## Facts

- Kurzweil Applied Intelligence, Inc. (KAI) manufactured and sold automated speech-recognition systems and reported its financial results as a public company.
- A group of KAI senior executives carried out a scheme intended to artificially increase KAI’s reported revenue and earnings.
- The executives caused KAI to record revenue from “sales” that had not yet occurred, including transactions they expected might close later (such as in a subsequent quarter).
- To support recording revenue early, the executives created false documentation, including forged sales contracts, to make the transactions appear completed.
- KAI shipped goods to a secret offsite warehouse to create the appearance that goods had been sold and delivered, and recognized revenue as of these shipments even when there was no bona fide customer sale.
- Some transactions were “finalized” with contingencies or side arrangements that allowed buyers to cancel, but KAI nevertheless recorded the transactions as current-period revenue.
- KAI’s executives deceived KAI’s independent auditors by providing false documents and misleading information about purported sales and shipments.
- These practices led to a significant overstatement of KAI’s revenue during the period covered by the scheme.
- The Securities and Exchange Commission (SEC) instituted an enforcement proceeding against KAI, alleging that KAI’s recording of these sales practices violated SEC requirements.

## Issues

1. Whether an issuer violates SEC reporting and accounting requirements by recognizing revenue for transactions that are unconsummated, contingent, or fictitious, resulting in materially overstated revenue and earnings.
2. Whether creating false sales documentation, using offsite shipments to simulate sales, and providing false materials to auditors violates SEC requirements relating to accurate books and records and accounting controls.

## Decision

- The SEC instituted an enforcement proceeding against KAI based on allegations that KAI recorded revenue from sales that had not yet occurred and from transactions lacking a completed, unconditional customer sale.
- The SEC’s release described conduct including forged contracts, sham shipment practices, contingent “sales” with cancellation rights, and deception of KAI’s auditors, which together caused a significant overstatement of reported revenue.
- The proceeding addressed KAI’s accounting and reporting practices as inconsistent with SEC requirements for truthful financial reporting and reliable company accounting records.

## Legal Principles

- Revenue recognition depends on a completed transaction; recording revenue before a sale is final, or when a buyer can cancel based on side arrangements, can materially misstate financial statements.
- The economic reality of a transaction controls over its paperwork; shipping goods to a warehouse or creating the appearance of delivery does not support revenue recognition without a real customer sale.
- False or forged documents used to support accounting entries can render an issuer’s books and records unreliable and can contribute to false or misleading periodic reporting.
- Misleading or deceiving independent auditors by supplying false contracts or shipment information can impair the audit process and is inconsistent with SEC expectations for accurate issuer reporting and accounting support.
- When senior executives intentionally cause improper revenue recognition and misstatements, the issuer’s financial reporting may violate SEC rules governing financial statement accuracy and recordkeeping.

## Conclusion

AAER No. 689 concerns the SEC’s enforcement action against Kurzweil Applied Intelligence, Inc. arising from allegations that senior executives used premature and fictitious revenue recognition—supported by forged contracts, sham offsite shipments, contingent transactions with cancellation rights, and misleading information given to auditors—resulting in a significant overstatement of KAI’s reported revenue and earnings.


In re Kurzweil Applied Intelligence, Inc., Accounting & Auditing Enforcement Release No. 689 [1995–1998 Transfer Binder] Fed. Sec. L. Rep. (CCH) ¶ 74,204 (July 25, 1995)