Table of Contents
Biovail Corporation, a major Canadian pharmaceutical company listed on the New York Stock Exchange, announces that it will miss its quarterly earnings target by $25 to $45 million, blaming $10 to $15 million of the shortfall on a truck accident involving a shipment that left its facility on the last day of the quarter. The case was ultimately prosecuted by the U.S. Securities and Exchange Commission (SEC). The case is centered on the question of revenue recognition and how the company should have accounted for the sales (FOB shipping or FOB destination). However, it also provides a rich setting permitting exploration of peripheral topics around the ethics of earnings management. For example, the case discusses stock analysts' reactions to the announcement; questions how much product was actually in the truck; questions how aggressively the company responds against the analysts who downgrade the stock; and highlights the role of the SEC in enforcement. Besides that, Biovail’s stock had listed on both the Toronto and New York stock exchanges. Biovail filed annual reports to the U.S. SEC and prepared financial statements in accordance with both U.S. and Canadian generally accepted accounting principles (GAAP). On 30 September 2003, there was a truck carrying a shipment of Wellbutrin® XL from Biovail’s manufacturing facility in Manitabo to Biovail’s Distributor, North Carolina was involved in a accident near Chicago. The company announced that the loss of the quarterly earnings which target by $260 million is because of the truck accident happened. There are several issues in this case which included accounting policy based on the revenue recognition; how Biovail Corporation should account the sales based on two different “Freight On Board” (FOB) point which are FOB Shipping point and FOB Destination point, and ethic of earning management where Biovail is suspected might significantly overestimate the value of the product that involved in the truck accident due to Biovail fail to meet its third quarter 2003 earnings guidance, downgrade of stock rating on Biovail, bad management control and corporation culture. (Unethical).
Statement of the Problem
1. Accounting policy based on the revenue recognition: How Biovail Corporation should account the sales based on two different “Freight On Board” (FOB) point which are FOB Shipping point and FOB Destination point. According to this article, Biovail’s CFO told the analyst that Biovail’s contract with the Distributor had title change in Manitoba when it left the shipping dock (FOB Shipping point), but the agreement between Biovail and the Distributor provided that the title to, and risk of loss with respect to, the product would not passed to the Distributor until the product was delivered to the Distributor’s facility (FOB Destination). These two different Freight On board (FOB) indicates different moments of revenue recognition. According to the FOB condition: Shipping Point: The Company should recognize revenue at the moment/in the period in which product leaves Biovail shipping dock at the warehouse since in that precise moment both ownership and responsibility over the goods is transferred from Biovail to the client. Destination: The Company should recognize revenue at the moment/in the period in which product is delivered to the Distributor’s facility since in that precise moment both ownership and responsibility over the goods is transferred from Biovail to the client. Four conditions must be met in order to recognize revenue that recognized by GAAP are ; 1. Persuasive evidence of an arrangement exists: Although the case does not provide extra information on this aspect, it seems clear that there is an ongoing relationship between Biovail and the Distributor and that certainly there was a bill, purchase order and/or invoice in order to support this sale. 2. Seller’s price to the buyer is fixed or determinable:...
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