EXECUTIVE SUMMARY Revenue Recognition and Wareham SC Systems, Inc. Wareham SC Systems, Inc. is a capital equipment and testing instrument manufacturer and supplier comprised of three divisions: the Glendale Division, the Advanced Technology Division and the Technical Devices Division (Anthony, Hawkins, & Merchant, 2011, p. 137). In 1999, Somai Desai, the company’s chief financial officer, received news that the Security Exchange Commision (SEC) issued a new set of revenue recognition and reporting guidelines which were to be implemented no later than the fourth quarter of 2000.
These new guidelines called the Staff Accounting Bulletin No. 101 (SAB 101), provided more specific criteria for revenue recognition and are listed as follows: Persuasive evidence of an order arrangement exists; Delivery of the ordered goods has occurred or services have been rendered; The seller’s price to the buyer is fixed or determinable; and, Collectibility of the sale proceeds is reasonably assured (Anthony et al. , 2010, p. 138).
Adoption of the SAB 101 standards meant that Desai would have to review the provisions contained in each of the three division’s sales contracts to determine what administrative changes need to be made to the company’s revenue recognition policy. GLENDALE DIVISION: ONSETCOM, INC. AND CATAUMET DEVICES, INC. The Glendale Division manufactures equipment that is generally sold in a standard model. Under their sales contract, customer acceptance is recognized after the customer received and tested the equipment which would then follow a formal sign-off or the passage of 90 days without a claim.
However, if a claim arose, the customer could either request a full refund, a replacement unit or require the division to repair the equipment according to the customers requirements. Payment is due 30 days after customer acceptance and title is passed to customers upon delivery. The problem with this contract is that the company’s current revenue recognition policy which states that “product revenue is recognized upon shipment” does not meet the SAB 101 criteria that requires revenue to be recognized when delivery of goods occur.
This means that under the company’s current policy, revenue is recognized too early, before delivery, while actual payment is not received until 30 days after customer acceptance or until the 90-day warranty period has ended. Furthermore, the 90 day warranty provision creates an uncertainty in the collectibility of sales proceeds. ADVANCE TECHNOLOGY DIVISION: SANDHAM, INC. AND XL SEMI INC. The advance technology division manufactures, develops, and sells specialized manufacturing equipment to include installation services which is sold on a time and materials basis. Title is also passed upon delivery.
The sales contract with Sandham Inc. included certain provisions that made the collectibility of sales proceeds uncertain due to the obligation that the equipment had to meet Sandham’s requirement of compatibility with manufactured equipment from other companies which Wareham could not replicate during testing at their facilities. This contract also provides customer acceptance provision that grants Sandham a full refund if the product was not accepted within 120 days. Due to high development and manufacturing costs, these factors increases the risk that the company will take a significant loss in revenue if the product is rejected.
For XL Semi, the provision outlining the cost of installation services which can vary from 1% to 3% of the total arrangement fee ignores the SAB 101 criteria which states that the sellers price to the buyer should be fixed or determinable. As was the case with the Glendale Division, the payment terms outlined in both Sandham and XL Semi’s sales contracts creates a situation where revenue recognition under the current company’s policy occurs prior to the actual receipt of sales proceeds and does not meet SAB 101 guidelines.
TECHNICAL DEVICES DIVISION: NEW STRATEGY AND ASHABAN INDUSTRIES The Technical Devices Division manufactures, develops and sells a variety of electrical, electronic and mechanical testing devices. Historically, the division’s internal sales force sold directly to high-volume customers while independent distributors sold to low-volume customers. Days before Desai announced her review of the company’s sales transactions, the Technical Devices Division turned over sale of high-volume mechanical testing devices over to independent distributors due to decreased demand and profitability.
Distributors were also asked to increase their inventory from a few weeks worth to two years worth. In doing so, the Technical Devices Division, recognizing that they may not meet the quarter’s profit goals, may be attempting to deceptively misrepresent revenues on the company’s financial statement. Not only does this defy the General Accepted Accounting Principles but is does not satisfy the criteria requiring them to provide persuasive evidence that an arrangement order exists.
To make matters worse, the contract with Ashaban Industries further increases the uncertainty that sales proceeds can be met due to former Soviet Republic’s political instability. Furthermore, the mechanical testing equipment sold to Ashaban will be installed by inexperienced local contractors versus the company’s engineers which will increase the number of product rejection by customers. CONCLUSION Analysis of each division’s selected sales transactions shows that the company’s Revenue Recognition Policy will have to be revised in order to meet SAB 101 regulations.
The current policy incorrectly recognizes revenues too early which may cause revenues for the upcoming period to become overstated. Additionally, the varying provisions in each of the division’s sales contracts compromises the companies ability to collect sales proceeds and increases the risk of significant losses in sales revenues. References Anthony, R. N. , Hawkins, D. F. , & Merchant, K. A. , (2011). Accounting: Text and Cases (13th ed. ). New York: McGraw Hill.
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