From the October 2003 issue of Entrepreneur

It wouldn't be the first time a telecom company's accounting chicanery made headlines, but the ongoing tussle between Qwest Communications International Inc. and the SEC brought a common industry practice under the microscope-and may have businesses thinking twice about certain strategic agreements. At least some of Qwest's trouble is about reportedly recognizing some $2 billion in revenue from "swap" sales dating back to 1999. The fact that the Denver-based telephone company swapped fiber-optic capacity with other telecommunications firms was hardly an anomaly; telecom companies had been trading capacity for years, seeing that as a cost-efficient alternative to each company building its own network in a particular area.

But rather than simply exchanging services, companies like Qwest began getting the idea to construct two separate transactions, with each side writing a check to the other. "That's where the accounting trick comes in," says Mark DeFond, professor of accounting at the University of Southern California's Leventhal School of Accounting in Los Angeles. "When I receive a check from you, I book that as revenue, but when I write a check to you, I don't book it as an expense." Rather, the expense is amortized over a period of time, while the revenue is booked upfront.

The SEC has said it plans to look more closely at swaps and other creative alliance agreements. So what will that mean for entrepreneurs who depend on barter arrangements and other creative wheeling and dealing to survive and thrive? Finding ways to trade products and services rather than laying out cash for them is particularly critical during harsh economic times. Do the high-profile cases mean swaps are just bad business?

Not when executed properly, experts say. "There's nothing wrong with engaging in swaps," says J. Edward Ketz, associate professor of accounting at Pennsylvania State University, University Park, and the author of Hidden Financial Risk: Understanding Off-Balance Sheet Accounting (John Wiley & Sons). It's all in how you account for swaps, and the rules, he says, are quite clear: "If the swap involves dissimilar resources-a car for a computer, for example-then record the new asset at its fair value, take off the swapped asset at its book value, and record the difference as a gain or loss," he explains. "If the swap involves similar resources-one bandwidth for another, for example-then record the new asset at the book value of the swapped asset. Don't recognize any gain or loss." And never discount the value of your service to trade it for something else you need.

The challenge comes when you have to assign a price tag to a product or service that's difficult to value. If the product or service being bartered is difficult to value, both parties have to demonstrate that they made a good faith effort to come up with a defensible valuation, says Joe Carcello, associate professor of accounting and business law at the University of Tennessee, Knoxville. "If the methodology you use is not defensible, if you're playing games with the accounting, then you're going to get in trouble if it comes to light," he says.

The deal should have a good, solid business case behind it, making it clear that you entered into it for the right reasons. "Don't walk into the transaction with the intent of trying to boost revenues as a result of the structure of the transaction," says DeFond. "Try to account for the transaction on its economic merit."

If ever in doubt, the best advice is to consult an external auditor on the transaction. "Most firms, unless they're incompetent," says Carcello, "are going to look at the transaction and say 'This is all wrong. We can fix this.'"


C.J. Prince is the executive editor of CEO Magazine. She can be reached at cjprince@chiefexecutive.net.