Question

Each part should be no more than 1 page in length.

Part I

The rules of accounting provide management with “some” latitude in determining when revenue is earned. Assume that a company normally required acceptance by its customers prior to recording revenue as earned, delivers a product to a customer near the end of the quarter. The company believes that customer acceptance is assured, but cannot obtain it prior to the quarter-end. Recording the revenue would assure “making its numbers” for the quarter. Although formal acceptance is not obtained, the salesperson records the sale, fully intending to obtain written acceptance as soon as possible.

1. What are the revenue recognition requirements in this case?

2. What are the ethical issues relating to this sale?

3. Assume you are on the board of directors of this company. What safeguards can you put in place to provide assurance that the company’s revenue recognition policy is followed?

Part II

Research and review what a financial statement derivative is. Identify an example and how company’s use to leverage the business activities.

Part III

A company’s return on net operating assets (RNOA = NOPAT/Average NOA) is commonly used to evaluate financial performance. If managers cannot increase NOPAT, they can still increase this return by reducing the amount of net operating assets (NOA). In bullet form, list specific ways that managers could reduce the following assets:

1. Receivables

2. Inventories

3. Plant, property equipment

Answer 1

Part I

1. Revenue recognition requirements in this case ,is the receipt of acceptance from the customer ,ie. Revenue is to recognised & recorded in the books of the company income only on or after conveyance of acceptance by the customer, to whom the product was sold.

2. As there is a requirement in the company, to record revenue only after receiving acceptance of the product delivered , from the customer , it becomes unethical ,if recorded before as that will escalate the revenue figure--- which results in violation of the company's internal policies ,normally believed by all teh stakeholders especially the owners.They might be misled to think that all sales have actually taken place as per the policy in-force.

3. To keep up with the company policy ,as well as not to lose on increased sales figure , the customers should be cajoled/requested to provide their acceptance/non-acceptance   before closing hours for products sold towards the very end of the quarter.

To obviate this , the company can relax its policy towards reporting-period ends , requiring acceptance from customers within a stipulated time or preparation & finalisation of financials ,whichever is later.

Part III

1. Ways to reduce Receivables

Improved collection mechanisms

Offering more discounts for early settlements

review of long-pending accounts & follow-up

Stating of terms with more clarity while invoicings

2. Inventories

Improved demand forecasting,taking care to match production to sales,without loss of opportnity

Reduce lead time in procurement

Elimination of obsolete stock

Testing for impairment or reduction in value

Economic order quantities without hindering production schedule

3.Plant& Equipment

Retirement/elimination of unwanted,obsolete & junk items of PP&E

Optimal purchase of the most required equipments

Sale/write-off of unproductive PP&E

Part II

A financial derivative is a financial instrument /contract between any two parties.

It does not have any value on its own but derives its value/price from the underlying asset & so its value changes as per the changes to the value of that asset.

Futures, options, forwards and swaps-- are all examples of derivatives

and the under lying assets are normally stocks, bonds, currency and commodites

Leverage/gearing is borrowing funds for use in the business, ie. debt-financing. Here, with derivatives, investors can enter bond/stock markets with little amount of money or sometimes with nothing at all. Even one with not-enough capital to trade in financial markets can trade with derivatives in these markets.

Capital needed is much ,much less than the capital needed to actually trade in bonds & stocks.

For example,Options trading enables the company to lever its business with bonds .