life cycles, and unexpected industry
downturns, which naturally lead to product return and pricing adjustment uncertainties. I
find that sell-through and combination firms are less likely to manage earnings compared
to sell-in firms. I also find that earnings are more informative for sell-through firms
compared to both sell-in and combination firms. These findings suggest that
manufacturers that sell products through the distribution channel should defer revenue
recognition until product return and pricing adjustment uncertainties are resolved.
Keywords: revenue recognition; earnings management; earnings informativeness;
distributors; manufacturers.
JEL Classications: M41.
Data Availability: Data are available from the sources identied in the text.
Stephanie J. Rasmussen is an Assistant Professor at The University of Texas at Arlington.

I gratefully acknowledge helpful comments and suggestions offered by Terry Shevlin (editor), two anonymous referees,
Anwer Ahmed (dissertation chair), Kris Allee, Cory Cassell, Mike Drake, Jap Efendi, Rebecca Files, Tom Omer, Dudley
Poston, Jaime Schmidt, Mary Stanford, Senyo Tse, Connie Weaver, and workshop participants at Texas A&M
University, University of Houston, The University of Texas at Arlington, and the 2009 AAA Annual Meeting. I am
indebted to the following practitioners for willingly sharing insights from their own experiences with revenue recognition
in the semiconductor industry: Sanjoy Chatterji, Wendy Clancy, Bernard Gutmann, Linda King, Carl Mangine, and
Laurie Martens. I thank Linying Zhou for research assistance. Financial support from Texas A&Ms Mays Business
School and The University of Texas at Arlington is greatly appreciated.
This paper is based, in part, on my dissertation completed at Texas A&M University.
Submitted: October 2011

Accepted: June 2012
Published Online: September 2012
Corresponding author: Stephanie J. Rasmussen
Email: srasmuss@uta.edu
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INTRODUCTION
evenue is one of the most important earnings components, usually the largest item on the
income statement, and a strong indicator of firm performance (e.g., Turner 2001). Revenue
is also very complex as evidenced by more than 200 publications (statements, opinions,
bulletins) that provide revenue recognition guidance under U.S. GAAP (FASB 2005). Given the
importance and complexity of revenue, it is imperative for financial statement users to have a strong
understanding of revenue recognition and its implications for evaluating firm performance and
valuation.
Standard-setters and academic researchers note that trade-offs exist between the relevance and
reliability of different accounting practices (see e.g., FASB 1980; Schipper 2003). Prior research
examines the implications of revenue recognition when uncertainties exist related to product
delivery (Altamuro et al. 2005; Zhang 2005) and the pricing of undelivered contract elements
(Srivastava 2011). These studies find that earnings are more informative, yet more likely to be
managed, when revenue recognition occurs before the uncertainties are resolved. I extend these
studies by examining the implications of revenue recognition for manufacturers that sell their
products to distributors. Such manufacturers face product return and pricing adjustment
uncertainties until the distributors resell products to end-customers. In addition, these manufacturers
have opportunities for real earnings management through channel stuffing. Channel stuffing
refers to either pulling in distributor orders from a future period or shipping large, unusual orders to
distributors in order to boost revenue (Penman 2007). Therefore, it is not clear whether prior
studies findings with respect to the implications of revenue recognition will hold for firms with
product return and pricing adjustment uncertainties.
Three revenue recognition methods exist for manufacturers sales to distributors. Under the
sell-in method, manufacturers recognize revenue upon delivery of product to the distributor (i.e.,
sales into the distribution channel) and maintain product return and pricing adjustment accruals
until distributor rights have lapsed at resale. Under the sell-through method, manufacturers
recognize revenue when the distributor resells product to an end-customer and all uncertainties have
been resolved (i.e., sales through the distribution channel). Manufacturers exclusively use one of
these methods to recognize revenue for sales to all distributors, or they use the sell-in method for
some sales to distributors and the sell-through method for other sales (hereafter, the combination
method).
Consistent with prior research (Altamuro et al. 2005; Srivastava 2011), I examine the trade-offs
between managerial discretion and earnings informativeness for differing revenue recognition
methods. Since the sell-in method recognizes revenue before product return and pricing adjustment
uncertainties are resolved, managers must estimate the likelihood of those events. Managers at
sell-in firms also have opportunities to intentionally manipulate their estimates or stuff the
distribution channel in order to meet or beat earnings benchmarks (Glass, Lewis & Co. 2004;
Greenberg 2006; Schilit and Perler 2010). In contrast, combination firms only have opportunities to
exercise discretion for a portion of all distributor revenue, and managerial discretion does not exist
for sell-through firms that defer revenue recognition until product resale by distributors. Due to the
differing opportunities for managers to exercise discretion, I expect that the incidence of earnings
management is less likely for sell-through and combination firms compared to sell-in firms.
While I expect earnings management differences among the revenue recognition methods for
sales to distributors, it is not clear whether the informativeness of manufacturers earnings differs
among the methods. On one hand, the sell-in method provides financial statement users with more
timely information than the combination and sell-through methods about the business transactions
between manufacturers and distributors. On the other hand, estimates of product returns and pricing
adjustments required under the sell-in method are susceptible to both intentional and unintentional
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Revenue Recognition, Earnings Management, and Earnings Informativeness
93
estimation errors. In addition, sell-in firms receive a greater benefit from channel stuffing compared
to combination and sell-through firms. Thus, the sell-in method would not reflect a firms actual
revenue-generating performance as well as the combination or sell-through method if these issues
prevail.
I examine revenue recognition methods for sales to distributors and their trade-offs using a
sample of 1,572 firm-quarters for 80 semiconductor manufacturers during 20012008. Thirty-two
percent of the sample uses the sell-in method, 20 percent of the sample uses the sell-through
method, and 48 percent of the sample uses a combination of the two revenue recognition methods. I
limit the sample to semiconductor firms because this industry experiences rapid product
obsolescence, declining prices over product life cycles, and unexpected industry downturns. These
issues contribute to channel stuffing, product return, and pricing adjustment uncertainties for
manufacturers with distributor customers. Semiconductor firms are also more likely to disclose
information about their relationships with distributors and less likely to have significant service- or
retail-related revenue (which could add noise to empirical analyses) than other firms that sell to
distributors. I begin the sample period in 2001 because revenue recognition principles have been
consistent since that year (first under Staff Accounting Bulletin [SAB] 101 and later under SAB
104).
I first test whether earnings management is less likely for sell-through and combination firms
compared to sell-in firms. Consistent with prior research (e.g., Barton and Simko 2002; Cheng and
Warfield 2005), I use the incidence of meeting or beating analysts consensus quarterly earnings
forecast as a proxy for earnings management to a benchmark. I find that sell-through and
combination firms are significantly less likely to meet or beat analysts consensus quarterly earnings
forecast compared to sell-in firms after controlling for other determinants of meeting or beating that
have been identified by prior work. The likelihood of meeting or beating analysts consensus
earnings forecast does not differ between sell-through and combination firms. These findings
suggest that earnings management is more likely for firms that recognize all revenue before product
return and pricing adjustment uncertainties are resolved.
Next, I test for earnings informativeness differences among sell-in, sell-through, and
combination firms. Specifically, I examine whether the earnings response coefficient, an indicator
of earnings informativeness, varies for firms with different revenue recognition methods (e.g.,
Altamuro et al. 2005; Srivastava 2011). I define unexpected earnings as the difference between
actual earnings per share and analysts last consensus earnings forecast prior to the quarterly
earnings announcement (scaled by stock price at quarter-end), and unexpected returns are
cumulative market-adjusted stock returns for two trading days beginning on the quarterly earnings
announcement date. I also control for many determinants of earnings response coefficients
identified by prior research. I find that the earnings response coefficient (the coefficient on
unexpected earnings) is significantly higher for sell-through firms compared to both sell-in and
combination firms. This finding suggests that earnings are more informative for firms that defer
revenue recognition until all product return and pricing adjustment uncertainties are resolved.
Collectively, this study suggests that manufacturers with product return and pricing adjustment
uncertainties should recognize revenue from sales to distributors after the uncertainties are resolved.
Although this conclusion differs from prior studies, which suggest that earnings are more
informative if firms recognize revenue before uncertainties are resolved (Altamuro et al. 2005;
Srivastava 2011), important differences exist between my setting and those examined in prior work.
First, the revenue recognition settings examined by Altamuro et al. (2005), and Srivastava (2011)
allow for manager manipulation of accounting estimates while my setting allows for both
manipulation of accounting estimates and real earnings management. Channel stuffing is a serious
concern of regulators, forensic accountants, and others (Glass, Lewis & Co. 2004; Greenberg 2006;
Schilit and Perler 2010), and egregious channel stuffing schemes have resulted in Securities and
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Exchange Commission (SEC) enforcement actions. It is likely that public awareness of channel
stuffing in my setting contributes to the finding that earnings are more informative when revenue
recognition is deferred until distributors have resold product to end-customers.
Second, I examine sample firms that consistently use the same revenue recognition method
throughout the sample period while Altamuro et al. (2005) and Srivastava (2011) do not. Forester
(2008) suggests that the cumulative-effect adjustment of an accounting change impacts earnings
informativeness in the transitional period following firms adoption of a new revenue recognition
method. When he excludes the transitional period from his analysis of Altamuro et al.s (2005)
setting, he finds that earnings are more informative for firms deferring revenue recognition under
SAB 101 compared to firms that accelerated revenue recognition prior to SAB 101. This result is
comparable to what I find with respect to the earnings informativeness of sell-through and sell-in
firms with distributor customers. Srivastavas (2011) results would not be affected by a transitional
period because firms in his setting were not required to report a cumulative-effect adjustment when
changing revenue recognition methods.
I expect that my study will interest students, managers, and other financial statement users
because it contributes to a growing literature that examines revenue recognition in specific
industries (Bowen et al. 2002; Zhang 2005; Srivastava 2011). Differences in revenue recognition
practices often make it difficult for financial statement users to compare revenue and earnings
among entities and industries (Schipper et al. 2009), and it is important to examine many settings in
order to improve our understanding of the implications of revenue recognition for firms. This study
is also potentially useful to investors, analysts, auditors, and regulators who monitor semiconductor
and other high-technology manufacturers that sell to distributors. Since the results suggest that
earnings management concerns about the sell-in method are warranted and earnings informativeness differs based on firms revenue recognition methods, these factors should be considered when
interpreting the financial statements and stock returns of manufacturers that sell to distributors and
comparing them to other firms.
The next section discusses background and develops hypotheses. I then discuss the empirical
models and describe the sample in the third section. Empirical evidence is presented the fourth
section and the final section summarizes and concludes.
BACKGROUND AND HYPOTHESES
Background
Distributors purchase products from manufacturers and later resell the products. This
arrangement benefits manufacturers because distributors (1) act as an additional sales force, (2)
aggregate and service small orders that manufacturers are otherwise unwilling to fulfill, and (3)
reduce manufacturers collection risk (Credit Suisse 2007). Many manufacturers rely heavily on
distributors. For example, research suggests that distributors service more than 25 percent of global
semiconductor/electronic component sales (Credit Suisse 2007), and some semiconductor
manufacturers indicate that at least 50 percent of their sales are to distributors (e.g., Cypress
Semiconductor 2006 10-K filing; Fairchild Semiconductor 2008 10-K filing).
In order for manufacturers to recognize revenue from sales to distributors, SAB 101 and later
SAB 104, both require that (1) persuasive evidence of an arrangement exists, (2) delivery has
occurred, (3) the final selling price is fixed or determinable, and (4) collectability is reasonably
assured (SEC 1999, 2003). Although manufacturers sales to distributors easily meet the
arrangement, delivery, and collectability requirements, the manufacturer must decide if the final
selling price is fixed or determinable. A conservative interpretation of the revenue recognition
standard suggests that the final selling price is indeterminable for sales subject to pricing
adjustments or rights-of-return. However, interpretive guidance suggests that a selling price is
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determinable if product returns and pricing adjustments can be reasonably estimated.1 Thus, the
revenue recognition standard allows managers some discretion to communicate private, valuerelevant information to financial statement users but there is also the risk that managers will use the
discretion to manipulate earnings (Healy and Wahlen 1999).
Depending on the fixed or determinable nature of the final selling price, a manufacturer will
recognize revenue from sales to distributors under one of three revenue recognition methods: sellin, sell-through, or combination. Under the sell-in method, the manufacturer records accounts
receivable, reduces inventory, and recognizes both revenue and cost of goods sold when product
is delivered to the distributor. This accounting method provides a timely reflection of product
transfer between the two parties. Since revenue is recognized at delivery, the manufacturer
maintains product return and pricing adjustment accruals for limited return rights on regular
purchases2 and pricing adjustments intended to compensate for falling market prices or
incentivize sales of certain products (Lee et al. 2000; Credit Suisse 2007). These accrual estimates
are typically based on historical distributor return and pricing adjustment data. Manufacturers
revenue recognition disclosures suggest that the sell-in method is used when (1) distributors do
not have product return and pricing adjustment rights (i.e., selling prices are fixed at the time of
sale), or (2) distributors product returns and pricing adjustments can be reasonably and reliably
estimated (see Appendix A).
Under the sell-through method, the manufacturer reduces inventory and records accounts
receivable, deferred revenue, and deferred cost of goods sold when product is delivered to the
distributor. The manufacturer recognizes revenue and cost of goods sold once notification is
received from the distributor that the product has been resold.3 This method more accurately reflects
end-customer demand, and product return and pricing adjustment accruals are not needed since
revenue is deferred until distributor rights have lapsed. Although distributors provide inventory and
resale data to manufacturers, challenges exist regarding data reliability and format. Chipalkatti et al.
(2007) note that once data are received from multiple distributors, manufacturers must remove
errors, validate the data, and convert the data into one consistent format.4 In order to address these
issues, sell-through revenue recognition requires additional internal controls beyond those needed
for other sales. Revenue recognition disclosures suggest that manufacturers typically use the sellthrough method to recognize revenue when they believe they are unable to accurately estimate
distributors product returns and pricing adjustments (see Appendix A).
A combination of the two methods occurs when a manufacturer recognizes revenue under the
sell-in method for some distributors and under the sell-through method for other distributors. Under
this method, product return and pricing adjustment accruals are maintained only for those sales to
distributors that are recognized under the sell-in method. Manufacturers disclosures suggest that
they use a combination of the sell-in and sell-through methods if the firm is able to reasonably and
1
SAB 104 interpretive guidance refers to Statement 48, }6 and 8, which state that revenue cannot be recognized if a
firm is unable to make a reasonable estimate of product returns (FASB 1981). SAB 104 also directs users to SOP
97-2, }26 and 30-33, which state that prices on products sold to distributors are not fixed and determinable if the
seller is unable to make reasonable estimates of pricing adjustments (AICPA 1997).
2
Manufacturers often give distributors the right to return a certain percentage of their inventory or exchange old
inventory for new inventory (i.e., stock rotation) (Chipalkatti et al. 2007). In addition, distribution agreements
typically include clauses that allow distributors to return any product on hand if the relationship with the
manufacturer is terminated (e.g., Arrow Electronics 2008 10-K filing; Ingram Micro 2008 10-K filing).
3
Practitioners indicated that, regardless of the revenue recognition method, manufacturers regularly receive resale
and inventory data from distributors. These data are used to understand end-customer demand and plan
production.
4
Texas Instruments cites lack of confidence in distributor data as one reason it uses the sell-in method (Greenberg
2006). KPMG LLP (2006) finds that at least 20 percent of resale reports from channel partners contain errors. Data
issues also affect accrual estimation under the sell-in method.
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reliably estimate product return and pricing adjustment accruals for some distributors but not for
others. Estimation abilities can differ among distributors based on (1) the availability of historical
data needed to predict future returns and pricing adjustments, or (2) differing inventory levels that
could influence distributor power over the manufacturer. Alternatively, manufacturers disclosures
suggest that some firms use a combination of the two methods if product return and pricing
adjustment rights are only given to some distributors.5
Manufacturers in many industries exhibit some use of the sell-in and sell-through methods
for sales to distributors (Glass, Lewis & Co. 2004; Greenberg 2006; Chipalkatti et al. 2007). I
focus my study on firms in the semiconductor industry for a variety of reasons. First, the
semiconductor industry experiences rapid product obsolescence, declining prices over product
life cycles, and unexpected industry downturns. These issues all contribute to product return and
pricing adjustment uncertainties for sales to distributors. Second, my review of SEC filings
indicates that semiconductor firms are more likely than firms in other industries to disclose
information about their distributor relationships. Specifically, more semiconductor firms disclose
the percentage of revenue attributable to all or some of their distributor customers, which
indicates firm reliance on the distribution channel. Third, I find that semiconductor firms generate
most of their revenue from product sales, while manufacturers selling to distributors in other
industries often have significant service-related revenue. Examining firms with a significant
amount of service revenue could add noise to my empirical analyses if revenue recognition
methods differ for products and services. Fourth, semiconductor firms are less likely than other
manufacturers to sell to retailers because semiconductor products are typically components used
in the assembly of a product. Sales to retailers could also add noise to my empirical analyses.
Finally, only examining the semiconductor industry allows me to focus on a set of manufacturers
with relatively homogeneous characteristics.
Hypotheses
The sell-in method offers opportunities for managers to manipulate earnings using both real
activities and accounting accruals. For example, managers can ship excess product to distributors at
the end of an accounting period in order to increase earnings (i.e., channel stuffing) (Penman 2007).
Channel stuffing boosts revenue of sell-in firms because revenue recognition occurs when product
is delivered to distributors. The SEC has investigated channel stuffing and brought enforcement
actions against firms with egregious channel stuffing activities (e.g., Vitesse Semiconductor). Lynn
Turner, former SEC chief accountant, summarizes concerns about these activities as follows: I
found nothing good about revenue recognition upon sell-in. Sooner or later, the urge to stuff the
channel, especially when things are not going well and numbers for the next quarter are short, is
very tempting (Greenberg 2006). In contrast, managers using the sell-through method are less
likely to stuff the distribution channel because revenue recognition is deferred until distributors
resell products to end-customers.
Managers at sell-in firms can also manage earnings through accrual manipulations. As
discussed earlier, sell-in firms maintain product return and pricing adjustment accruals until
distributor rights have lapsed. Estimation of these accruals is subject to managerial discretion, and
extensive accounting research suggests that managers use accruals to manage earnings (see Healy
5
Changes in a manufacturers ability to estimate product returns and pricing adjustments or contractual rights
offered to a distributor over time could lead the manufacturer to change the revenue recognition method for the
distributor in question. Such a change in the revenue recognition method necessitates that the firm report the
accounting change and a cumulative-effect adjustment, which should discourage opportunistic revenue
recognition changes.
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and Wahlen 1999; Beneish 2001; Fields et al. 2001 for surveys).6 In contrast, sell-through firms do
not have the opportunity to manipulate product return and pricing adjustment accruals for
distributor customers since these accruals are not maintained.
Prior research suggests that earnings management occurs through both real activities
manipulation and accrual manipulation (e.g., Healy and Wahlen 1999; Fields et al. 2001; Graham
et al. 2005; Roychowdhury 2006).7 Sell-in firms have opportunities to manage earnings from
distributor sales using both types of manipulation while sell-through firms do not. In addition, sellin firms have more manipulation opportunities than combination firms since the combination
method recognizes revenue at product delivery for only a portion of a firms sales to distributors.
My first hypotheses (stated in the alternative form) are as follows:
H1a: The incidence of earnings management is less likely for sell-through firms compared to
sell-in firms.
H1b: The incidence of earnings management is less likely for combination firms compared to
sell-in firms.
Earnings informativeness could also differ based on a firms revenue recognition method for
sales to distributors. Earnings that provide new information to the market about expectations of
future cash flows, as evidenced by changes in stock prices, are considered to be informative
(Kothari 2001). On one hand, the sell-in method provides a timely reflection of product transfer
between manufacturers and distributors. New accounting information is more quickly incorporated
into the financial statements under this method compared to the sell-through and combination
methods and should be useful to the market assuming that accrual estimates are accurate and
manufacturers do not stuff the distribution channel. When sell-in revenue recognition results in
accurate and reliable financial statements, earnings should be more informative for sell-in firms
compared to sell-through and combination firms.
On the other hand, if sell-in firms have intentional performance manipulations (i.e., channel
stuffing, accrual manipulation), earnings reported by these firms are not earned and earnings
informativeness should suffer. In addition, unintentional estimation errors can reduce the
informativeness of earnings. Marketing theory suggests that powerful distributors have the ability
to heavily influence trade terms with manufacturers (e.g., Tsay 2002). Since manufacturers often
sell a large amount of product to distributors and 75 percent of semiconductor/electronic component
distributors purchases represent speculation and forecasts of future end-customer orders (Credit
Suisse 2007), distributors have leverage to pressure manufacturers into accepting special return or
pricing adjustment requests if end-customer demand does not materialize. For example, BCD
Semiconductor responded to distributor requests following a recent industry downturn by allowing
distributors to return nearly four times more product than what was required under the companys
standard return rights (BCD Semiconductor 2008 Registration Statement). Distributors are also
likely to request special returns for product that was previously stuffed into the channel. Thus, if
6
Use of product return and pricing adjustment accruals under the sell-in method also increases the risk of
unintentional accrual estimation errors by management.
Earnings management opportunities also exist for sales to non-distributor customers. Revenue recognition
disclosures for sample firms suggest that manufacturers typically recognize revenue from non-distributor
customers at the time of product delivery and sales returns are only allowed for defective products. Thus,
managers have opportunities to stuff non-distributor channels and manipulate warranty accruals. Since sell-in,
sell-through, and combination firms all have the opportunity to stuff the non-distribution channel and manipulate
non-distributor sales accruals, I attempt to control for these activities in my empirical test of earnings
management.
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sell-in revenue recognition results in inaccurate earnings or product returns estimates, earnings
should be less informative for sell-in firms compared to sell-through and combination firms.
Because it is unclear whether earnings informativeness differs based on a manufacturers
revenue recognition method for sales to distributors, my final hypothesis (stated in the null form) is
as follows:
H2: Earnings informativeness does not differ among sell-in, sell-through, and combination
firms.
METHOD
Revenue Recognition and Earnings Management
I use the following logistic regression model to examine if sell-through and combination firms
manage earnings less than sell-in firms (H1a and H1b):
MeetBeatit a0 a1 SellThroughit a2 Comboit a3 Sales Growthit a4 Rank of MTBit
a5 NOAit a6 Rank of Sharesit a7 Rank of Sizeit a8 Reportit
a9 Report 3 Avg Disty Revenueit a10 Bonus%it a11 Options%it
a12 Analystsit a13 CVAFit a14 Revise Downit ax Time Indicators e: 1
Degeorge et al. (1999) find that a disproportionate number of firms meet or beat analysts earnings
forecasts. Consistent with prior literature (e.g., Barton and Simko 2002; Cheng and Warfield 2005),
I use the incidence of meeting or beating analysts consensus earnings forecast as a proxy for
managing earnings to a benchmark. MeetBeat is an indicator variable that equals 1 if the firm meets
the last I/B/E/S consensus earnings forecast prior to the quarterly earnings announcement or beats it
by any amount, and 0 otherwise. I examine the incidence of meeting or beating analysts consensus
earnings forecast and not analysts consensus revenue forecast because (1) revenue recognition
methods for sales to distributors affect both revenues and cost of goods sold, and (2) executives
report that earnings is a more important performance metric than revenues (Graham et al. 2005).
The main variables of interest in Model 1 are Sell-Through and Combo, which are indicators equal
to 1 if the firm uses the sell-through or combination revenue recognition method for sales to
distributors, and 0 otherwise. Consistent with H1a and H1b, I expect negative coefficients on SellThrough and Combo, respectively, indicating that earnings management is less likely under the sellthrough and combination methods compared to the sell-in method.
Model 1 includes a variety of control variables that prior research suggests are associated with
meeting or beating analysts consensus earnings forecast. Consistent with prior research (e.g., Das
et al. 1998; Barton and Simko 2002; Cheng and Warfield 2005), I control for the following firm
characteristics: growth opportunities (Sales Growth, Rank of MTB), constraints on earnings
management (net operating assets [NOA], shares outstanding [Rank of Shares]), and firm size (Rank
of Size). NOA is an accrual-based measure of net assets, and Barton and Simko (2002) find that
prior abnormal accruals are positively associated with NOA. High NOA suggests overstated assets
and previous earnings management through abnormal accruals, which should make it more difficult
for managers to manipulate earnings in the current quarter.
I control for the percentage of revenue attributable to distributor customers8 because reliance
on the distribution channel likely influences firms revenue recognition practices and opportunities
8
Revenue attributable to distributor customers (if reported) is disclosed in the 10-K filing. However, not all firms
follow consistent reporting practices. For instance, some firms report revenue attributable to all distributor
customers while other firms only report revenue attributable to their top one or two distributor customers. In
addition, some firms do not report revenue attributable to distributor customers every year while other firms never
report this information.
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to stuff non-distributor channels and/or manipulate non-distributor sales accruals.9 Report controls
for the fact that not all firms report how much of their revenue is attributable to distributor
customers. This variable is an indicator set to 1 for those firms reporting revenue attributable to
distributor customers at least once during the sample period and 0 for those firms never reporting
this information. Report 3 Avg Disty Revenue is the interaction between Report and the average of
all annual revenue attributable to distributor customers reported by the firm during the sample
period. This variable is set to 0 for firms that never report revenue attributable to distributor
customers. I control for the percentage of CEO compensation attributable to cash-based incentives
(Bonus%) and stock options (Options%) because prior research suggests that management incentive
compensation is associated with earnings management activities (e.g., Cheng and Warfield 2005;
Bergstresser and Philippon 2006; Cornett et al. 2008) and accounting choices (e.g., Aboody et al.
2000; Aboody et al. 2004; Efendi et al. 2007).
Consistent with prior research (e.g., Johnson 1999; Payne and Robb 2000; Barton and Simko
2002; Cheng and Warfield 2005), I also control for characteristics of the analysts forecasts
including the number of analysts following a firm (Analysts), variation among analysts forecasts
(CVAF), and recent downward revisions in analysts forecasts (Revise Down). Finally, Model 1
includes calendar-quarter fixed effects and clusters standard errors by firm (Petersen 2009). All
variables included in Model 1 are defined in either Table 1 or Table 2.
Revenue Recognition and Earnings Informativeness
I use the following regression model to examine if earnings informativeness differs among sellin, sell-through, and combination firms (H2):
URit b0 b1 UEit b2 SellThroughit b3 Comboit b4 UEit 3 SellThroughit
b5 UEit 3 Comboit bx Controlsit by UEit 3 Controlsit bz Time Indicators e:
2
Prior accounting research models stock price as a function of future dividends (which are assumed
to be related to future earnings), and derivations of this model lead to an association between
unexpected stock returns and unexpected earnings (see e.g., Collins and Kothari 1989; Lev 1989;
Kothari 2001). The coefficient on unexpected earnings (i.e., the earnings response coefficient) is
considered to be an indicator of earnings informativeness (e.g., Francis et al. 2006), and Model 2
examines whether the earnings response coefficient varies based on firms revenue recognition
methods for sales to distributors.
Consistent with the recommendations of Berkman and Truong (2009), I measure
unexpected returns (UR) as the cumulative market-adjusted stock return for two trading days
beginning on the quarterly earnings announcement date. Unexpected earnings (UE) equals the
difference between actual earnings per share and analysts last consensus earnings forecast prior
to the quarterly earnings announcement (both reported by I/B/E/S), scaled by stock price at
quarter-end. This definition of UE is similar to prior studies (see e.g., Lopez and Rees 2002;
Nelson et al. 2008; Wilson 2008; Chen et al. 2011) and is consistent with MeetBeat in Model
1.10 Sell-Through and Combo are as previously defined.
9
NOA should help to control for non-distributor accrual manipulation. However, a measure of revenue attributable
to distributor customers further controls for any managerial discretion involving non-distributor sales that affects
the likelihood of a firm meeting or beating analysts consensus earnings forecast.
10
Prior studies calculate unexpected earnings as the difference between actual earnings and either analysts consensus
earnings forecast or actual earnings from a prior period (see Lev [1989] and Kothari [2001] for surveys of the literature).
However, recent research suggests that managers use earnings guidance to influence analysts forecasts (e.g., Cotter et al.
2006), which could affect the UE measure used in my main test. As a sensitivity test, I use an unexpected earnings
measure based on the earnings time series, and inferences are unchanged.
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The main variables of interest in Model 2 are UE, UE 3 Sell-Through, and UE 3 Combo. UE
represents the earnings response coefficient (ERC) for sell-in firms. UE 3 Sell-Through and UE 3
Combo indicate the incremental ERC for sell-through and combination firms, respectively,
compared to sell-in firms. Positive and significant coefficients for UE 3 Sell-Through and UE 3
Combo will indicate that earnings are more informative (i.e., ERCs are higher) for sell-through and
combination firms compared to sell-in firms. Negative and significant coefficients for the
interactions will indicate that earnings are less informative for sell-through and combination firms
compared to sell-in firms.
Model 2 also controls for factors that are expected to affect the relationship between unexpected
earnings and unexpected returns. Prior research finds that ERCs are affected by firm size (Collins and
Kothari 1989), the market-to-book ratio (Collins and Kothari 1989), earnings persistence (Kormendi
and Lipe 1987), equity beta (Collins and Kothari 1989; Easton and Zmijewski 1989), incidence of a
net loss (Hayn 1995), fourth-quarter earnings announcements (Salamon and Stober 1994), and the
number of analysts following the firm (Shores 1990). Prior research also suggests that managers are
incentivized to exercise accounting discretion when their incentive compensation is based on earnings
performance (e.g., Bowen et al. 2003). Measures of executive compensation can control for
managerial discretion (other than that exercised under the revenue recognition method) that affects
ERCs. I also expect that ERCs are affected by a manufacturers over or under reliance on distributors
compared to other customers. Thus, I include the following control variables in the model: Rank of
Size, Rank of MTB, Persist, Beta, Loss, Fourth Quarter, Analysts, Bonus%, Options%, Report, and
Report 3 Avg Disty Revenue; and, I interact each of these control variables with UE. All variables
included in Model 2 are defined in Table 1, Table 2, or Table 3.
Sample
In order to develop my sample, I first obtain quarterly data for all semiconductor firms (SIC
3674) in the Compustat Fundamentals Quarterly database during 20012008. I begin the sample
period in 2001 because SAB 101, which offered additional guidance on revenue recognition
disclosures, became effective in that year. SAB 104 later rescinded guidance in SAB 101 that was
superseded by the FASBs Emerging Issues Task Force (EITF) 0021, but SAB 104 did not change
the revenue recognition principles in SAB 101 (SEC 1999, 2003). Next, I hand collect all available
annual SEC filings during 20012008 for the semiconductor firms with Compustat data. I exclude a
firm from the sample if it did not file at least one annual report (10-K or 20-F) with the SEC during
the sample period, or if the annual SEC filings indicate that the firm (1) is not a semiconductor
manufacturer, (2) does not sell products to distributors, (3) has significant consignment agreements,
(4) generates more than half of its revenue from service activities, (5) sells to retailers,11 (6) does
not offer product return privileges or pricing adjustments to distributors,12 or (7) changed revenue
recognition methods during the sample period.13 I also exclude firms lacking the Compustat, CRSP,
I/B/E/S, and ExecuComp data required for my analyses. The final sample includes 80 unique
semiconductor firms with required data for 1,572 firm-quarters.
I classify the sample firms as sell-in, sell-through, or combination based on the revenue
recognition disclosures presented in their annual SEC filings (10-K or 20-F). Sell-in firms are those
firms that use the sell-in revenue recognition method for all sales to distributors. Sell-through firms
11
I exclude firms with significant consignment agreements, service revenue, and retail sales because revenue
generated from these activities could add noise to the empirical analyses.
This restriction ensures that all firms in my sample have product return and pricing adjustment uncertainties
related to sales to distributors.
13
Fourteen firms appeared to switch revenue recognition methods during the sample period. Because this subsample
was so small, I was unable to perform empirical tests that examined only these firms.
12
Accounting Horizons
March 2013
101
use the sell-through revenue recognition method for all sales to distributors. Combination firms use
the sell-in revenue recognition method for some distributor sales and the sell-through revenue
recognition method for other distributor sales.
EMPIRICAL EVIDENCE
Descriptive Statistics
Table 1, Panel A presents descriptive statistics for the full sample of 1,572 firm-quarters, while
Panel B presents descriptive statistics for the sell-in, combination, and sell-through subsamples.
Twenty percent of the observations represent use of the sell-through method exclusively (SellThrough), 48 percent of the observations represent a combination of both the sell-in and sellthrough methods (Combo), and 32 percent of the observations represent use of the sell-in method
exclusively. As expected, deferred revenue is smallest for firms recognizing revenue for all
distributors when products are delivered (sell-in) and largest for firms deferring revenue recognition
for all distributors until the products have been resold (sell-through). Mean (median) current
deferred revenue scaled by total assets at quarter-end (Deferred Revenue) is 0.00 (0.00), 0.01 (0.00),
and 0.02 (0.01) for sell-in, combination, and sell-through firms, respectively, and the means
(distributions) significantly differ at p , 0.000 for all three types of firms. Actual reported revenue
attributable to distributor customers (Raw Disty Revenue) is available for two-thirds of the firmquarters, and significant differences exist among the firms reporting this information. Raw Disty
Revenue is highest, on average, for sell-through firms (54 percent) followed by combination firms
(34 percent) and sell-in firms (30 percent). Meanwhile, 82 percent of the firm-quarters represent
firms that report revenue attributable to distributor customers at least once during the sample period
(Report). Mean Report 3 Avg Disty Revenue, the distributor revenue variable included in the
empirical tests, is 29 percent for the full sample, 51 percent for sell-through firms, 25 percent for
combination firms, and 23 percent for sell-in firms. Report 3 Avg Disty Revenue is significantly
higher for sell-through firms compared to both combination and sell-in firms.
With respect to the other variables included in the analyses, firms meet or beat analysts
consensus earnings forecast (MeetBeat) in 79 percent of the full sample quarters, 82 percent of the
sell-in quarters, 77 percent of the combination quarters, and 79 percent of the sell-through firmquarters. Mean and median tests suggest that the incidence of meeting or beating analysts
consensus earnings forecast significantly differs only between sell-in and combination firms.
Meanwhile, mean unexpected stock returns (UR) are 0.002 for the full sample, 0.002 for sell-in
firms, 0.002 for combination firms, and 0.007 for sell-through firms, but there is little evidence that
these returns significantly differ among the three types of firms. Table 1, Panel B also suggests that
many of the control variables used in the empirical analyses significantly differ among sell-in,
combination, and sell-through firms.14
Revenue Recognition and Earnings Management
Table 2 presents estimation results for Model 1, with examines the incidence of earnings
management for sell-in, sell-through, and combination firms. The sample used to estimate this
model consists of the 1,572 firm-quarters during 20012008 with required data for all analyses. The
Pseudo R2 is 10 percent and the area under the ROC curve is 72 percent, suggesting that the model
14
Recent studies examining the earnings-returns association (Hirshleifer et al. 2009; Drake et al. 2012) use decile
ranks of firm size and market-to-book measures in their empirical models instead of raw values. I follow this
approach and include Rank of Size and Rank of MTB in Model 1 and Model 2. I also correct for skewness of
Shares by including the decile rank of this measure (Rank of Shares) in Model 1.
Accounting Horizons
March 2013
Sell-Through
Combo
Deferred Revenue
Raw Disty Revenue
Report
Report 3 Avg Disty Revenue
Analysts
Beta
Bonus%
CVAF
Loss
MeetBeat
MTB
NOA
Options%
Persist
Revise Down
Sales Growth
Size ($M)
Shares ($M)
UE
UR
Panel A: Full Sample
0.20
0.48
0.01
0.37
0.82
0.29
12
2.66
0.10
0.03
0.23
0.79
2.93
4.26
0.48
0.40
0.82
0.11
1,820.41
186.98
0.0005
0.002
Mean
0
0
0.00
0.19
1
0.11
5
1.69
0.00
0.00
0
1
1.43
2.63
0.07
0.16
1
0.08
228.19
30.96
0.0000
0.054
25% Quartile
0
0
0.00
0.36
1
0.27
10
2.61
0.05
0.03
0
1
2.39
3.67
0.56
0.40
1
0.08
718.93
87.29
0.0004
0.002
Median
Full Sample (n 1,572)
Descriptive Statistics
TABLE 1
(continued on next page)
0
1
0.01
0.53
1
0.46
17
3.53
0.16
0.10
0
1
3.93
5.31
0.79
0.62
1
0.26
2,122.71
255.75
0.0020
0.059
75% Quartile
102
Rasmussen
Accounting Horizons
March 2013
Accounting Horizons
March 2013
25%
Qrtl.
Med.
75%
Qrtl.
Mean
25%
Qrtl.
Med.
Combo (n 750)
75%
Qrtl.
Mean
25%
Qrtl.
Med.
Sell-Through (n 315)
75%
Qrtl.
(continued on next page)
Panel A presents descriptive statistics for a sample of 1,572 quarterly observations for 80 unique semiconductor firms during 20012008. Panel B presents descriptive statistics for
the sell-in, combination, and sell-through subsamples. Mean (median) differences at p , 0.10 using a two-tailed t-(Wilcoxon Sum-Rank) test are denoted by a(b) for sell-in firms
versus combination firms, c(d) for sell-in firms versus sell-through firms, and e(f ) for combination firms versus sell-through firms.
All continuous variables are winsorized at the 1st and 99th percentiles.
Deferred Revenuea,b,c,d,e,f
0.00
0.00
0.00
0.00
0.01
0.00
0.00
0.02
0.02
0.00
0.01
0.04
Raw Disty Revenuea,b,c,d,e,f
0.30
0.15
0.29
0.47
0.34
0.17
0.32
0.48
0.54
0.30
0.55
0.73
Reporta,b,c,d,e,f
0.82
1
1
1
0.75
1
1
1
0.97
1
1
1
Report 3 Avg Disty Revenuec,d,e,f
0.23
0.03
0.23
0.36
0.25
0.10
0.25
0.43
0.51
0.32
0.51
0.70
Analystsc,d,e,f
11
6
10
16
11
5
10
16
14
5
14
21
Betaa,b,e,f
2.51
1.53
2.48
3.30
2.81
1.86
2.75
3.75
2.55
1.48
2.57
3.43
Bonus%a,b,e,f
0.11
0.00
0.07
0.19
0.09
0.00
0.04
0.14
0.11
0.01
0.07
0.16
CVAFc,d,e,f
0.01
0.00
0.03
0.09
0.04
0.00
0.02
0.11
0.07
0.00
0.04
0.09
Lossc,d,e,f
0.25
0
0
1
0.26
0
0
1
0.13
0
0
0
MeetBeata,b
0.82
1
1
1
0.77
1
1
1
0.79
1
1
1
MTBa,b,c,d,f
2.47
1.38
1.93
3.11
3.13
1.43
2.50
4.16
3.20
1.62
3.29
4.46
NOAa,b,c,d
4.50
3.04
4.05
5.37
4.22
2.27
3.31
5.56
3.98
2.42
3.47
5.05
Options%a,b,c,d
0.45
0.12
0.50
0.70
0.50
0.10
0.56
0.80
0.51
0.00
0.65
0.82
Persistb,c,d,e,f
0.36
0.10
0.33
0.59
0.38
0.17
0.38
0.58
0.51
0.27
0.49
0.76
Revise Downa,b,e,f
0.84
1
1
1
0.79
1
1
1
0.86
1
1
1
Sales Growtha,e
0.09 0.09
0.09
0.26
0.13 0.09
0.08
0.30
0.08 0.04
0.09
0.21
Size ($M)a,c,d,f
2,285.03 211.04 681.85 2,012.20 1,577.92 207.92 648.15 2,088.11 1,649.93 313.08 1,458.78 2,512.31
Shares ($M)a,b,c,d,f
215.96
30.63
72.75
152.55
168.69
35.89
91.34
291.89
183.86
29.86
175.79
335.85
UEb,d,e
0.0008 0.0000 0.0006
0.0021
0.0001 0.0000 0.0003
0.0021
0.0009 0.0000
0.0003
0.0013
URd
0.002 0.060 0.005
0.059
0.002 0.058 0.004
0.061
0.007 0.038
0.008
0.051
Mean
Sell-In (n 507)
Panel B: Sell-In, Combination, and Sell-Through Subsamples
TABLE 1 (continued)

103
Variable Definitions:
Sell-Through indicator variable equal to 1 if the firm uses the sell-through revenue recognition method for sales to distributors, and 0 otherwise;
Combo indicator variable equal to 1 if the firm uses the combination revenue recognition methods for sales to distributors, and 0 otherwise;
Deferred Revenue current deferred revenue scaled by total assets at quarter-end;
Raw Disty Revenue percentage of annual revenue attributable to distributor customers and is assigned to all of the firms quarterly observations during the fiscal year (these data
are available for 1,058 of the sample firm-quarters);
Report indicator set variable set to 1 if the firm reports annual revenue attributable to distributor customers at least once during the sample period, and 0 otherwise;
Report 3 Avg Disty Revenue average of all annual revenue attributable to distributor customers reported by the firm during the sample period and is assigned to all of the firms
quarterly observations, or is set to 0 for firms that do not report this information in any of the sample years;
Analysts number of analyst earnings forecasts included in the last I/B/E/S consensus forecast prior to the quarterly earnings announcement;
Beta systematic risk from the market model for the twelve-month period ending before the start of the quarter;
Bonus% CEOs cash-based incentive compensation scaled by the CEOs total annual compensation and is assigned to all of the firms quarterly observations during the fiscal
year;
CVAF coefficient of variation (the standard deviation scaled by the mean) of the last I/B/E/S consensus earnings forecast prior to the quarterly earnings announcement;
Loss indicator variable equal to 1 if actual quarterly earnings reported by I/B/E/S are negative, and 0 otherwise;
MeetBeat indicator variable equal to 1 if the firm meets the last I/B/E/S consensus earnings forecast prior to the quarterly earnings announcement date or beats it by any amount,
and 0 otherwise;
MTB market value of equity at quarter-end scaled by book value of equity at quarter-end;
NOA net operating assets at the end of the prior quarter, scaled by sales for the prior quarter;
Options% dollar value of new options granted to the CEO during the year scaled by the CEOs total annual compensation and is assigned to all of the firms quarterly
observations during the fiscal year. (I follow the approach used by Cheng and Farber [2008] and Efendi et al. [2013] to create this variable);
Persist first-order autocorrelation coefficient of quarterly earnings estimated over the past four years;
Revise Down indicator variable equal to 1 if at least one analyst revised down his/her earnings forecast for the firm during the period between the prior quarters earnings
announcement and the current quarters earnings announcement, and 0 otherwise;
Sales Growth sales for the quarter divided by sales from the same quarter in the prior year, less one;
Size total assets at quarter-end;
Shares average number of common shares outstanding during the quarter;
UE difference between actual earnings per share and the last consensus earnings forecast prior to the quarterly earnings announcement date (both reported by I/B/E/S), scaled by
stock price at quarter-end (reported by CRSP); and
UR cumulative stock return for two trading days beginning on the quarterly earnings announcement date, adjusted by the value-weighted market index.
TABLE 1 (continued)
104
Rasmussen
Accounting Horizons
March 2013
105
has acceptable predictive power of the incidence of meeting or beating analysts consensus earnings
forecast (Hosmer and Lemeshow 2000). Although the model controls for calendar-quarter fixed
effects, I do not tabulate the fixed effects coefficients for parsimony.
Consistent with H1a and H1b, the Sell-Through and Combo coefficients are negative and
significant (a1 0.457, p 0.067; a2 0.493, p 0.015, respectively), suggesting that sellthrough and combination firms are both less likely to meet or beat analysts consensus earnings
forecast than sell-in firms. Since combination firms have more opportunity to manage earnings
compared to sell-through firms, it is surprising to find that the Combo coefficient appears larger in
magnitude and has a stronger statistical significance compared to the Sell-Through coefficient.
However, an untabulated v2 test indicates that the Sell-Through and Combo coefficients do not
significantly differ. In order to quantify the impact of the revenue recognition method on the
likelihood of a firm meeting or beating analysts consensus earnings forecast, I calculate average
partial effects (untabulated).15 The average partial effect of the sell-through (combination) method
decreases the likelihood of a firm meeting or beating analysts consensus earnings forecast by 6.9
(7.0) percent, and this decrease is significant at the p 0.041 (0.017) level.16 Since sell-through and
combination firms are less likely to meet or beat analysts consensus earnings forecast (the proxy
for earnings management), these findings suggest that sell-in firms exercise discretion under their
revenue recognition method to manage earnings. With respect to control variables, Sales Growth,
Rank of MTB, Bonus%, and Analysts are positively associated with MeetBeat, while Revise Down is
negatively associated with MeetBeat.
In an untabulated test, I use the Heckman procedure (Heckman 1979; Wooldridge 2002) to
control for the possibility that determinants of the revenue recognition method are correlated with
the likelihood that a firm meets or beats analysts consensus earnings forecast. I estimate two
selection equations, each predicting use of either the sell-through or the combination method. Each
selection equation includes all control variables from Model 1 plus two instrument variables: the
decile rank of firm age and an indicator representing use of an industry specialist auditor (auditor
with the highest market share in the semiconductor industry).17 I then calculate the inverse Mills
ratios from the selection equations and include these inverse Mills ratios in the outcome equation
predicting the likelihood of meeting or beating analysts consensus earnings forecast. Sell-Through
and Combo remain negatively and significantly associated with MeetBeat in the outcome equation
(results untabulated), consistent with Table 2.18
15
Average partial effects equal the sample average of marginal effects computed for each observation (Wooldridge
2002, 2224). Since Sell-Through and Combo are indicator variables representing different categories of a single
underlying variable (revenue recognition), I follow Bartus (2005) and restrict the observations used to compute
average partial effects to the category of interest and the reference group. When calculating the average partial
effect of Sell-Through, observations are restricted to sell-through and sell-in firms. Similarly, when calculating
the average partial effect of Combo, observations are restricted to combination and sell-in firms.
16
The average partial effect of Sell-Through (Combo) decreases the likelihood of a firm meeting or beating analysts
consensus earnings forecast from 83.3 (82.7) percent to 76.4 (75.8) percent. These likelihoods can be compared
to the 78.8 percent unconditional mean for the full sample (1,239 firm-quarter observations meeting or beating
analysts consensus earnings forecast versus 1,572 sample observations).
17
Heckmans procedure requires at least one instrument variable in the selection model. Untabulated results of the
logistic regression selection models indicate that the decile rank of firm age is negatively and significantly
associated with Sell-Through ( p , 0.000). Use of the industry specialist auditor is positively and significantly
associated with Combo ( p , 0.000).
18
Correlation tests indicate that the inverse Mills ratios calculated from the two selection equations have a strong
negative correlation (0.575, p , 0.000). As an alternative to including both inverse Mills ratios in the outcome
equation, I estimate two outcome equations. The first outcome equation is estimated using the subsample of sellin and sell-through firms and includes Sell-Through and the inverse Mills ratio calculated when predicting SellThrough. The second outcome equation is estimated using the subsample of sell-in and combination firms and
includes Combo and the inverse Mills ratio calculated when predicting Combo. The coefficient of interest (SellThrough or Combo), is negatively and significantly associated with MeetBeat in each of these outcome equations.
Accounting Horizons
March 2013
Rasmussen
106
TABLE 2
The Association between Earnings Management, Revenue Recognition Methods for Sales to
Distributors, and Control Variables
Variable
Intercept
Sell-Through
Combo
Sales Growth
Rank of MTB
NOA
Rank of Shares
Rank of Size
Report
Report 3 Avg Disty Revenue
Bonus%
Options%
Analysts
CVAF
Revise Down
Prediction
/

/
/
/
/

/
Calendar-quarter fixed effects

n
Pseudo R2
Area under ROC curve
Coeff.
p-value
0.334
0.457
0.493
0.459
1.018
0.010
0.055
0.241
0.449
0.624
1.716
0.075
0.044
0.043
0.754
(0.559)
(0.067)
(0.015)
(0.042)
(0.004)
(0.393)
(0.945)
(0.703)
(0.202)
(0.311)
(0.024)
(0.395)
(0.033)
(0.428)
(0.001)
Yes
1,572
0.10
0.72
This table presents the results of Model 1 where the dependent variable is MeetBeat. Variables are defined in Table 1
with the following exceptions. Rank of MTB, Rank of Shares, and Rank of Size are decile ranks of MTB, Shares, and Size,
scaled to range between 0 and 1. All standard errors are clustered by firm (Petersen 2009). Bold coefficients and p-values
indicate statistical significance at the 0.10 level or less. One-tailed tests are used when a direction is predicted, and twotailed tests are used when there is no prediction.
Collectively, the results presented in Table 2 and the additional analysis indicate that earnings
management to a benchmark does differ based on firms revenue recognition methods for sales to
distributors. Specifically, the results suggest that earnings management is more likely for firms that
recognize all revenue before product return and pricing adjustment uncertainties are resolved. This
finding implies that earnings management concerns about the sell-in method are warranted.
Revenue Recognition and Earnings Informativeness
Table 3 presents estimation results for Model 2, which examines the ERCs of firms with
different revenue recognition methods. The sample used to estimate this model consists of the 1,572
firm-quarters during 20012008 with required data for all analyses. The model specification
explains 3.5 percent of unexpected returns, which is consistent with prior studies that examine the
earnings-returns association (Lev 1989). For parsimony, I do not tabulate the coefficients for the
control variables or their interactions with UE.
Unexpected earnings (UE) are positively and significantly associated with unexpected returns
(UR) (b1 4.371; p 0.003), indicating a positive ERC for sell-in firms. The main effects of SellThrough and Combo and the UE 3 Combo coefficient are insignificant. However, the UE 3 SellThrough coefficient is positive and significant (b4 2.302; p 0.065). Because UE 3 Sell-Through
indicates the incremental ERC for sell-through firms compared to sell-in firms, this finding suggests
Accounting Horizons
March 2013
107
that the unexpected earnings of sell-through firms are more informative (have a stronger association
with unexpected stock returns) than the unexpected earnings of sell-in firms. In addition, the
insignificant UE 3 Combo coefficient indicates that sell-through firms also have a significantly
higher ERC compared to combination firms. Untabulated coefficients for the interactions between
UE and control variables indicate that ERCs are lower during the firms fourth quarter and when the
firm reports a loss. Meanwhile, ERCs are higher as analyst following increases.
I perform a variety of untabulated tests to assess the robustness of the results presented in Table
3. First, I use the Heckman procedure (Heckman 1979; Wooldridge 2002) to control for potential
endogeneity of the revenue recognition method. The selection equations predict use of the sellthrough and combination methods and include all controls from Model 2 plus the decile rank of
firm age and an indicator representing use of the industry specialist auditor.19 Inverse Mills ratios
generated from the selection equations are included in the outcome equation.20 Second, instead of
measuring unexpected returns over a short window surrounding the earnings announcement, I
measure UR over the window starting two days after the prior quarters earnings announcement
date and ending one day after the current quarters earnings announcement date. Since many of the
sample firm-quarter return windows overlap in this untabulated test, I include calendar-quarter fixed
effects. Third, I use an alternate measure of UE based on the earnings time series. Specifically, I
calculate UE as the difference between actual earnings per share for the current quarter and actual
earnings per share for the same quarter in the prior year (both reported by I/B/E/S), scaled by stock
price at quarter-end. Untabulated results for all of these independent tests indicate that UE 3 SellThrough is positively and significantly associated with unexpected returns while the UE 3 Combo
coefficient is insignificantly different from zero.21
Finally, I examine the effect of the revenue recognition method on the association between
unexpected returns and unexpected gross margin. For this analysis, unexpected gross margin
(UGM) equals the difference between actual gross margin percentage and analysts last consensus
gross margin percentage forecast prior to the quarterly earnings announcement (both reported by I/
B/E/S), scaled by analysts last consensus gross margin percentage forecast.22 There are 411 firmquarter observations during 20062008 with data available for UGM. When UGM replaces UE in
Model 2 and is interacted with the revenue recognition indicators and control variables, the UGM 3
Sell-Through coefficient is positive and significant (p 0.004) and UGM 3 Combo is
insignificantly different from zero.
In sum, the results presented in Table 3 and the additional analyses suggest that unexpected
earnings are more strongly associated with unexpected returns for sell-through firms compared to
both sell-in and combination firms. Stated differently, the results suggest that earnings are more
informative for firms that defer revenue recognition until all product return and pricing adjustment
uncertainties are resolved.
19
20
21
22
Untabulated results of the logistic selection models indicate that the decile rank of firm age is negatively and
significantly associated with Sell-Through ( p , 0.000) and use of the industry specialist auditor is positively and
significantly associated with Sell-Through and Combo ( p 0.10 and p , 0.000, respectively).
As with the MeetBeat analysis, correlation tests indicate that the inverse Mills ratios calculated from the two
selection equations have a strong negative correlation (0.543, p , 0.000). Untabulated results indicate that
inferences with respect to UE 3 Sell-Through and UE 3 Combo are the same for a full-sample specification of the
outcome equation as well as separate outcome equations estimated using either the sell-through/sell-in or
combination/sell-in subsample of firms.
The statistical significance of the UE 3 Sell-Through coefficient using a two-tailed test is marginal (0.11) for the
quarterly returns test and less than 0.10 for all other untabulated tests.
Since gross margin forecasts are percentages, I use analysts last consensus gross margin percentage forecast as
the scalar instead of the stock price at quarter-end.
Accounting Horizons
March 2013
Rasmussen
108
TABLE 3
The Association between Unexpected Returns, Unexpected Earnings, Revenue Recognition
Methods for Sales to Distributors, and Control Variables
Variable
Intercept
UE
Sell-Through
Combo
UE 3 Sell-Through
UE 3Combo
Controls
UE 3Controls
n
Adjusted R2
Prediction
/
/
/
/
/
Coeff.
p-value
0.025
4.371
0.004
0.007
2.302
0.264
(0.012)
(0.003)
(0.639)
(0.168)
(0.065)
(0.714)
Yes
Yes
1,572
0.035
This table presents the results of Model 2 where the dependent variable is UR. The control variables include: Rank of
Size, Rank of MTB, Persist, Beta, Loss, Fourth Qtr, Analysts, Bonus%, Options%, Report, and Report 3 Avg Disty
Revenue. Variables are defined in Table 1 and Table 2 with the following exception. Fourth Qtr is an indicator variable
equal to 1 if the firm is announcing fourth-quarter earnings, and 0 otherwise. Bold coefficients and p-values indicate
statistical significance at the 0.10 level or less. One-tailed tests are used when a direction is predicted, and two-tailed tests
are used when there is no prediction.
SUMMARY AND CONCLUSIONS

Although revenue is one of the most important figures reported on the income statement, little
research exists on specific revenue recognition methods and their implications for firms. This study
examines the revenue recognition methods of semiconductor firms and their implications for
earnings management and earnings informativeness. Semiconductor firms sell a significant amount
of product to distributors and face product return and pricing adjustment uncertainties until the
distributors resell the product to end-customers. I find that firms deferring revenue recognition until
product return and price adjustment uncertainties are partly or fully resolved are less likely to meet
or beat analysts consensus earnings forecast than firms immediately recognizing revenue for sales
to distributors. This finding suggests that earnings management is more likely when firms recognize
revenues before all uncertainties are resolved. I also find that earnings are more informative (the
earnings-returns association is stronger) for firms that defer revenue recognition until products are
resold to end-customers (i.e., all product return and pricing adjustment uncertainties have been
resolved).
This study extends a growing stream of research that examines the implications of revenue
recognition for firms in different industries (Bowen et al. 2002; Zhang 2005; Srivastava 2011) and
can help students, practitioners, and other financial statement users better understand revenue
recognition methods and their associations with earnings management and earnings informativeness. This study is also potentially useful for investors, analysts, and auditors who monitor
high-technology manufacturers because the results imply that earnings management concerns about
the sell-in method are warranted and earnings are less informative when revenue is immediately
recognized for sales to at least some distributors. This study is also potentially informative for
regulators and standard-setters because the findings suggest that manufacturers with significant
product return and pricing adjustment uncertainties should only recognize revenue from sales to
distributors once all of the uncertainties are resolved.
Accounting Horizons
March 2013
109
This study is subject to limitations. First, because I limit my sample to semiconductor firms, I
have not examined if the findings generalize to all industries and revenue recognition methods.
Second, although I have attempted to control for the characteristics of firms with different revenue
recognition methods in the empirical tests, it is possible that the results reflect inherent differences
among sell-in, sell-through, and combination firms. Even with these limitations, the study provides
insight into the observed effects and improves our understanding of firms with different revenue
recognition methods.
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APPENDIX A
EXCERPTS OF SELECT REVENUE RECOGNITION DISCLOSURES FROM NOTES
TO FINANCIAL STATEMENTS
Bold indicates the information that led to classification of the revenue recognition method.
Simtek Corporation 10-K as of December 31, 2007Sell-In
Product sales revenue is recognized when a valid purchase order has been received with
a fixed price and the products are shipped to customers FOB origin (Colorado Springs,
Colorado; Manila, Philippines; or Dresden, Germany), including distributors. Based on
historic business with the majority of the Companys customers and, in the case of new customers,
based on credit checks, the Company is reasonably assured that collectability on our shipments will
occur. Customers receive a one-year product warranty and sales to distributors are subject to a
limited product exchange program and price protection in the event of changes in the Companys
product prices. The Company provides a reserve for possible product returns, product price
protection, and warranty costs at the time the sale is recognized. The Company has a detailed
Accounting Horizons
March 2013
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112
procedure to ensure that its estimates for reserves are reasonable and reliable. The reserve for
product returns is based on upon historical credits issued for actual stock rotation returns from the
Companys distributors. The Companys distributors are permitted to rotate up to 5 percent of their
stock every six months with the stipulation that they must submit a replacement order of equal
dollar value to the stock that they are returning. The reserve for price protection is used when the
Company authorizes special pricing to one of its distributors for a specific customer. To date, the
estimates have not been materially different from the credits the Company has issued under these
reserves.
Micro Linear Corporation 10-K as of January 1, 2006Combo
We recognize revenue from product shipped directly to OEM customers at the time of
shipment, provided that we have received a signed purchase order, the price is fixed or
determinable, title has transferred, and collection of the resulting receivable is reasonably assured.
Sales to our OEM customers are made without a right-of-return and revenue on these sales is
recognized upon shipment. We defer recognition of revenue from sale of our products to
distributors under agreements that allow certain rights-of-return and price adjustments on
unsold inventory. The associated cost of product on these sales to distributors is included in
inventory. Revenue and cost of product is recognized when the distributor resells the product to its
customers. Some sales to distributors are below contract pricing and do not allow price
adjustments or return privileges. Such sales are recognized as revenue upon shipment.
ON Semiconductor Corporation 10-K as of December 31, 2008Sell-Through
Title to products sold to distributors typically passes at the time of shipment by the Company
so the Company records accounts receivable for the amount of the transaction, reduces its inventory
for the products shipped, and defers the related margin in its consolidated balance sheet. The
Company recognizes the related revenue and cost of revenues when it is informed by the
distributor that they have resold the products to the end-user. As a result of the Companys
inability to reliably estimate up front the effects of the returns and allowances with these
distributors, the Company defers the related revenue and margin on sales to distributors.
Although payment terms vary, most distributor agreements require payment within 30 days.
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March 2013
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Accounting Horizons

Vol. 27, No. 1

American Accounting Association

Revenue Recognition, Earnings Management,

Stephanie J. Rasmussen is an Assistant Professor at The University of Texas at Arlington.

Submitted: October 2011

Revenue Recognition, Earnings Management, and Earnings Informativeness

Revenue Recognition, Earnings Management, and Earnings Informativeness

Revenue Recognition, Earnings Management, and Earnings Informativeness

Revenue Recognition, Earnings Management, and Earnings Informativeness

Revenue Recognition, Earnings Management, and Earnings Informativeness

Panel A: Full Sample

Full Sample (n 1,572)

(continued on next page)

(continued on next page)

Panel B: Sell-In, Combination, and Sell-Through Subsamples

Revenue Recognition, Earnings Management, and Earnings Informativeness

Revenue Recognition, Earnings Management, and Earnings Informativeness

Calendar-quarter fixed effects

Revenue Recognition, Earnings Management, and Earnings Informativeness

SUMMARY AND CONCLUSIONS

Revenue Recognition, Earnings Management, and Earnings Informativeness

Revenue Recognition, Earnings Management, and Earnings Informativeness

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