1. What factors might have led analysts to question Oracle Systems’ method of revenue recognition in mid-1990? Are these legitimate concerns?
Analysts might have been led to question Oracle’s method of revenue recognition because of revenue recognition timing, quality of receivables, and aggressive sales practice. These were all legitimate concerns.
Oracle recognized licensing and sublicensing revenues on the date of contract rather than upon delivery when certain conditions were met. The company justified the practice stating its contractual obligation had been substantially performed at the time of signing the agreement. The concerns over this accounting method is legitimate because the company obviously did not consider delivery of its products a substantial part of obligation, while the wording of FASB Concepts Statement No. 5 suggests differently. The concerns grew further as many other software firms began recognizing revenues only after the delivery.
Quality of receivables was another concern because Oracle’s days receivable exceeded 160 days which was significantly longer than competitor average of 62 days even after considering that Oracle recognized revenues early. Like most companies, Oracle based employees’ incentives on sales, so sales manipulation had always been a concern.
In 1990, concerns over Oracle’s aggressive sales practice were legitimate because the company had potentially greater credit risk in receivables, and aggressive sales likely had contributed to the questionable quality of receivables.
2. Estimate the earnings impact for Oracle from recognizing revenue at delivery, rather than when a contract is signed.
If Oracle recognized revenue at delivery rather than when a contract is signed, we estimate that the company would report decreased earnings of $(55,065), $149,784, and $95,984 for fiscal years ended March 31 1990, 1989, and 1988 respectively, as opposed to reported $117,410,...