Industrial Equipment Ltd.
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Seminar #3Revenue Recognition andAccounting JudgmentsReview from lecture:In a cash based accounting system, revenue is recorded when cash is received.How do we know when to recognize (record) revenue under accrual accounting?-Performance is substantially complete-Revenue and the related expenses are known or estimable-Collection is reasonably assuredWhat is the potential problems with this sort of approach?Tax minimizationCash flow prediction (adjusting cash flow to meet certain goals)Profit maximizationProviding information that maximizes the change to get loanHow do we manage those potential problems?Accounting standards (GAAP – IFRS/ASPE)Laws (tax law, securities law)Independent auditsFacts surrounding events or transactions being accounted forDemands of powerful stakeholders (e.g., banks might want to see specific information)Problem #1:Industrial Equipment Ltd. manufactures and sells parts used in various types of heavy equipment. The most popular parts sold are those for graders. Since they were manufacturing a number of parts for graders already, Industrial decided to expand its operations to manufacture and sell their own brand of grader. After many meetings, Industrial was able to persuade management at Northern Alberta Construction Co. (NACC) to purchase a grader. Industrial received an order from NACC at the end of August for 1grader to be delivered in October. NACC intends to provide one year warranties, but in order to get the NACC order, Industrial agreed to a 2-year warranty on this initial unit.The specific events relating to this order for Year 1are:August 29 Industrial receives the orderSeptember 2 Industrial receives a signed, binding purchase order for a graderSeptember 5 Industrial orders the materials needed to manufacture the graderSeptember 10 Industrial receives a deposit from NACC for half of the total sales priceSeptember 29 Production of the grader is completedOctober 1 Industrial ships the grader to NACC
October 5 Industrial receives confirmation that the grader was received by NACCOctober 15 Industrial receives payment for the balance of the sales price owingFrom October 1, year 1 to September 30, year 3 Industrial provides warranty parts and service. The amounts are the same that others in the industry experience.What dates are possible choices for Industrial to recognize the revenue? What are the problems with each? October 1 – delivered the equipment, they may have other performance requirements so they may not be substantially completeOctober 15 – Collection is reasonably assured, we may not be able to estimate the warranty expenses related to the sale of the genderSeptember 30, year 3 – all uncertainties are resolved, but it delays revenue to a much later accounting periodAssume that Industrial’s year end is October. How does that impact the revenue recognition decision? What if the year end was September 30 instead? Year-end is October – then it does not matter as much if we picked a date in September or October to recognize revenue the revenue will still be recorded in Year 1 with exception of the Year 3 date September – this would have an impact on both Year 1 & year 2 revenue depending on the date of recognition if it was October or SeptemberRevenue Recognition – ExampleFrom its 2013 Annual Report:“ALARMFORCE INDUSTRIES INC. is a leading manufacturer and provider of proprietary security systems. AlarmForce installs and monitors its proprietary products from coast to coast across Canada and in select markets in the United States including North Carolina, Ohio, Georgia, Minnesota and Florida. Since its establishment in 1988, the Company’s primary focus has been to install and monitor affordable, state-of-the art security systems in the residential market. AlarmForce is listed on the Toronto Stock Exchange under the symbol AF.