Analysis of case 1.4
Sunbeam: The Revenue Recognition Principle
1. Company history
← In April 1996, Sunbeam appointed Albert Dunlap as its CEO and chairman.
← Immediately, the CEO began replacing nearly all of the upper management team and led the company into aggressive corporate restructuring.
← As at end of March 1997, the company arranged special sales contract with the wholesaler provided that the wholesaler could return all of the merchandise, with Sunbeam paying all costs of shipment and storage. This represented a new distribution channel for the company.
← By the 4th quarter of 1997, Sunbeam had recognized $29 million in revenues from bill and hold sales after it began promoting this program. This contributed an additional $4.5 million toward net income in bill and hold sales.
← Bill and hold sales contributed to 10% of the 4th quarter’s revenue of 1997.
← In May 1998, Sunbeam disappointed investors with its announcement that it had earned a worse-than-expected loss of $44.6 million in the 1st quarter of 1998.
← The CEO and chairman Dunlap was fired in June 1998.
← In Oct. 1998 Sunbeam restated its financial statements for 1996, 1997, and 1998.
2. Sunbeam’s Revenue Recognition practice
➢ The SEC found that Sunbeam’s bill and hold sales were not requested by its customers and served no business purpose other than to accelerate revenue recognition by Sunbeam. Accordingly, the company had recognized revenue of $29 million from bill and hold sales in 1997.
➢ Sunbeam encourages the sales to occur long before the customer actually needed the goods, through offering financial incentives such as discounted pricing to its customers.
➢ Sunbeam holds the product until delivery was requested by the customer.
➢ Sunbeam’s customers had the right to return the unsold product.
➢ Sunbeam was unable to set an appropriate level of reserves for any returns.
➢ Through its new distribution program, the company accelerated the recognition of sales revenue in advance of actual retail demand.
3. Revenue Recognition Principle
← Revenue must be both earned and realized before it is recognized. The realization principle requires that the earnings process should be judged complete or virtually complete.
← The risks and rewards of ownership of merchandise must be transferred to the buyer.
← The product must have been delivered or the services must have been provided to the customer.
← The amount of the sale needs to be fixed and determinable.
← In addition, there is a reasonable certainty as to the collectability of the asset to be received (usually cash) in a timely manner.
Thus, disclosure of such accounting principle, assumptions and treatments is very important to the users of financial statements to better understand and make evaluations and judgments about the company at reasonable cost.
4. Pertinent Laws and Regulations (Acts)
a) Sarbanes-Oxley Act of 2002: This Act is one of a United States federal law issued by the Congress to protect investors by improving the accuracy and reliability of corporate disclosures made pursuant to the securities laws, and for other purposes. ← Section 204 stipulated that the “audit committee of an issuer shall be directly responsible for the appointment, compensation, and oversight of the work of any registered public accounting firm employed by that issuer.” ← Section 301 states that “all critical accounting policies and practices to be used; all alternative treatments of financial information within generally accepted accounting principles that have been discussed with management officials of the issuer, implication of the use of such alternative disclosures and treatments, and the treatment preferred by the registered public...
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