Question

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, 2016 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 earn bonuses for all top management. A reputable customer ordered $120,000 of parts to be shipped on January 15, 2017. 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 2016, 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. Argue in favor of Tony Smith's proposal to include January's sales on this years report. 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 learned accounting principles).

Answer 1

As per the revenue recognizing principle an amount should to be considered as sales revenue if and only if its performance obligation is complete. The performance obligation means delivery of goods and receiving by customer, which are not done in the month of December, 2016; but still it could be considered as sales revenue in the month of December, since this is the best way as follows:

1) Matching principle of accounting suggests that expenses are matched with respective revenues during a period. If the revenue of $120,000 is recorded in the coming year, such principle doesn’t follow; because some of its expenses incurred in this year are already recorded in 2016 and can’t be transferred to 2017, like electricity expense, depreciation, etc. Therefore, it is better to record such revenue in this year since it covers all the costs within this year.

2) Since the customer is reputed, the adequate reliability is there that the order is not going to cancel in anyway; therefore, whatever amount is going to be shown as revenue in the coming year could be shown in this year as well.

3) The order is complete by December; the internal performance obligation, which is the main part of whole performance obligation, is done during the year 2016. Therefore, there is no harm of including it as sales revenue during 2016. Management would be more motivated once they get incentive out of it.