SSNT5_Income+Msmt - Income Measurement and Profitability...

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Unformatted text preview: Income Measurement and Profitability Analysis The Precision Parts Corporation manufactures automobile parts. The company has reported a profit every year since the companys inception in 1977. Management prides itself on this accomplishment and believes one important contributing factor is the companys incentive plan that rewards top management a bonus equal to a percentage of operating income if the operating income goal for the year is achieved . However, 2009 has been a tough year, and prospects for attaining the income goal for the year are bleak. Tony Smith, the companys chief financial officer, has determined a way to increase December sales by an amount sufficient to boost operating income over the goal for the year and earn bonuses for all top management. A reputable customer ordered $120,000 of parts to be shipped on January 15, 2010. Tony told the rest of top management I know we can get that order ready by December 31 even though it will require some production line overtime. We can then just leave the order on the loading dock until shipment. I see nothing wrong with recognizing the sale in 2009, since the parts will have been manufactured and we do have a firm order from a reputable customer. The companys normal procedure is to ship goods f.o.b. destination and to recognize sales revenue when the customer receives the parts. Realization Principle The realization principle requires that two criteria be satisfied before revenue can be recognized: 1. REALIZED : The earnings process is judged complete or virtually complete (the earnings process refers to the activity or activities performed by the company to generate revenue) 2. REALIZABLE : There is reasonable certainty as to the collectibility of the asset to be received (usually cash). Earnings Management Recognize revenue before the process is complete Pressure to hit earnings / performance targets Channel stuffing SEC Staff Accounting Bulletin No. 101 The SEC issued Staff Accounting Bulletin No. 101 to crackdown on earnings management. The bulletin provides additional criteria for judging whether or not the realization principle is satisfied: 1. Persuasive evidence of an arrangement exists. 2. Delivery has occurred or services have been performed. 3. The sellers price to the buyer is fixed or determinable. 4. Collectibility is reasonably assured. In most situations, the revenue recognition criteria are satisfied at the point of product delivery. Earnings Process and Revenue Recognition Methods Completion of the Earnings Process within a Single Reporting Period When the product or service has been delivered to the customer and cash has been received or a receivable has been generated that has reasonable assurance of collectibility....
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This note was uploaded on 07/08/2011 for the course ACG 3482C taught by Professor Tinaker during the Fall '09 term at University of Florida.

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SSNT5_Income+Msmt - Income Measurement and Profitability...

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