GOLD TEAM 4| ACC 401| Assignment 2 – Analysis of the Financial Statements for J. P. Morgan Chase and Citigroup| | Evan Aloe Joohyung Han Takahito Fukui Bhadra Menon| 10/3/2011| | ACC401 Financial Accounting HW#1 Q1. Dr Accounts Receivable $ 22 M
Cr Net Sales $ 22 M Dr Cost of Goods Sold $ 9. 9 M (COGS to net sales ratio: 45% and the additional net sales at the end of 1993 = $22 million) Cr Inventories $ 9. 9 M Q2. B&L’s accounting treatment of the product shipment arising from its new sales strategy is correct. Our opinion is based on the revenue recognition of the accounting rules. There are two conditions for revenue recognition.
One is completion of the earning process, which means that the seller’s obligation to provide goods or services must be performed, or almost performed. Another is the receipt of assets from customers – cash should be collected or cash collectability reasonably guaranteed. According to the article, B&L had already delivered its products, contact lenses to 30 of its distributers. So, it completed its obligation to provide goods and services. Additionally, the inventories are in the distributors’ warehouses and not in B&L’s warehouses.
So, the first condition of revenue recognition is satisfied. The article states that the payment schedules between B&L and distributors were set up as five monthly small payments. In addition to this, each distributor was expected to pay the balance amount for the goods in June 1994. This leads to the assumption that the second requirement for recognizing revenue was met. Based on these arguments, B&L’s accounting treatment is in conformity with generally accepted accounting principles.
Q3. The annual report of Bausch & Lomb Incorporated was audited by Price Waterhouse, but we strongly believe that B&L overstated its net income by improperly recognizing revenue for the following reasons. According to GAAP, revenues should be recognized when a company has substantially accomplished its duty and when cash collectability is assured. In this case, it was unlikely that B&L’s distributors would be able to sell all contact lenses that were in their warehouses.
Again, B&L increased the credit limit of its distributors without any valid basis. This means that B&L would undertake the risk in cases where distributors are not able to sell the contact lenses. B&L also provided various marketing strategies such as a financial incentive package along with its distributors. Thus, we definitely believe that B&L was still involved in selling process, and B&L didn’t hand over full risk of ownership to its distributors.
We believe that the arrangement between B&L and the distributors was more of a consignment (where the goods are transferred, but the ownership is retained until the goods are sold). In addition, there was no guarantee of payment from all the distributors. Some distributors might become insolvent because some of them increased their inventories by more than 100% and they might not be able to sell all the goods. So, the cash collectability requirement was also not perfectly met. In conclusion, we definitely believe that B&L overstated its 1993 net income.