Question

1. Topic: Revenue Recognition Medical Devices Inc. is a public company that trades its securities on the American Stock Exchange. The company needs to increase sales in the month of December by $3 million. Management has determined that the company has products available to ship to customers prior to year-end. Medical Devices’ CEO calls three specific customers and convinces each customer to order $1 million worth of products, which Medical Devices delivers prior to year-end. In reviewing Medical Devices’ normal and customary business practice for these types of customers, you notice that a written sales agreement with an authorized customer signature is required for the sale to be binding. Medical Devices prepared and signed the sales agreements and faxed them to the three customers prior to year-end. One customer signed and dated the agreement on 12/29 and returned it to Medical Devices. The other two customers did not sign their agreements until 1/10 of the following year due to a required review by their legal departments. However, they reported to Medical Devices that this was just a formality and the agreements should be returned by 1/15. As a result of these verbal commitments, the CEO had the accounting department record the $3 million as sales in the current year.

Required: Medical Devices’ controller is questioning whether the $3 million in sales related to these three customers can be recorded this year as revenue. SEC interpretations directly address this issue. Is the SEC guidance addressing this issue still in effect? Be sure to cite the SEC guidance supporting your answer. (Hint: look at Staff Accounting Bulletins (SABs)).

Answer 1

Yes the SEC guidance addressing this issue is still in effect. SEC guidance states as follows :

Revenue generally is realized or realizable and earned when all of the following criteria are met:

• Persuasive evidence of an arrangement exists,
  
• Delivery has occurred or services have been rendered,
  
• The seller’s price to the buyer is fixed or determinable, and
  
• Collectibility is reasonably assured.

Now applying the above SEC guidance in the current scenario, the answer is as follows :

Since it is normal and customary business practice for Medical Devices Inc to have a written sales agreement with an authorized customer signature for the sales to be binding, Medical Device Inc can only recognize 1 Million $ revenue relating to the customer who has signed the agreement on 29th December. Medical Devices Inc cannot recognize revenue for the other 2 customers as they have signed the written agreements post year-end and hence the revenue can only be recognized in the next year since the condition "Persuasive evidence that an agreement exists" has only been satisfied in the next year and not in the current year.

Had Medical Devices customary practice been different like having an oral agreement and not requiring a written agreement for sales to be binding, our answer would have also been different.