Audit Internet Problem 14-1

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The following answers are based on the SEC’s Litigation Release No. 20470 and related press releases associated with the fraud at Bally Total Fitness Holding Corporation:

a.According to the SEC press releases and Litigation Release No. 20470, Bally fraudulently accounted for three types of revenue it received from members: initiation fees, prepaid dues, and reactivation fees.

Initiation fees: Bally fraudulently and prematurely recognized revenue from initiation fees. Part of the price of a Bally health club membership was a one-time initiation fee that was either paid in full when the member joined or was financed over a period of time, typically 36 months. Regardless of how the initiation fee was paid, accounting standards prohibit Bally from recognizing all the revenues from initiation fees immediately. Instead, accounting standards require that Bally recognize initiation fee revenue over the entire membership life. This means that for members who maintained their memberships beyond the financing period, or initial period of membership, Bally was required to defer initiation fee revenue and recognize it over the estimated membership life, not over the term of the initial period of membership. However, Bally prematurely recognized its members’ initiation fee revenue over a period that was not only shorter than the estimated membership life, but in most instances even shorter than the initial period of membership.

Personal Training Services: In addition to selling health club memberships, Bally also sold personal training services (i.e., exercise sessions with personal trainers). Some customers prepaid for sessions with personal trainers. Accounting standards require that revenue from prepaid personal training services be recognized only when earned, which is when the personal training services were actually provided. Bally, however, recognized revenue related to personal training services before those services were actually provided.

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