Revenue Recognition for a Computer Hardware Company - Report Example

Caltron Computer Board of Directors Financial Advisor Accounting Issues report December 31, 2001 Caltron Computer is currently in a critical stage that requires the company’s reputation and financial affairs to be in order. During the first trimester of 2002 Caltron Computers’ plans are to issue a secondary public stock offering to raise additional capital to be utilized for the next stage of growth of the company. The company has been able in the past to raise a lot of capital in the stock market evidenced by the $450 million market capitalization metric. It is extremely important for public companies such as Caltron Computers to demonstrate financial diligence and compliance to its investors. At the beginning of 2001 the Enron Corporation scandal was covered by the media. The consequence of cooking up the numbers for Enron was a complete depreciation of its corporate stocks and an eventual bankruptcy filing. In this current market investors are weary and need reassurances that public companies are making sure its accounting and financial numbers are legit. The smallest irregularities could seriously affect the firm’s secondary stock issuance which is set for February of 2002. There are some issues that need to be attended immediately concerning the revenue recognition practices of the company. The company’s main auditors, Peale & Gowell & Quill, are concerned about four particular financial transactions that occurred recently. I am also concern about the transactions which involved revenue recognition. Most of these transaction are not recognizing the company’ revenue in the correct manner and will affect this financial results of this fiscal year by overstating the actual income of the company. The transactions are violating the generally accepted accounting principles (GAAP) and accounting theory. The revenue recognition principle states that revenue may be recognize in the accounting period in which it is earned (Weygant & Kieso & Kimmel, 2002, p.90). The first irregular transaction involves a transaction between the company and Elegant Housing. In this sale the company took a $20,000 non-refundable retainer and gave Elegant $400,000 of merchandise on trail a basis for six months. The company recognized the entire sum as earned revenue. This transaction is wrong and should not be registered in this way. An accountant must always follow the principle of conservatism, which states that when in doubt the accounting alternative that is least likely to overstate assets and profits should be chosen (Narayanan & Bukart, 2005). A proper recognition of the transaction would be recognizing $20,000 as earned income and the other $380,000 as unearned income. The possibility of the item being return is high, thus the company would be misleading the public claiming a sale actual took place when the transaction occurred. When trial period expires the unearned income can be converted to earned income. The second transaction the company realized that must be adjusted to comply with GAAP is the sale to Alation Electronics. The company’s accounting system recognizes revenue once merchandise is shipped. In this case the client paid $175,000 and stills owe $75,000. The merchandise has not left the company’s premises. Accounting information follows the principle of consistency which means that a company uses the same accounting principles and methods from year to year (Waygant et. al, 2002, p.491). The company recognized the revenue without the merchandise leaving the company premises an action which breaks the consistency of the company’s accounting system. Since the company did receive some money that cash must be registered in the system. One alternative to recognize this transaction is to debit cash and credit an accounts payable account. This transaction recognizes the company is holding money which is not theirs in case the client pulls out of the deal, if that occurred the company owes the client the $175,000 in the accounts payable account. This transaction would follow both the conservatism and consistency accounting principles. If the sale is finalized then all the revenue is recognize and the original transaction can be reversed to even out the numbers in the system. The third transaction that is being audited and must be adjusted is the sales of merchandise to BTU Computer Leasing. The entire sale of $955,000 was recognized as revenue which is not the proper way to treat this transaction. The company took a $190,000 down payment on the condition the equipment is placed in a warehouse and that the company help BTU Computer Leasing find clients to lease the equipment. This transaction involves other elements which required additional work. The proper transaction would have been to recognize $190,000 as revenue and $760,000 as unearned revenue. The revenue is recognized as soon as the company gets paid which will occur when they find rental clients for BTU Computer Leasing. The other financial transaction that must be fixed involved Harvey Industries. Caltron Computers gave this client $220,000 worth of merchandise on a trial basis. The accounting staff recognized half the money as revenue and the other half as a sales allowance since they believed it was a 50-50 chance of the transaction finalizing as a complete sale. This treatment is erroneous and is making estimates based on intuition. None of the $220,000 should be recognized as revenue based on conservatism. The entire amount should have been recorded as unearned revenue until the trial period expires. The financial accounting standards board (FASB) is the main agency currently involved in setting accounting standards for the profession. The FASB utilize a conceptual framework to guide them in the accounting standards creation. The conceptual framework provides a foundation for setting standards and concepts for resolving accounting and reporting questions (Foster & Johnson, 2001). The standard setting process is an unbiased process since the personal opinions of the board working at the FASB is not relevant in the process since all members must follow the same framework. This methodology also creates consistency through time for the future creation of standards. The accounting profession has always followed a tradition of being a self regulated profession. There are rumors that after the accounting scandal at Enron that the US government is going to create some type of legislation that will chance corporate governance forever. The two politicians in charge of the movement are Senator Sarbanes and Congressman Oxley. Along with the FASB there are other organization helping in the standard setting process. Accounting has expanded and the US accounting policies are not the only consideration to consider anymore. International accounting has become a reality for all businesspeople. The main organization helping in the standard setting process internationally is International Accounting Standard Board (IASB) which was founded this year. The Accounting profession has one unique set of standards in the United States. These standards are created for the purpose of having consistency between all companies. The system is created that way in order for investors and other stakeholders to be able to evaluate the financial statements of companies in a similar fashion. The accounting system breaks all barriers and operational system among companies. The numbers of a company in the agricultural business and one in the computer business can be compared and a lot of the basic analysis such as the amount of total revenues, net income, total assets and cash will be reported in a similar fashion. In the case of Caltron Computers which is in the process of launching a new offering of stocks the current accounting system of having a standardizing way of reporting things will benefit the company. Investors who typically invest in certain areas can come our way due to the fact they do a need special industry understanding of the computer field in order to comprehend what the company’s financial statement are presenting. The current way of doing things helps prevent fraudulent behavior. One negative aspect of the system is that it does not allow companies to provide the consumers alternate views of visualizing a same financial reality. It is not really fair that Caltron can not present as revenue a lot of the sales we are generating, but is the way things are currently set up and the company must abide by the established rules to make sure our legitimate operation is not perceived as anything else. If the accounting profession changed its ways it could benefit a lot of different companies in various industries. It would not be that hard to have various specific set of rules to choose from. In the law field the professionals have a chance to utilize tens or even hundreds of laws for a similar subject matter. The accounting profession is not very flexible. The way business is performed in the 21st century is different of what occurred in the last century. Things are moving faster and there are new business models which take into consideration higher levels of service. Personally I believe the trail basis is a great revenue generation models which is generating extra sales for the enterprise. The company incurred in the expense of buying or manufacturing equipment and the accounting profession surely wants the company to recognize the expense immediately. It should be same with our innovative sales model. The possibility of the customer keeping the merchandise is high, thus this sales should be recognized in our financial books. Unfortunately the system does not allow that yet, and Caltron Computers has to comply with the current system. The addition or reduction of $1.8 million in revenue will not change the investor perception of our overall financial performance. On the other hand the potential risk of investors perceiving this company as an unethical entity with illegitimate financial books would have a devastating impact on the company. The accounting adjustment and future treatment of revenue must follow the GAAP principles mentioned in this report. The future of the company is the board of directors hands, corrective action must be ordered immediately by the board immediately. References Foster, J. M., Johnson, L.T. (2001). Understanding the Issues. Financial Accounting Standards Board. Retrieved September 24, 2007 from http://www.fasb.org/articles&reports/conceptual_framework_uti_aug_2001.pdf Narayanan, S., Burkart, M. (2005). The Role of Accounting Conservatism in a well-functioning Corporate Governance System. Stockhold School of Economics. 5. Retrieved September 24, 2007 from http://mpra.ub.uni-muenchen.de/4458/01/MPRA_paper_4458.pdf Weygant, J. J. Kieso, D.E., Kimmel, P.D. (2002). Accounting Principles (6th ed.). New York: John Wiley & Sons, Inc. Read More