Industrial Equipment Ltd.
Essay by bearpond • October 5, 2016 • Case Study • 1,477 Words (6 Pages) • 1,097 Views
Seminar #3
Revenue Recognition and
Accounting Judgments
Review from lecture:
In a cash based accounting system, revenue is recorded when cash is received.
How do we know when to recognize (record) revenue under accrual accounting?
-Performance is substantially complete
-Revenue and the related expenses are known or estimable
-Collection is reasonably assured
What is the potential problems with this sort of approach?
Tax minimization
Cash flow prediction (adjusting cash flow to meet certain goals)
Profit maximization
Providing information that maximizes the change to get loan
How do we manage those potential problems?
Accounting standards (GAAP – IFRS/ASPE)
Laws (tax law, securities law)
Independent audits
Facts surrounding events or transactions being accounted for
Demands of powerful stakeholders (e.g., banks might want to see specific information)
Problem #1:
Industrial Equipment Ltd. manufactures and sells parts used in various types of heavy equipment. The most popular parts sold are those for graders. Since they were manufacturing a number of parts for graders already, Industrial decided to expand its operations to manufacture and sell their own brand of grader. After many meetings, Industrial was able to persuade management at Northern Alberta Construction Co. (NACC) to purchase a grader. Industrial received an order from NACC at the end of August for 1grader to be delivered in October. NACC intends to provide one year warranties, but in order to get the NACC order, Industrial agreed to a 2-year warranty on this initial unit.
The specific events relating to this order for Year 1are:
August 29 Industrial receives the order
September 2 Industrial receives a signed, binding purchase order for a grader
September 5 Industrial orders the materials needed to manufacture the grader
September 10 Industrial receives a deposit from NACC for half of the total sales price
September 29 Production of the grader is completed
October 1 Industrial ships the grader to NACC
October 5 Industrial receives confirmation that the grader was received by NACC
October 15 Industrial receives payment for the balance of the sales price owing
From October 1, year 1 to September 30, year 3 Industrial provides warranty parts and service. The amounts are the same that others in the industry experience.
- What dates are possible choices for Industrial to recognize the revenue? What are the problems with each?
October 1 – delivered the equipment, they may have other performance requirements so they may not be substantially complete
October 15 – Collection is reasonably assured, we may not be able to estimate the warranty expenses related to the sale of the gender
September 30, year 3 – all uncertainties are resolved, but it delays revenue to a much later accounting period
- Assume that Industrial’s year end is October. How does that impact the revenue recognition decision? What if the year end was September 30 instead?
Year-end is October – then it does not matter as much if we picked a date in September or October to recognize revenue the revenue will still be recorded in Year 1 with exception of the Year 3 date
September – this would have an impact on both Year 1 & year 2 revenue depending on the date of recognition if it was October or September
Revenue Recognition - Example
From its 2013 Annual Report:
“ALARMFORCE INDUSTRIES INC. is a leading manufacturer and provider of proprietary security systems. AlarmForce installs and monitors its proprietary products from coast to coast across Canada and in select markets in the United States including North Carolina, Ohio, Georgia, Minnesota and Florida. Since its establishment in 1988, the Company’s primary focus has been to install and monitor affordable, state-of-the art security systems in the residential market. AlarmForce is listed on the Toronto Stock Exchange under the symbol AF.
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