Lumbersell Limited Case Analysis
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TO: CFO (LSL)
FROM: Company controller (LSL)
DATE: November 5th, 2010
SUBJECT: Issues reflected in financial statements
LumberSell Limited (LSL) has prepared the year-end financial statement for many years, considered it important in business, and decided to adopt IFRS early. The management is still thriving and expecting opportunities.
As the company controller, we should analyze the issues from stakeholders objectives:
Accountant wants to assess the past company performance and act in the best interest of LSL to predict the development pessimistically for handling accidents in conservative view.
Auditors want to measure if the statement is misleading or materially misstated, which assesses the reliability of LSL-fair presentation in fair presentation.
Bank wants to measure if the line of credit could be increased by assessing if it can recapture the credit they lend to LSL in conservative view.
Management wants to maximize the line of credit with the presentation of their best performance, which is aggressive.
In order to avoid the objectives of role conflict, the objective is displaying a comparably fair presentation.
Issue#1: How should we explain the revenue LSL received from selling BIs technology and product?
Alternative #1: Recognize the revenue as the gross revenue.
IFRS states that this option applies when the company acts as a principal in transaction, taking titles and possessing the risks and rewards of ownership of the goods. LSL may buy the technology and products from BI, and sell them subsequently, which means that LSL has the risks and rewards of ownership of goods. Therefore, the royalty resembles to a cost of goods sold, with a minimum of $350,000. The revenue will be recognized and the gross profit will be reduced by the royalty in the income statement, and then the bank will disapprove to advance the line of credit, but net income and the bottom line stays stable.
Alternative #2: Recognize the revenue as the net revenue.
IFRS states that the revenue should be recognized as net revenue, when the company acts as an agent, without titles or risks and rewards of the ownership of goods. Correspondingly, the licensing agreement grants the exclusive sales and distribution rights to LSL, which pays BI a royalty fee, and the title, risks and rewards of ownership of goods may still belong to BI as a consignment sale. Therefore, the revenue may be recognized as net revenue in the income statement, but the royalty fees are recorded as an expense. The net income is the same, but the line of credit may be advanced for the high gross profit.
Conclusion: Recognizing the revenue as net revenue will increase the gross profit compared to the first alternative, which makes the bank tend to increase the line of credit, however, the net income and the bottom line stays the same. Therefore, the second treatment is