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. . 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 collegiality 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. . Pertinent Laws and Regulations (Acts) 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 stirred 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 accounting firm should be timely reported to the audit committee of the issuer by the accounting firm”. B) Auditing Standard No. 5 of Public Company Accounting Oversight Board
The Public Company Accounting Oversight Board (PEPCO) is a non-profit corporation created by the Serbians-Solely Act of 2002 to oversee the auditors of public companies with a purpose to protect the interests of investors and further the public interest in the preparation of informative, fair, and independent audit reports. Audit Standard No. 5 – Paragraph No. 69 articulates that existence of “ineffective oversight of the company’s external financial reporting and internal control over financial reporting by the company’s audit committee” is an indicator of a material weakness in internal control.
Under the same paragraph it was indicated that “restatement of previously issued financial statements to reflect the correction of a material misstatement” is also an indication of a material weakness in internal control. C) SEC Staff Accounting Bulletin No. 101 (mentioned in the case). The SEC had stipulated that the following criteria must be met for revenue to be recognized in bill and hold transactions: The risks of ownership must have passed to the buyer.
The buyer must have made a fixed commitment to purchase the goods. The buyer must request the transaction be on a bill and old basis and must have a substantial business purpose for this request. There must be a fixed schedule for delivery of the goods. The seller must not have retained any specific performance obligations, such that the earning process is not complete. The ordered goods must be segregated from the seller’s inventory. The goods must be complete and ready for shipment.
Bill and Hold Sales (inappropriate revenue recognition and disclosure) Sunbeam did not unveil the 10 percent contribution increase of the bill and hold sales to the 4th quarter’s revenue in 1997; rather the company only disclosed a 3% of unconsolidated revenue at the year end. The company had recognized revenue of $29 million from bill and hold sales in 1997, although those sales were not requested by its customers and served no business purpose other than to accelerate revenue recognition.
This practice is in violation of the provisions mentioned in SEC laws. Sunbeam failed to set an appropriate level of reserve for future sales returns, despite existence of its bill and hold sales. Violated Auditing Standard No. 5 of PEPCO (in restatement of its previously issued financial statements to reflect the correction of a material misstatement). All bill and hold sales had been reversed in 1997. Violated sections 301 and 204 of Serbians-Solely Act of 2002. 6) Solution 1) Definition of revenue recognition principle is given above.
Constraints of GAP GAP has not adequately addressed the assumptions and conditions in revenue recognition from bill and hold transactions in detail. 2) Provide one specific example of how Sunbeam violated the revenue recognition principle in this situation. Sunbeam inappropriately recognized revenue before completion of the earning process. One indicator is that, the risks and rewards of ownership of researched have not been fully transferred to the buyer, particularly in its bill and hold transactions.
Sunbeam’s liberal return policies are not in compliance with the revenue recognition principle, as the company (for instance) had recognized sales with full right to return without having a practice of setting aside an allowance or a reserve against possible future returns. 3) Evidence: Examine the company’s sales contracts (document) with wholesalers and other cash to be received. Examine the sales Journal for reviewing the revenue recognition process. Examine goods order or request by the customers of Sunbeam.
Examine the intention of giving special discounts and incentives to customers. 4) Identify one action to be taken by the Audit committee Had there been effective oversight of the audit committee on the company’s internal control system and external financial reporting, such fraudulent activities by the management in revenue recognition would not have occurred. Hence, audit committee has to ensure existence of effective oversight on external financial reporting in accordance with Serbians-Solely Act of 2002 Section 301 and Section 204 s well as Paragraph No. 9 of Audit Standard No. 5 of PEPCO. The audit committee has to strengthen the internal control system to ensure compliance of the company with all applicable laws, regulations as well as GAP. 5) Conclusion The management of Sunbeam has knowingly violated GAP and other applicable laws mentioned above. As a result, a very pervasive fraud: involving improper sales revenue recognition, understatements of the reserves for sales returns and bad debts, abuse of the rules governing consignment sales, and other manipulations have been committed.
