Question

Ethical Delima

The Precision Parts Corporation manufactures automobile parts. The company has reported a profit every year since the company’s inception in 1980. Management prides itself on this accomplishment and believes one important contributing factor is the company’s incentive plan that rewards top management a bonus equal to a percentage of operating income if the operating income goal for the year is achieved. However, 2018 has been a tough year, and prospects for attaining the income goal for the year are bleak

Tony Smith, the company’s chief financial officer, has determined a way to increase December sales by an amount sufficient to boost operating income over the goal for the year and secure bonuses for all top management. A reputable customer ordered $120,000 of normally stocked parts to be shipped on January 15, 2019. Tony told the rest of top management “I know we can get that order ready by December 31. We can then just leave the order on the loading dock until shipment. I see nothing wrong with recognizing the sale in 2018 since the parts will have been manufactured and we do have a firm order from a reputable customer.” The company’s normal procedure is to ship goods f.o.b. destination and to recognize sales revenue when the customer receives the parts.

Read through the scenario presented there. You will be arguing in favor of Tony Smith's proposal to include the January sales on this year's report. Remember to use logic and accounting principles to develop your argument. You must include at least three points as to why this route is the best route to go (with one of those points being related to the accounting principles).

Thank you!

Answer 1

The realization principle indicates that revenue is to be recognised

(a) when the earnings process is substantially complete, and

(b) whether there is reasonable certainty of collection of the cash to be received.

This decision depends on delivery of the product by the seller to the buyer. At delivery, the earning process is virtually complete and the seller records either cash or a receivable.

It may be the case, sometimes, that revenue should be deferred to a point afterdelivery because the seller is unable to estimate whether the buyer will return the product or pay the receivable. However, in this scenario, the order is placed and delivery and payment made certain. Therefore, the revenue can be recognised in 2018 as per his suggestion.

Accounting principle of prudence states that no revenue is to be recognised before it is receivable. However, when the goods are moved to the dock for delivery to the buyer, there is constructive delivery, as risk and rewards move out of the seller's hands. Therefore, the amount becomes receivable in the books, and can be recognised in spite of prudence.