Side Letter
Definition
An informal or undisclosed written agreement between a buyer and seller that modifies the terms of the primary contract. Side letters are a primary vehicle for revenue fraud because they may grant informal return rights, extend payment terms, or condition the sale on future events, each of which would prevent revenue recognition under IFRS 15 or ASC 606.
- Nature
- Informal or undisclosed agreement modifying the primary sales contract
- Common terms hidden
- Return rights, extended payment terms, conditions on future events
- Accounting standards implicated
- IFRS 15 and ASC 606 (revenue recognition)
- Fraud mechanism
- Undisclosed terms prevent the sale from meeting recognition criteria on paper
Common questions
Why does a side letter undermine revenue recognition even if the main contract looks clean?+
Revenue recognition standards require that the substance of the full arrangement, not just the signed contract, be assessed. A hidden side letter granting return rights or making payment conditional on a future event means the underlying transaction may not actually meet the criteria for recognising revenue when the main contract says it does, so the reported revenue misstates the real economics.
How do forensic accountants typically uncover side letters in a fraud investigation?+
Common techniques include reviewing sales staff email and messaging for undisclosed terms, interviewing customers directly about the full agreement, comparing actual payment and return patterns against contract terms for anomalies, and examining sales commission structures that may incentivise undisclosed concessions.
Related terms
- Bill-and-Hold
- An arrangement in which a seller bills a customer but retains physical possession of the product. Revenue recognition depends on control and...
- Bill-and-Hold Arrangement
- A transaction in which a seller invoices a customer for goods that remain physically on the seller's premises at the customer's request....
- Channel Stuffing
- Excessive shipments to distributors or other intermediaries, sometimes used with concealed terms to inflate revenue. Whether recognition is improper depends on the...
- Days Sales Outstanding (DSO)
- Days sales outstanding estimates the collection period by comparing receivables with average daily relevant sales over a stated period. Definitions and inputs...
- Fictitious Revenue
- Fictitious revenue is an entry representing a sale or earning event that lacks the claimed economic substance. Investigators test contracts, delivery, customer...
- IFRS 15 / ASC 606
- The converged international (IFRS 15) and US (ASC 606) standards that replaced predecessor revenue rules from 2018. Both apply a five-step model:...
- Performance Obligation
- Under IFRS 15 and ASC 606, the distinct promise to transfer a good or service to a customer. Revenue can only be...
- Premature Revenue Recognition
- Premature revenue recognition records revenue before the applicable reporting requirements are satisfied, potentially shifting results between periods. Investigators examine contracts, performance, control...
- Round-Tripping
- A circular transaction in which cash or assets flow between two or more related parties so that each records revenue without any...