1. In general, evaluate Caltron’s revenue recognition policy and the quality of Caltron’s earnings. Caltron Computers, Inc. , a computer hardware company, is publicly held with market capitalization amounting to over $450 million. Carlton’s system designs enable their mini-computer systems to measure up to the power of mainframes with small cost outlays. The accounting practices at Carlton normally permit revenue recognition after the shipment of the computer systems. Peale, Gower and Quill, Carlton’s auditors, are worried about the accounting practices regarding revenue recognition of certain transactions during the last quarter of 20X1.
They are also worried about the adverse effects of such accounting on the company’s quality of earnings and thereby on its planned public stock offering in February 20X2. The present US GAAP (Generally Accepted Accounting Principles) revenue recognition model comprises over 100 standards and interpretations, many industry specific and inconsistent (PwC, 2010). Yet, the fundamental revenue recognition standards lead to the conclusion that Caltron’s accounting practices adversely impact the quality of its earnings and accounting statements.
2. Discuss how and why Peale, Gower & Quill should recommend that Caltron account for and report the four transactions in the fourth quarter of 20X1. Include in your discussion specific reference to bill and hold arrangements and accounting pronouncements that you used to formulate the basis of your recommendation. The customers’ rights to return goods are considered to be types of customer acceptance provisions. These provisions permit customers to return goods or cancel agreements if their performance is not satisfactory. These provisions could also entail product assessments on a trial basis.
Revenue recognition under the well recognized ‘SEC (Securities Exchange Commission) SAB (Staff Accounting Bulletin) 104’ specifies that when such provisions exist, revenue should only be recognized either on customer acceptance or on the expiry of the acceptance provisions, whichever event is earlier. Further, acceptance could be either by means of an affirmative customer acceptance or on the customer not taking specific action to reject the product shipments (Grant Thornton, 2010). In the instant case of Elegant Housing, Inc. neither has the affirmative customer acceptance been received by Caltron Computers, Inc. or has the 6 month trial period ending on May 15, 20X2 lapsed. In light of the above circumstances and the revenue recognition provisions, it is recommended that the revenue of $400,000 should not be recognized. Certain business situations necessitate that customers take title to the goods purchased, agree to pay for them and yet not be in a position to accept delivery of the goods. In such cases, the sellers fulfill the manufacturing requirements and segregate the goods in their warehouses so as to make the goods available to the customers for shipment. Such transactions are labeled ‘bill and hold’ agreements (Grant Thornton, 2010).
SAB 104 lays down the following conditions that should all be fulfilled to enable revenue recognition in cases on non-delivery of goods: (1) The risks of ownership need to have been transferred to the purchasers, (2) The customers have made commitments, preferably written, to procure the goods, (3) The purchasers call for the ‘bill and hold’ transactions, (4) The buyers should be able to justify such requests with significant business purposes, (5) There should be fixed delivery schedules of the goods that are both practical and in line with the purchasers’ business purposes, (6) The sellers have no remaining performance obligations that show an incomplete earnings process, (7) The goods are isolated and available only for such purchase agreements, and (8) The products are in a finished condition and awaiting shipment (Grant Thornton, 2010). Issued in 2009, the FASB’s ASC (Accounting Standards Codification) comprises only general guidance on assessing alleged bill-and-hold agreements in Concepts Statement 5 and AICPA SOP (Statement of Position) 97-2.
Additionally, SEC has averred that US GAAP do not permit public companies to complete bill-and-hold contracts without the buyers having convincing business purposes for asking for postponements in shipment of goods (Clark & Ryerson, 2010). In the case of the bill-and-hold arrangement with Alation Electronics, there is no fixed delivery schedule. Also there appears to be a complete lack of compelling business purpose to request for postponement of the shipment of goods until the first quarter of 20X2, particularly in terms of the lack of clarity regarding the consignee details of the shipment. In view of the same, it is recommended that the revenue of $250,000 should not be recognized.
Under the terms of the third transaction viz. the bill-and-hold arrangement with BTO Computer Leasing, there is no fixed delivery schedule even for the single user that has been identified. Indeed, the other 4 end-users have yet to be identified. Again, there seems to be a lack of compelling business purpose to request for holding the goods. In view of the above, it is again recommended that the revenue of $950,000 should not be recognized. In accordance with the provisions of SAB 104 stated earlier, when customer acceptance terms exist revenue can be recognized either on buyer acceptance or on the termination of the acceptance terms, whichever is earlier.
Further, in case a realistic estimate of returns is feasible in accordance with the conditions of general rights of return laid down in ‘ASC 605-15-25-1 to 25-4’, revenue can be recognized if all the other revenue recognition conditions are satisfied. It is laid down that a large volume of homogenous contracts are essential for an organization to realistically estimate product returns (Grant Thornton, 2010). In this transaction with Harvey Industries the affirmative customer acceptance has not been received and the 4 month trial period ending on March 27, 20X2 has also not lapsed. Additionally, there is inadequate volume of similar past contracts to realistically predict the product returns. Therefore, it is recommended that the revenue of $110,000 also should not be recognized.