Legal issues and standards
Standards for revenue recognition are described and interpreted under several clauses. Financial Accounting Standards Board (FASB) Concept No. 5 states that “generally, revenue is recognized when it has been earned, and realized, or realizable” (Jarnagin, 2008, p. 30). The Concept No. 5 defines ‘earned’ as the condition in which the seller has accomplished all that is necessary to be entitled to benefits in the form of revenues (FASB, 2008).
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Realizable is when benefits are expected to be received by the seller with a specified level of certainty. Realized is when benefits have been received by the seller (Jarnagin, 2008). The $1.2 million transaction fails to meet the standards because it may be unrealizable, and it is not completely earned. It is not earned because Excello Telecommunications has not completed all the requirements that make it entitled to receive benefits.
The SEC requirements are summarized in the SEC Accounting Bulletin (SAB) 104 released in December 2003. SAB 104 requires that there be “a persuasive evidence of agreement exists, delivery has occurred, the seller’s price is fixed or determinable, and collectability is reasonably assured” (Epstein, Nach & Bragg, 2009, p. 380).
SAB 104 clarifies the same points outlined in SAB 101. In Excello Telecommunications’ case, the price is determinable if they offer a discount. It meets the requirement of SAB 104 on price. Collectability of payment is only assured if the company delivers the goods as requested by Data Equipment Systems.
Delivery can only be considered to have taken place when the goods are on the shipment. Delivery can also be considered to have taken place when the goods are given to a third party who assumes all the risk of delivery. The same standards are reinforced by the Accounting Principles Board (APB) Opinion No. 10 on which delivery, realization of benefits, and complete removal of assumed risk are considered (Jarnagin, 2008).
The seller is not allowed to have any managerial responsibility for the goods in case there are delivered to a warehouse far from the company’s premises. Under IFRS, the Internal Accounting Standard (IAS) 18 part (14) requires the transfer of risk from the seller to the buyer (IAS 18 Revenue, 2012).
It also requires that the seller should not continue with managerial involvement to a degree that can be performed by the owner. It also mentions realization of benefits. IFRS may be consistent with some parts of GAAP in revenue recognition. Excello Telecommunications should not hold any managerial responsibility when it transfers the goods into another warehouse.
ASC 605 – 25 – 50 – 2 (d) requires that firms disclose provisions for “performance-, cancellation, termination, and refund-type” (FASB, 2009, p. 14). Part (h) of the same section requires disclosure to the effect of changes in the selling price. ASC 605 – 25 – 30 – 6 requires that cancellation be used in determining the extent to which an amount that should recorded (FASB, 2009).
It may require to some extent that the firm records the amount that can be legally recovered when the cancellation occurs. Excello Telecommunications will be required to disclose that it has offered a refund provision to Data Equipment Systems.
Recording of the transaction can be captured under sections 302, 304, 401, and 406. SEC 302 (a) (2) states that the issuer shall “fairly present in all material respects the financial condition and results of operations of the issuer as of, and for, the period presented in the report (Public Law 107-204 107th Congress, 2002, p. 777).
The issuer is a company that is publicly listed under stocks exchange. Excello Telecommunications wants to list a transaction that should be recognized in the future. It would violate the requirements of SEC 302 (a) (2).
SEC 304 (a) (1) states that the CEO and the CFO “shall reimburse the issuer for any bonus or other incentive-based or equity-based compensation received by that person during the 12-month period” (Public Law 107-204 107th Congress, 2002, p. 778). It goes to the beneficiaries of the misreport that all their benefits that are derived from the misappropriation shall be nullified. SEC 304 (a) (2) includes nullification of profits derived from the sale of securities as a result of the financial misappropriation.
SEC 401 (b) (1) states that information contained in financial reports must be true, and not misleading. SEC 401 (b) (2) requires that “financial conditions and results of operations must be reconciled with GAAP” (Public Law 107-204 107th Congress, 2002, p. 786). GAAP revenue recognition requirements have been captured by SAB 104, and FASB Concept No. 5. Excello Telecommunications may put its financial conditions under GAAP by choosing procedures that may make the goods to be considered as delivered before the end of the year.
SEC 406 (a) requires that firms disclose their adherence to the code of ethics. SEC 406 (c) (1) describes that the code of ethics refers to honesty and fairness (Public Law 107-204 107th Congress, 2002).
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AICPA (American Institute Certified Public Accountants) code of professional conduct
The AICPA code of professional conduct requires that members of the AICPA assume responsibilities more than has been specified by law in maintaining and broadening trust and public confidence. ET Section 51 part (1) specifies that members have obligations “above and beyond the requirements of the laws and regulations” (AICPA, 2010, p. 1689). It shows that Excello Telecommunications CFO will be judged based on honorable behavior that can be subjected to the views of the FASB, and the public.
ET Section 53 article II states that AICPA members must serve the public interest, and honor their trust. Part (1) describes the public as “clients, credit grantors, governments, employers, investors, the business and financial community, and others who rely on the objectivity and integrity certified accountants” (AICPA, 2010, p. 1693). Excello Telecommunications has a responsibility to ensure that the information given to the public is trustworthy.
The public rely on the information to make investment decisions. Information that misleads the public may make the public assume risks without returns that match those risks. High risk should be matched by the promise of high returns in the form of interest rates. The information can be used by the public to allocate resources efficiently in areas that incur a higher opportunity cost.
ET Section 53 article II part (2) states that when resolving conflicts associated with the interests, the AICPA member shall be “guided by the precept that when members fulfill their responsibility to the public, clients’ and employers’ interest are best served” (AICPA, 2010, p. 1693). In Excello Telecommunications’ case, the clients and employers are the shareholders. The interest of the shareholders is served when they assume foreseeable risks based on the outcome of the firm’s actual financial performance.
ET Section 53 article II part (3) states the acceptable conduct is to “enter into fee arrangements” (AICPA, 2010, p. 1693). It requires that in case Excello Telecommunications holds the goods for Data Equipment Systems till needed, then it must charge a fee.
ET Section (54) article III part (2) emphasizes the subordination of personal gain to public trust and service. Part (3) of the same section states that “integrity shall be measured in terms of what is right and just” (AICPA, 2010, p. 1695). It is unethical for the CFO to place his personal interest above those of the client, and the public. Stock options and bonuses are personal gains.
Stock prices may also constitute a personal gain when the executive members hold large amounts of the company’s stock. It may appear like an ethical dilemma because the CFO wants to prevent the stock price from falling because of a poor performance which may serve the interest of shareholders. However, it may attract the public making investors to allocate resources inefficiently by allocating their finances to a firm with low financial performance.
The best alternative
The best option is to offer Data Equipment a 10% discount. It may reduce receivables by a large amount ($120,000) but it does not violate any of the GAAP requirements. When Excello transfers the goods to an off-site warehouse it owns, it does not meet the requirements of GAAP.
The seller must transfer all risks to the buyer for payment to be realizable. The seller must also not assume any managerial responsibility. When the goods are delivered with a refundable provision, the requirements are that there should be a full disclosure about the arrangement.
The cancellation provision also requires that only the amount that can be legally recovered be recorded. Excello plans to offer a full refund, there is nothing legally binding in case of a cancellation. It means Excello is not entitled to a realizable benefit. The best option remains to offer a 10% discount. Another weakness of this option is that there is no guarantee that Data Equipment may respond positively to the incentive.
AICPA. (2010). Code of professional conduct: As adopted January, 1988, unless otherwise indicated. Web.
Epstein, B., Nach, R., & Bragg, S. (2009). Wiley GAAP 2010: Interpretation and application of generally accepted accounting principles. Hoboken, NJ: Chichester Publication.
FASB. (2009). Accounting standards update: Revenue recognition (Topic 605). Web.
IAS 18 Revenue. (2012). Web.
Jarnagin, B. (2008). 2009 U.S. master GAAP guide. Chicago, IL: CCH.
Public Law 107-204 107th Congress. (2002). Web.