Question

1. In 2010, LinkedIn reported trade payable obligations totaling $10.8 million in other accrued expenses within accrued liabilities instead of accounts payable. In 2011, note 2 in the 10-K financial statements described the use of accrued liabilities instead of accounts payable as a classification. Do you believe LinkedIn’s accounting qualifies as a financial shenanigan?

2. Tineseltown Construction just received a $2 billion contract to construct a modern football stadium in the City of Industry, located in southern California, for a new National Football League (NFL) team called the Los Angeles Devils of Industry. The company estimates that it will cost $1.5 billion to construct the stadium. Explain how Tineseltown can make revenue recognition decisions each year that enable it to manage earnings over the three-year duration of the contract.

Answer 1

1. Accounts payable generally relates to suppliers' invoices that have been received and booked and must be paid. The amount in accounts payable agrees with supporting documents such as invoices.

On the other hand, accrued expenses is the total liability that is payable for goods and services that have been received but not been billed. In most cases, accrued expenses relates to adjusting entries made at the end of the year for expenses incurred like utilities, interest, etc, (i.e., services received) during the year, but invoices for the same have not been received, which is why they cannot be booked as accounts payable.

If in the case of LinkedIn as mentioned above, the amount of trade payables booked as accrued expenses within accrued liabilities, then the classification is appropriate.

However, if it includes amounts, for which invoices are available and have been booked as trade payables, and then been classified as accrued expenses to manipulate accounts, we may call the same as a financial shenanigan.

2. Revenue, cost and profits from a construction contract whose total period of contract is likely more than 1 tax year are recognized as per percentage of completion method (POCM)

As per this method, percentage of completion is calculated for each year by dividing the total cost incurred till date (i.e., till the end of a particular year) by the estimated total costs (cost incurred till date + estimated cost to complete contract) that will be incurred over the entire period of the contract.

Total contract revenue is then multiplied with this % and contract revenue to be recognized till end of that year is calculated.

Above calculated contract revenue - total cost incurred till date = Profit on contract till date.

From this any profit recognized in earlier years by the same method are reduced, and the difference is recognized as profit for the year.

In the given case, % completion shall be calculated by dividing the total cost incurred till date (ie., till the end of a particular year) by $ 1.5 billion. This % shall be applied to $ 2 billion to calculate contract revenue to be recognized till date.

If Tineseltown recognizes revenue each year in this manner, it can manage earnings over the three-year duration of the contract.