Revenue Recognition and How You Date Contracts

One of the pleasures of contract drafting is that the parties are as a general matter left to their own devices. Of course you have to structure any given transaction in a way that takes into account legal, tax, regulatory, or other considerations, but as a rule how you do that is up to you.

But sometimes outsiders are going to have a say. Here’s an example: A participant in my recent New York seminar mentioned that his company’s auditors have required, as part of the company’s revenue-recognition process, that all its contracts be dated by reference to dated signatures rather than a date in the introductory clause.

The standard way to date a contract is to include a date in the introductory clause. But it’s commonplace for that date to be a date other than the date that one or more parties actually signed the contract. (See MSCD 2.14–20.)

It might be that the discrepancy is only a day or two and is due to the sort of minor delay that is commonplace in business—for example, one of the signatories might be travelling. In such cases, using a date in the introductory clause has the benefit of simplicity and predictability. (Regarding use of an as of date in such circumstances, see MSCD 2.17.)

But the discrepancy might also be longer. For example, if a company signs a distribution agreement and sends it to a potential distributor for its review and signature, a couple of weeks might pass before the distributor gets around to signing and returning it.

I’ve suggested that in the latter circumstance, it would be best to omit the date from the introductory clause, have the signatories date their signatures, and provide in the contract that it becomes effective when the last party signs. See MSCD 2.11 and 5.4. If you do that, you’d want the concluding clause to read Each party is signing this agreement on the date stated opposite that party’s signature rather than The parties are signing this agreement on the date stated in the introductory clause. See MSCD 5.4.

But given what the New York participant said, at least one accounting firm is requiring that companies adopt this sort of approach for all their contracts. Evidently the reason for this is the revenue-recognition rules.

The Securities and Exchange Commission released Staff Accounting Bulletin (SAB) 101, Revenue Recognition in Financial Statements, in 1999. In 2003, the SEC revised that guidance in SAB 104. SAB 104 states that revenue generally is realized or realizable and earned when all of the following criteria are met:

  • persuasive evidence of an arrangement exists
  • delivery has occurred or services have been rendered
  • the seller’s price to the buyer is fixed or determinable
  • collectability is reasonably assured

How contracts are dated comes into play in connection with the first criterion, that persuasive evidence of an arrangement exists.

SAB 104 discusses the following situation: Company Beta places an order for Company A’s product, and Company A delivers the product before the end of its current fiscal quarter. Company A’s practice is to enter into a written sales contract for such orders, and before the end of the quarter it prepares and signs a contract for this transaction. But Customer Beta doesn’t sign the contract, as it’s waiting for its legal department to approve the contract. Customer Beta’s purchasing department has orally agreed to make the purchase and has indicated that it expects the contract to be approved during the first week of Company A’s next fiscal quarter. SAB 104 poses the question whether Company A could recognize revenue from the sale during the current fiscal quarter if the contract isn’t in fact signed until the next fiscal quarter, and it provides the answer—no.

In this context, dating a contract by means of a date in the introductory clause could be misleading. Whether unwittingly or with intent to deceive, Company A could use in the introductory clause of the contract in question a date from the current quarter; that would give the impression that Company Beta too had signed the contract on that date. If questions subsequently arise regarding when Company Beta had actually signed the agreement on that date, Company A could legitimately claim that in using a date in the introductory clause it had simply been following a standard contracting practice.

Its understandable why an auditor checking on a company’s revenue-recognition practices might want the company’s contracts to make clear, by means of dated signatures, which signatory signed on which date. A company could, of course, simply provide fake dates, but that would require outright falsehood, a far riskier proposition than disingenuous reliance on a misleading date in the introductory clause.

I haven’t found anything in the revenue-recognition literature on how contracts should be dated. Ronald Clark, professor of accounting at Auburn University and author of a 2006 CPA Journal article on revenue recognition, has told me that he wouldn’t be surprised if an auditing firm were to insist on dated signatures: The final decision regarding recognition of sales involves a judgment call by auditors. Given the recent string of mega-frauds, auditors have become much more conservative in deciding what would be required in order for them to find that “persuasive evidence of an arrangement” exists.

Adding to the pressure is the fact that revenue recognition factors into a company’s compliance with the Sarbanes-Oxley requirement that companies document and evaluate the effectiveness of their internal controls and procedures for financial reporting.

Professor Clark tells me that although SAB 101/104 applies only to public companies, the word has filtered down to auditors of non-public companies. All auditors are now taking an aggressive stance when it comes to revenue recognition.

This raises the question whether companies that wish to run a tight ship when it comes to revenue recognition should as a matter of policy require that their contracts be dated by reference to dated signatures rather than a date in the introductory clause.

I’d be interested to hear from any readers—and their auditors!—who have encountered this issue.

About the author

Ken Adams is the leading authority on how to say clearly whatever you want to say in a contract. He’s author of A Manual of Style for Contract Drafting, and he offers online and in-person training around the world. He’s also chief content officer of LegalSifter, Inc., a company that combines artificial intelligence and expertise to assist with review of contracts.