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Caltron Electronics

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Caltron Electronics, Inc. Reporting
ACC 541 – Accounting Theory and Research
April 22, 2013

MEMORANDUM

To: Scott Calvin, Chief Financial Officer
From: Chief Financial Analyst
Subject: Peale, Gower & Quill Audit Report
Date: April 22, 2012

Issue

Results of the audit report prepared by Peale, Gower & Quill raised concern’s regarding four transactions and revenue recognition. Transactions in question involve Unix-based, high power minicomputers causing a total market capitalization in excess of $450 million. Currently, Caltron Computers, Inc. recognizes revenue when minicomputers are shipped. Orders involving bill-and-hold are recognized by the entire amount recorded as revenue. Current revenue recognition and bill-and-hold processes conflict with GAAP requirements, which indicate a need for change. Presented in this memo are the four transactions in question, explanations for concern, and detailed recommendations.

Transactions in question

Four transactions in question involve Elegant Housing, Inc., Alation Electronics, BTO Computer Leasing, and Harvey Industries.

Elegant Housing, Inc. purchased two minicomputer systems totaling $400,000. A six-month trial period was allotted to ensure customer satisfaction with an option to return the two systems if unsatisfied. Elegant Housing, In. paid $20,000 at the time of shipment, November 15, 2011.

Alation Electronics purchased one minicomputer system under a bill-and-hold arrangement. $250,000 of revenue was recognized. The system had not shipped as of December 31, 2011. However, Alation Electronics paid $175,000 on December 15, 2011 requiring Caltron Computers, Inc. to hold the shipment until first quarter of 2012. The remaining balance of $75,000 was arranged for payment when the systems were shipped.

Another bill-and-hold agreement was made with BTO Computer Leasing for five minicomputer systems on November 1, 2011. $190,000 was paid as a down payment under an agreement that Calton would hold the systems and assist BTO in finding leases. $950,000 of revenue was recognized in 2011. One lease was found and in negotiation stages as of December 31, 2011.

Harvey Industries purchased a minicomputer system on a four-month trial bases. $220,000 of revenue was recognized. $110,000 was allotted to allowance for sales and returns. On November 27, 2011 the system shipped. Harvey paid $110,000 when the system shipped.

Recommendations

The Securities and Exchange Commission (SEC) outlines revenue recognition requirements through SAB Topic 13. SAB Topic 13 explains that proper revenue recognition cannot occur until the transaction is realizable and earned (FASB Accounting Standards Codification, 2013). Usually this is valid by the time the product has been delivered. However, Caltron recognizes revenue when product is shipped, which does not ensure collectability or delivery making revenue recognition premature. Two transactions are based on bill-and-hold arrangements. To recognize bill-and-hold transactions without delivery: the risks of ownership must have passed by the buyer; the customer must have made a fixed commitment to purchase the goods; the buyer, not the seller, must request that the transaction be on a bill and hold basis having a substantial business purpose; there must be a fixed schedule for delivery of goods; the seller must not have retained any specific performance obligations such that the earning process is not complete; the ordered goods must have been segregated from the sellers inventory; the equipment must be complete and ready for shipment (FASB Accounting Standards Codification, 2013).

Elegant Housing
The Elegant Housing transaction collected $20,000 at the time of sale. Because the transaction is based on a six-month trial the collectability is not reasonably ensured, thus violating proper revenue recognition. SAB Topic 13 notes that collectability must be reasonably assured in FN6 with further explanation in FASB 605-10-25-3 (FASB Accounting Standards Codification, 2013).

Alation Electronics
The Alation Electronics transaction is a bill-and-hold agreement. SAB Topic 13, FN17 notes that revenue recognition cannot take place without evidence of delivery (FASB Accounting Standards Codification, 2013). Although Alation Electronics has paid $175,000 of the total order, there is no evidence of the equipment being separated from the sellers inventory or the risk of ownership passed on to the buyer. Although shipment was arranged for first quarter, in point of fact actual schedule has not been identified. Therefore, revenue should not be recognized.

BTO Computer Leasing
The BTO transaction is also a bill-and-hold arrangement. $950,000 was recognized. Though $190,000 was paid by BTO as down payment and assurance of the agreement no computers were shipped. Terms of the lease were beginning to be carried out and no shipment dates were set. Also no evidence exists showing the order has been separated from the sellers inventory and risk of ownership has not yet been passed to the buyer.

Harvey Industries
The Harvey Industries transaction recognized $220,000. Harvey Industries paid $110,000 with a four-month trial agreement. SAB Topic 13 also applies to this transaction. $110,000 has been paid and is reasonably ensured therefore it can be recognized. $110,000 was allotted for allowance for sales and returns and has not been received; therefore it should not be recognized. Collectability of $110,000 is not reasonably ensured.

Conclusion

Each of the four transactions in question is not in compliance with GAAP. Revenue should not have been recognized for most of the transactions because of not meeting requirements of recognizable revenue and terms of bill-and-hold agreements. Financial statements should be adjusted to reflect the changes. Caltron, Inc. should redefine financial reporting practices to align with acceptable practices.

Reference

FASB Accounting Standards Codification. (2013). 605 Revenue Recognition 10 Overall S99
SEC Materials. Retrieved from https://asc.fasb.org/section&trid=2559211&search_marker=searchresult&query=QmlsbCthbmQraG9sZA==

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